Tuesday, August 31, 2010
Via email, Jim Bullard, President of the St. Louis Fed, responds to Tim Duy:
I read your "Fed watch" column this morning in our news clips. You do an excellent job of summarizing important issues facing the FOMC. I have three comments, all of which I have made publicly recently, and I think they are critical ones for the direction policy will take:
--on the "raising interest rates" question: I am not sure if you have looked at my paper, "Seven Faces of the Peril," but if not please take a look at Figure 1 there (web page below) and contemplate the left hand side of the picture. This convinces me that staying with the near-zero interest rate policy alone--and promising to stay near-zero for a long time without doing anything else--risks a deflationary trap. To avoid this, I am recommending additional QE as a supplement to the near-zero rate policy as our best option. You actually have one of the world's experts on the question of the dynamics behind Figure 1 at the U. of Oregon: George Evans. Rajiv Sethi's summary of this issue as linked in your blog is very good, but citing Howitt--a fine paper, to be sure--is missing the more sophisticated analysis of Evans and Honkapohja that I cite in my paper. I am not saying I necessarily agree with the Evans and Honkapohja policy conclusions, but they have good analytics for framing these issues.
--on the effectiveness of QE: I do not agree that asset purchases are somehow ineffective. I talk about this in my CNBC interview at Jackson Hole (also posted on my web page). The direct empirical evidence on the effectiveness of QE both in the U.S. and the U.K. is fairly strong. For example, see the paper by Chris Neely of our staff cited in the "Perils" paper.
--on the "disciplined" QE program: The quote from Vince Reinhart, who is a great guy, gives the "shock and awe" view of QE. I do not think this is remotely correct. We know how monetary policy works: through the expected future path of policy, not through the actual move on a particular day. When we make 25 basis point moves on the federal funds rate, those are small viewed in isolation, but they have important effects for macroeconomic stabilization because they imply an expected interest rate path over the coming years. The same is true for QE. A move on a particular day may seem small, but it implies a path for future policy, and a series of smaller moves may add up to a very large move if the incoming data are consistent with such an outcome. The "shock and awe" view, if applied to interest rate targeting, would suggest very large interest rate movements in response to relatively small changes in incoming data, a policy that most would view as destabilizing for the macroeconomy. The same is true for QE. So the point is that QE moves should be commensurate with the incoming data (a.k.a. "state contingent"). Of course we can argue about the incoming data--and I know you have strong views on that--but I think my position on a "disciplined" QE program is correct and that the dangerous policy is to make destabilizing moves out of line with the incoming data. Concerning the data itself, your colleague Jeremy Piger will update his recession probabilities shortly so I will be anxious to see how that comes out.
I hope these comments are not too confused, I enjoyed your blog and I think you do a fine job of tracking the issues in the Fed.
I am about to do a video with George Evans who will explain the issues involved with dynamics at the zero bound, how Howitt fits in, how learning changes things, etc., so please stay tuned...
I have a new column up at the Fiscal Times:
Insulating Fiscal Policy from a Dysfunctional Congress: The economic crisis has made two things clear. First, monetary policy won’t always be capable of stabilizing the economy on its own. When the problems become large enough, fiscal policy must be part of the response.
Second, even when our economic problems are severe and righting the ship ought to be the primary concern, Congress is incapable of implementing fiscal policy with the timeliness and effectiveness that is needed. As Alan Blinder said recently, “I’m looking at the political system turning itself into a paralyzed beast.” ... [...continue reading...]
Is there a way around this problem?
Tim Duy is "anything but" reassured by Ben Bernanke's recent speech outlining the Fed's possible policy actions, and what it will take to put them into action:
Unless every able American pitches in, Congress and I cannot do the job. Winning our fight against inflation and waste involves total mobilization of America's greatest resources—the brains, the skills, and the willpower of the American people. --- President Gerald Rudolph Ford, "Whip Inflation Now" Speech (October 8, 1974)Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. --- Federal Reserve Chairman Ben Bernanke, "The Economic Outlook and Monetary Policy" Speech (August 27, 2010)
Rereading Federal Reserve Chairman Ben Bernanke's recent speech and measuring it against the incoming data leaves me with a pit in my stomach. I sense Bernanke reveals in this speech he is the proverbial emperor without clothes, short on policy options but long on hope. A last ditch attempt to persuade us that as long as we don't believe deflation will be a problem, it will not be a problem. But he faces the same challenge as did then President Gerald Ford. All hat and no cattle. You need to be ready to back up your talk with credible policy options. While Bernanke outlined possible policy options, reading between the lines makes clear he lacks conviction in the viability of any of those options. Simply put, Bernanke is not ready to embrace the paradigm shift bold action requires.
First, it is worth considering the economic context of the policy environment via the lens of July Personal Income and Outlays report. Real gains fells short of what I believe to be already diminished expectations, with a clearly suboptimal trend in place:
When Bernanke expresses concern for the near term pace of economic growth, he is concerned with failing to track the current path of economic activity, as illustrated by the path of consumption since July of last year. This already is a substantial lowering of the bar, and appears to be a resignation that previous trends are unattainable. That is a problem in many respects, the most important of which is that previous trends were consistent with full employment. The failure to acknowledge the importance of re-achieving the previous path is, in my opinion, an admission of the willingness to accept a protracted period of high unemployment. This, of course, has been essentially admitted by Bernanke:Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.
As I have already commented, if unemployment is a concern, and there is no conflict between the Fed's dual mandate, then why is the Fed waiting for further evidence of disinflation before acting? Indeed, Scott Sumner saw a line in the sand in Bernanke's speech of a one percent inflation rate. The most recent PCE data suggests we are perilously close to testing that line already:
Maxine Udall is enlightened and discouraged by a conversation with an elderly relative:
...[T]he spectre of "socialized medicine" prevents us moving to single payer, where the incentives for prudent life cycle management of risk across all age and income groups would be better aligned. Why, when we already have what is in effect single payer for the elderly and the poor, do some believe that single payer is "socialized medicine" and why do they fear it so?
I gained some insight into this recently when an elderly relative started complaining about "Obamacare" and how it would lead to "socialized medicine." Knowing the person had heart surgery courtesy of Medicare and was receiving ongoing monitoring and care, I said, "I didn't realize you were so unhappy with Medicare." To which I received the reply: "I'm not talking about Medicare, I'm talking about socialized medicine."
"How is Medicare different from socialized medicine?" I asked.
"Medicare isn't socialized," came the reply. "I pay for it. I pay every month and when I've had surgery, I've had to pay some of it. Medicare is like any other insurance."
"Well," I said, "I know you're paying a premium for Part B and I know there are copayments and deductibles, but Medicare is a government run health insurance program."
To which the reply was: "But I'm talking about socialized medicine. You know that whenever the government gets involved in anything, it never does a good job."
"I had no idea you were having problems with Medicare." said I. "I always had the impression you were pretty satisfied with it. And with the VA, too. I know you've used the VA for some care recently. What problems have you had with Medicare or the VA?"
"Well, none with Medicare or the VA, but I'm not talking about Medicare. I'm talking about socialized medicine."
"So you're happy with Medicare?"
"Would you mind if your [adult] children could buy into it? Your son is unemployed. Would it be OK if he could buy into Medicare?"
"Well, sure. As long as he has to pay like I do."
You were all wondering how someone could say, "Keep your government hands off my Medicare?" Well, there you have it. Now that I've told you, I'm still not sure I understand it. It was one of the most frustrating and at the same time enlightening conversations I have had in a long time. The person with whom I was conversing is intelligent, educated, and not senile.
I'm just not sure how to use the above information. I was unable to persuade my elderly relative. I confess that since the conversation, I have despaired that the national conversation will ever be much better.
Monday, August 30, 2010
- 100 years of US obesity - voxeu
- Criteria for assessing economic models - UnderstandingSociety
- Economix - links
- New Deal 2.0 - links
- Felix Salmon - links
- FT Alphaville - links
- Credit Writedowns - links
- Free Exchange - links
- Market Talk - links
- Marginal Revolution - links
- Abnormal Returns - links
- naked capitalism - links
- Brad DeLong - links
Robert Reich is unhappy with Robert Barro:
The Obscenity of the Right-Wing Professoriat, by Robert Reich: ...Harvard Professor Robert Barro ... opined in today’s Wall Street Journal that America’s high rate of long-term unemployment is the consequence rather than the cause of today’s extended unemployment insurance benefits. ...
In point of fact, most states provide unemployment benefits that are only a fraction of the wages and benefits people lost when their jobs disappeared. Indeed, fewer than 40 percent of the unemployed in most states are even eligible for benefits... So it’s hard to make the case that many of the unemployed have chosen to remain jobless and collect unemployment benefits rather than work. Anyone who bothered to step into the real world would see the absurdity of Barro’s position. ... Right now, there are roughly five applicants for every job opening in America. ...
Barro argues the rate of unemployment in this Great Jobs Recession is comparable to what it was in the 1981-82 recession, but the rate of long-term unemployed is nowhere as high. He concludes this is because unemployment benefits didn’t last nearly as long in 1981 and 82 as it they do now.
He fails to see – or disclose – that the 81-82 recession was far more benign than this one, and over far sooner. It was caused by Paul Volcker and the Fed yanking up interest rates to break the back of inflation – and overshooting. When they pulled interest rates down again, the economy shot back to life. ...
A record number of Americans is unemployed for a record length of time. This is a national tragedy. It is to the nation’s credit that many are receiving unemployment benefits. This is good not only for them and their families but also for the economy as a whole, because it allows them to spend and thereby keep others in jobs. That a noted professor would argue against this is obscene.
Alex Tabarrok is unimpressed with Barro's work:
Barro v. Barro, by Alex Tabarrok: Robert Barro today in the WSJ, The Folly of Subsidizing Unemployment, estimates that UI extensions have increased the unemployment rate by 2.7 percentage points.
To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then ... the unemployment rate would have been 6.8% rather than 9.5%.
It's not clear to me why we should assume that the share of long-term unemployment in this recession should equal that in 1983.
Barro also argues:
We have shifted toward a welfare program that resembles those in many Western European countries.
In contrast Josh Barro, son of Robert, in How much do UI Extensions Matter for Unemployment, concluded that 0.4% was probably on the high side:
...Two Fed studies suggest that [extensions of UI] may have contributed 0.4 to 1.7 percentage points to current unemployment. But a closer look at this research makes me skeptical that the effects have been so large.
...The incentive effects of UI extension must also be weighed against the stimulative effects of paying UI benefits. For some reason it’s become almost taboo to note this on the Right, but UI recipients tend to be highly inclined to spend funds they receive immediately, meaning that more UI payments are likely to increase aggregate demand. UI extension also helps to avoid events like foreclosure, eviction and bankruptcy, which in addition to being personal disasters are also destructive of economic value.
As a result, I am inclined to favor further extension of UI benefits while the job market remains so weak. I am not concerned that this leads us down a slippery slope to permanent, indefinite unemployment benefits (which historically have been one of the drivers of high structural employment in continental Europe) as the United States has gone through many cycles of extending unemployment benefits in recession and then paring them back when the economy improves, under both Republican and Democratic leadership.
I call this one on both counts for Josh.
Arnold Kling says that if incentive problems exist for unemployment -- and he's right to be skeptical of the claim -- there's more than one way to fix them:
...Robert Barro ... claims that the unemployment rate would be much lower now if Congress had not passed any extensions of unemployment benefits. I have not gone through his analysis, but I suspect that I, like Alex Tabarrok, would not find it persuasive. Nonetheless, I think there is a case to be made for allowing people to continue to collect unemployment benefits after they find a new job, until their benefits are scheduled to expire. We can argue about how generous the unemployment benefits should be overall, but for any level of benefits it is possible to reduce the disincentive to find work.
Shoe Staring: Robert Barro Edition, by Karl Smith: Based on Cable News and a notable NYT column one might think that economists are perpetually at one another’s throats. This is far from the truth. The hierarchical nature of the economics profession lends an ecclesiastical air to many of our interactions. Brilliant figures are treated with enormous reverence.
To wit, when an eminent figure like Robert Barro says something that strikes most of as inane the most common reaction is shoe staring. For example, Barro writes:
To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%.
Upon hearing this no one wants to make eye contact for fear of revealing that he sees that the emperor – or esteemed economist in this case – is without his clothes.
For better or worse the blogosphere has changed that. Economists of all stripes will descend upon Barro over the next 36 hours. If he replies, which I suspect he will not, this will be an interesting moment.
Calling Barro's claim questionable, as in the title, was probably too generous.
What effect does immigration have on U.S. job markets? "Data show that, on net, immigrants expand the U.S. economy’s productive capacity, stimulate investment, and promote specialization that in the long run boosts productivity. Consistent with previous research, there is no evidence that these effects take place at the expense of jobs for workers born in the United States":
The Effect of Immigrants on U.S. Employment and Productivity, by Giovanni Peri, FRBSF Economic Letter: Immigration in recent decades has significantly increased the presence of foreign-born workers in the United States. The impact of these immigrants on the U.S. economy is hotly debated. Some stories in the popular press suggest that immigrants diminish the job opportunities of workers born in the United States. Others portray immigrants as filling essential jobs that are shunned by other workers. Economists who have analyzed local labor markets have mostly failed to find large effects of immigrants on employment and wages of U.S.-born workers (see Borjas 2006; Card 2001, 2007, 2009; and Card and Lewis 2007).
This Economic Letter summarizes recent research by Peri (2009) and Peri and Sparber (2009) examining the impact of immigrants on the broader U.S. economy. These studies systematically analyze how immigrants affect total output, income per worker, and employment in the short and long run. Consistent with previous research, the analysis finds no significant effect of immigration on net job growth for U.S.-born workers in these time horizons. This suggests that the economy absorbs immigrants by expanding job opportunities rather than by displacing workers born in the United States. Second, at the state level, the presence of immigrants is associated with increased output per worker. This effect emerges in the medium to long run as businesses adjust their physical capital, that is, equipment and structures, to take advantage of the labor supplied by new immigrants. However, in the short run, when businesses have not fully adjusted their productive capacity, immigrants reduce the capital intensity of the economy. Finally, immigration is associated with an increase in average hours per worker and a reduction in skills per worker as measured by the share of college-educated workers in a state. These two effects have opposite and roughly equal effect on labor productivity.
Karl Whelan identifies the questionable assumptions used by Jean Claude Trichet to support his calls for austerity:
The economy, it is sometimes argued, is at present too fragile and thus consolidation efforts should be postponed or even new fiscal stimulus measures added. As I pointed out recently, I am sceptical about this line of argument. Indeed, the strict Ricardian view may provide a more reasonable central estimate of the likely effects of consolidation. For a given expenditure, a shift from borrowing to taxation should have no real demand effects as it simply replaces future tax burden with current one.
The written version of the speech cites two papers by Robert Barro as supporting evidence for this position.
I think it’s worth noting that the Ricardian equivalence idea put forward by Barro—that consumers see deficits and taxes as basically the same thing—has been tested many many times. And the general consensus on this, as I understand it, is that there is very little evidence to support the idea.
Moreover, though the idea works in one very simplified model set up, there are lots of reasons why the proposition does not hold in reality (liquidity constraints, people having finite lives, people not having rational expectations, uncertainty about the path of government spending—see this extract from David Romer’s textbook.) Very few economists emerge from graduate schools believing in the Ricardian equivalence idea.
There are, of course, lots of arguments in favour of European governments setting out their long-term plans for the restoration of fiscal stability. However, it is a pity to see economic theories that are known to have little support regularly rolled out as arguments for fiscal austerity.
Trichet follows up on his Ricardian equivalence comments by arguing that expansionary fiscal contractions “are not just a theoretical curiosity” with the footnotes citing the old Giavazzi and Pagno paper with its two examples: Denmark in the mid-1980s and, of course, Ireland in the late 1980s. I’ve already said my bit about this, so I won’t repeat it. Suffice to say, this is pretty weak evidence that Trichet is serving up.
Trichet must know that the evidence for Ricardian equivalence is pretty shaky, and he must know that one or two papers with questionable results hardly offsets the build of the evidence pointing in the other direction. Yet the best case he can build revolves around those points. That tells you what you need to know about the strength of his argument.
Let me also add this from the "said my bit" link above:
The Enduring Influence of Ireland’s 1987 Adjustment, by Karl Whelan: When I was a junior economist in short trousers, the first research I ever did was inspired by Ireland’s successful 1987-89 fiscal adjustment. Many international researchers looked at Ireland and decided that our successful adjustment stemmed from consumers stepping into the breach filled by the government spending cuts. The story was that increased consumer confidence, fueled by expectations of lower future taxes, was the key to the recovery.
From the research I did on this topic (both on my own and with John Bradley) I came away fairly convinced that this was not what had happened. Rather, the 1987 boom seemed to be fueled more by strong exports to the UK thanks to Nigel Lawson’s tax cutting exercise.
However, Ireland’s 1987 experience continues to pop up in discussions of fiscal austerity. I have to admit that I’ve not been too impressed by Alberto Alesina’s work (here and here) on how fiscal adjustment can be expansionary—work that has had a lot of influence this year. Well, sure enough, Paul Krugman now cites work from Arjun Jayadev and Mike Konczal showing that the only country that ever cut its way to growth in a slump was, you guessed it, Ireland in 1987. The power of this datapoint endures.
"This is going to be very, very ugly":
It’s Witch-Hunt Season, by Paul Krugman, Commentary, NY Times: The last time a Democrat sat in the White House, he faced a nonstop witch hunt by his political opponents. Prominent figures on the right accused Bill and Hillary Clinton of everything from drug smuggling to murder. And once Republicans took control of Congress, they subjected the Clinton administration to unrelenting harassment — at one point taking 140 hours of sworn testimony over accusations that the White House had misused its Christmas card list.
Now it’s happening again — except that this time it’s even worse. Let’s turn the floor over to Rush Limbaugh: “Imam Hussein Obama,” he recently declared, is “probably the best anti-American president we’ve ever had” ..., bear in mind that he’s an utterly mainstream figure within the Republican Party; bear in mind, too, that unless something changes the political dynamics, Republicans will soon control at least one house of Congress. This is going to be very, very ugly. ...
What we learned from the Clinton years is that a significant number of Americans just don’t consider government by liberals — even very moderate liberals — legitimate. Mr. Obama’s election would have enraged those people even if he were white. Of course, the fact that he isn’t, and has an alien-sounding name, adds to the rage.
By the way, I’m not talking about the rage of the excluded and the dispossessed: Tea Partiers are relatively affluent, and nobody is angrier these days than the very, very rich. Wall Street has turned on Mr. Obama with a vengeance:... And powerful forces are promoting ... this rage..., the superrich Koch brothers and their war against Mr. Obama has generated much-justified attention, but ... only the scale of their effort is new: billionaires like Richard Mellon Scaife waged a similar war against Bill Clinton.
Meanwhile, the right-wing media are replaying their greatest hits. ...Mr. Limbaugh used innuendo to feed anti-Clinton mythology, notably the insinuation that Hillary Clinton was complicit in the death of Vince Foster. Now ... he’s doing his best to insinuate that Mr. Obama is a Muslim. ... [And] Mr. Limbaugh is ... tame compared with Glenn Beck.
And where, in all of this, are the responsible Republicans, leaders who will stand up and say that some partisans are going too far? Nowhere to be found. To take a prime example: the hysteria over the proposed Islamic center in lower Manhattan... On this issue, as on many others, the G.O.P. establishment is offering a nearly uniform profile in cowardice.
So what will happen if, as expected, Republicans win control of the House? ...Politico reports that they’re gearing up for a repeat performance of the 1990s, with a “wave of committee investigations” — several ... over supposed scandals that we already know are completely phony. We can expect the G.O.P. to play chicken over the federal budget, too; I’d put even odds on a 1995-type government shutdown sometime over the next couple of years.
It will be an ugly scene, and it will be dangerous, too. The 1990s were a time of peace and prosperity; this ... time ... we’re still suffering the after-effects of the worst economic crisis since the 1930s, and we can’t afford to have a federal government paralyzed by an opposition with no interest in helping the president govern. But that’s what we’re likely to get.
If I were President Obama, I’d be doing all I could to head off this prospect, offering some major new initiatives on the economic front in particular, if only to shake up the political dynamic. But my guess is that the president will continue to play it safe, all the way into catastrophe.
Let me explain, as simply as I can, the underlying reason for the strong reaction to Minnesota Fed president Narayana Kocherlakota's suggestion that raising interest rates would be helpful.
When a Federal Reserve president calls for an increase in interest rates while the economy is still struggling to recover, something that repeats the errors of 1937-38, all of his buddies in academia should expect a reaction. It comes with the job. The fact that he can point to a model that failed to provide much help with the situation we're in to justify the statement isn't of much comfort, and there are serious questions about the validity of the claim in any case.
This isn't just a theoretical exercise where finding novel, counter-intuitive results that may or may not have real world applicability draws the admiration of peers, people's livelihoods are at stake. Real people in the real world are depending on the Fed to get this right, and suggestions that the Fed raise interest rates to help with the recession go against every intuitive bone I have in my body. More importantly, for those who think those bones might be broken, it goes against the existing empirical evidence. This is not a game, actual policy is at stake that will affect people's lives, and we cannot be careless in how we approach it.
If I reacted strongly, it's because I don't want us to repeat the mistakes we made in the past, mistakes that would hurt people who have suffered enough already. Do the advocates of this policy really believe, way down deep, that raising interest rates is the right thing to do in this situation? Perhaps, but I sure don't, and I can't let it pass without comment.
Sunday, August 29, 2010
It falls to the Fed to fuel recovery, by Clive Crook, Commentary, Financial Times: The US recovery is stalling. As a matter of economics the balance of risks strongly favors further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America’s leaders are letting the country down. ...
Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.
The political problem is that US voters ... have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the ... first package...
One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession’s downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama’s defense of his policy has been strangely diffident. ...
Meanwhile, there is monetary policy. At the end of last week,... Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. ... Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. ... But the balance of risks has moved. They need to go further. ...
This has annoyed me for several years now. Why won't the Kansas City Fed make the papers for the Jackson Hole conference available until after the conference is over? What's the purpose of this? None that I can think of, other than making themselves special, but that's no way for a public agency to behave.
This is the opposite of transparency. I can understand waiting until the final versions are submitted, but at that point, why not post the papers so we can read them prior to the conference and give more informed commentary on the event? As it stands, I have to rely upon reporters to accurately tell me what's in the papers and, while I do trust some of them to mostly get things right (but not all), I'd like to be able to check the papers for myself. Sometimes participants will give a report after the event is over, but that's a bit late and even then I'd like to be able to come to my own conclusions, or at least verify the reports from reading the papers themselves. What's the point in locking them up? (As far as I can tell, the authors aren't even allowed to post the papers on their own sites.)
The pdfs will also be copy protected when they are posted, another step that places unnecessary hurdles in the way of commenting on the papers. Under the KC Fed's policy, which extends to speeches by the president of the KC Fed but isn't followed by other district banks, reproducing a graph or a few paragraphs then becomes tedious. The copy protection doesn't stop anyone who really wants to post a paragraph or two as you are permitted to do, it's simply harder and hence discouraging (and the speeches themselves are supposed to be in the public domain and hence fully reproducible). But why discourage conversation about these papers? Why make it so that we can't actually read the papers and comment on them until the conference is over and people have lost interest in the event. Why make it as hard as possible to even take small excerpts? How is that helpful?
Creating an exclusive event like this does give the people involved power, it makes them special, it gives them the power to include and exclude people, and so on. But their duty is to serve the public interests, not create a special little club that only some can participate in, and then dribble out the important information in a way that maintains their exclusivity and power.
I can live with the copy-protection, but the attempts to discourage access to the conference papers is puzzling when viewed through the Fed's mission to serve the public interest.
[Maybe I've missed something obvious, it certainly wouldn't be the first time that's happened, and there's a good reason for this policy. If someone at the KC Fed wants to explain why they can't do what most conferences do and make the papers available prior to or at the beginning of the conference, or at the very least at the time of or right after a session is over, I will post the explanation. It would be nice if the explanation also included the reasons for trying to lock up other documents such as Fed speeches, something no other Fed tries to do.]
Did low interest rates cause the financial crisis as John Taylor and others contend? (I've argued that the low interest rate policy contributed to the crisis, but by itself was not the major factor. That is roughly consistent with their conclusion, though their numbers on the degree to which interest rates mattered are lower than I would have predicted):
Can interest rates explain the US housing boom and bust?, by Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko: Between 2001 and the end of 2005, the Standard and Poor’s/Case-Shiller 20 City Composite House Price Index rose by 46% in real terms. By the first quarter of 2009 the index had dropped by about one-third before stabilizing. The volatility of the Federal Housing Finance Agency (FHFA) repeat-sales price index was less extreme but still severe. That index rose by 53% in real terms between 1996 and 2006 and then fell by 10% between 2006 and 2008. As many financial institutions had invested in or financed housing-related assets, the price decline helped precipitate enormous financial turmoil.
Much academic and policy work has focused on the role of interest rates and other credit market conditions in this great boom-bust cycle.
- One common explanation for the boom is that easily available credit, perhaps caused by a “global savings glut,” led to low real interest rates that boosted housing demand (Himmelberg et al. 2005, Mayer and Sinai 2009, Taylor 2009).
- Others have suggested that easy credit market terms, including low down payments and high mortgage approval rates, allowed many people to act at once and helped generate large, coordinated swings in housing markets (Khandani et al. 2009).
Those easy credit terms may have been a reflection of agency problems associated with mortgage securitization (Keys et al., 2009, 2010, Mian and Sufi, 2009 and 2010, Mian et al. 2008).
If correct, these theories would provide economists with comfort that we understood one of the great asset market gyrations of our time; they would also have potentially important implications for monetary and regulatory policy. But economists are far from reaching a consensus about the causes of the great housing market fluctuation. For example, Shiller (2003, 2006) long has argued that mass psychology is more important than any of the mechanisms suggested by the research cited above.
Re-evaluating the missing link
Motivated by this question, we re-evaluate the link between housing markets and credit market conditions, to determine if there are compelling conceptual or empirical reasons to believe that changes in credit conditions can explain the past decade’s housing market experience.
The discussion starts around the 2:00 minute mark. Via C&L
Holtz-Eakin is encouraging us to balance the budget even though the economy is still relatively weak, and in doing so, to make the same mistake we made during the Great Depression. A quick look at recent data, and all the talk about the chance of a double dip we've been hearing, shows that we are anything but certain we we will be back at full employment anytime soon. Recovery from a financial crisis is often a long, drawn out process, and that may be true this time as well, but that means the economy needs more help over a longer period, not a premature return to austerity that risks sending the economy back into recession.
Why would we want to risk sending the economy back into a recession by beginning to balance the budget before the economy is growing robustly on its own? Republicans believe some sort of confidence effect from the decline in the deficit -- one that cannot actually be observed in the data but is, nevertheless, asserted to be there anyway -- will somehow more than offset the certain decline in demand from the reduction in the government deficit. But the problem is that the decline in demand will have it's own confidence effect on businesses, one that is negative, more certain, and likely much larger than any positive effects from deficit reduction.
And is anyone else getting tired of the "Obama is creating business uncertainty" argument from the Party that is creating most of the uncertainty and uneasiness about what crazy things might happen should they be elected? It worked out so well for the economy the last time they were in power and emphasized growth above all else. We're still trying to get out of that sinkhole -- talk about creating uncertainty. In any case, as noted by Paul Krugman on the video, there's nothing at all to indicate that businesses are, in fact, holding back due to uncertainties created by the administration's policies. Businesses face lots of uncertainties due to lack of demand for their products, and perhaps over what might change if Republicans take power, something that can hardly be blamed on the administration. But balancing the budget as Holtz-Eakin would have us do would reduce demand and cause fewer paying customers to walk through their doors. That makes the uncertainty problem worse, not better.
Putting it more succinctly, the Party in power when we got into this mess wants to be given another chance so it can try policies that failed during the Great Depression. And some people think that's a good idea.
Ben Bernanke certainly knows that the work of James Stock and Mark Watson is worth taking seriously. So why take this risk?:
Slack Could Lead to Sharper Inflation Decline, by Jon Hilsenrath, RTE: Inflation could fall much further in the next year, thanks to the enormous slack that built up in the U.S. economy during recession... Harvard University’s James Stock and Princeton’s Mark Watson — two respected econometricians... — project that the Federal Reserve’s favored measure of inflation could fall by 0.8 percentage points by the second quarter of 2011 from its 2010 second quarter rate of 1.5%, based on relationships they’ve drawn from past recessionary cycles.
Some measures of inflation are already below the Fed’s unofficial target of 1.5% to 2%. A decline to near zero, if it materialized, would likely be greeted with alarm at the Fed and would give officials added incentive to take new steps to forestall such a move. Fed Chairman Ben Bernanke said at the same conference today that the Fed is on guard against further disinflation. ...
Saturday, August 28, 2010
Laura Tyson makes the case for more stimulus spending:
Why We Need a Second Stimulus, by Laura Tyson, Commentary, NY Times: Our national debate about fiscal policy has become skewed, with far too much focus on the deficit and far too little on unemployment. There is too much worry about the size of government, and too little appreciation for how stimulus spending has helped stabilize the economy and how more of the right kind of government spending could boost job creation and economic growth. By focusing on the wrong things, we are in serious danger of failing to do the right things to help the economy recover from its worst labor market crisis since the Great Depression. ... [...continue reading...]
I have put up a few posts on the loss of US manufacturing, many of which claimed it was to the detriment of the US. However, I meant to explore ideas, not endorse a position, though there were those who objected to even raising the issue and asking these questions. My inclination is toward open borders coupled with more social support -- much more than we have presently -- for those who are on the losing end of international reallocations (yeah, I know, fire away in comments...). I also believe that the degree to which you create the proper foundation through education, infrastructure, etc. influences the nature of those reallocations. In any case, I want to let Jagdish Bhagwati push pack a bit in the other direction:
The Manufacturing Fallacy, by Jagdish Bhagwati, Commentary, Project Syndicate: Economists long ago put to rest the error that Adam Smith made when he argued that manufacturing should be given primacy in a country’s economy. Indeed, in Book II of The Wealth of Nations, Smith condemned as unproductive the labors of “churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, etc.” We may agree with Smith (and Shakespeare) about the uselessness of lawyers perhaps, but surely not about Olivier, Falstaff, and Pavarotti. But the manufacturing fetish recurs repeatedly, the latest manifestation being in the United States in the wake of the recent crisis.
In mid-1960’s Great Britain, Nicholas Kaldor, the world-class Cambridge economist and an influential adviser to the Labour Party, raised an alarm over “deindustrialization.” His argument was that an ongoing shift of value added from manufacturing to services was harmful, because manufactures were technologically progressive, whereas services were not. ...
Kaldor’s argument was based on the erroneous premise that services were technologically stagnant. ... In fact, the dubious notion that we should select economic activities based on their presumed technical innovativeness has been carried even further, in support of the argument that we should favor semiconductor chips over potato chips. While rejection of this presumption landed Michael Boskin, Chairman of President George H.W. Bush’s Council of Economic Advisers, in rough political waters, the presumption prompted a reporter to go and check the matter... It turned out that semiconductors were being fitted onto circuit boards in a mindless, primitive fashion, whereas potato chips were being produced through a highly automated process (which is how Pringles chips rest on each other perfectly). ...
While these episodes ... died early deaths, the same cannot be said for the latest revival of the “manufactures fetish” in the US and Great Britain. The latest flirtation with supporting manufactures has come from the current crisis ... and is therefore likely to have greater prospects for survival. The fetish is particularly rampant in the US, where the Democrats in Congress have gone so far as to ally themselves with lobbyists for manufactures to pass legislation that would provide protection and subsidies to increase the share of manufactures in GDP.
Because of the financial crisis, many politicians have accepted the argument, in a virtual throwback to Adam Smith, that financial services are unproductive – even counterproductive – and need to be scaled back by governmental intervention. It is then inferred that this means that manufactures must be expanded. But this does not follow. Even if you wanted to curtail financial services, you could still focus on the multitude of non-financial services.
Diesel engines and turbines are not the only alternatives; many services, like professional therapy, nursing, and teaching are available. The case for a shift to manufacturing remains unproven, because it cannot be proved.
Rajiv Sethi, who I've come to trust to get things right, has a nice summary of the recent controversy over the relationship between interests rate and inflation:
Lessons from the Kocherlakota Controversy, by Rajiv Sethi: In a speech last week the President of the Minneapolis Fed, Narayana Kocherlakota, made the following rather startling claim:
Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.
To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.
The proposition that a commitment by the Fed to maintain a low nominal interest rate indefinitely must lead to deflation (rather than accelerating inflation) defies common sense, economic intuition, and the monetarist models of an earlier generation. This was was pointed out forcefully and in short order by Andy Harless, Nick Rowe, Robert Waldmann, Scott Sumner, Mark Thoma, Ryan Avent, Brad DeLong, Karl Smith, Paul Krugman and many other notables.
But Kocherlakota was not without his defenders. Stephen Williamson and Jesus Fernandez-Villaverde both argued that his claim was innocuous and completely consistent with modern monetary economics. And indeed it is, in the following sense: the modern theory is based on equilibrium analysis, and the only equilibrium consistent with a persistently low nominal interest rate is one in which there is a stable and low level of deflation. If one accepts the equilibrium methodology as being descriptively valid in this context, one is led quite naturally to Kocherlakota's corner.
But while Williamson and Fernandez-Villaverde interpret the consistency of Kocherlakota's claim with the modern theory as a vindication of the claim, others might be tempted to view it as an indictment of the theory. Specifically, one could argue that equilibrium analysis unsupported by a serious exploration of disequilibrium dynamics could lead to some very peculiar and misleading conclusions. I have made this point in a couple of earlier posts, but the argument is by no means original. In fact, as David Andolfatto helpfully pointed out in a comment on Williamson's blog, the same point was made very elegantly and persuasively in a 1992 paper by Peter Howitt.
Howitt's paper is concerned with the the inflationary consequences of a pegged nominal interest rate, which is precisely the subject of Kocherlakota's thought experiment. He begins with an old-fashioned monetarist model in which output depends positively on expected inflation (via the expected real rate of interest), realized inflation depends on deviations of output from some "natural" level, and expectations adjust adaptively. In this setting it is immediately clear that there is a "rational expectations equilibrium with a constant, finite rate of inflation that depends positively on the nominal rate of interest" chosen by the central bank. This is the equilibrium relationship that Kocherlakota has in mind: lower interest rates correspond to lower inflation rates and a sufficiently low value for the former is associated with steady deflation.
The problem arises when one examines the stability of this equilibrium. Any attempt by the bank to shift to a lower nominal interest rate leads not to a new equilibrium with lower inflation, but to accelerating inflation instead. The remainder of Howitt's paper is dedicated to showing that this instability, which is easily seen in the simple old-fashioned model with adaptive expectations, is in fact a robust insight and holds even if one moves to a "microfounded" model with intertemporal optimization and flexible prices, and even if one allows for a broad range of learning dynamics. The only circumstance in which a lower nominal rate results in lower inflation is if individuals are assumed to be "capable of forming rational expectations ab ovo".
Howitt places this finding in historical context as follows (emphasis added):
In his 1968 presidential address to the American Economic Association, Milton Friedman argued, among other things, that controlling interest rates tightly was not a feasible monetary policy. His argument was a variation on Knut Wicksell's cumulative process. Start in full employment with no actual or expected inflation. Let the monetary authority peg the nominal interest rate below the natural rate. This will require monetary expansion, which will eventually cause inflation. When expected inflation rises in response to actual inflation, the Fisher effect will put upward pressure on the interest rate. More monetary expansion will be required to maintain the peg. This will make inflation accelerate until the policy is abandoned. Likewise, if the interest rate is pegged above the natural rate, deflation will accelerate until the policy is abandoned. Since no one knows the natural rate, the policy is doomed one way or another.
This argument, which was once quite uncontroversial, at least among monetarists, has lost its currency. One reason is that the argument invokes adaptive expectations, and there appears to be no way of reformulating it under rational expectations... in conventional rational expectations models, monetary policy can peg the nominal rate... without producing runaway inflation or deflation... Furthermore... pegging the nominal rate at a lower value will produce a lower average rate of inflation, not the ever-higher inflation predicted by Friedman...
Thus the rational expectations revolution has almost driven the cumulative process from the literature. Modern textbooks treat it as a relic of pre-rational expectations thought... contrary to these rational expectations arguments, the cumulative process is not only possible but inevitable, not just in a conventional Keynesian macro model but also in a flexible-price, micro-based, finance constraint model, whenever the interest rate is pegged... the essence of the cumulative process lies not in an economy's rational expectations equilibria but in the disequilibrium adjustment process by which people try to acquire rational expectations... under a wide set of assumptions, the process cannot converge if the monetary authority keeps interest rates pegged and that the cumulative process is a manifestation of this nonconvergence.
Thus the cumulative process should be regarded not as a relic but as an implication of real-time belief formation of the sort studied in the literature on convergence (or nonconvergence) to rational expectations equilibrium... Perhaps the most important lesson of the analysis is that the assumption of rational expectations can be misleading, even when used to analyze the consequences of a fixed monetary regime. If the regime is not conducive to expectational stability, then the consequences can be quite different from those predicted under rational expectations... in general, any rational expectations analysis of monetary policy should be supplemented with a stability analysis... to determine whether or not the rational expectations equilibrium could ever be observed.
To this I would add only that a stability analysis is a necessary supplement to equilibrium reasoning not just in the case of monetary policy debates, but in all areas of economics. For as Richard Goodwin said a long time ago, an "equilibrium state that is unstable is of purely theoretical interest, since it is the one place the system will never remain."
[The title of the post refers to Samuelson's Correspondence Principle, and I want to make clear that I understand its limitations in the DSGE context. See, for example, the introduction to this paper for a discussion of its applicability to DSGE models with learning.]
Friday, August 27, 2010
Tim Duy is puzzled by Ben Bernanke's reasons for keeping the Fed on hold:
Driving Me Crazy, by Tim Duy: No time for a long post this afternoon, just a short comment.
Today's speech by Federal Reserve Chairman Ben Bernanke contains one of those little inconsistencies that drives me nuts. In his assessment of economy:
The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.
I was already beginning to view this as a throw away line, something that Bernanke feels he has to say but doesn't really intend to worry much about. That sense was reinforced later in his speech:
Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.
If in the current environment - note that traditionally "current" means "right now" - there is already disinflation and little or no conflict between the dual mandates, then why, why, WHY do we need to wait until conditions deteriorate and risk additional disinflation before monetary policymakers turn to the problem of high unemployment that Bernanke claims distresses him?
If there is no conflict, then there is room to maneuver. Not later, now. So either Bernanke actually believes there is a conflict, or his concern about unemployment is disingenuous. I still don't know which.
My reaction to Bernanke's speech:
What would you add?
Stephen Williamson says the reason that New Keynesian economics is popular is because of Michael Woodford's magical ability to persuade economists:
This really has nothing to do with empirical evidence. ... New Keynesian economics is successful, because Mike Woodford has been a brilliant salesman.
When your lead argument against a class of models is as weak as this -- when you rely upon an argument that people cannot see the truth because they are fooled by a slick sales effort -- it's revealing.
I expect that some of you are completely lost in the debate over the relationship between interest rates and inflation that has been going on lately. I'm hoping this will provide some general background on monetary models that will help to sort things out, at least at a very general level.
But the main reason for doing this is to emphasize something that has not been talked about much, how the empirical evidence led economists to move away from flexible price models and consider models featuring wage and price rigidities (and for those of you ready to jump on me about the empirical evidence regarding wage and price rigidities, how the evidence changes with disaggregation and the like, those objections have been presented here, e.g. see this post for one example, or even better, see here, or better yet, scroll down here).
This is an important, too little discussed point. In models with flexible prices, matching the short-run dynamics contained in actual U.S. data with a defensible theoretical model is a challenge, one that can only be overcome with assumptions that are highly unpalatable. We do much better when we add wage inflexibility, but that alone is not enough to get both the size and the sign of all the correlations in the data correct, and it also fails to match the magnitude and duration of the responses to shocks. When price rigidities are tacked onto the model so that both price and wage inflexibilities are present, we get much closer in matching signs of correlations, durations, and magnitudes contained within U.S. data.
Even then, problems remain. One has to do with whether the actual degree of price rigidity in the data is enough to generate the persistence and magnitudes that are needed -- that's the point of the papers linked above. Another is the need to assume unrealistic values for labor supply elasticities in order to get the right degree of labor responsiveness in the model. The values needed do not match the estimated values. In addition, the Calvo pricing assumption is often attacked as ad hoc instead of being derived from first principles, an unrealistic approximation of the true process (e.g. it's not state dependent), and so forth. And this list is by no means exhaustive.
But these models -- New Keynesian models -- are the best we have presently in terms of matching the data empirically. Some proponents of alternatives, e.g. flexible price models, will protest that they can, in fact, do as well or better at matching the data, but they will rely upon assumptions, decompositions, shock characteristics and the like that the larger profession has deemed unsupportable. When the proponents of alternatives to the New Keynesian model produce a model of their own that does a better job of explaining the data without resorting to these assumptions, then it will be time to pay more attention. But for now, for policy analysis in particular, the New Keynesian models are the best we have. I understand that, particularly recently, best does not necessarily imply good -- the models need to be fixed and some people, like Stiglitz don't think they can be fixed at all. But, again, for now they are the best we have, particularly in terms of matching the empirical evidence and for policy analysis.
This is from Carl Walsh's book "Monetary Theory and Policy" (I need to get my hands on his 3rd edition). The sections below provide some background on the evolution of monetary models, as well as more on the point about needing wage and price rigidities to match the empirical evidence:
2 Money-in-the-Utility Function
The neoclassical growth model, due to Ramsey (1928) and Solow (1956), provides the basic framework for much of modern macroeconomics. Solow's growth model has just three key ingredients: a production function allowing for smooth substitutability between labor and capital in the production of output, a capital accumulation process in which a fixed fraction of output is devoted to investment each period, and a labor supply process in which the quantity of labor input grows at an exogenously given rate. Solow showed that such an economy would converge to a steady-state growth path along which output, the capital stock, and the effective supply of labor all grew at the same rate.
When the assumption of a fixed savings rate is replaced by a model of forward-looking households choosing savings and labor supply to maximize lifetime utility, the Solow model becomes the foundation for dynamic stochastic models of the business cycle. Productivity shocks or other real disturbances affect output and savings behavior, with the resultant effect on capital accumulation propagating the effects of the original shock over time in ways that can mimic some features of actual business cycles (see Cooley 1995).
The neoclassical growth model is a model of a nonmonetary economy, and while goods are exchanged and transactions must be taking place, there is no medium of exchange -- that is, no "money" -- that is used to facilitate these transactions. Nor is there an asset, like money, that has a zero nominal rate of return and is therefore dominated in rate of return by other interest-bearing assets. To employ the neoclassical framework to analyze monetary issues, a role for money must be specified so that the agents will wish to hold positive quantities of money. A positive demand for money is necessary if, in equilibrium, money is to have positive value.
A fundamental question in monetary economics is the following: How should we model the demand for money? How do real economies differ from Arrow-Debreu economies in ways that give rise to a positive value for money? Three general approaches to incorporating money into general equilibrium models have been followed: (1) assume that money yields direct utility by incorporating money balances directly into the utility functions of the agents of the model (Sidrauski 1967); (2) impose transactions costs of some form that give rise to a demand for money, either by making asset exchanges costly (Baumol 1952; Tobin 1956), requiring that money be used for certain types of transactions (Clower 1967), assuming that time and money can be combined to produce transaction services that are necessary for obtaining consumption goods, or assuming that direct barter of commodities is costly (Kiyotaki and Wright 1989); or (3) treat money like any other asset used to transfer resources intertemporally (Samuelson 1958). All involve shortcuts in one form or another... An important consideration in evaluating different approaches will be to determine whether conclusions generalize beyond the specific model or are dependent on the exact manner in which a role for money has been introduced. We will see examples of results that are robust, such as the connection between money growth and inflation, and others that are sensitive to the specification of money's role, such as the impact of inflation on the steady-state capital stock. ...
The ... assumption that prices and wages are perfectly flexible will be maintained... Thus, the focus is on flexible price models that emphasize the transactions role of money. The approaches adopted in these models can also be used to incorporate money into models in which prices and/or wages are sticky. The implications of introducing nominal rigidities into general equilibrium models of monetary economies are discussed in [later] chapters...
The models we have examined in this and the previous chapter are variants of Walrasian economies in which prices are perfectly flexible and adjust to ensure that market equilibrium is continuously maintained. The ... approaches discussed all represent means of introducing valued money into the Walrasian equilibrium. Each approach captures some aspects of the role that money plays in facilitating transactions. ...
However, the dynamics implied by these flexible-price models fail to capture the short-run behavior that appears to characterize modem economies.
That is perhaps not surprising; most economists believe that sluggish wage and price adjustment, absent from the models of this chapter, play critical roles in determining the short-run real effects of monetary disturbances and monetary policy. Although systematic monetary policy can have real effects with flexible prices, simulations suggest that these effects are small, at least at moderate inflation rates. To understand how the observed short-run behavior of money, interest rates, the price level, and output might be generated in a monetary economy, we need to introduce nominal rigidities, a topic discussed in chapter 5. ...
5 Money, Output, and Inflation in the Short Run
Chapter 1 provided evidence that monetary policy actions have effects on real output that persist for appreciable periods of time. The empirical evidence from the United States is consistent with the notion that positive monetary shocks lead to a hump-shaped positive response of output, and Sims (1992) finds similar patterns for other OECD economies. We have not yet discussed why such a response is produced.
Certainly the models of chapters 2-4 did not seem capable of producing such an effect. So why does money matter? Is it only through the tax effects that arise from inflation? Or are there other channels through which monetary actions have real effects? This question is critical for any normative analysis of monetary policy, since designing good policy requires understanding how monetary policy affects the real economy and how changes in the way policy is conducted might affect economic behavior.
In the models examined in earlier chapters, monetary disturbances did cause output movements, but these movements arose from substitution effects induced by expected inflation. The simulation exercises suggested that these effects were too small to account for the empirical evidence on the output responses to monetary shocks. In addition, the evidence in many countries is that inflation responds only slowly to monetary shocks. If actual inflation responds gradually, so should expectations. Thus, the evidence does not appear supportive of theories that require monetary shocks to affect labor-supply decisions and output by causing shifts in expected inflation.
In this chapter,... we move from the general equilibrium models built on the joint foundations of individual optimization and flexible prices to the class of general equilibrium models built on optimizing behavior and nominal rigidities that are employed in most discussions of monetary policy issues. ...
It is easy to see why nominal price stickiness is important. As we have seen in the previous chapters, the nominal quantity of money affects equilibrium in two ways.
First, its rate of change affects the rate of inflation. Changes in expected inflation affect the opportunity cost of holding money, leading to real effects on labor-leisure choices and the choice between cash and credit goods. However, these substitution effects seem small empirically. Second, money appears in ... the form of real money balances. If prices are perfectly flexible, changes in the nominal quantity of money via monetary policy actions will not necessarily affect the real supply of money. When prices are sticky, however, changing the nominal stock of money does initially alter the real stock of money. These changes then affect the economy's real equilibrium. Short-run price and wage stickiness implies a much more important role for monetary disturbances and monetary policy. ...
Why aren't monetary and fiscal policymakers doing more to boost the economy?:
This Is Not a Recovery, by Paul Krugman, Commentary, NY Times: What will Ben Bernanke, the Fed chairman, say in his big speech Friday in Jackson Hole, Wyo.? Will he hint at new steps to boost the economy? Stay tuned. ...
Unfortunately,... this isn’t a recovery, in any sense that matters. ... The important question is whether growth is fast enough to bring down sky-high unemployment. We need about 2.5 percent growth just to keep unemployment from rising... Yet growth is currently running somewhere between 1 and 2 percent, with a good chance that it will slow even further in the months ahead. Will the economy actually enter a double dip, with G.D.P. shrinking? Who cares? If unemployment rises for the rest of this year, which seems likely, it won’t matter whether the G.D.P. numbers are slightly positive or slightly negative.
All of this is obvious. Yet policy makers are in denial.
After its last monetary policy meeting, the Fed released a statement declaring that it “anticipates a gradual return to higher levels of resource utilization” — Fedspeak for falling unemployment. Nothing in the data supports that kind of optimism. Meanwhile, Tim Geithner, the Treasury secretary, says that “we’re on the road to recovery.” No, we aren’t.
Why are people who know better sugar-coating economic reality? The answer, I’m sorry to say, is that it’s all about evading responsibility.
In the case of the Fed, admitting that the economy isn’t recovering would put the institution under pressure to do more. And so far, at least, the Fed seems more afraid of the possible loss of face if it tries to help the economy and fails than it is of the costs to the American people if it does nothing, and settles for a recovery that isn’t.
In the case of the Obama administration, officials seem loath to admit that the original stimulus was too small. True, it was enough to limit the depth of the slump..., but it wasn’t big enough to bring unemployment down significantly.
Now,... officials could, with considerable justification, place the onus for the non-recovery on Republican obstructionism. But they’ve chosen, instead, to draw smiley faces on a grim picture, convincing nobody. And the likely result in November — big gains for the obstructionists — will paralyze policy for years to come.
So what should officials be doing, aside from telling the truth about the economy?
The Fed has a number of options. ... Nobody can be sure how well these measures would work, but it’s better to try something that might not work than to make excuses while workers suffer.
The administration has less freedom of action, since it can’t get legislation past the Republican blockade. But it still has options. It can revamp its deeply unsuccessful attempt to aid troubled homeowners. It can use Fannie Mae and Freddie Mac ... to engineer mortgage refinancing that puts money in the hands of American families — yes, Republicans will howl, but they’re doing that anyway. It can finally get serious about confronting China over its currency manipulation...
Which of these options should policy makers pursue? If I had my way, all of them.
I know what some players both at the Fed and in the administration will say: they’ll warn about the risks of doing anything unconventional. But we’ve already seen the consequences of playing it safe, and waiting for recovery to happen all by itself: it’s landed us in what looks increasingly like a permanent state of stagnation and high unemployment. It’s time to admit that what we have now isn’t a recovery, and do whatever we can to change that situation.
The arguments below concerning Fannie and Freddie's role in the crisis have been made many times here over the last several years, see the second link at the end, but it's worth a reminder given the concerted attempt by anti-government types to make people think that Fannie and Freddie played a large role in causing the crisis. They didn't. That's not to say that Fannie and Freddie are defensible in their present form, see this discussion for example, or this from Dean Baker. But placing the blame for the crisis in the wrong places will lead to ineffective and potentially counterproductive attempts to prevent this from happening again:
An Autopsy of Fannie Mae and Freddie Mac, by Binyamin Applebaum, NY Times: Here’s a last-minute option for summer reading material: An autopsy on Fannie Mae and Freddie Mac by their overseer, the Federal Housing Finance Agency.
The report aims to inform the continuing debate in Washington about the future of the government’s role in housing finance. ... And it does a good job of making a few key points:
1. Fannie and Freddie did not cause the housing bubble. In fact, you can think of the bubble as all the money that poured into the housing market on top of their regular and continuing contributions. There’s a good chart on Page 4 of the report illustrating this...
The market share of the two government-sponsored companies plunged after 2003, and did not recover until 2008. In 2006, at the peak of the mania, the companies subsidized only one-third of the mortgage market.
2. This was not for a lack of trying. The companies bought and guaranteed bad loans with reckless abandon. Their underwriting standards jumped off the same cliff as every other participant in the mortgage market.
3. Importantly, the companies’ losses are mostly in their core business of guaranteeing loans, not in their investment portfolios. The guarantee business is the reason the companies were created. ...
Thursday, August 26, 2010
- Global Imbalances: Good for the World? - MacroMania
- We Are What We Read (I Think) - Maxine Udall
- Why Boehner's Blaming Bureaucrats - Robert Reich
- The return of beggar-my-neighbour policy - Samuel Brittan
- No Bailout Needed for Social Security - CBPP
- Economic analysis of localvore choices - Knowledge Problem
- Mechanisms of contention reconsidered - UnderstandingSociety
I know how much some of you will disagree with this, but I have a hard time ascribing bad motives to people at the Fed and using it to explain policy decisions. I think people at the Fed believe in their heart of hearts that they are doing what's best for the economy as a whole as opposed to what's best for a particular party or some small group of people pulling the strings, but they are relying on bad assumptions, questionable models, convenient interpretations, etc. To me, some of the beliefs held by the other side are astoundingly unbelievable, but they would, of course, say the same thing about me. I don't deny that those beliefs can be convenient for the person holding them, but the idea that people at the Fed are consciously holding down the larger economy in order to benefit Republicans or some group of people is hard for me to buy into. There are certainly ideological divides that lead the other side to policies that I think are misdirected, or even counterproductive, but the bad motive explanation is hard to swallow. I'm more inclined to think this goes on in Congress where to some, winning the election is the only thing, but even then it's hard to assert this as a general proposition. But perhaps I have too much belief that people mostly try to do the right thing, and I am hopelessly trusting and naive (though see here). I expect to be told that I am.
Here's Andy Harless:
The Real Activity Suspension Program, by Andy Harless: (Think of this as a guest post by the Cynic in me. I’m not sure my Cynic is entirely right on either the facts or the economics, but he has a provocative point. And I apologize for the fact that he misuses the word “recession” to include the period since our inadequate recovery began.)
Americans got angry when the federal government tried to bail out banks by buying assets or taking capital positions. Whatever you may think of those bailout programs, they at least had the advantage that taxpayers were getting something in return for their money. There is another bank bailout program going on now – one that allows the federal government to recapitalize banks with public money, receive nothing at all in return, and somehow escape criticism for doing so. That bailout program is called the Recession.
How does the Recession allow the government to bail out banks? With the recession going on, people are afraid to do anything risky with their assets, so they keep them deposited in banks, earning no interest. Banks can then invest these deposits in Treasury notes and credit the interest on those Treasury notes to their bottom line, thus improving their balance sheets. So the government pays to recapitalize banks while receiving nothing in return.
Now this bailout program is not without its risks. The biggest risk is that the economy will recover, which would be a disaster for the program. Suddenly, not only would banks be holding losses on their Treasury notes, but their cost of funds would go up, as depositors realized that there were more attractive investments available than zero-interest bank deposits.
Another risk, with similar implications, is an increase in the expected inflation rate. That would also lead to capital losses on the banks’ Treasury note holdings and an increase in their cost of funds.
Finally, there is reinvestment risk. Treasury notes mature and need to be rolled over, the coupon payments need to be reinvested, and banks have new inflows of funds that need to be invested. A substantial decline in the yields on Treasury notes (perhaps a continuation of what we are seeing now) would benefit banks in the short run because of the capital gains involved, but ultimately it would effectively terminate the bailout program, since banks would no longer be able to earn a large spread on their safe investments.
So the success of this bailout program depends on avoiding recovery, avoiding increases in inflation expectations, and avoiding major declines in Treasury note yields. Now do you understand why the Federal Reserve Bank presidents – representatives of the banking sector – are the most hawkish voices at the FOMC’s policy meetings?
It's my understanding that the editors at Bloomberg will not let their columnists say certain things, and that's one of the reasons I stopped, for the most part, sending any traffic in their direction. If the columnist persists and tries to say it anyway, the column is spiked.
I don't know the extent to which Kevin Hassett is constrained by these puppet strings, but it's interesting to hear the change in tone when he is not writing for Bloomberg.
Let's start this with a recent Hassett opinion piece at Bloomberg entitled "Bury Keynesian Voodoo Before It Can Bury Us":
Bury Keynesian Voodoo Before It Can Bury Us All, by Kevin Hassett: Initial claims for unemployment benefits surged to 500,000 in mid-August, a level more typical of a recession than a recovery. ...
In all likelihood, the data will soon be so convincingly bad that we’ll again debate the need for an economic stimulus. Let’s hope that when that begins, all will finally concede that the ideas of John Maynard Keynes are as dead as the man himself, and that Keynesianism is the real voodoo economics.
And here's Kevin Hassett when he's not writing for Bloomberg:
Conservative Economist: 'Find the Unemployed and Hire Them', by Derek Thompson: Let's put this gently: economist Kevin Hassett is no Keynesian.
Hassett, the director of economic-policy studies at the American Enterprise Institute and an economic adviser to Sen. John McCain, recent attacked President Obama's economic plan as "voodoo economics"...
But when I got him on the phone to talk about the unemployment crisis, he struck a different tone. ... The problem, he said, was that Obama's stimulus was not direct enough.
With the Recovery Act, the White House eschewed direct hiring and aimed instead to raise overall economic output in the hope that more activity would lead to more demand...
"My idea is simpler. Find the unemployed and hire them."
If the government had spent the stimulus hiring people directly, we could have supported 23 million jobs, Hassett claimed. Hiring millions of unemployed workers directly into government organizations that already exist -- such as the military and the Army Corps of Engineers -- would be a much more efficient use of government funds.
Hassett defended direct government hiring, which the federal government used en masse during the Great Depression...
"Employers don't want to take a chance on some guy without a job for two years," he said. "The cycle is so long and deep that the cyclical becomes the structural." The easiest way for the government to end somebody's jobless spell is, very simply, to end it by straight-up hiring the worker.
"Since the economy has created this class of long-term jobless, the arguments for government hiring becomes stronger," he said. "If you give the person a job for a while, it helps them get a job later. You remove the stigma."
I'm getting some pushback on my post entitled "Jaws are Dropping," which is derived from a statement in one of the links I provided in the post. I think it must be either the title of the post or, when correcting a typo, the afterthought I added about the right answer to the question of whether a low federal funds rate eventually leads to a fall in inflation that has some people so worked up (good to see that Williamson has taking a break from his exhibitions of Krugman Derangement Syndrome, bashing Krugman seems to be the main point of his blog lately). It can't be anything else I said since my main point was that I didn't have time to say much about the whole controversy due to an impending deadline.
The main issue revolves around this statement from Minnesota Fed President Narayana Kocherlakota:
To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation
I think the assertion that it "must" lead to that outcome is unsupportable, there are models where that isn't true, but he means "must" in terms of a very specific model of how the economy works, including an assumption of the super neutrality of money (which is asserted as an uncontroversial assumption, but I'd quarrel with that). So, yes, it's possible to write down a very specific model that has this as an implication, but does that make it generally true? Not to me.
In any case, here's an email from a friend of Narayana defending his statements:
And, he sends along an update:
I rarely comment on posts on blogs, since most of the discussion seems to be most interested in scoring political points than in economic analysis. However today I will make an exception since Kocherlakota's words come directly from any standard treatment of monetary theory, and hence, they should have been anything except controversial.
In a large class of monetary models, the Euler equation of intertemporal maximization is:
FFR = (1/beta) *(u'(ct)/u'(ct+1))*inflation
where u'(.) is the marginal utility of consumption, FFR is the federal funds rate, and beta is the discount factor (see, for instance, equation 1.21 in page 71 of Mike Woodford's Interest and Prices for a derivation in a simple context).
Let us take first the case where money is neutral, probably an implausible case but a good starting point. In this situation, the ratio of marginal utilities is unaffected by the change in inflation or the FFR. Thus, a lower FFR means lower inflation. Otherwise, there are arbitrage opportunities left on the table. What is more, in such a world, the Fed can control inflation by controlling the FFR, so the relation is causal in a well-defined sense.
Now, let's move to the much more empirically relevant case of a New Keynesian model (here I am thinking about the standard NK model people use these days to analyze policy in the style of Mike Woodford, Larry Christiano or Martin Eichenbaum, with a lot of nominal and real rigidities, so I will not discuss the assumptions in detail).
Imagine that the Fed is targeting the FFR and decides to lower the long run target from, let's say 4% to 2%. What happens? Well, in the very short run, nominal rigidities imply that we will have a transition where inflation might (but not necessarily, it depends on details of the model) be temporarily higher but, after the necessary adjustments in the economy had occurred (adjustments that can be quite painful, generate large unemployment, and might reduce welfare by a considerable amount), we settle down in the lower inflation path. Again, the reason is that in most New Keynesian models, the ratio of marginal utilities is independent of the FFR (this will happen even in many models with long-run non-neutralities) and the Euler equation will reassert itself: the only way we can have a real interest rate of 3% when the target FFR is 2% is with a 1% deflation.
Hence, in the long run, as Kocherlakota's speech explicitly says:
"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."
An alternative way to see this is to think about a Taylor rule of the form:
Rt/R = (πt/π)γ
where γ>1 (here I am eliminating extra terms in the rule for clarity) where Rt is the FFR, R is the long run target for the FFR, πt is inflation, and π is the long run target for inflation. In a general equilibrium model, the Fed can only pick either R or π but not both. If it decides to pick a lower R, the only way the rule can work is through a fall in π.
While one may disagree with many aspects of modern monetary theory (and I have my own troubles with it), one must at least acknowledge that Kocherlakota's treatment of this issue or the relation between the FFR and inflation in the long run is what would appear in any standard macro model.
One thing I forgot to mention: I guess that the intuition that most people have (and that reacts in a somewhat surprised way to Narayana's words) comes from a New Keynesian model, where lowering the FFR with respect to what the Taylor rule indicates (what we call a "monetary shock") increases inflation in the short run. But here we are not talking about the effects on inflation of a transitory monetary shock, but, as Narayana clearly says in his speech, about the long run effects of a change in the target of the FFR.
If you commit to a single class of models and the interpretation of the shocks within them, the kind of models and interpretations that Narayana Kocherlakota has questioned, at least in their standard forms, and if you buy all the embedded assumptions that are needed to obtain the result, not all of which are easy to defend (e.g. the assumption of long-run neutrality), then yes, "must" is correct. But "must" must be interpreted in a rather limited context, and in a more general setting it's not at all clear that this result will hold.
However, my real problem with this defense is that it doesn't deal with the assertion that if real rates normalize and the Fed doesn't raise its target rate in response, it will lead to deflation., i.e. it doesn't address Nick Rowe's point. If the target real rate is below the normal real rate, how does that cause deflation? That's the part that caused the objection in the first place, and the part that still leaves me puzzled. Here's Nick:
"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."
That could be interpreted two ways: a wrong way, and maybe, just maybe, a right way.
"When real returns are normalized, inflationary expectations could well be negative, and there may still be a considerable amount of structural unemployment. If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation."
Nope. He definitely meant it the wrong way. If the economy returns to normal, and the natural rate of interest rises, the Fed must raise its target rate of interest. (So far so good). If it doesn't, the result would be....deflation. ("Inflation" would be the right answer).
I also wonder if a permanent shock is the right way to think about this type of a policy, but I'll leave that as a question since I don't want to distract from Nick's point.
Update: Here's more from Nick:
What standard monetary theory says about the relation between nominal interest rates and inflation, by Nick Rowe: This is what I understand "standard" monetary theory to say about the relation between inflation and nominal interest rates.
I want to distinguish two cases.
In the first case the central bank pegs the time-path of the money supply. The money supply is exogenous. The nominal interest rate is endogenous. Standard monetary theory says that a permanent 1 percentage point increase in the growth rate of the money supply will (in the long run) cause both the nominal interest rate and the rate of inflation to rise by 1 percentage point. The Fisher relation holds as a long-run equilibrium relationship. The real interest rate is unaffected by monetary policy in the long run.
In the second case the central bank pegs the time-path of the nominal rate of interest. The nominal interest rate is exogenous. The money supply is endogenous. Start in equilibrium (never mind how we got there). Standard monetary theory says that if the central bank pegs the time-path of the nominal interest rate permanently 1 percentage point higher, this will cause the price level, and the rate of inflation, and the stock of money, to fall without limit. The Fisher relation will not hold, because there is no process that will bring us to a new long run equilibrium. The real interest rate will rise without limit.
These two cases are very different, because a different variable is assumed exogenous in each case.
I am assuming super-neutrality of money, in long-run equilibrium. The Fisher relation is a long run equilibrium relationship. We never get to the new long-run equilibrium in the second case, and so the Fisher relation does not hold.
Update: Brad DeLong comments.
This must have been embarrassing:
Rural fire engine burns in Alvadore, by Emily Gillespie, The Register-Guard: The Santa Clara fire station responded to a fire at the Alvadore fire station near Junction City at around 8:45 p.m. on Tuesday night where a fire engine was burning. The 1980s-era vehicle was lost in the fire and is also presumably the cause of the fire...
Chuck Marr of the Center on Budget and Policy Priorities on the relationship between tax policy and inequality:
Inequality and the High-End Bush Tax Cuts, Off the Charts, CBPP: As I’ve said before, from the standpoint of economic efficiency there’s a clear-cut case for letting the Bush tax cuts for people over $250,000 expire on schedule in December. Sunsetting the high-income tax cuts makes just as much sense from the standpoint of equity. Recent data from the Congressional Budget Office (CBO) show a stunning shift in income away from the middle class and towards the highest-income people in the country over the last three decades:
- In 1979, the middle fifth of Americans took home 16.5 percent of the nation’s total after-tax income. By 2007, after several decades of stagnant incomes in the middle and surging incomes at the top, the middle fifth’s share had dropped to 14.1 percent. Over the same period, the top 1 percent’s share more than doubled, from 7.5 percent of total after-tax income to 17.1 percent (see graph below). So by 2007, the top 1 percent had a bigger slice of the national income pie than the middle 20 percent.
- If the distribution of after-tax incomes had remained unchanged between 1979 and 2007, the after-tax income of the average family in the middle would have been $9,000 (16 percent) higher in 2007 than it actually was. Instead of an income of $55,300, this typical family would have had $64,700 (see table below). ...
Here’s how that income shift looks in graph form:
Tax policy is one of the best tools we have to help offset the troubling trend of growing inequality. Unfortunately, the Bush tax cuts have had the opposite effect, providing much larger benefits — both in dollar terms and as a percentage of income — to people at the very top than to middle- and lower-income people. People making more than $1 million get an average of about $124,000 each year in tax cuts, according to the Urban-Brookings Tax Policy Center. The main reason, of course, is the large tax cuts targeted specifically at high-income households.
So this fall, when policymakers decide whether to extend the high-end tax cuts, they should keep in mind just how unequal incomes in the United States have become. As former Federal Reserve Vice Chairman Alan Blinder wrote recently in the Washington Post, is the rationale for extending these tax cuts “that America needs more income inequality? Seems to me we have enough.” To me, too.
Is Ben Bernanke about to "stake out a public position"?:
Fed to Outline Future Actions Friday, by Sewell Chan, NY Times: With fresh signs that the housing market is weakening,... Ben S. Bernanke, on Friday will offer his outlook on the economy, explain the Fed’s recent modest move to halt the slide and possibly outline other actions. ...
It is not known what Mr. Bernanke will say, but some insight may come from an episode in his past: his concern, soon after he became a Fed governor, that the economy was at risk of deflation as the nation gradually recovered from the dot-com bust a decade ago.
Mr. Bernanke’s worry then is similar to what troubles the Fed now, and his views will have no small bearing on the Fed’s course of action. ... Whether policy makers should take big steps to tackle the economic doldrums — by printing even more money and buying even more assets — [is] the dominant question...
Within the central bank, several officials are alarmed at the threat of the economy falling into a dangerous cycle of declining demand, wages and prices not experienced since the Depression. They say that a deflationary, double-dip recession is unlikely, but want to formulate concrete steps to ward it off.
Other officials contend the economic indicators, while dismaying, do not represent an immediate threat, and worry that additional monetary stimulus by the Fed could erode the already shaky confidence of the markets, or even backfire by eventually spurring uncontrolled inflation. ...
The risks are not symmetric. An extended period of stagnation is a highly undesirable outcome, and the Fed needs to take steps to try to prevent this from happening.
Wednesday, August 25, 2010
The Room for Debate asks:
Can the economy recover without a turn-around in home sales? Many say that job improvement has to come first, but the bad news on housing sales has put a new gloom on expectations of a recovery. Does the housing market have to lead the way out of the hole? If so, why?
The 800 word version of my response is below, but if you prefer, the edited, less wordy 400 word version, it is here along with responses from Jennifer H. Lee, Jeffrey Frankel, Patrick Newport, and Dean Baker [all responses]. Among other things, I wish I'd talked more about employment:
The bad news for recovery seems to be nonstop lately, with new home sales, which were at a record low in July, and durable goods orders, which came in far below expectations, continuing the trend. What does this say about the prospects for recovery?
It’s useful to break down the economy into four major sectors — households, businesses, government, and the foreign sector — and consider how each will affect both long-run and short-run prospects for growth.
Household consumption, which excludes the purchase of new homes (more on this in a moment), is unlikely to be the engine of growth that it has been in recent decades. Consumption before the crash was largely debt fueled, based on the false promise of continuously rise housing prices, and therefore unsustainable.
It’s widely believed that consumers will move to a lower level of consumption and a higher level of savings after the recession. During this transition, lower consumption growth will be a substantial drag on the economy — this would be on top of the decline in consumption caused by the recession itself. So while growth may return to normal in the long-run, it’s unlikely that this sector will lead the way to recovery.
If consumption by households isn’t the answer, what about investment? In the national income accounts, the purchase of new homes is counted as part of investment. Can investment by businesses or home purchases pick up the slack?
While housing will some day grow normally again, the large excess inventory of homes, poor sales, and other problems right now means that day is far, far away. In the short-run, looking to housing to lead the recovery is likely to lead to disappointment.
Business investment does not provide much hope either (the weak report durable goods orders on Wednesday is no comfort). Business investment might pick up some once there are signs of improvement in the economy, and if the Fed lowers long-term interest rates through quantitative easing, but this sector will follow the expectation of better times, it won’t lead them.
As for foreign exports, which is one of our best hopes for growth in the long-run, it hard to see that sector leading the recovery since the rest of the world is having troubles too.
So there’s very little besides government that can provide the needed boost to the economy in the immediate future. If government can provide the bridge across our short-run problems, then the other sectors can take over and generate long-run growth, and the hope is that the growth will be as robust as before the recent crash. But there’s guarantee that hope will be realized.
Minnesota Fed President Narayana Kocherlakota recently argued that low interest rates will eventually cause inflation deflation (sorry for the typo, it's hard to write the wrong answer). I'm trying to understand why people at the Fed are so reluctant to do more to help the economy, what the reasoning is, etc., but I have to meet a deadline and need to stop using the blog as a distraction. So let me just note that there is a lot of "jaw dropping" over Kocherlakota's claim. See, for example, Andy Harless, Nick Rowe, and Robert Waldmann. [Please see the update to this post.]
More bad news about the economy. New home sales were at a record low during July:
Sales of new single-family houses in July 2010 were at a seasonally adjusted annual rate of 276,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 12.4 percent (±10.8%) below the revised June rate of 315,000 and is 32.4 percent (±8.7%) below the July 2009 estimate of 408,000.
And durable goods orders also came in well below expectations:
New orders for manufactured durable goods in July increased $0.6 billion or 0.3 percent to $193.0 billion, the U.S. Census Bureau announced today. This increase followed two consecutive monthly decreases including a 0.1 percent June decrease. Excluding transportation, new orders decreased 3.8 percent.
I wonder if the people at the Fed who are standing in the way of more help for the economy will revise their belief that the recovery is underway and, although it is proceeding slower than they'd like to see, nothing needs to be done, nothing more can be done, to help? I doubt they will, instead they'll find a way to fit this into the narrative they want to believe in. I'd ask a similar question about Congress, fiscal policy is likely to be more effective than monetary policy in a severe recession, but I gave up on them long ago.
I am one of the "cycs" in the article below. I have given my view on this, and Brad DeLong adds more evidence on the side of those arguing that the problems in our our economy are due primarily to a collapse in demand, not a structural shift:
Identifying Cyclical vs. Structural Unemployment: A Guide for Slate Writers, by Brad DeLong: Over at Slate, James Ledbetter says that he cannot referee between the two gangs of economists warring over the causes of high unemployment.
But he is wrong.
Here is how:
Suppose that you have not cyclical unemployment generated by a collapse in aggregate demand but structural unemployment generated by mismatch, suppose you have a situation in which the structure of demand by consumers is different from the jobs that workers are capable of filling. Suppose--this is Berkeley, after all--that we were in a nice equilibrium in which some workers were baristas making lattes and other workers were yoga instructors teaching classes and that all of a sudden we have had a big shift in demand: that consumers decide that they want few moments of wired, frenetic caffeination and more moments of inner peace.
What would we expect to find happening?
We would expect, first, coffee bars to stand empty as people hoarded their quarters for the next yoga lesson. We would expect coffee bars to fire baristas, and to close down. But we would also expect yoga studios to be crowded, and yoga instructors to be teaching extra classes, and working long hours, and raising their prices, and training ex-baristas to chant properly, do the downward-facing dog and the lizard, and teach others how to achieve inner peace.
The size and duration of the excess unemployment of ex-baristas might be substantial and long-lasting. It takes quite a while to retrain a barista as a yoga instructor. Those seeking training might have a difficult time getting the attention of and apprenticing themselves to the yoga instructors doing land-office business--given how mercenary and grasping and eager to catch the wave of the market we all know yoga instructors to be.
But depression in the coffee-bar sector and unemployment among ex-baristas would be balanced by exuberance in the yoga-studio sector, rising prices for yoga lessons, and long hours and high wages for yoga instructors.
That is what "mismatch" structural unemployment looks like--one sector depressed with a lot of idle excess labor, a second sector booming with rising wages and prices.
What do we have in America today?
Well, over the past three years...
- employment in logging and mining has risen by 11 thousand
- employment in construction has fallen by 2.1 million
- employment in manufacturing has shrunk by 2.4 million
- employment in wholesale trade has fallen by 437 thousand
- employment in retail trade has fallen by 912 thousand
- employment in transportation and warehousing is down by 333 thousand
- employment in publishing, except internet is down by 147 thousand
- employment in motion picture and sound recording is down by 34 thousand
- employment in broadcasting, except internet is down by 41 thousand
- employment in telecommunications is down by 54 thousand
- employment in financial activities is down by 921 thousand
- employment in professional and business services is down by 1.3 million
- employment in educational services is up by 197 thousand
- employment in health care is up by 789 thousand
- employment in leisure and hospitality is down by 467 thousand
- employment in other services is down by 32 thousand
- employment by the federal government is down by 330 thousand
- employment by state and local governments is down by 127 thousand.
All this in the decline from 137.83 million people employed in July 2007 to 129.95 million people employed in July 2010--a 7.88 million decline in employment during a period in which the adult population has grown by 6 million.
I see employment growth in (a) internet, (b) health care, and (c) logging and mining. I see employment declines everywhere else.
That does not look like a story of "mismatch" unemployment--in which demand shifts in a direction that the existing labor force cannot cope with, and the result is structural unemployment in declining sectors and occupations and boom times and rising wages and prices in those sectors and occupations to which demand has shifted. That does not look like that at all.
Tuesday, August 24, 2010
- Tax Jujitsu: Why Democrats Should Propose a "People's Tax Cut" - Robert Reich
- Still striving for MLK's dream in the 21st century - Martin Luther King III
- Hangover Theory At The Fed - Paul Krugman
- Size doesn’t matter, but age does - FT Alphaville
- Economix - links
- Abnormal Returns - links
- Marginal Revolution - links
- Free Exchange - links
- naked capitalism - links
- Credit Writedowns - links
- New Deal 2.0 - links
- FT Alphaville - links
- Brad DeLong - links
A letter to my students, by Michael O'Hare: Welcome to Berkeley, probably still the best public university in the world. Meet your classmates, the best group of partners you can find anywhere. The percentages for grades on exams, papers, etc. in my courses always add up to 110% because that’s what I’ve learned to expect from you, over twenty years in the best job in the world.
That’s the good news. The bad news is that you have been the victims of a terrible swindle, denied an inheritance you deserve by contract and by your merits. And you aren’t the only ones; victims of this ripoff include the students who were on your left and on your right in high school but didn’t get into Cal, a whole generation stiffed by mine. This letter is an apology, and more usefully, perhaps a signal to start demanding what’s been taken from you so you can pass it on with interest.
Swindle–what happened? Well, before you were born, Californians now dead or in nursing homes made a remarkable deal with the future. (Not from California? Keep reading, lots of this applies to you, with variations.) They agreed to invest money they could have spent on bigger houses, vacations, clothes, and cars into the world’s greatest educational system, and into building and operating water systems, roads, parks, and other public facilities, an infrastructure that was the envy of the world. They didn’t get everything right: too much highway and not enough public transportation. But they did a pretty good job.
Young people who enjoyed these ‘loans’ grew up smarter, healthier, and richer than they otherwise would have, and understood that they were supposed to “pay it forward” to future generations, for example by keeping the educational system staffed with lots of dedicated, well-trained teachers, in good buildings and in small classes, with college counselors and up-to-date books. California schools had physical education, art for everyone, music and theater, buildings that looked as though people cared about them, modern languages and ancient languages, advanced science courses with labs where the equipment worked, and more. They were the envy of the world, and they paid off better than Microsoft stock. Same with our parks, coastal zone protection, and social services.
This deal held until about thirty years ago, when for a variety of reasons, California voters realized that while they had done very well from the existing contract, they could do even better by walking away from their obligations and spending what they had inherited on themselves. “My kids are finished with school; why should I pay taxes for someone else’s? Posterity never did anything for me!” An army of fake ‘leaders’ sprang up to pull the moral and fiscal wool over their eyes, and again and again, your parents and their parents lashed out at government (as though there were something else that could replace it) with tax limits, term limits, safe districts, throw-away-the-key imprisonment no matter the cost, smoke-and-mirrors budgeting, and a rule never to use the words taxes and services in the same paragraph.
Now, your infrastructure is falling to pieces under your feet, and as citizens you are responsible for crudities like closing parks, and inhumanities like closing battered women’s shelters. It’s outrageous, inexcusable, that you can’t get into the courses you need, but much worse that Oakland police have stopped taking 911 calls for burglaries and runaway children. If you read what your elected officials say about the state today, you’ll see things like “California can’t afford” this or that basic government function, and that “we need to make hard choices” to shut down one or another public service, or starve it even more (like your university). Can’t afford? The budget deficit that’s paralyzing Sacramento is about $500 per person; add another $500 to get back to a public sector we don’t have to be ashamed of, and our average income is almost forty times that. Of course we can afford a government that actually works: the fact is that your parents have simply chosen not to have it.
I’m writing this to you because you are the victims of this enormous cheat (though your children will be even worse off if you don’t take charge of this ship and steer it). Your education was trashed as California fell to the bottom of US states in school spending, and the art classes, AP courses, physical education, working toilets, and teaching generally went by the board. Every year I come upon more and more of you who have obviously never had the chance to learn to write plain, clear, English. Every year, fewer and fewer of you read newspapers, speak a foreign language, understand the basics of how government and business actually work, or have the energy to push back intellectually against me or against each other. Or know enough about history, literature, and science to do it effectively! You spent your school years with teachers paid less and less, trained worse and worse, loaded up with more and more mindless administrative duties, and given less and less real support from administrators and staff.
Many of your parents took a hike as well, somehow getting the idea that the schools had taken over their duties to keep you learning, or so beat-up working two jobs each and commuting two hours a day to put food on the table that they couldn’t be there for you. A quarter of your classmates didn’t finish high school, discouraged and defeated; but they didn’t leave the planet, even if you don’t run into them in the gated community you will be tempted to hide out in. They have to eat just like you, and they aren’t equipped to do their share of the work, so you will have to support them.
You need to have a very tough talk with your parents, who are still voting; you can’t save your children by yourselves. Equally important, you need to start talking to each other. It’s not fair, and you have every reason (except a good one) to keep what you can for yourselves with another couple of decades of mean-spirited tax-cutting and public sector decline. You’re my heroes just for surviving what we put you through and making it into my classroom, but I’m asking for more: you can be better than my generation. Take back your state for your kids and start the contract again. There are lots of places you can start, for example, building a transportation system that won’t enslave you for two decades as their chauffeur, instead of raising fares and cutting routes in a deadly helix of mediocrity. Lots. Get to work. See you in class!
Here is the CBO's latest estimate of the impact of the ARRA:
Estimated Impact of the Stimulus Package on Employment and Economic Output, CBO: ...A CBO report released this afternoon ... provides CBO’s estimates of ARRA’s overall impact on employment and economic output in the second quarter of calendar year 2010. ...
When ARRA was being considered, CBO and the staff of the Joint Committee on Taxation estimated that it would increase budget deficits by $787 billion between fiscal years 2009 and 2019. CBO now estimates that the total impact over the 2009–2019 period will amount to $814 billion. Close to half of that impact is estimated to occur in fiscal year 2010, and about 70 percent of ARRA’s budgetary impact will have been realized by the close of that fiscal year.
CBO’s Estimates of ARRA’s Impact on Employment and Economic Output
Looking at recorded spending to date as well as estimates of the other effects of ARRA on spending and revenues, CBO has estimated the law’s impact on employment and economic output using evidence about the effects of previous similar policies on the economy and using various mathematical models that represent the workings of the economy. On that basis, CBO estimates that in the second quarter of calendar year 2010, ARRA’s policies:
- Raised the level of real (inflation-adjusted) gross domestic product (GDP) by between 1.7 percent and 4.5 percent,
- Lowered the unemployment rate by between 0.7 percentage points and 1.8 percentage points,
- Increased the number of people employed by between 1.4 million and 3.3 million, and
- Increased the number of full-time-equivalent (FTE) jobs by 2.0 million to 4.8 million compared with what those amounts would have been otherwise. (Increases in FTE jobs include shifts from part-time to full-time work or overtime and are thus generally larger than increases in the number of employed workers.)
The effects of ARRA on output and employment are expected to gradually diminish during the second half of 2010 and beyond. The effects of ARRA on employment and unemployment are expected to lag slightly behind the effects on output; they are expected to wane gradually in 2011 and beyond.
Although CBO has examined data on output and employment during the period since ARRA’s enactment, those data are not as helpful in determining ARRA’s economic effects as might be supposed because isolating the effects would require knowing what path the economy would have taken in the absence of the law. Because that path cannot be observed, the new data add only limited information about ARRA’s impact. ...
"The effects of ARRA on output and employment are expected to gradually diminish during the second half of 2010 and beyond," and it doesn't look like the private sector is ready yet to take up the slack.
There is a real risk of extended stagnation or even further decline, but monetary and fiscal policymakers don't seem to fully recognize the threat we face and the urgency to do something about it. For once, it would be nice to see policymakers get out in front of a threat and head it off before it does damage instead of waiting until the threat becomes a reality and then trying to play catch up. That hasn't worked to date, and it won't work now.
The meeting was a case study in Mr. Bernanke's management style, which reflects his days as chairman of Princeton University's economics department when he had to manage a collection of argumentative academics with strong personalities and often divergent views. Mr. Bernanke encourages debate and disagreement, and then weighs in at the end with his own decision, which has helped him win loyalty at the Fed, even among those who disagree with him, several officials say.
Tim Duy responds:
Uuhhg – I am too tired to address the WSJ Fed piece, and I don’t have time to tackle the piece, but you can add this if you wish:
I understand why his colleagues appreciate Bernanke’s management style, and why the media likes to ooze quiet praise on that style, but shouldn’t he be showing some leadership in the public as well? After all, the Federal Reserve, last time I checked, was not a University economics department. It is not the same. As we like to say in academics, the disputes are bitter because so little is at stake. Not so for the Fed. As an institution, it serves the public directly, and much, much is at stake. Perhaps it is time for Bernanke to stake out a public position. How exactly does he view the current economic situation in light of his work on Japan? For many of us, that work points to a much more aggressive policy stance. Is this the direction Bernanke wants to take? If so, why is he dragging his heels? If not, then what is different? This is the conversation I want to see him have with the public, on the record. And the sooner, the better.
What good is served by leaving so much uncertainty over what the Fed is likely to do next if various scenarios such as a stronger, weaker, or stagnant economy unfold? What could be the reason for Bernanke's reluctance to take his case to the public?
If Bernanke takes a particular position on future policy, that makes it very difficult for the Fed to do anything else without losing its credibility, and hence makes it difficult for other members of the FOMC to vote against such a proposal no matter how much they might disagree. If the Fed chair indicates one thing, and then the Fed lurches in another direction, that will hurt the Fed's credibility at a time when it doesn't have any credibility to waste. Even if Bernanke tries to make it clear that he is expressing his own views and not speaking on behalf of the FOMC, his views will still set the benchmark for thinking about where the Fed is headed next.
Unlike the Fed under Greenspan where the Fed chair used his influence to determine policy pretty much on his own, Bernanke has attempted to make the Fed a "a collection of argumentative academics" where everyone is allowed to have a say in the outcome. If he goes out in public and binds the Fed in advance, that undermines the more democratic committee process he has tried to create.
Should we worry about that?
I'm not sure I want to go back to the days of Greenspan, the other members of the committee should at least have some say in the policy decisions. It's true that the chair of the Fed should have the most influence over policy, that's intended in the design of the Fed as an institution, but the Chair should not run the entire show.
However, when there is considerable uncertainty due to disagreement on the FOMC, the Fed chair needs to use the influence bestowed upon him or her by the Fed's institutional arrangements, set a firm course for policy, and resolve the uncertainly. That might mean having lots of informal discussions with other members of the FOMC to make sure their views get a fair hearing, and some back and forth in the process, but at some point the Fed chair needs to step up and lead. Right now is one of those times.