Economist's View

'What is the Price of Freedom?'

Comments on this?:

What is the price of freedom?, by James Choi: Are some things still worth dying for? Is the American idea one such thing? Are you up for a thought experiment? What if we chose to regard the 2,973 innocents killed in the atrocities of 9/11 not as victims but as democratic martyrs, “sacrifices on the altar of freedom”? In other words, what if we decided that a certain baseline vulnerability to terrorism is part of the price of the American idea? And, thus, that ours is a generation of Americans called to make great sacrifices in order to preserve our democratic way of life—sacrifices not just of our soldiers and money but of our personal safety and comfort? In still other words, what if we chose to accept the fact that every few years, despite all reasonable precautions, some hundreds or thousands of us may die in the sort of ghastly terrorist attack that a democratic republic cannot 100-percent protect itself from without subverting the very principles that make it worth protecting? Is this thought experiment monstrous? Would it be monstrous to refer to the 40,000-plus domestic highway deaths we accept each year because the mobility and autonomy of the car are evidently worth that high price? ... What are the effects on the American idea of Guantánamo, Abu Ghraib, PATRIOT Acts I and II, warrantless surveillance, Executive Order 13233, corporate contractors performing military functions, the Military Commissions Act, NSPD 51, etc., etc.? Assume for a moment that some of these measures really have helped make our persons and property safer—are they worth it? --David Foster Wallace, The Atlantic, on the trade-off between liberty and security.

The Toulouse School of Economics

Just a quick note to say how impressed I've been with the progress that The Toulouse School of Economics (TSE) has made in attracting first-rate scholars to their program. They have an excellent department -- I didn't realize how excellent it was until I got here (which, I suppose, was part of the reason to bring me here to the TIGER forum). I talked to Olivier Blanchard a bit about the progress that Europe more generally has made in economics, and he told me that there were some fairly special conditions that allowed Toulouse to make such great progress, and he also cited a few other universities that have also made large strides (again, also due to special conditions, in particular having advocates within the bureaucratic structure). 

But, special conditions or not, it is clear that Europe is making more progress than I was aware of, and it has attracted far more high powered brain power in macroeconomics than I realized (it is highly probable that the same is true in microeconomics, but since I mainly attended the macrofinance seminars at this conference, I can't speak to that first-hand -- but all the evidence points strongly in that direction). The sessions I attended were every bit as good as any NBER session, and the gains that Europe is making is an encouraging development. If the universities that have made the greatest strides continue to be successful, then perhaps lessons will be learned and it won't be necessary to exploit special conditions to the same degree in order for European universities to prosper academically (though there are significant institutional hurdles).

Toulouse itself is also a wonderful place to visit, and some of the sessions/dinners were hold in awesome places (e.g. Trichet's talk was at at the Augustins museum). The hospitality has been unsurpassed (thanks to Paul Seabright for all the tips about places to visit while I'm here, this is my first time to France so I really appreciated that and am taking full advantage of his suggestions). If you get a chance to attend this conference, go for it! I'm looking forward to returning in 2014 (this was their first attempt, and it will only get better in future years).

TypePad Comments

Good news. TypePad says they can now "whitelist" specific commenters, so when I release your comments from here on I will also send them the info they need to add you to the list. *If* this works, it should help quite a bit.

Links for 06-08-2013

• Weird, Unsettling Graph of the Day - Jared Bernstein
• Depressing Slow Recovery Graphs - Carola Binder
• Weak Productivity Growth, the Secret to Job Growth - Dean Baker
• The last Labour Government: the influence of economists - mainly macro
• The Culprit Behind High U.S. Health Care Prices - Uwe Reinhardt
• ObamaCare in California – Reuters Rehashes Avik Roy’s Lie - pgl
• Who Has Draghi’s Back? - Paul Krugman
• The Sequester Starts to Show - Economix
• A Case Against Japan's Latest Economic Plan - NYT
• The Premium From a College Degree - Economix
• Aggregate Supply and Demand - Arnold Kling
• Hard Money Men - Paul Krugman
• The Economics of Maple Syrup - Tim Taylor
• Fiscal Policy Issues in the United States - Brad DeLong
• Exit strategies: Time to think about them - Vox EU
• The Hiring Forecasts of Small Firms - macroblog
• Employment in U.S. Lags Where It Was in 2007 - NYT
• Why the Fed Hates the Word ‘Tapering’ - WSJ
• Tax Shelters and Intimidation of the IRS - ataxingmatter
• How Will the Fed Trim Bond Purchases? - WSJ

Total Information Awareness

Dan Little:

Total information awareness?, Understanding Society: I'm finding myself increasingly distressed at this week's revelations about government surveillance of citizens' communications and Internet activity. First was the revelation in the Guardian of a wholesale FISA court order to Verizon to provide all customer "meta-data" for a three-month period -- and the clarification that this order is simply a renewal of orders that have been in place since 2007. (One would certainly assume that there are similar orders for other communications providers.) And commentators are now spelling out how comprehensive this data is about each of us -- who we call, who those people call, when, where, … This comprehensive data collection permits the mother of all social network analysis projects -- to reconstruct the widening circles of persons with whom person X is associated. This is its value from an intelligence point of view; but it is also a dark, brooding risk to the constitutional rights and liberties of all of us.

Second is the even more shocking disclosure -- also in the Guardian -- of an NSA program called PRISM that claims (based on the secret powerpoint training document published by the Guardian) to have reached agreements with the major Internet companies to permit direct government access to their servers, without the intermediary of warrants and requests for specific information. (The companies have denied knowledge of such a program; but it's hard to see how the Guardian document could be a simple fake.) And the document claims that the program gives the intelligence agencies direct access to users' emails, videos, chats, search histories, and other forms of Internet activity.

Among the political rights that we hold most basic are the rights of political expression and association. It doesn't matter much if a government agency is able to work out the network graph of people with whom I am associated around the project of youth soccer in my neighborhood. But if I were an Occupy Wall Street organizer, I would be VERY concerned about the fact that government is able to work out the full graph of my associates, their associates, and times and place of communication. At the least this fact has a chilling effect on political organization and protest -- both of which are constitutionally protected rights of US citizens. At the worst it makes possible police intervention and suppression based on the "intelligence" that is gathered. And the activities of the FBI in the 1960s against legal Civil Rights organizations make it clear that agencies are fully capable of undertaking actions in excess of their legal mandate. For that matter, the rogue activities of an IRS office with respect to the tax-exempt status of conservative political organizations illustrates the same point in the same news cycle!

The whole point of a constitution is to express clearly and publicly what rights citizens have, and to place bright-line limits on the scope of government action. But the revelations of this week make one doubt whether a constitutional limitation has any meaning anymore. These data collection and surveillance programs are wrapped in tight secrecy -- providers are not permitted to make public the requests that have been presented to them. So the public has no legitimate way of knowing what kind of information collection, surveillance, and intelligence activity is being undertaken with respect to their activities. In the name of homeland security, the evidence says that government is prepared to transgress what we thought of as "rights" with abandon, and with massive force. (The NSA data center under construction in Utah gives some sense of the massiveness of these data collection efforts.)

We are assured by government spokespersons that appropriate safeguards are in place to ensure and preserve the constitutional rights of all of us. But there are two problems with those assurances, both having to do with secrecy. Citizens are not provided with any account by government about how these programs are designed to work, and what safeguards are incorporated. And citizens are prevented from knowing what the exercise and effects of these programs are -- by the prohibition against telecom providers of giving any public information about the nature of requests that are being made under these programs. So secrecy prevents the very possibility of citizen knowledge and believable judicial oversight. By design there is no transparency about these crucial new tools and data collection methods.

All of this makes one think that the science and technology of encryption is politically crucial in the Internet age, for preserving some of our most basic rights of legal political activity. Being able to securely encrypt one's communications so only the intended recipients can gain access to them sounds like a crucial right of self-protection against the surveillance state. And being able to anonymize one's location and IP address -- through services like TOR router systems -- also seems like an important ability that everyone ought to consider making use of. Voice services like Skype seem to be fully compromised -- Microsoft, the owner of Skype, was the first company to accept the PRISM program, according to the secret powerpoint. But perhaps new Internet-based voice technologies using "trust no one" encryption and TOR routers will return the balance to the user. Intelligence and law enforcement agencies sometimes suggest that only people with something to hide would use an anonymizer in their interactions on the Web. But given the MASSIVE personalized data collection that government is engaged in, it would seem that every citizen has an interest in preserving his or her privacy to whatever extent possible. Privacy is an important human value in general; and it is a crucial value when it comes to the exercise of our constitutional rights of expression and association.

Government has surely overstepped through creation of these programs of data collection and surveillance; and it is hard to see how to put the genie back in the bottle. One step would be the creation of much more stringent legal limits on the data collection capacity of agencies like NSA (and commercial agencies, for that matter). But how can we trust that those limits will be respected by agencies that are accustomed to working in the dark?

TypePad's Broken Comments

In a long response to my complaint about coments and the post recommending people avoid TypePad (actually two responses after (I reactred a bitr negatively to the first), I'm told it's a top priority, blah, blah, assured it's more than lip service, and that:

We're also working on integrating Disqus as an option. That will take a lot of testing but it's in progress.

Hoping we'll get that option soon (or the spam filter begins behaving).

Fed Watch: More of the Same

Tim Duy:

More of the Same, by Tim Duy: Unless you thought the job market tanked in May, the employment report contained little if any new information. The labor market continues to grind upward at a pace that most of us consider subpar, but fast enough that monetary policymakers are willing to consider pulling back on asset purchases as early as September. I don't see anything is this report that will alter the Fed's rhetoric on tapering one way or the other. Expect policymakers to continue to say "Not now, maybe in a few months."

Nonfarm payrolls rose 175k in May, just above the consensus forecast of 167k. March was revised up, April down, for a net loss of 12k compared to previous estimates.  The payroll gain was almost exactly the twelve-month average:

Taken in context of the Yellen indicators, tough to say that much has changed:

The unemployment rate did tick up as the labor force rose. In theory, a rapid rise in labor force participation could dissuade the Fed from tapering as it would push back the expected date of hitting the 6.5% unemployment threshold. But the little gain in this month's report would be considered just noise at this point.  

Other labor market indicators are generally holding their previous trends, for better or worse:

The lack of wages gains is a disappointment and a clear signal that plenty of slack remains in the labor market. That slack is revealed in underemployment indicators, which remain elevated and making only gradual improvement:

A hint of good news in the decline of those not in the labor force, but available for work. Perhaps an early sign of a more general acceleration in labor markets? Too early to tell, but something to watch.

Bottom line:  An unexciting report.  Little to change the view that the economy continues to shuffle forward despite the numerous negative shocks since the recovery began.  At best, some hints of future strength in the labor force gains.  Overall, little reason to believe the employment report will alter thinking on Constitution Ave.

Paul Krugman: The Spite Club

Why are many Republican-dominated states opting out of Obamacare's federally financed expansion of Medicaid?:

The Spite Club, by Paul Krugman, Commentary, NY Times: House Republicans have voted 37 times to repeal ObamaRomneyCare... Nonetheless, almost all of the act will go fully into effect at the beginning of next year.

There is, however, one form of obstruction still available to the G.O.P. Last year’s Supreme Court decision upholding the law’s constitutionality also gave states the right to opt out of one piece of the plan, a federally financed expansion of Medicaid. Sure enough, a number of Republican-dominated states seem set to reject Medicaid expansion, at least at first.

And why would they do this? ... The ... only way to understand the refusal to expand Medicaid is as an act of sheer spite. And the cost of that spite won’t just come in the form of lost dollars; it will also come in the form of gratuitous hardship for some of our most vulnerable citizens. ...

A new study from the RAND Corporation ... examines the consequences if 14 states whose governors have declared their opposition to Medicaid expansion do, in fact, reject the expansion. The result ... would be a huge financial hit: the rejectionist states would lose more than $8 billion a year in federal aid, and would also find themselves on the hook for roughly $1 billion more to cover the losses hospitals incur when treating the uninsured.

Meanwhile, Medicaid rejectionism will deny health coverage to roughly 3.6 million Americans, with essentially all of the victims living near or below the poverty line. And since past experience shows that Medicaid expansion is associated with significant declines in mortality, this would mean a lot of avoidable deaths: about 19,000 a year, the study estimated.

Just think about this... It’s one thing when politicians refuse to spend money helping the poor and vulnerable; that’s just business as usual. But here we have a case in which politicians are, in effect, spending large sums, in the form of rejected aid, not to help the poor but to hurt them.

And ... it doesn’t even make sense as cynical politics. ... What it might do ... is drive home to lower-income voters — many of them nonwhite — just how little the G.O.P. cares about their well-being, and reinforce the already strong Democratic advantage among Latinos, in particular.

Rationally, in other words, Republicans should accept defeat on health care, at least for now, and move on. Instead, however, their spitefulness appears to override all other considerations. And millions of Americans will pay the price.

 

Links for 06-07-2013

• Monetary policy and US inequality, again - FT Alphaville
• The Unbearable Lightness of Being Right - Paul Krugman
• Inequality and Opportunity - Miles Corak
• Some news about preferential international market access - Vox EU
• Does Mervyn King deserveblame for Britain's broken economy? - Neil Irwin
• Dodd-Frank isn't close to implemented - Dylan Matthew
• 4 Firms for Treasury Counterparty Pilot Program - WSJ
• The Facts of the Case and Why We’re Not Following Them - Jared Bernstein
• Plosser: Too-Big-to-Fail Banks to Hold More Capital - WSJ
• Time to Hit the Fiscal Reset - Kevin Drum
• Alpine lakes reflect climate change - EurekAlert
• Global factors in capital flows and credit growth - Vox EU
• A theory of the price level is a theory of inflation... - Nick Rowe
• Mechanism Design Approach to Peer Review - Leisure of the Theory Class
• There's Nothing Wrong with Making Money - Andrew Samwick
• Normalization? - Brad DeLong
• Raskin, The Case for Timely Implementation of Capital Rules - FRB
• Yellen, Regulatory Landscapes: A U.S. Perspective - FRB
• Bad Faith and Civility, Health Care Edition - Paul Krugman
• Nazi Islamic Bikes From Hell - Paul Krugman
• Labor's Falling Share, Everywhere - Tim Taylor
• Weekly Initial Unemployment Claims decline - Calculated Risk
• Who Predicted The Crisis-Redux - EconoSpeak
• Reducing Financial Fragility by Ending Too Big to Fail - Charles Plosser
• Multinational Corporations’ Support for Big Banks - Simon Johnson
• Greek Regrets - Paul Krugman
• Political Extremism: Do German Lessons Generalize? - Brad DeLong
• Why the ECB is reluctant to “go negative” - Gavyn Davies
• Pieria Debate on Electronic Money and Negative Rates - Miles Kimball

Legitimate Comments Marked as Spam

I just let Typepad know that the comment situation is unacceptable. They need to allow me to approve commenters by IP so this doesn't happen, fix it themselves, or I am going to have to switch to a new blog provider. I can't take this much longer.

For now, if you are thinkig of starting a blog, I'd recommend something other than Typepad.

Mark

'The Hidden Jobless Disaster'

Ed Lazear:

The Hidden Jobless Disaster, by Edward Lazear, Commentary, WSJ: The ... unemployment rate is not the best guide to the strength of the labor market, particularly during this recession and recovery. Instead, the Fed and the rest of us should be watching the employment rate. There are two reasons.

First, the better measure of a strong labor market is the proportion of the population that is working, not the proportion that isn't. ... By this measure, the labor market's health has barely changed over the past three years.

Second... Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely, reducing the number actively seeking work. The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line...

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. ...

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards. ...

No problems so far, but  the next part goes off the rails:

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago's Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. ...

These disincentives to seek work may also help explain the unusually high proportion of the unemployed who have been out of work for more than 26 weeks. ...

If the Mulligan story doesn't hold, then the conclusion about QE below doesn't hold either (notice the qualifier "may" in Lazear's statement "disincentives to seek work may also help explain the unusually high proportion of the unemployed")

The Fed may draw two inferences from the experience of the past few years. The first is that it may be a very long time before the labor market strengthens enough to declare that the slump is over. The lackluster job creation and hiring that is reflected in the low employment-to-population ratio has persisted for three years and shows no clear signs of improving.

The second is that the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.

We don't know what job growth would have been without fiscal policy and QE -- it could have been even worse (as many econometric examinations imply).

Why am I skeptical about the claim above? There's no evidence that I'm aware of that shows conclusively (or at all) that the supply of workers rather than the demand for workers is the problem. That is, with the ratio of the number of people seeking jobs to the number of available jobs so high, how is it that jobs are going unfilled due to social insurance programs? Do we see, for example, wages rising as firms have trouble finding workers (because they are all enjoying the meager benefits they get so much that there is a shortage)?

Maybe I'm missing something, but if no jobs are going unfilled, then how are social insurance programs holding back the recovery rather than making life a bit less miserable for those who cannot find work?

'The Great Persuasion: Reinventing Free Markets Since the Depression'

The end of an era?:

Persuasion, Great and Intimate, by David Warsh: ...The Great Persuasion: Reinventing Free Markets Since the Depression by Angus Burgin, of Johns Hopkins University ... is the latest of a lengthening shelf of books by intellectual historians that seek to explain the election of Ronald Reagan in 1980 in terms of the influence of ideas or money or both. To most of those writing the narrative of American politics in the 1970s, the enthusiasm for markets and reduced government that accompanied “the Reagan revolution” (or, earlier, the deregulation of transportation, under Jimmy Carter, or finance, under Richard Nixon and Gerald Ford), seemed to come out of nowhere. They were expecting, per Keynes and Schumpeter, “the end of laissez-faire.”

Burgin’s argument is that a group of market advocates formed in the late 1930s,   around a discussion of Walter Lippmann’s The Good Society, then took flight after World War II as the Mont Pelerin Society, and subsequently influenced the evolution of postwar economic and political thought. That thought isn’t new, but Burgin’s is the by far the best account of the organization’s history. The MPS was the brainchild of  Austrian economist and social philosopher Friedrich von Hayek, then in the process of relocating from London to Chicago.  He intended the organization to be “something halfway between a scholarly association and a political society.”   Thirty nine persons attended its first meeting, in April 1947, at a mountain hotel near Vevey, Switzerland, on the north shore of Lake Geneva, not far from Lausanne.

Among them were economists (Hayek, Lionel Robbins, Maurice Allais, Fritz Machlup, Ludwig von Mises, Frank Knight, Milton Friedman, George Stigler, Aaron Director); philosophers (Karl Popper, Michael Polanyi, Bertrand de Jouvenal); journalists (Henry Hazlitt, John Davenport); and activists (Leonard Read and representatives of the Volker Fund, the Kansas City, Mo., foundation that bankrolled the Americans’ participation) – a regular Who’s Who of young men (only one woman, British historian Veronica Wedgewood, was included). They would become influential theorists of the turn towards markets.

Burgin, a historian, shows that from the beginning the group comprised two factions, European traditionalists and American upstarts.  The Europeans were concerned with the difficulty of reconciling capitalism with social traditions that had evolved over the centuries. The Americans were not.  Eventually, Burgin writes, Milton Friedman got the upper hand and brought in “a more strident version” of market fundamentalism.  His predecessors’ work, Burgin writes, had been “ingrained with a sense of caution at the knife’s edge of catastrophe. Friedman’s was infused with Cold War dualisms…. Friedman’s philosophical models brooked no concessions to communism, and the America of his time found a ready audience for a philosophy that did not allow itself to be measured in degrees.”

For all his fascination with Friedman, Burgin does not pay much attention to developments in economics itself. Robert Solow, of the Massachusetts Institute of Technology, has written that Burgin tends to endow the MPS with more significance than it ever really has, whether within the economics profession or in the world at large.”  And surely Burgin stints the debates that gave rise to the Mont Pelerin Society.  He doesn’t mention the “calculation debate” about the technical possibility of planning that had preoccupied the Austrians economists since Germany’s surprisingly successful administration of its national economy during World War I; nor the controversy over the New Deal’s National Industrial Recovery Act of 1933, which was the background for the Lippmann book; nor the various crises of peacetime planning that were unfolding in Europe as the group first met.

Moreover, as a historian of ideas, Burgin ignores various more purely experiential means of persuasion by which faith in markets was renewed in the 1960s,’70s and ’80s.  There was the success of Toyota, for example, in improving standards of automotive quality.  Then, too, the Cultural Revolution in China and the Prague Spring of 1968 had powerful effects on views of political economy, in both East and West; so did the US war in Vietnam.  Populism, meaning the durable sectional rivalries within the US itself (Midwest vs. the Coasts, South vs. North) played a role as well. So did rivalries between the United States and Europe.

For my money, Burgin’s real find (apparently for his, too, since his book ends with an account of it) is a 1988 essay by Milton and Rose Friedman (his economist wife and collaborator) tucked away in a Hoover Institution volume, Thinking About America: The United States in the 1990s. In “The Tide in the Affairs of Men,” they discerned a tendency of powerful social movements to begin as works of opinion, spread eventually to the conduct of policy, then generate (often) their own reversal, only to be succeeded by another tide. The Friedmans discerned three such movements in the past 250 years – a laissez-faire or Adam Smith tide, beginning in 1776 and lasting until around 1883 in Britain and the United States (with policy lagging: 1820-1900 in Britain, 1840-1930 in the US);  a Welfare State or Fabian tide, beginning around 1883 and lasting until 1950 in Britain and 1970 in the US (policy tide 1900-1978 in Britain, 1930-1980 in the US); and a resurgence of free markets or Hayek tide, beginning around 1950 in Britain and 1980 in the US, whose opinion phase was “approaching middle age” and whose policy phase twenty-five years ago was “still in its infancy.”

This is standard cycle theory, familiar to readers of Ralph Waldo Emerson, Henry Adams, Arthur Schlesinger Sr. and Jr, Albert Hirschman and a host of others, unexceptional except insofar as it portends, even in the Friedmans’ view, not exactly the end of laissez-faire, but the beginning of some new tide of emphasis on the social.  Burgin doesn’t make much of it except to note that, at the height of the financial crisis, in the autumn of 2008, “commentators on both sides of the political aisle declared that a long era in American political history was drawing to a close.” ...

Orphanides and Wieland: Complexity and Monetary Policy

A paper I need to read:

Complexity and Monetary Policy, by Athanasios Orphanides and Volker Wieland, CFS Working Paper: Abstract The complexity resulting from intertwined uncertainties regarding model misspecification and mismeasurement of the state of the economy defines the monetary policy landscape. Using the euro area as laboratory this paper explores the design of robust policy guides aiming to maintain stability in the economy while recognizing this complexity. We document substantial output gap mismeasurement and make use of a new model data base to capture the evolution of model specification. A simple interest rate rule is employed to interpret ECB policy since 1999. An evaluation of alternative policy rules across 11 models of the euro area confirms the fragility of policy analysis optimized for any specific model and shows the merits of model averaging in policy design. Interestingly, a simple difference rule with the same coefficients on inflation and output growth as the one used to interpret ECB policy is quite robust as long as it responds to current outcomes of these variables.

Links for 06-06-2013

• The Semantics of Monetary Policy - macroblog
• Ben Bernanke, Force of Nature - Paul Krugman
• The Ultimate Probability Distribution Explorer - Dave Giles
• Drilling Down into Core Inflation - Liberty Street Economics
• States want drug tests for welfare recipients, a terrible idea - Harold Pollack
• Now is the time to be an infrastructure hawk, not a deficit hawk - Ezra Klein
• The Government's Debt-Sustainability Transversality Condition - Brad DeLong
• Five questions Obama should ask candidates for Fed chair -Neil Irwin
• Lowest Core Inflation in 50 Years and "Expectations" - Rortybomb
• IMF admits to errors in bailout of Greece - FT.com
• Mystery of the missing Fed regulator - MacroScope
• The Hidden Jobless Disaster - Edward Lazear
• Heritage Shock - Paul Krugman
• Mystified on AS/AD - mainly macro
• The Logical Inconsistencies of AS-AD - EconoSpeak
• Discovery of oldest primate skeleton - EurekAlert
• Nobel Economists, And Beard Statistics… - Economists Do It With Models
• Macroeconomic Consequences of the Allocation of Talent - Carola Binder
• Paul Krugman on Ireland’s failure - The Irish Economy
• Interview with Barry Eichengreen - Owen Zidar
• Supporting AD - Gloomy European Economist
• ECB Faces Resistance on Banking Union - WSJ
• On crossing the ECB interest-rate streams - FT Alphaville
• Global Biodiversity for $80 Billion Per Year - Tim Taylor
• Multinationals’ Support for Big Banks Not Persuasive - Simon Johnson
• Greek Regrets - Paul Krugman

Fed Watch: Falling Inflation Expectations

Tim Duy:

Falling Inflation Expectations, by Tim Duy: I had thought that early iterations of quantitative easing were flawed because they were based on a fixed amounts of total purchases. The size and length of the programs were effectively arbitrary as they were not linked to economic outcomes. This, combined with clear indications that policymakers desired to reduce the balance sheet as soon as possible, meant that the Fed was not able to sufficiently affect longer term expectations about the future price level or inflation to yield sustained improvement in economic activity.

In effect, the Fed was shooting itself in the foot with temporary programs. I had thought that open-ended quantitative easing tied to economic outcomes would resolve the problem of stabilizing expectations of future inflation, thus supporting a "stronger and sustainable" recovery.

The initial gains in inflation expectations seemed to justify such optimism. But a funny thing happened on the way to the show - inflation expectations reversed course:

TIPS-measured inflation expectations began falling in March, and now stand at pre-QE3 levels. Also telling is the Cleveland Federal Reserve Measures of inflation expectations. Longer run expectations remain well below 2%:

and, with perhaps more important policy implications, the term structure of expected future inflation has shifted down over the past year:

 

Arguably, by these measures a lot of policy has gone into accomplishing very little. The Fed, however, will tend to take solace from the Survey of Professional Forecasters:

The median is hovering near 2%, but at the bottom end of the range. So even if financial markets are anticipating lower inflation, professional forecasters are not. But professional forecasters really have not deviated from 2% since prior to the crisis, whereas the Fed has seen sufficient numerous threats to price stability to engage in repeated asset purchase programs. So one wonders how much weight the Fed places on this measure. Or, probably more accurately, they place more weight on this measure when it suits their purposes, such as if they are interested in ending the asset purchase program.

Form the perspective of policy, however, I am not so confident the survey is the best measure of inflation expectations. The Federal Reserve transmits policy through financial markets, and if those markets are not signaling stable or, more importantly, higher inflation expectations, then it is arguable that by itself, quantitative easing has limited impacts on economic activity. It can put a floor under the economy, but not accelerate activity.

Perhaps at best, quantitative easing does not cause higher inflation. At worst, some argue it is actually deflationary. The latter argument, however, will not get much support at the Federal Reserve, at least not yet.

Alternatively, one could argue that the Fed can indeed affect inflation expectations and really what is going on is that the Fed botched policy. Again. This is the "they have some slow learners on Constitution Avenue" story. Inflation expectations turned down in March, just when the Fed started sending signals that tapering was on the horizon. In this story, the Fed extrapolated a handful of data into the future and decided enough was enough. But that data was endogenous to Fed policy, and threatening to remove that policy once again undermined the economic outlook. In short, just by talking about tapering in an uncertain economic environment, the Fed pulled the plug on a successful policy.

But what should the Fed do now? Can they reverse the decline of inflation expectations merely by ending expectations of tapering? I am somewhat doubtful; the cat is out of the bag. They may very well have to expand asset purchases if they want market participants to believe "no, we were just kidding."

Indeed, I suspect that at least one policymaker, current voting member St. Louis Federal Reserve President James Bullard, would push for expanding asset purchases given the inflation and inflation expectations data. It would be interesting if he dissented a "hold steady" statement at the next meeting on that basis.

There will be, however, strong resistance to raising the pace of asset purchases. Yes, I know the Fed said they could move up or down. But I think the idea of "up" would only come after a "down." And clearly, if inflation expectations are any guide, market participants are getting the message that "down" is what is coming. And they are not getting that from just the hawkish policymakers. The doves too have been getting in on the action.

Moreover, I have to imagine that the recent market action in Tokyo has made some policymakers a little bit nervous about the limits to quantitative easing. The Nikkei's rise and fall seems to indicate that at some point asset purchases do in fact become destabilizing.

My view is that asset purchases would be most effective if coupled with fiscal stimulus. Working only through financial markets may be simply too restrictive to yield broad-based economic improvement. It is almost as if the Fed is trying to force a fire hose of policy through a garden hose. Keep turning up the volume, and eventually that hose bursts. And that might be what we are seeing in Japan.

Bottom Line: Inflation expectations are falling, and that by itself should complicate the Fed's expectation that they can start scaling back asset purchases at the end of the summer. But falling inflation expectations may complicate monetary policy more broadly by revealing the limits to quantitative easing. And Japan isn't helping.

'Welfare for the Wealthy'

Deficit reduction as a "sacred excuse for ... cruelty":

Welfare for the Wealthy, by Mark Bittman, Commentary, NY Times: The critically important Farm Bill is impenetrably arcane, yet as it worms its way through Congress, Americans who care about justice ... can parse enough of it to become outraged. The legislation costs around $100 billion annually, determining policies on matters that are strikingly diverse...

The current versions of the Farm Bill in ... the House ... is proposing $20 billion in cuts to SNAP — equivalent ... to “almost half of all the charitable food assistance that food banks and food charities provide to people in need.”

Deficit reduction is the sacred excuse for such cruelty, but the first could be achieved without the second. Two of the most expensive programs are food stamps, the cost of which has justifiably soared since the beginning of the Great Recession, and direct subsidy payments.

This pits the ability of poor people to eat — not well, but sort of enough — against the production of agricultural commodities. That would be a difficult choice if the subsidies were going to farmers who could be crushed by failure, but in reality most direct payments go to those who need them least.

Among them is Congressman Stephen Fincher, Republican of Tennessee, who justifies SNAP cuts by quoting 2 Thessalonians 3:10:  “For even when we were with you, we gave you this command: Anyone unwilling to work should not eat.”

Even if this quote were not taken out of context... [there is no need] to break a sweat countering his “argument”... 45 percent of food stamp recipients are children, and in 2010, the U.S.D.A. reported that as many as 41 percent are working poor. ... Fincher himself [is] a hypocrite.

For the God-fearing Fincher is one of the largest recipients of U.S.D.A. farm subsidies in Tennessee history; he raked in $3.48 million in taxpayer cash from 1999 to 2012, $70,574 last year alone. The average SNAP recipient in Tennessee gets $132.20 in food aid a month; Fincher received $193 a day. ...

Fincher is not alone in disgrace, even among his Congressional colleagues, but he makes a lovely poster boy for a policy that steals taxpayer money from the poor and so-called middle class to pay the rich...

Have Blog, Will Travel: TIGER Forum in Toulouse, France

I am at the TIGER Forum: Economic Growth: Challenges for Regulatory Change in Toulouse, France today (TIGER = Toulouse - Industry - Globalization - Environment - Regulation).

Lots of good speakers, e.g. Jean-Claude Trichet  talks tomorrow evening.

Links for 06-05-2013

• About Michael Kinsley - Brad DeLong
• Politics Can’t Handle the Truth About Austerity - Clive Crook
• Simulating Critical Values for Some Test Statistics - Dave Giles
• Is the euro a foreign currency to member states? - Vox EU
• Inequality update - The Berkeley Blog
• Why innovation thrives in cities - MIT News
• Brazil slashes financial transactions tax - FT.com
• The usefulness of AS-AD, an example - Nick Rowe
• What economists say about carbon pricing - Scientific American
• Welfare for the Wealthy - NYT
• Government Construction - WSJ
• A Word About Skittish Markets - Jared Bernstein
• In Wireless Spectrum, Competition Is Critical - NYT
• America owes a lot to Bernanke - FT.com
• Moral Derpitude - Paul Krugman
• Interrogating p-values - Andrew Gelman
• How JFK Moved the World Towards Peace - Jeffrey Sachs
• Better Late Than Never on Deeming Nonbanks TBTF - DealBook
• Global Spillovers and Economic Cycles - Econbrowser
• Should We Trust Economists? - Noah Smith
• Fox News Fact Check on political bias? - Scientific American

Is the Information Technology Revolution Over?

Quick one, then I have to figure out how to get to Toulouse (missed connection, in Paris now ... but should be able to get there ... long day so far):

Is the Information Technology Revolution Over?, by David M. Byrne, Stephen D. Oliner, and Daniel E. Sichel, FRB: Abstract: Given the slowdown in labor productivity growth in the mid-2000s, some have argued that the boost to labor productivity from IT may have run its course. This paper contributes three types of evidence to this debate. First, we show that since 2004, IT has continued to make a significant contribution to labor productivity growth in the United States, though it is no longer providing the boost it did during the productivity resurgence from 1995 to 2004. Second, we present evidence that semiconductor technology, a key ingredient of the IT revolution, has continued to advance at a rapid pace and that the BLS price index for microprocesssors may have substantially understated the rate of decline in prices in recent years. Finally, we develop projections of growth in trend labor productivity in the nonfarm business sector. The baseline projection of about 1¾ percent a year is better than recent history but is still below the long-run average of 2¼ percent. However, we see a reasonable prospect--particularly given the ongoing advance in semiconductors--that the pace of labor productivity growth could rise back up to or exceed the long-run average. While the evidence is far from conclusive, we judge that "No, the IT revolution is not over."

Help Students from Low Income Households Attend College

New column:

How a College Education Can Close the Income Gap

The title doesn't quite capture the main topic -- it's a plea to do more to help students from low income households attend college.

Links for 06-04-2013

• NGDP targets and UK Monetary Policy: Criticism and Reaction - mainly macro
• The Secret Science of Scalping Tickets - NYT
• Sussing Out Whether Debt Affects Future Growth - Supply-Side Liberal
• The origins of entrepreneurship and innovation clusters - Vox EU
• How big are productivity gains from FDI? - Vox EU
• The Triumph of Peter Kenen, The Revenge of Robert Mundell - Paul Krugman
• The Effectiveness of the Non-Standard Policy Measures - FRB Working Papers
• Ben Bernanke Endorses A 73 Percent Tax Rate - Paul Krugman
• Fed’s Lockhart: Nearing Time to Trim Bond Purchases - WSJ
• Fed’s Williams Open to Trimming Bond Purchases - WSJ
• Does High Home-Ownership Impair the Labor Market? - NBER
• Partisan Bias in Factual Beliefs about Politics - NBER
• Proposition 13 at Age 35 - Economix
• The E.U.’s Feeble War on Unemployment - International Herald Tribune
• Recession culprits? Start with Greenspan and Trichet - Dean Baker
• Time to throw some light on shadow banking - FT.com
• The Fed and Inequality - Economix
• A Legal Right to Paid Vacation? - Tim Taylor
• The Fed, Inequality and Accounting Identities - Dean Baker
• Is the Fed Squeezing the Shadow Banking System? - David Beckworth
• ...Just Dump Everything in ArXiv - Mike the Mad Biologist
• Fighting back in cybercrime - Digitopoly
• IRS To No Longer “Waste” Money on Training - EconoSpeak
• The Macroeconomics of European Disunion - Paul Krugman
• The Impending Deluge - NYT

FRBSF Economic Letter: Fiscal Headwinds: Is the Other Shoe About to Drop?

Long, long travel day ahead, and to add to the fun a flight delay means I'll miss a connection in Paris (tomorrow's links may be a bit delayed), so a quick one before departure:

Fiscal Headwinds: Is the Other Shoe About to Drop?, by Brian Lucking and Daniel Wilson, FRBSF Economic Letter: Federal fiscal policy during the recession was abnormally expansionary by historical standards. However, over the past 2½ years it has become unusually contractionary as a result of several deficit reduction measures passed by Congress. During the next three years, we estimate that federal budgetary policy could restrain economic growth by as much as 1 percentage point annually beyond the normal fiscal drag that occurs during recoveries.

The current recovery has been disappointingly weak compared with past U.S. economic recoveries. Researchers and policymakers have pointed to a number of potential causes for this unusual weakness, including contractionary fiscal policy. For example, Federal Reserve Vice Chair Janet Yellen (2013) argues that three tailwinds that typically help drive strong recoveries—investment in housing, consumer confidence, and discretionary fiscal policy—have been absent or turned into headwinds this time.

Changes in fiscal policy have been substantial over the past two years, including passage of the Budget Control Act of 2011, which led to sequestration spending cuts. In addition, temporary payroll tax cuts expired and income tax rates for higher-income taxpayers rose following passage of the American Taxpayer Relief Act of 2012. Two important questions are how much has federal fiscal policy been a drag on growth in the recovery to date and to what extent will it affect growth over the next few years? Moreover, is this fiscal drag unusual or part of the normal pattern in which government spending tends to fall and tax collections tend to rise as economic activity gains momentum?

In this Economic Letter, we examine these questions by estimating what fiscal policy would be if it followed historical patterns in the relationship between fiscal policy and the business cycle. We then compare this historically based estimate with actual fiscal policy during the recession and recovery to date. We also look at government projections of fiscal policy over the next three years to see how these compare with estimates based on the historical norm. Finally, we discuss what these trends in federal fiscal policy imply for economic growth.

The historical norm of federal fiscal policy

Historically, fiscal policy tends to be expansionary in recessions. As economic activity slows, tax revenue falls and government spending rises, giving a boost to the economy. The opposite occurs during expansions, as tax revenue rises and government spending falls. Much of this countercyclical pattern is by design. During a recession, so-called automatic stabilizers kick in. These are programs that boost government spending and reduce tax receipts without explicit legislative action. For example, income taxes fall and unemployment insurance and Medicaid automatically rise during downturns, adding to the federal deficit and ideally stimulating economic activity. During upturns, the process automatically reverses as spending on safety net and income-support programs falls and tax revenue rises, trimming the federal deficit.

Much of the analysis of the countercyclical effects of federal fiscal policy only takes these automatic stabilizer programs into account. For instance, the Congressional Budget Office regularly produces estimates of the cyclical component of the federal deficit based on automatic stabilizers (CBO 2013). Yet, automatic programs are only part of the picture. Discretionary fiscal policy, that is, legislated tax and spending changes, often tends to be countercyclical. Congress commonly passes temporary tax cuts or stimulus spending to counteract downturns. Therefore, to fully capture the cyclical effects of government budgetary trends, we consider both automatic stabilizers and discretionary fiscal policy.

To analyze whether recent fiscal policy has followed historical patterns, we use a statistical model of the relationship between fiscal policy and the business cycle based on three variables: government spending other than interest payments, tax revenue, and the difference between the two, which is known as the primary deficit (see Lucking and Wilson 2012). We measure these over time as a share of gross domestic product. We measure the business cycle using the difference between actual GDP and the CBO’s estimate of potential GDP, which is known as the output gap.

Our model allows us to estimate what fiscal policy is likely to be at any point in time given the state of the business cycle. We call these estimates the historical norm since they are based on the average historical relationship between fiscal policy and the business cycle. We can also use this model to estimate a historical-norm level of fiscal policy in coming years given CBO’s projections of the output gap.

Fiscal policy in the recession and the recovery

Figure 1 compares actual fiscal policy with estimates based on the historical norm for noninterest federal spending, tax revenue, and the primary deficit. It shows that federal fiscal policy was unusually expansionary during the Great Recession. Federal spending grew more and tax receipts fell more than usual, even taking into account the recession’s severe depth and duration, and the resulting very large output gap. This reflects both automatic stabilizers and discretionary changes in spending and tax policy, such as the American Recovery and Reinvestment Act, the economic stimulus program passed by Congress in 2009. As a consequence, federal government saving in the recession fell faster—that is, the deficit grew faster—than our historical norm would predict.

This more-expansionary-than-usual federal fiscal policy continued through the recession and into the early part of the recovery. But in mid-2010, fiscal policy sharply reversed course. Since then, federal fiscal policy has been much more contractionary than normal. Spending has fallen sharply since 2011, and tax revenue has grown faster than usual given the weak recovery. However, the larger-than-usual deficit growth early in the recovery has offset the larger-than-usual drop in the deficit since mid-2010. As a result, overall for the recovery, fiscal policy has been only slightly more contractionary than the historical norm.

Figure 1
U.S. fiscal policy: Projections vs. historical norm

Source: Bureau of Economic Analysis, CBO, and authors’ calculations.

Measuring excess fiscal drag in the recovery

Analysts often measure the “fiscal impetus” of policy, that is, how much policy changes contribute to real GDP growth over a given period. Positive impetus indicates expansionary policy changes and negative impetus, contractionary changes. Thus, fiscal impetus can be thought of as measuring the degree to which policy is a tailwind or headwind for economic growth.

Estimating fiscal impetus has two components. The first is the change in fiscal policy as a share of GDP. The second is the multiplier, that is, the change in GDP caused by a given change in government spending or taxes. Researchers do not agree on what multipliers are most accurate. Here, we use a multiplier of one, which is near the middle of the range of empirical estimates (see Wilson 2012). Doing so allows us to focus on the effects of changes in fiscal policy on fiscal impetus.

Figure 1 shows our calculations of fiscal impetus based on actual and historical-norm estimates of noninterest spending, tax revenue, and the primary deficit. In Figure 1, the vertical line divides our results into two periods: the recovery from mid-2009 to the end of 2012, and the three years through the end of 2015. We refer to the difference between historical-norm and actual fiscal impetus as the excess drag of fiscal policy. The excess drag tells exactly how much fiscal policy is slowing the current recovery beyond the historical norm.

Panel C of Figure 1 shows the actual and the historical-norm primary deficits. The fiscal impetus based on both the actual and historical-norm deficits since the start of the recovery has been identical, −0.2 percentage point per year. In other words, federal fiscal policy has been a modest headwind to economic growth so far in the recovery, but no more so than usual given the weak pace of growth.

Fiscal drag in coming years

To assess whether fiscal policies might cause excess drag in the future, we look at projections through 2015 from the CBO for the output gap, as well as for federal spending, revenue, and the deficit. We base our calculations on the CBO’s February 2013 outlook report, which contained scenarios both with and without the sequestration budget cuts, rather than the most recent May report, which omitted the scenario without sequestration. The results for the scenario including sequestration using the May projections are very similar to those based on the February projections.

While our estimates show that fiscal policy has held back the recovery slightly to date, the effect over the next three years looks much bigger. The CBO projects that the federal deficit as a share of GDP will drop 1.4 percentage points per year over the next three years. This projection would ease slightly to 1.2 percentage points per year if sequestration spending cuts were reversed. By contrast, our calculation of the historical-norm deficit decline through 2015 is 0.4 percentage point per year based on the CBO’s output gap projections. This implies that the excess drag from the rapidly shrinking deficit would reduce real GDP growth annually by between 0.8 and 1.0 percentage point, depending on whether sequestration is reversed. Thus, with or without sequestration, fiscal policy is expected to be a much greater drag on economic growth over the next three years than it has been so far.

Surprisingly, despite all the attention federal spending cuts and sequestration have received, our calculations suggest they are not the main contributors to this projected drag. The excess fiscal drag on the horizon comes almost entirely from rising taxes. Specifically, we calculate that nine-tenths of that projected 1 percentage point excess fiscal drag comes from tax revenue rising faster than normal as a share of the economy. As Panel B shows, at the end of 2012, taxes as a share of GDP were below both their historical norm in relation to the business cycle and their long-run average of about 18%. However, over the next three years, they are projected to rise much faster than our estimate of the usual cyclical pattern would indicate. The CBO points to several factors underlying this “super-cyclical” rise, including higher income tax rates for high-income households, the recent expiration of temporary Social Security payroll tax cuts, and new taxes associated with the Obama Administration’s health-care legislation.

Conclusion

Federal fiscal policy has been a modest headwind to economic growth so far during the recovery. This is typical for recovery periods and in line with the historical relationship between the business cycle and fiscal policy. However, CBO projections and our estimate based on the countercyclical history of fiscal policy suggest that federal budget trends will weigh on growth much more severely over the next three years. The federal deficit is projected to decline faster than normal over the next three years, largely because tax revenue is projected to rise faster than usual. Given reasonable assumptions regarding the economic multiplier on government spending and taxes, the rapid decline in the federal deficit implies a drag on real GDP growth about 1 percentage point per year larger than the normal drag from fiscal policy during recoveries.

References

Congressional Budget Office. 2013. “The Effects of Automatic Stabilizers on the Federal Budget as of 2013.” Report, March.

Lucking, Brian and Daniel Wilson. 2012. “U.S. Fiscal Policy: Headwind or Tailwind?” FRBSF Economic Letter 2012-20 (July 2).

Wilson, Daniel. 2012. “Government Spending: An Economic Boost?” FRBSF Economic Letter 2012-04 (February 6).

Yellen, Janet. 2013. “A Painfully Slow Recovery for America’s Workers: Causes, Implications, and the Federal Reserve’s Response.” Remarks at the “A Trans-Atlantic Agenda for Shared Prosperity,” conference sponsored by the AFL-CIO, Friedrich Ebert Stiftung, and IMK Macroeconomic Policy Institute, Washington, DC (February 11).

Fed Watch: More Tapering Talk

One more from Tim Duy:

More Tapering Talk, by Tim Duy: Despite the soft ISM number this morning, two Federal Reserve policymakers reiterated their expectation that asset purchases will slow in the months ahead. First up is Atlanta Federal Reserve President Dennis Lockhart, who was on the speaking circuit today. Via the Wall Street Journal:

“We are approaching a period in which an adjustment to the asset purchase policy can be considered,” Mr. Lockhart said in the interview. Referring to coming Fed policy meetings, he said of a potential slowing in the purchases: “Whether that’s June, August, September or later in the year, to me, isn’t really the issue,” even as he acknowledged, “It’s the issue for the markets.”

Of course, June is probably out of the question:

It would be too soon to pull back now, Mr. Lockhart said. “I don’t think that as of today we have a set of conditions that absolutely justify an adjustment,” he explained. While the official suggested the most likely direction would be to slow the buying from its current pace, he said he doesn’t have “a fixed sense” of how the Fed should slow down on the buying.

No, June is too early - they are waiting for more jobs data before making a move. Lockhart is also selling the story that less is not really less:

If the Fed does slow the pace of its bond buying, “this is not a decisive removal of accommodation. This is a calibration to the state of the economy and the outlook. It is not a big policy shift, and I would hope the markets understand that,” Mr. Lockhart said.

I know that the Fed does not want market participants to associate a slowing of asset purchases with tighter policy. I am not sure, however, that it will be easy to persuade Wall Street otherwise. After all, if the Fed wanted looser policy, they would increase the pace of asset purchases. If more is "looser," then why isn't less "tighter?" Alternatively, is "less accommodative" really different from "tighter"?

Lockhart adds this:

The central banker acknowledged that markets are struggling with the issue, and he said any perception that the Fed has been sending mixed messages is mainly a function of the complexity of the ongoing debate Fed officials are having about the issue. But he also cautioned market participants not to get ahead of themselves in trying to divine the monetary-policy outlook.

Isn't that one of the jobs of market participants? To engage in various trading strategies based on the expected path of, among other things, monetary policy? After all, that seems to be the primary reason for the intense interest in policy.

Separately, San Francisco Federal Reserve President also reiterated his expectation that policy would be making a shift sooner or later. Again, via the Wall Street Journal:

“If the forecast goes as I hope and we see continuing good signs from the labor market [and] overall economic conditions [and] continued confidence in that forecast of substantial improvement, I could see, my own view is that as early as this summer [there could be] some adjustment, maybe modest adjustment downward, in our purchase program,” San Francisco Fed President John Williams told reporters on the sidelines of a conference here.

The outlook is of course data dependent. At the current pace of data flow, however, policymakers have their eye on tapering. Williams also makes some comments on inflation, via Reuters:

Williams noted that underlying inflation was at 1 percent, below the Fed's target of 2 percent. Speaking on the sidelines of a seminar in the Swedish capital, he said he saw temporary factors as being the main reason inflation was being held low and expected the inflation rate to return to 2 percent.

Still, it was one of the factors the Fed should watch when deciding on policy, he said.

"If we see continued low inflation and, more worrisome, a fall in long-term inflation expectations, well below 2 percent, then those would be factors that argue for, all else equal, greater total purchases for our program than otherwise," he said.

If the employment outlook holds steady, but price trends conspire to put the Fed's inflation forecast in jeopardy, expect the Fed to push back the timing of a policy shift.

Bottom Line: Fed is looking to pull back on asset purchases. They expect the data to give them room to do so.

Fed Watch: Slow Start

Tim Duy:

Slow Start, by Tim Duy: ISM data came in on the soft side this morning, with a sub-50 reading:

I would be a little cautious about saying that "manufacturing is contracting" based on a diffusion index. That said, the headline number suggests overall weakness. What is the source of that weakness? I think once again the external sector is a drag. While new orders were down slightly:

exports orders were down sharply:

But note that import orders held their ground:

Import orders should be a reflection of domestic demand. The steady reading in those suggests that manufacturing weakness in the headline numbers stems from external sources which has not yet filtered broadly into the domestic economy.

That, at least, is the optimistic view. Also more optimistic was the 52.3 manufacturing number from the competing Markit report. But optimism aside, put this morning's ISM report under the "delay tapering" column.

Paul Krugman: The Geezers Are All Right

All the hand-wringing you hear over the cost of social insurance programs such as Medicare and Social Security is a ploy from the right designed to get you to support cuts -- don't fall for it:

The Geezers Are All Right, by Paul Krugman, Commentary, NY Times: Last month the Congressional Budget Office released its much-anticipated projections for debt and deficits, and there were cries of lamentation from the deficit scolds who have had so much influence on our policy discourse. The problem, you see, was that the budget office numbers looked, well, O.K... But if you’ve built your career around proclamations of imminent fiscal doom, this definitely wasn’t the report you wanted to see.

Still... Doesn’t the rising tide of retirees mean that Social Security and Medicare are doomed unless we radically change those programs now now now?

Maybe not.

To be fair, the reports of the Social Security and Medicare trustees released Friday do suggest that America’s retirement system needs some significant work. The ratio of Americans over 65 to those of working age will rise inexorably over the decades ahead, and this will translate into rising spending on Social Security and Medicare as a share of national income.

But the numbers aren’t nearly as overwhelming as you might have imagined,... the data suggest that we can, if we choose, maintain social insurance as we know it with only modest adjustments. ...

So what are we looking at here? The latest projections show the combined cost of Social Security and Medicare rising by a bit more than 3 percent of G.D.P. between now and 2035, and that number could easily come down with more effort on the health care front. Now, 3 percent of G.D.P. is a big number, but it’s not an economy-crushing number. The United States could, for example, close that gap entirely through tax increases, with no reduction in benefits at all, and still have one of the lowest overall tax rates in the advanced world.

But haven’t all the great and the good been telling us that Social Security and Medicare ... are unsustainable, that they must be totally revamped — and made much less generous? Why yes, they have; they’ve also been telling us that we must slash spending right away or we’ll face a Greek-style fiscal crisis. They were wrong about that, and they’re wrong about the longer run, too.

The truth is that the long-term outlook for Social Security and Medicare, while not great, actually isn’t all that bad. It’s time to stop obsessing about how we’ll pay benefits to retirees in 2035 and focus instead on how we’re going to provide jobs to unemployed Americans in the here and now.

 

Fed Watch: On September

Tim Duy:

On September. by Tim Duy: We are heading into a big data week, beginning with ISM and culminating with the employment report for May. As I believe the Fed is seriously looking at September to pull back on QE, I will be looking for data that pushes that timing off to December. The employment report is the most important release of course, not just for what nonfarm payrolls tell us about "stronger and sustainable," but also the unemployment rate. The latter is the specific concern of the threshold condition for reviewing the stance of interest rates, but it is also a concern for the pace of asset purchases. The faster we are moving toward 6.5%, the sooner policymakers will want to pull the plug on QE.

Consider the path of unemployment:

Unemployment is declining at a very steady pace, and at that pace will hit the 6.5% threshold in September of 2014. To be sure, past performance is no guarantee of future performance. We may see, for example, the long-awaiting return to rising labor force participation rates. But we could also see an acceleration in job growth, perhaps sufficient to more than offset any increase in labor force participation, and thus the unemployment rate falls faster than anticipated. A safe bet, however, is more of the same steady decline in rates that we have seen since 2010.

The Fed, I suspect, wants to conclude asset purchases well before they hit the 6.5% threshold and have to make a decision about interest rates. That will take at least three months, but they would probably error on the side of caution and shoot for six months out. That suggests they would like to wind down quantitative easing by March of 2014. Assume further that they do not want to go cold turkey, but rather reduce the pace of purchases across multiple meetings, maybe slowly at first, but more quickly later. So you need about 6 months, or 4 meetings, to wind down asset purchases. That pretty much pushes you back to the September meeting of this year.

To be sure, everything is data dependent. But my point is that the calendar is probably a driving force in timing the end of QE. Just estimate when the unemployment rate will hit 6.5%, work backwards, and it becomes evident why so many Fed officials appear to be leaning toward ending quantitative easing sooner rather than later.

But, you wisely say, but what about inflation? Because inflation is clearly not a problem - or, more specifically, high inflation is not a problem. Arguably low inflation is a problem:

Clearly trending down and away from the Fed's definition of price stability, or 2% inflation. Smoking gun, you say. The Fed can't think about backing off QE with inflation trending down.

Perhaps. But let me offer another interpretation. Consider the claim that the failure of inflation to fall further was taken by some as evidence that the economy was near potential output, and that much of the unemployment was structural. The counterargument was that downward nominal wage rigidities keep a floor on wage gains, and thus there is a floor on inflation as well. Thus, the failure of inflation to fall even further, or tip into deflation, tells us little about structural unemployment.

Indeed, the fact that inflation has fallen even as unemployment rates come down is further evidence that structural unemployment was limited. Score one for the importance of downward nominal wage rigidities.

But now those rigidities become a double-edged sword. Policymakers can be relatively confident that deflation will not emerge even when the economy is faced with substantially unemployment gap. Consequently, there is very little chance of deflation, inflation expectations are thus well-anchored, and there is no reason that low inflation should dissuade the Fed from slowing the pace of asset purchases as long as we continue to see "stronger and sustainable" improvement in labor markets.

By extension, policymakers will have an asymmetric response to inflation because they see a lower bound on the downside, but no such bound on the upside. But we can come back to that when rising inflation is a problem.

But what if inflation falls even further? There must be some non-negative rates that prompts additional easing, or, at a minimum, a halt to efforts to reduce asset purchases? Yes, one would be rational to believe that the Fed pushes any policy shift back to December if inflation continues to decline. That said, however, I think you are also still in the world of costs and benefits, and here I will hazard another another conjecture: If I was an monetary policymaker, and I were to look at some of the crazy volatility in Japan, I might reasonably conclude that yes, there may be a point where the destabilizing impacts outweigh the benefits. And the benefits to further action may be very limited considering that the steady decline in the unemployment rate suggests that monetary policy can put a floor under the economy, but may not be able to further lift the pace of activity.

Bottom Line: As always, the data will drive the Fed's next move. My expectation is that data evolves in such a way that policy will shift in September. I think there is currently a bias toward ending QE, so I anticipate a willingness of policymakers to focus on stronger numbers and downplay the importance of weaker numbers. In other words, I think we need to see some reasonably big downside misses to push policy back to December or later. Policymakers will be watching the unemployment rate, realizing that it has steadily declined despite a number of negative shocks since the recession ended. Expectations of continued declines help focus policymakers on winding down by the end of this year or early next year. If they want to meet that goal while not cutting asset purchases abruptly, then they will need to begin sooner than later. Hence why September comes into focus.

Links for 06-03-2013

• AS-AD: Counting the Ballots - EconoSpeak
• In defence of the AS-AD framework - Nick Rowe
• On Dorman on AS-AD on the Web - Robert Waldmann
• A Sad Story — I Mean, AS-AD Story - Paul Krugman
• Why is insider trading on the rise? - James Surowiecki
• Being economical with the data - Tim Harford
• Mortgaged Diplomas - Nancy Folbre
• The Ten Suggestions - Ben Bernanke
• In Praise of Trolls - Miles Kimball
• Lack of character? - UnderstandingSociety
• Who profits from trade-facilitation initiatives? - Vox EU
• Social networks and tax compliance - Frances Woolley
• Non-prophet Economics - Paul Krugman
• Why austerity is like a B-movie monster - FT.com
• Economic Crisis Enlivens Scholars - WSJ
• Transport Madness - Paul Krugman
• A Shredded Safety Net - The American Prospect
• Health Care Costs: Don't Blame the Free Market - Dean Baker
• Forward Guidance vs. Commitment - John Cochrane
• Persuasion, Great and Intimate - Economic Principals
• The “Spat” - Paul Krugman

Bernanke's Plans for the Future?

Is this a clue about Bernanke's plans for the future (i.e. if he wants to be renewed as Fed chair)?:

I wrote recently to inquire about the status of my leave from the university...

It's in the introduction to a graduation speech he gave at Princeton. Calculated Risk comments: on a different passage:

I enjoyed this speech, but Bernanke's comment that "careful economic analysis ... can help kill ideas that are completely logically inconsistent or wildly at variance with the data" is at odds with the sequestration budget cuts, "debt ceiling" nonsense, expansionary austerity, and more. I wish data and careful analysis could actually kill bad ideas, but I'm not sure what Paul Ryan would do with his life.

Yep. [Update: I probably should have noted that, for the most part, the speech has been widely praised.]

Update: On his inquiry about leave from Princeton, not sure when this footnote was added, but I just noticed it:

Note to journalists: This is a joke. My leave from Princeton expired in 2005.

'We Must Not Accept This New Normal'

Senator Bernie Sanders:

We must not accept this economic 'new normal', by Bernie Sanders, guardian.co.uk: The front pages of American newspapers are filled with stories about how the US economy is recovering. ... But in the midst of this slow recovery, we must not accept a "new normal".

We must not be content with an economic reality in which the middle class of this country continues to disappear, poverty is near an all-time high and the gap between the very rich and everyone else grows wider and wider. ...

The American people get the economic realities. According to a Gallup poll, nearly six out of 10 believe that money and wealth should be more evenly distributed among a larger percentage of the people in the US, while only a third of Americans think the current distribution is fair. A record-breaking 52% of the American people believe that the federal "government should redistribute wealth by heavy taxes on the rich".

The United States Congress and the president must begin listening to the American people. While there clearly has been some improvement in the economy over the last five years, much more needs to be done. We need a major jobs program which puts millions back to work rebuilding our crumbling infrastructure. We need to tackle the planetary crisis of global warming by creating jobs transforming our energy system away from fossil fuels and into energy efficiency and sustainable energy.

We need to end the scandal of one of four corporations paying nothing in federal taxes while we balance the budget on the backs of the elderly, the children, the sick and the poor.

It would be better termed the "New Abnormal" and there's no reason to accept that it's inevitable.

The Aggregate Supply—Aggregate Demand Model in the Econ Blogosphere

Peter Dorman would like to know if he's wrong:

Why You Don’t See the Aggregate Supply—Aggregate Demand Model in the Econ Blogosphere: Introductory textbooks are supposed to give you simplified versions of the models that professionals use in their own work. The blogosphere is a realm where people from a range of backgrounds discuss current issues often using simplified concepts so everyone can be on the same page.

But while the dominant framework used in introductory macro textbooks is aggregate supply—aggregate demand (AS-AD), it is almost never mentioned in the econ blogs. My guess is that anyone who tried to make an argument about current macropolicy using an AS-AD diagram would just invite snickers. This is not true on the micro side, where it’s perfectly normal to make an argument with a standard issue, partial equilibrium supply and demand diagram. What’s going on here?

I’ve been writing the part of my textbook where I describe what happened in macro during the period from the mid 70s to the mid 00s, and part of the story is the rise of textbook AS-AD. Here’s the line I take:

The dominant macro model, now crystallized in DSGE, is much too complex for intro students. It is based on intertemporal optimization and general equilibrium theory. There is no possible way to explain it to students in their first exposure to economics. But the mainstream has rejected the old income-expenditure models that graced intro texts in the 1970s and were, in skeleton form, the basis for the forecasting models used back in those days. So what to do?

The solution has been to use AS-AD as a placeholder. It allows instructors to talk about both prices and quantities in a rough market context. By putting Y on one axis and P on another, you can locate any macroeconomic outcome in the upper-right quadrant. It gets students “thinking like economists”.

Unfortunately the model is unsound. If you dig into it you find contradictions that can’t be papered over. One example is that the AS curve depends on the idea that input prices for firms systematically lag output prices, but do you really want to argue the theoretical and empirical case for this? Or try the AD assumption that, even as the price level and real output in the economy go up or down, the money supply remains fixed.

That’s why AS-AD is simply a placeholder. It has no intrinsic value as an economic model. No one uses it for policy purposes. It can’t be found in the econ blogs. It’s not a stripped down version of DSGE. Its only role is to occupy student brain cells until the real work of macroeconomic instruction can begin in a more advanced course.

If I’m wrong I’d like to know before I cut off all lines of retreat.

This won't fully answer the question (many DSGE adherents deny the existence of something called an AD curve), but here are a few counterexamples. One from today (here), and two from the past (via Tim Duy here and here).

Update: Paul Krugman comments here.

Links for 06-02-2013

• We Are Not Having A Serious Discussion... - Paul Krugman
• Evaluating Monetary Policy - Narayana Kocherlakota
• The tax break state - Mike Konczal
• Tax Expenditures and Credits by Income Group - Owen Zidar
• ASEAN: Does convergence mean polarisation? - Vox EU
• Breadwinner Wives and Nervous Husbands - Richard Thaler
• New challenges for bank competition policy - Vox EU
• Those in Poverty Go Wanting, Even in The Times - Public Editor
• Dube on Growth, Debt and Past versus Future Windows - Rortybomb
• Support for the Multiverse Hypothesis? - Scientific American
• What We Have Here Is A Failure To Communicate - Paul Krugman
• Monopolistic Competition vs the Plucking Model - Nick Rowe
• Connecting Asset and Labor Markets  - Narayana Kocherlakota
• Andrew Haldane on TBTF (14+ min mark) - FestivalEconomia
• Unexpected linkages - UnderstandingSociety

Simon Wren-Lewis: My verdict on NGDP Targets

Simon Wren-Lewis:

My verdict on NGDP Targets: At the beginning of the year I decided I needed to firm up my views on nominal GDP (NGDP) targets... I think I have now done enough to reach a tentative conclusion. I also gave a policy talk at the Bank of England yesterday, which was a useful incentive to get my thoughts in order.

Here is a link to the slides from my presentation. What I first do is compare targeting the level of NGDP to an ideal discretionary monetary policy. That is a demanding standard of comparison, but I argue that NGDP targets have the potential advantage over discretion that they may allow central banks to pursue a time inconsistent policy after inflation shocks that would otherwise be politically difficult (see this post). More speculatively, the uncertainty for borrowers of NGDP variation may be more costly than uncertainty over inflation, as Sheedy argues (see this post).

Against these advantages, I see two major negatives. First, following a shock to inflation, I think NGDP targets would hit output more than is optimal (see here and here). Second, if there is inflation inertia..., then targeting the level of NGDP is welfare reducing, because it is better in that case to let bygones be bygones. (There is a related point about ignoring welfare irrelevant movements in non-core inflation, but that probably needs an additional post to develop.)

So far, so typical two handed economist. But now let’s shift the comparison to actual monetary policy, rather than some ideal. Or in other words, how does actual policy as practiced in the UK, US and Eurozone compare to an ideal policy? While NGDP targets may well hit output too hard following inflation shocks (and more generally gets the short run output inflation trade off wrong), current policy seems even worse. One interpretation of this is that policymakers are obsessed with fighting what they see as the last war. Outside the US this is often institutionalized by having inflation targets... As attitudes or institutional frameworks are unlikely to change soon, moving to NGDP targets represent a move towards optimality.

This bias in policy is particularly unfortunate when we are at the zero lower bound (ZLB), because unconventional monetary policy is far less predictable and efficient. Although fiscal stimulus is likely to be less costly as a way of raising output at the ZLB than committing to higher future inflation, monetary policy has to work with fiscal policy as it is. (However policymakers have a responsibility to let the public know when inappropriate fiscal policy is making it difficult for monetary policy to meet its objectives...)

With perverse fiscal policy and uncertain unconventional monetary policy, we need to raise inflation expectations as a means of overcoming the ZLB and raising demand. Here I agree with Christina Romer: we need to indicate something rather more fundamental than the kind of marginal change implied by the forward guidance we currently have in the US and are likely to have soon in the UK. My proposal is therefore the adoption of a target path for the level of NGDP that monetary policy can use as a guide to efficiently achieving either the dual mandate, or the inflation target if we are stuck with that. NGDP would not replace the ultimate objectives of monetary policy, and policymakers would not be obliged to try and hit that reference path come what may, but this path for NGDP would become their starting point for judging policy, and if policy did not move in the way indicated by that path they would have to explain why.

To some supporters of NGDP targets this advocacy may seem a little wimpish. Why limit NGDP to an intermediate target that can be overridden? Given the problems with NGDP targets that I mention above, it would I believe be foolish to force monetary policymakers to follow them regardless. In general I think intermediate targets should never supplant ultimate objectives, and NGDP is an intermediate target. ...

'Little Cause for Inflation Worries'

Remember those predictions that we'd have runaway inflation by now?:

Little Cause for Inflation Worries, by Catherine Rampell, NYT: Periodically I am asked whether we should worry about inflation, given how much money the Federal Reserve has pumped into the economy. Based on the Bureau of Economic Analysis data released Friday morning, this answer is still emphatically no.

The personal consumption expenditures, or P.C.E., price index, which the Fed has said it prefers to other measures of inflation, fell from March to April by 0.25 percent. On a year-over-year basis, it was up by just 0.74 percent. Those figures are quite low by historical standards...

When looking at price changes, a lot of economists like to strip out food and energy, since costs in those spending categories can be volatile. Instead they focus on so-called “core inflation.” On a monthly basis, core inflation was flat. But year over year, this core index grew just 1.05 percent, which is the lowest pace since the government started keeping track more than five decades ago. ...

Links for 06-01-2013

• Newt Economic Thinking - Paul Krugman
• Art wants to be shared - Digitopoly
• Generation X Hit Hardest By Recession - NYT
• Why Did Criminals Trust Liberty Reserve? - James Surowiecki
• Behind the Numbers: PCE Inflation Update, April 2013 - FRB Dallas
• Special Tax Breaks for Capital Gains and Dividends Strike Out - CBPP
• Fed Regulators on Lookout for Weaknesses That Could Cause Shocks - WSJ
• Social Security and Medicare Trustees Report Released - Calculated Risk
• The Third Age of Financial Globalization - Tim Taylor
• How to Choose a Bank, Past and Present - Liberty Street Economics
• Debt and Growth: The State of the Debate - Paul Krugman
• India records slowest growth in a decade - FT.com

Does Infinity Really Exist?

'Public Colleges are Often No Bargain for the Poor'

Remember all those calls from both conservatives and liberals for (sufficiently) equal opportunity? How's that working out?:

Public colleges are often no bargain for the poor, by Renee Schoof, McClatchy: Many public colleges and universities expect their poorest students to pay a third, half or even more of their families’ annual incomes each year for college, a new study of college costs has found.

With most American students enrolling in their states’ public institutions in hopes of gaining affordable degrees, the new data shows that the net price – the full cost of attending college minus scholarships – can be surprisingly high for families that make $30,000 a year or less.

The numbers track with larger national trends: the growing student-loan debt and decline in college completion among low-income students.

Because of the high net price, “these students are left with little choice but to take on heavy debt loads or engage in activities that lessen their likelihood of earning their degrees, such as working full time while enrolled or dropping out until they can afford to return,” Stephen Burd wrote in a recent report for the New America Foundation...

There's a graphic in the article that shows the "Average net annual cost of public 4-year schools for in-state students in families earning $30,000" (scroll over a state to see the cost). For Oregon, it's $10,701 according to their calculations.

'The Beginning of the End for Eurozone Austerity?'

The other day I posted a link to an article at Spiegel titled "Austerity About-Face: German Government to Gamble on Stimulus." Here's Gavyn Davies on whether this is really "The beginning of the end for Eurozone austerity?":

Fiscal austerity, a concept which German Chancellor Merkel says meant nothing to her before the crisis, may have passed its heyday in the eurozone.  ...

this may not be the end of eurozone austerity, or even the beginning of the end, but it is the end of the beginning.

Substance here.

Paul Krugman: From the Mouths of Babes

The "ugly, destructive war against food stamps":

From the Mouths of Babes, by Paul Krugman, Commentary, NY Times: ...I usually read reports about political goings-on with a sort of weary cynicism. Every once in a while, however, politicians do something so wrong, substantively and morally, that cynicism just won’t cut it; it’s time to get really angry instead. So it is with the ugly, destructive war against food stamps. ...

Food stamps have played an especially useful — indeed, almost heroic — role in recent years. In fact, they have done triple duty. First, as millions of workers lost their jobs..., food stamps ... did significantly mitigate their misery. Food stamps were especially helpful to children...

But there’s more. ... We desperately needed (and still need) public policies to promote higher spending on a temporary basis — and the expansion of food stamps ... is just such a policy. Indeed, estimates from ... Moody’s Analytics suggest that each dollar spent on food stamps in a depressed economy raises G.D.P. by about $1.70...

Wait, we’re not done yet. Food stamps greatly reduce food insecurity among low-income children, which, in turn, greatly enhances their chances of ... growing up to be successful, productive adults. So food stamps are ... an investment in the nation’s future...

So what do Republicans want to do with this paragon of programs? First, shrink it; then, effectively kill it.

The shrinking part comes from the latest farm bill released by the House Agriculture Committee... That bill would push about two million people off the program. ...

These cuts are, however, just the beginning... Remember,... Paul Ryan’s budget is still the official G.O.P. position..., and that budget calls for converting food stamps into a block grant program with sharply reduced spending. If this proposal had been in effect when the Great Recession struck,... it ... would have meant vastly more hardship, including a lot of outright hunger, for millions of Americans, and for children in particular.

Look, I understand the supposed rationale: We’re becoming a nation of takers, and doing stuff like feeding poor children and giving them adequate health care are just creating a culture of dependency — and that culture of dependency, not runaway bankers, somehow caused our economic crisis.

But I wonder whether even Republicans really believe that story — or at least are confident enough in their diagnosis to justify policies that more or less literally take food from the mouths of hungry children. As I said, there are times when cynicism just doesn’t cut it; this is a time to get really, really angry.

 

Links for 05-31-2013

• Rethinking macroeconomic policy: Getting granular - Vox EU
• What does it mean to have "predicted the crisis"? - Noahpinion
• Why is the moon’s gravity so uneven? - MIT News
• Inequality on the Horizon of Need - Brad DeLong
• Government Potholes on Road to Recovery - WSJ
• Who Should Actually Have Say on Pay? - Justin Fox
• Economic policy is largely being driven by obstructionism - EPI
• At Least One Reason Why People Shouldn't Hate QE - macroblog
• The Flight of Sergei Guriev - EconoSpeak
• Paul Volcker Interview - Neil Irwin
• On Wang-Kimball - Evan Soltas
• Spurring growth in an era of constraints - Econbrowser
• Contra the Renegade Noah Smith - Robert's Stochastic Thoughts
• Weekly Initial Unemployment Claims increase - Calculated Risk

'Labor Union Decline, Not Computerization, Main Cause of Rising Corporate Profits'

I haven't read this paper, so I can't say a lot about how much confidence to place in the results, but it did grab my attention (and I believe it's in one of the top journals for sociology):

Labor union decline, not computerization, main cause of rising corporate profits, EurekAlert: A new study suggests that the decline of labor unions, partly as an outcome of computerization, is the main reason why U.S. corporate profits have surged as a share of national income while workers' wages and other compensation have declined.

The study, "The Capitalist Machine: Computerization, Workers' Power, and the Decline in Labor's Share within U.S. Industries," which appears in the June issue of the American Sociological Review, explores an important dimension of economic inequality...

Tali Kristal, an assistant professor of sociology at the University of Haifa in Israel ... found that from 1979 through 2007, labor's share of national income in the U.S. private sector decreased by six percentage points. This means that if labor's share had stayed at its 1979 level (about 64 percent of national income), the 120 million American workers employed in the private sector in 2007 would have received as a group an additional $600 billion, or an average of more than $5,000 per worker, Kristal said.

"However, this huge amount of money did not go to the workers," Kristal said. "Instead, it went to corporate profits, mostly benefiting very wealthy individuals."

The question is: why did this happen?

"Some economists contend that computerization is the primary cause and that it has increased the productivity of machines and skilled workers, prompting firms to reduce their overall demand for labor, which resulted in the rise of corporate profits at the expense of workers' compensation," Kristal said. "But, if that were the case,... then labor's share should have declined in all economic sectors, reflecting the fact that computerization has occurred across the board in the past 30 to 40 years."

This is not the case, however... "It was highly unionized industries — construction, manufacturing, and transportation — that saw a large decline in labor's share of income," Kristal said. "By contrast, in the lightly unionized industries of trade, finance, and services, workers' share stayed relatively constant or even increased. So, what we have is a large decrease in labor's share of income and a significant increase in capitalists' share in industries where unionization declined, and hardly any change in industries where unions never had much of a presence. This suggests that waning unionization, which led to the erosion of rank-and file workers' bargaining power, was the main force behind the decline in labor's share of national income."

In addition to the erosion of labor unions, Kristal found that rising unemployment as well as increasing imports from less-developed countries contributed to the decline in labor's share.

"All of these factors placed U.S. workers in a disadvantageous bargaining position versus their employers," said Kristal...

'A Note on Debt, Growth and Causality'

Arin Dube (via email):

Spurred by renewed interest on the topic, especially as evidenced by the work by Kimball and Wang,  I decided to finally post this short working paper on my website that builds on my guest blog post from a month and half ago:

A Note on Debt, Growth and Causality: Abstract: This note documents the timing in the relationship between the debt-to-GDP ratio and real GDP growth in advanced economies during the post World War II period using the Reinhart and Rogoff dataset. I first show that the debt ratio is more clearly associated with the 5-year past average growth rate, rather than the 5-year forward average growth rate–indicating a problem of reverse causality. Indeed, there is little evidence of a lower growth rate above the 90 percent threshold when using the 5-year forward average growth rate. I use a number of simple tools to account for some of the reverse causality in the bivariate regression–such as using forward growth rate, instrumenting the current debt ratio with its lag, and controlling for lagged GDP growth rates. These simple methods of accounting for reverse causality diminish the size of the association by between 50 and 70 percent, with the linear regression estimate indistinguishable from zero. Finally non- and semi-parametric plots provide visual confirmation that the relationship between debt-to-GDP ratio and growth is essentially flat for debt ratios exceeding 30 percent when we (1) use forward growth rates, (2) control for past GDP growth, or both.

Here's the Kimball and Wang work he mentions: After Crunching Reinhart and Rogoff’s Data, We Found No Evidence That High Debt Slows Growth.

Fed Watch: Steady As She Goes

One more from Tim Duy:

Steady As She Goes, by Tim Duy: The BEA released revisions to Q1 GDP numbers today, taking growth down a hair from the original 2.5% to 2.4%. Bloomberg is claiming that the downward revision to GDP and a rise in initial unemployment claims account for today's gain in equities. The idea is that the weaker data will dissuade the Fed from slowing down the pace of asset purchases this year.

It is of course dangerous to assign a cause to every fluctuation in asset prices. In this case, I am hard pressed to see that today's data has any meaningful impact on policy. If anything, a focus on the data over a longer period rather than the month-to-month or quarter-to-quarter movements should convince you that little has changed since 2010. Gross domestic product and income in levels:

Gross domestic product and income year-over-year:

Abstracting from inventory changes, look at the remarkable consistency of real final sales growth:

And as far as initial claims are concerned, you must have pretty sharp eyesight to conclude that something fundamentally changed last week:

Also note the the Fed may discount soft GDP numbers in any event. Recall the words of New York Federal Reserve President William Dudley:

“The important thing to recognize about the U.S. economy is that things are actually improving underneath the surface,” Dudley said in the interview. “We don’t really see that so much in the activity data yet because of the large amount of fiscal drag.”

Policymakers are trying to look past the fiscal drag to see if it is bleeding through to the broader economy. If not, they will conclude that growth is set to jump next year as the fiscal impact wanes. And they want to be ahead of the jump with respect to QE. Hence why the next few months of data are so important.

Bottom Line: Today's data is not likely to have an impact on monetary policy.

Fed Watch: More Uncertainty?

Tim Duy:

More Uncertainty?, by Tim Duy: I was reading this Business Insider report on an analyst's mea culpa on a bad trade when this jumped out:

Last week, we advised investors to add to their 7s/30s and 10s/30s yield curve steepening positions with the view that Chairman Bernanke would calm expectations for tapering by September this year – helping keep rates and volatility low. These curves have since flattened back to the levels at which we suggested investors enter steepeners. Given the uncertainty Bernanke injected into the market, we suggest investors pare down positions to more sustainable levels. At the same time, we keep to our core steepening view. [emphasis added]

I find it curious the analyst believes that Federal Reserve Chairman Ben Bernanke increased uncertainty. I think it was just the opposite. Prior to Bernanke's remarks, opinion on policy was scattered among some looking for the Fed to scale back asset purchases as early as June and as late as 2014. Bernake narrowed that range to September as a likely date, and cleared the way for New York Federal Reserve President WIlliam Dudley and Boston Federal Reserve President Eric Rosengren to point us at September as well. Overall, it looks like more, not less, certainty.

Perhaps market participants are unhappy with the path Bernanke laid out, but that path is more obvious than it was a week ago.

Links for 05-30-2013

• Do falling tax rates explain the rising incomes of the top 1%? - Miles Corak
• QE and Stock Markets: Boom or Crash? - Antonio Fatas
• Gains from trade: Firms and productivity - Vox EU
• This Time is Not So Different: The Euro Crisis and the 1840s - Carola Binder
• The Spinal Tap Approach to Government Loan Accounting - Jared Bernstein
• The Fed's tricky messaging: Tapering is not tightening - Ylan Q. Mui
• NPR: How Much Should We Trust Economics? - Supply-Side Liberal
• Austerity will drag hard on the economy in 2013 and 2014 - EPI
• The Fed's been keeping the economy afloat. That's the problem. - Neil Irwin
• High Debt/GDP Primarily a Result of Slower Growth - Brad DeLong
• Some International Minimum Wage Comparisons - Tim Taylor
• A Way to Tax Corporations That They Cannot Escape - Dean Baker
• Kids, Poverty, Safety Net, Recession…Over at TAP - Jared Bernstein
• Why Can’t America Be Sweden? - NYT
• Piggy Banks - Liberty Street Economics
• Stiglitz on globalization - ataxingmatter
• The Irish Recovery - Dean Baker
• The Neverending Irish Success Story - Paul Krugman
• Data, Theory and Central Bank Models - mainly macro
• The Case for a Profit Motive in Conserving the Environment - NYT
• Natural Resources and Political Institutions: Democracy - Why Nations Fail
• Volcker Plans to Restore Faith in Government - NYT
• Rate Stories - Paul Krugman

'DSGE + Financial Frictions = Macro that Works?'

This is a brief follow-up to this post from Noah Smith (see this post for the abstract to the Marco Del Negro, Marc P. Giannoni, and Frank Schorfheide paper he discusses):

DSGE + financial frictions = macro that works?: In my last post, I wrote:

So far, we don't seem to have gotten a heck of a lot of a return from the massive amount of intellectual capital that we have invested in making, exploring, and applying [DSGE] models. In principle, though, there's no reason why they can't be useful.

One of the areas I cited was forecasting. In addition to the studies I cited by Refet Gurkaynak, many people have criticized macro models for missing the big recession of 2008Q4-2009. For example, in this blog post, Volker Wieland and Maik Wolters demonstrate how DSGE models failed to forecast the big recession, even after the financial crisis itself had happened...

This would seem to be a problem.

But it's worth it to note that, since the 2008 crisis, the macro profession does not seem to have dropped DSGE like a dirty dishrag. ... Why are they not abandoning DSGE? Many "sociological" explanations are possible, of course - herd behavior, sunk cost fallacy, hysteresis and heterogeneous human capital (i.e. DSGE may be all they know how to do), and so on. But there's also another possibility, which is that maybe DSGE models, augmented by financial frictions, really do have promise as a technology.

This is the position taken by Marco Del Negro, Marc P. Giannoni, and Frank Schorfheide of the New York Fed. In a 2013 working paper, they demonstrate that a certain DSGE model was able to forecast the big post-crisis recession.

The model they use is a combination of two existing models: 1) the famous and popular Smets-Wouters (2007) New Keynesian model that I discussed in my last post, and 2) the "financial accelerator" model of Bernanke, Gertler, and Gilchrist (1999). They find that this hybrid financial New Keynesian model is able to predict the recession pretty well as of 2008Q3! Check out these graphs (red lines are 2008Q3 forecasts, dotted black lines are real events):

I don't know about you, but to me that looks pretty darn good!

I don't want to downplay or pooh-pooh this result. I want to see this checked carefully, of course, with some tables that quantify the model's forecasting performance, including its long-term forecasting performance. I will need more convincing, as will the macroeconomics profession and the world at large. And forecasting is, of course, not the only purpose of macro models. But this does look really good, and I think it supports my statement that "in principle, there is no reason why [DSGEs] can't be useful." ...

However, I do have an observation to make. The Bernanke et al. (1999) financial-accelerator model has been around for quite a while. It was certainly around well before the 2008 crisis. And we had certainly had financial crises before, as had many other countries. Why was the Bernanke model not widely used to warn of the economic dangers of a financial crisis? Why was it not universally used for forecasting? Why are we only looking carefully at financial frictions after they blew a giant gaping hole in the world economy?

It seems to me that it must have to do with the scientific culture of macroeconomics. If macro as a whole had demanded good quantitative results from its models, then people would not have been satisfied with the pre-crisis finance-less New Keynesian models, or with the RBC models before them. They would have said "This approach might work, but it's not working yet, let's keep changing things to see what does work." Of course, some people said this, but apparently not enough.

Instead, my guess is that many people in the macro field were probably content to use DSGE models for storytelling purposes, and had little hope that the models could ever really forecast the actual economy. With low expectations, people didn't push to improve the existing models as hard as they might have. But that is just my guess; I wasn't really around.

So to people who want to throw DSGE in the dustbin of history, I say: You might want to rethink that. But to people who view the del Negro paper as a vindication of modern macro theory, I say: Why didn't we do this back in 2007? And are we condemned to "always fight the last war"?

My take on why these models weren't used is a bit different.

My argument all along has been that we had the tools and models to explain what happened, but we didn't understand that this particular combination of models -- standard DSGE augmented by financial frictions -- was the important model to use. As I'll note below, part of the reason was empirical -- the evidenced did matter (though it was not interpreted correctly) -- but the bigger problem was that our arrogance caused us to overlook the important questions.

There are many, many "modules" we can plug into a model to make it do various things. Need to propagate a shock, i.e. make it persist over time? Toss in an adjustment cost of some sort (there are other ways to do this as well). Do you need changes in monetary policy to affect real output? Insert a price, wage, or information friction. And so on.

Unfortunately, adding every possible complication to make one grand model that explains everything is way too hard and complex. That's not possible. Instead, depending upon the questions we ask, we put these pieces together in particular ways to isolate the important relationships, and ignore the more trivial ones. This is the art of model building, to isolate what is important and provide insight into the question of interest.

We could have put the model described above together before the crisis, all of the pieces were there, and some people did things along these lines. But this was not the model most people used. Why? Because we didn't think the question was important. We didn't think that financial frictions were an important feature of modern business cycles because technology and deregulation had mostly solved this problem. If the banking system couldn't collapse, why build and emphasize models that say it will? (The empirical evidence for the financial frictions channel was a bit wobbly, and that was also part of the reason these models were not emphasized. But that evidence was based upon normal times, not deep recessions, and it didn't tell us as much as we thought about the usefulness of models that incorporate financial frictions.)

Ex-post, it's easy to look back and say aha -- this was the model that would have worked. Ex-ante, the problem is much harder. Will the next big recession be driven by a financial collapse? If so, then a model like this might be useful. But what if the shock comes from some other source? Is that shock in the model? When the time comes, will we be asking the right questions, and hence building models that can help to answer them, or will we be focused on the wrong thing -- fighting the last war? We have the tools and techniques to build all sorts of models, but they won't do us much good if we aren't asking the right questions.

How do we do that? We must have a strong sense of history, I think, at a minimum be able to look back and understand how various economic downturns happened and be sure those "modules" are in the baseline model. And we also need to have the humility to understand that we probably haven't progressed so much that it (e.g. a financial collapse) can't happen again. History alone is not enough, of course, new things can always happen -- things where history provides little guidance -- but we should at least incorporate things we know can be problematic.

It wasn't our tools and techniques that failed us prior to the Great Recession. It was our arrogance, our belief that we had solved the problem of financial meltdowns through financial innovation, deregulation, and the like that closed our eyes to the important questions we should have been asking. We are asking them now, but is that enough? What else should we be asking?

Fed Watch: September Looking Good

Tim Duy:

September Looking Good, by Tim Duy: Boston Federal Reserve President Eric Rosengren, considered to be on the dovish side of the Federal Reserve, had this to say about the outlook for monetary policy:

However, I would also say that it may be undesirable to abruptly stop purchases, so it may make sense to consider a modest reduction in the pace of asset purchases if we see a few months more of gradual improvement in labor markets and improvement in the overall growth rate in the economy – consistent, by the way, with my forecast, which is somewhat more optimistic than that of many private forecasters.

A "few more months" I interpret as June, July, and August, which puts the beginning of tapering at the September FOMC meeting. I think that Fed speakers are sending pretty clear signals to prepare for a September policy change.

Some big names on Wall Street don't agree. Vincent Reinhart at Morgan Stanley believes the data will push the Fed back to December. The view at Goldman Sachs is reportedly similar. To be sure, the data might cut in that direction, but I think that the bar to tapering might be lower than believed by those looking for a shift in December. We may believe the Federal Reserve's dual mandate argues for a longer period of QE at its current pace, but I am thinking that for the Federal Reserve, the dual mandate has more to do with the lift-off date from ZIRP than the end of QE. They have tended to argue for more or less QE on the basis of "stronger and sustainable" improvement in labor markets, and, given the obvious shift in tone among Fed speakers, I think we have reached that benchmark. At this point, they are just looking for a little more confirmation, in their minds erring on the side of being "too easy."

A lot of data will be coming in the door over the next week and a half, culminating in the all-important employment report on Friday, June 5. I think even a moderately positive run of data will further cement a September shift. And I think the Federal Reserve would place less weight on a weak employment report than a strong employment report. The recent pattern of general upward revisions argues for a asymmetrical response. Moreover, I sense they are wary of being trapped by one weak number - I don't think they would have expanded QE last September if they knew that job growth for August was 165k rather than the initially reported 96k. They don't want to make that mistake again.

Bottom Line: I think the Federal Reserve is leaning toward a September policy shift. While it is as always data dependent, I think the data will need to be pretty weak to push the Fed to December.

Stupid Spam Filter

I just realesed 150+ comments trapped in spam (many were duplicates, I tried to only post the original comment when that happened).

Apologies for getting so far behind, and for the continuing problems with the spam filter.

'No One Really Believes in Equality of Opportunity'

Ezra Klein on the equality of opportunity:

No one really believes in ‘equality of opportunity’, by Ezra Klein: ...Everyone in American life professes to believe in equality of opportunity. But nobody really believes in it. ... You can’t have real equality of opportunity without equality of outcome. A rich parent can purchase test prep a poor parent can’t. A rich parent can usher their children into social networks a poor parent can’t. A rich parent can make donations to Harvard that a poor parent can’t. ...

When people say they believe in “equality of opportunity,” they really mean they believe in “sufficiency of opportunity.” They don’t believe all children should start from the same place. But they believe all children should start from a good enough place. They believe they should have decent nutrition and functioning schools and a safe community and loving parents. They believe they should have a chance.

The question is what they’re willing to do about that belief. Democrats who believe in sufficiency of opportunity tend to want to spend more on health care and education for the poor. ... They believe that the less children or their parents need to worry about staying afloat, the more they’ll be free to work to get ahead.

On the Republican side, Rep. Paul Ryan (Wis.) has taken the lead in arguing that conservatives should focus on opportunity. But his approach largely consists of cuts to the safety net. ... These are not policies required by the finances of government. ... Rather, they’re required by Ryan’s theory of opportunity, which is that a key problem for the poor is the transformation of “our social safety net into a hammock, which lulls able-bodied people into lives of complacency and dependency.” His budget reflects this theory. According to the Center on Budget and Policy Priorities, almost two-thirds of his cuts come from programs that serve the poor.

Helping the poor by cutting the programs they rely on is, to say the least, a risky theory of uplift. It’s easier to see what Ryan’s plan does to impede sufficiency of opportunity than to spread it. ...

I don't see how we can achieve equality of opportunity without some degree of income redistribution. Republicans, of course, generally oppose income redistribution.

I've obscured the point of Ezra Klein's post in the extract above, it's mostly about whether "conservative reformers" who profess to believe in equal opportunity are serious, or simply using the mantra of "equal opportunity" to defend the same old policies that favor key constituencies. There are certainly people in the Republican Party who truly believe that government intervention harms the poor, but for the most part this looks like an excuse to pursue "you're on your own" polices that lower taxes and favor those at the top.

[Note: I have been battling an allergic reaction for the last several days, nothing serious but it is a big annoyance and distraction (the itchiest hives you can imagine from head to toe along with scary tongue swelling, hands a bit swollen, etc., no idea what causes it but Benadryl in large doses provides relief). I'm hoping it will be over soon, in the past it has never lasted this long and I'm "itching" for it to end, but in the meantime it's been hard to focus on blogging (or anything else) -- hence the mostly "echo blogging" the last few days.]

'The Real IRS Scandal'

Linda Beale:

The Real IRS Scandal, ataxingmatter: ... It does not appear to be quite so clear that the IRS actions were either "outrageous" (as so many hopping on the IRS "scandal" bandwagon suggest) or even "inappropriate". ...

Most of the media--which is generally right of center--has foamed at the mouth over the "scandal", puffing it up to bigger and bigger proportions with each day. ... A great deal of that coverage (much of it from the right) involves super emphasis on the word "scandal" and not much emphasis on the underlying facts of the matter.

So kudos to the New York Times for a recent story on the issue that probes the question of politicking much more closely. Confessore & Luo, Groups Targeted by IRS Tested Rules on Politics, New York Times (May 26, 2013). See also Barker & Elliot, 6 things you need to know about dark money groups, Salon.com (May 27, 2013).

Here are the Times writers' descriptions of a few of the groups that applied for C-4 status and "cried foul" about the IRS's selection of them for closer scrutiny for politicking:

• CVFC: "its biggest expenditure [the year it applied for C-4 status] was several thousand dollars in radio ads backing a Republican candidate for Congress"
• Wetumpka Tea Party, Alabama: in the year it applied, it "sponsored training for a get-out-the-vote initiative dedicated to the 'defeat of President Barack Obama' "
• Ohio Liberty Coalition: its head "sent out e-mails to members about Mitt Romney campaign events and organized members to distribute Mr. Romney’s presidential campaign literature"

As noted in the report, "a close examination of these groups and others reveals an array of election activities that tax experts and former I.R.S. officials said would provide a legitimate basis for flagging them for closer review." That is what the IRS is supposed to do, suggesting that much of the scandal mongering that is going on is more about furthering the anti-tax/anti-government rightwing goal of "starving the beast" than it is about ensuring that the law is appropriately enforced. The stakes are high, since the ability of politicking groups to use C-4 status permits high-powered donors and strategists to cloak their campaign activities behind the veneer of social welfare activity.

Which is probably why of the right-wing bloviators are bloviating over this in Congress, calling for jail time for IRS employees, calling for a special prosecutor, insisting that this is a "scandal" along the lines of Watergate that goes to the heart of Obama's presidency. Hogwash, folks, pure and simple. This so-called "scandal" is just another instance of right-wing obstructionism that is willing to sacrifice good government for maintaining or increasing political power.

'Inflation in the Great Recession and New Keynesian Models'

DSGE models are "surprisingly accurate":

Inflation in the Great Recession and New Keynesian Models, by Marco Del Negro, Marc P. Giannoni, and Frank Schorfheide: It has been argued that existing DSGE models cannot properly account for the evolution of key macroeconomic variables during and following the recent Great Recession, and that models in which inflation depends on economic slack cannot explain the recent muted behavior of inflation, given the sharp drop in output that occurred in 2008-09. In this paper, we use a standard DSGE model available prior to the recent crisis and estimated with data up to the third quarter of 2008 to explain the behavior of key macroeconomic variables since the crisis. We show that as soon as the financial stress jumped in the fourth quarter of 2008, the model successfully predicts a sharp contraction in economic activity along with a modest and more protracted decline in inflation. The model does so even though inflation remains very dependent on the evolution of both economic activity and monetary policy. We conclude that while the model considered does not capture all short-term fluctuations in key macroeconomic variables, it has proven surprisingly accurate during the recent crisis and the subsequent recovery. [pdf]