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Friday, November 18, 2005

Another Look at Euro Area Labor Markets

The Economist says to take another look at labor markets in the euro zone:

Seeing Europe the right way up, The Economist: ...Europe's performance has been better than the conventional wisdom says. Although America has outpaced Europe this year, over the past five years GDP per head, the best single measure of economic performance, grew at an average rate of 1.4% in the euro area, just behind America's 1.5%. Ah, but America is better at creating jobs, isn't it? Actually, no. Employment has grown a tad faster in the euro area than in America whether one looks at the past five years or the past ten-a striking improvement on the decade to the mid-1990s (see chart).


Since 1996 the proportion of the population of working age with jobs has fallen from 73% to 71% in America; in the euro area it has risen from 59% to 65%. The fact that the euro area has achieved its growth without enormous increases in its current-account and budget deficits might also indicate that its record is more sustainable than America's. This is not to say that everything is rosy in euroland. Far from it. Europe has to cope with a shrinking workforce and an ageing population, as well as fiercer global competition. Europe's markets will have to become more flexible... and its productivity growth must improve. ...

    Posted by on Friday, November 18, 2005 at 12:12 AM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (35) 


    St. Louis Fed President Poole on Tracking Inflation

    William Poole, president of the St. Louis Fed, discusses how the Fed tracks and forecasts inflation in conducting policy. He also talks about his view of current inflation trends and says "...the FOMC has tightened its policy stance considerably." and "... core inflation and inflation expectations have been contained, but underlying determinants of inflation suggest caution." Here are excerpts from the speech:

    Tracking Inflation, by William Poole, St. Louis Fed President:  ...I have said previously that I favor a goal of zero inflation, properly measured. In practice, because of various statistical problems in measuring prices, that goal translates, approximately, to price changes of something like a 1 percent annual rate of increase in the chain-price index for Personal Consumption Expenditures—the PCE ... for short. In its day-to-day policymaking, the Fed focuses on the core PCE price index, which excludes volatile food and energy prices... On average over time, the total and core indexes change at almost identical rates. Even putting volatile food and energy prices aside, it is not possible to achieve an inflation target precisely year by year; thus, my goal might be stated as a change in the core PCE index of 0.5 to 1.5 percent per year. That range itself needs to be a bit elastic to allow for special circumstances that might be important in a particular year. ... I believe that all of us have in mind inflation goals that are so close one to the other that differences in the goal are not really an issue. However, there is an important issue that I struggle with every time I go to an FOMC meeting: What policy will yield an outcome close to the inflation goal? ...

    Continue reading "St. Louis Fed President Poole on Tracking Inflation" »

      Posted by on Friday, November 18, 2005 at 12:06 AM in Economics, Fed Speeches, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (1) 


      Thursday, November 17, 2005

      Hal Varian: The Mortgage Interest Deduction Causes Large Distortions in Housing Markets

      Hal Varian of UC Berkeley talks about the housing subsidies built into our tax structure, how it distorts markets, the often overlooked opportunity cost of the distortions, and the political realities limiting the ability to take corrective action:

      An Opportunity to Consider if Homeowners Get Too Many Breaks, Economic Scene, by Hal R. Varian: The President's Advisory Panel on Federal Tax Reform struggled long and hard to come up with some economically sensible and politically feasible ways to reform the tax code. ... Some, like simplifying the crazy quilt of tax-deferred savings plans, are relatively noncontroversial. But proposals like eliminating the federal deduction for state and local taxes are much more contentious. ... Certainly the panel's least popular suggestion is to limit the mortgage interest deduction. ... A change of this sort would probably have a significant impact on housing values, particularly at the high end, and therefore would be unpopular with homeowners. Neither party wants to alienate solid middle-class voters, so this suggestion has not been greeted with enthusiasm in Washington.

      But many economists would argue ... [i]t would make a lot of sense to eliminate the housing mortgage deduction entirely. ...[H]ousing is highly subsidized in this country and we would probably be better off if the tax treatment of housing were brought more into line with that of other assets. How is housing subsidized? ... First, there is the mortgage interest deduction. Second, the deduction for property taxes. Third, the capital gains exclusion... Fourth, the deduction for points on mortgage loans. Fifth, the deduction ... on home equity loans. And there are many more tax breaks, among them home office deductions. There are also more subtle ways that housing investment is favored by the tax system. The most fundamental subsidy is that homeowners are not taxed on the implicit rent they receive from their housing investment. Think of it this way. Suppose you buy a house outright... If you rent the house out to someone else, you owe tax on the rental payments you receive. If you live in the house, you are effectively renting it to yourself, but no taxes are due on the transaction. ... True, you have to pay a local property tax on your house's value. But property taxes are used to support local services like schools, roads and fire departments, which also enhance the value of a house...

      Even if one thinks that homeownership deserves some subsidy, does it really deserve as much as it gets? An excessive subsidy on one asset means that less will be invested in other assets. The money put into building those huge villas on the hillside could have been put into factories, office buildings and schools. Investment in physical capital and human capital makes the economy as a whole more productive, unlike investment in housing.

      Given the huge subsidies to housing, it is likely that we as a country have overinvested in this area. Cutting back some of those subsidies would be good economic policy. That being said, I hasten to add that this is unlikely to happen anytime soon. ... The housing tax subsidy has been built into housing prices ... and cutting back could lead to painful capital losses on home values. If you give a lollipop to a baby, it may make him smile, but you will pay dearly for that smile if you try to take the candy away. The best thing to do is to distract the baby with other sweets, while you gradually extricate the lollipop from that sticky hand. That is pretty much what the tax panel has proposed: it offers reduced tax rates on other forms of investment, along with the mortgage interest credit, to make cutting housing subsidies less painful. Carefully tuned policies of this sort may be a politically palatable way to reduce housing subsidies. But I'm not holding my breath.

        Posted by on Thursday, November 17, 2005 at 12:31 AM in Economics, Housing, Taxes | Permalink  TrackBack (3)  Comments (24) 


        Sharing the Costs and Benefits of Economic Growth

        Gene Sperling, President Clinton's National Economics Advisor, answers questions about his book The Pro-Growth Progressive: An Economic Strategy for Shared Prosperity:

        Transcript from Washington Post: Laurel, Md.: One thing that's always bothered me about "pro-growth" economics as usually considered (i.e. from the right-wing) is that they seem to think that measuring the GDP captures every aspect of our well-being; so that any money diverted out of the private economy and spent for the public good reduces our standard of living. Lots of things government does admittedly reduces economic growth. But economic libertarians don't seem to understand that the benefits of building bridges, operating parks and libraries, regulating pollution or vaccinating children benefit us in ways that aren't measured by GDP. ... Does your book address ways we can get people to see the things that aren't counted in the GDP?
        Gene Sperling: My book does not go into trying to come up with a new definition of GDP that might include more quality of life issues, but it does do related things. One, ... the book is based on the notion that the type of growth we aspire for ... is shared growth .... This is particularly relevant right now, because GPD and productivity has been solid in the recent years, and yet .... [w]eekly wages for example have fallen ... Another premise of the book is that ... it will hurt our nation if we get stuck in the outdated, ideological view that less government is always better for growth. ... One of the important points is that many of the things you mention in your question are clearly good for growth - it is just that they pay-off over a longer period of time, and a wise nation would be smart to invest in them.

        Saint Louis, Missouri: How is it possible for a nation that created such a strong infrastructure of "looking out for each other" as a way of life lost that perspective? We ... are currently in the process of destroying the middle class and returning to the extremes of the landed and servant class.
        Gene Sperling: ...[W]hen it comes to economic change and globalization we have a real cost-sharing crisis. The benefits -- lower prices, innovation, more choices -- are shared broadly, but the costs are concentrated sometimes very harshly on random communities and workers. Despite this our system for helping families during severe dislocations is pretty pathetic. You could go to any city in the US and know how to instantly find the movies, a pizza, or a one-stop mega store - but at the moment a breadwinner loses a job that threatens ... economic security -- hardly anyone knows where to go and what to do. ...

        Arlington, Va.: How would you characterize the economic policies you advocate in your book? Do you consider yourself "new-Keynesian"?
        Gene Sperling: I have never put that type of label on myself ... What I want to make clear is the following: some people have misunderstood the Clinton economic team as rejecting basic Keynesian economics. Not the case. ...

        Philadelphia, Penn.: How will we be able to implement effective job training? ...
        Gene Sperling: This is an important question. Right now some just want to say that retraining have not been effective enough and wash their hands of it. That would be a very counter-productive and defeatist attitude. One thing I do think is that we have to get more serious about ongoing education -- not just after you have lost a job...

        Washington, D.C.: What do you think the most pressing economic issue is right now and why?
        Gene Sperling: ...Let me answer this way: I think the paramount economic challenge of this era will be to ensure that the process of globalization leads to a strengthened middle class... If you are super-educated you are okay: if your job has to be done here you are okay: but how we keep creating new strong middle class jobs when so many that are now in the middle are contestable by global labor markets ...

        Cincinnati, Ohio: Is the good "lunch pail" job a thing of the past? ... jobs with great benefits and head of household incomes that permitted a middle class existence to the skilled but non-degreed worker. What's the outlook for the generation coming out of high school now?
        Gene Sperling: The fact of the matter is many manufacturing jobs are under fire right now. ... But that doesn't mean that manufacturing can't be viable or that people working in manufacturing now, who lack a degree cannot succeed. It is true that there are some trade issues - like China currency undervaluation that should be dealt with -- but in the long run the key is moving both the manufacturing sector and its workers to the cutting edge. ...

          Posted by on Thursday, November 17, 2005 at 12:27 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (5) 


          George Will on Rent-Seeking in Politics

          Is acquiescence to rent-seeking behavior (defined here) and capitulation to special interests inevitable for those in power, moderates in particular, and does that explain why conservatives have been unable to limit spending and the reach of social conservatives? George Will thinks so:

          Grand Old Spenders, by George F. Will, Washington Post: The storm-tossed and rudderless Republican Party should particularly ponder the vote last week in Dover, Pa., where all eight members of the school board seeking reelection were defeated. This expressed the community's wholesome exasperation with the board's campaign to insinuate religion, in the guise of "intelligent design" theory, into high school biology classes, beginning with a required proclamation that evolution "is not a fact." But it is. And President Bush's straddle on that subject -- "both sides" should be taught -- although intended to be anodyne, probably was inflammatory, emboldening social conservatives. Dover's insurrection occurred as Kansas's Board of Education, which is controlled by the kind of conservatives who make conservatism repulsive to temperate people, voted 6 to 4 to redefine science. ... "It does me no injury," said Thomas Jefferson, "for my neighbor to say there are twenty gods, or no God. It neither picks my pocket nor breaks my leg." But it is injurious, and unneighborly, when zealots try to compel public education to infuse theism into scientific education. The conservative coalition, which is coming unglued for many reasons, will rapidly disintegrate if limited-government conservatives become convinced that social conservatives are unwilling to concentrate ... on the private institutions that mediate between individuals and government, and instead try to conscript government into sectarian crusades.

          But, then, the limited-government impulse is a spent force ...  most Republicans are moderates as that term is used by persons for whom it is an encomium: Moderates are people amiably untroubled by Washington's single-minded devotion to rent-seeking -- to bending government for the advantage of private factions. ... Gerard Alexander of the University of Virginia ... says: "Perhaps conservatives were naive to expect any party, ever, to resist rent-seeking temptations when in power. ..." Perhaps. But if so, limited-government conservatives will dissociate from a Republican Party more congenial to overreaching social conservatives. Then those Republican congressional caucuses will be smaller, and Republican control of the executive branch will be rarer.

          I'm not sure I would ascribe the main problem to "Moderates ... untroubled by Washington's single-minded devotion to rent-seeking." I think politicians would change in an instant to protect their power if they felt this behavior would hurt them at the ballot box, so I think voters bear some responsibility. But others don't always agree that is a big factor in explaining the burgeoning deficit and other government behavior. The bridge to nowhere, now eliminated is perhaps one example, though it is noted that Alaska still gets the money and is fully free to build a bridge to nowhere else.

            Posted by on Thursday, November 17, 2005 at 12:16 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (14) 


            Ether Or?

            Economics is often criticized because our models are in a constant state of flux. At any point in time there are competing models, and over time there are classical, neoclassical, Keynesian, new classical, new Keynesian, real business cycle, and of course, synthesis models. Why isn't there just one model that works and what's the deal with recycling models and sticking the work new in front of them? How come there isn't a new real business cycle model? This stands in stark contrast to other disciplines like, say, physics where everything is fully settled:

            An Echo of Black Holes, Scientific American (sub.): When Albert Einstein proposed his special theory of relativity in 1905, he rejected the 19th-century idea that light arises from vibrations of a hypothetical medium, the “ether.” Instead, he argued, light waves can travel in vacuo without being supported by any material—unlike sound waves, which are vibrations of the medium in which they propagate. This feature of special relativity is untouched in the two other pillars of modern physics, general relativity and quantum mechanics. Right up to the present day, all experimental data, on scales ranging from subnuclear to galactic, are successfully explained by these three theories. Nevertheless, physicists face a deep conceptual problem. As currently understood, general relativity and quantum mechanics are incompatible. Gravity, which general relativity attributes to the curvature of the spacetime continuum, stubbornly resists being incorporated into a quantum framework. Theorists have made only incremental progress toward understanding the highly curved structure of spacetime that quantum mechanics leads them to expect at extremely short distances. Frustrated, some have turned to an unexpected source for guidance: condensed- matter physics, the study of common substances such as crystals and fluids. Like spacetime, condensed matter looks like a continuum when viewed at large scales, but unlike spacetime it has a well understood microscopic structure governed by quantum mechanics. Moreover, the propagation of sound in an uneven fluid flow is closely analogous to the propagation of light in a curved spacetime. By studying a model of a black hole using sound waves, we and our colleagues are attempting to exploit this analogy to gain insight into the possible microscopic workings of spacetime. The work suggests that space time may, like a material fluid, be granular and possess a preferred frame of reference that manifests itself on fine scales— contrary to Einstein’s assumptions. ... If so, ... [t]he unification of general relativity and quantum mechanics may lead us to abandon the idealization of continuous space and time and to discover the “atoms” of spacetime. Einstein may have had similar thoughts when he wrote to his close friend Michele Besso in 1954, the year before his death: “I consider it quite possible that physics cannot be based on the field concept, that is, on continuous structures.” But this would knock out the very foundation from under physics, and at present scientists have no clear candidate for a substitute. Indeed, Einstein went on to say in his next sentence, “Then nothing remains of my entire castle in the air, including the theory of gravitation, but also nothing of the rest of modern physics.” Fifty years later the castle remains intact, although its future is unclear. Black holes and their acoustic analogues have perhaps begun to light the path and sound out the way.

            Bonus question:

              Posted by on Thursday, November 17, 2005 at 12:06 AM in Economics, Science | Permalink  TrackBack (0)  Comments (37) 


              Wednesday, November 16, 2005

              The CPI Report

              There is excellent commentary on today's CPI report and it makes my job really easy. All I have to do is post the links - they've got it covered and then some:

              macroblog: My Cost Of Living Went Down. How About Yours?
              macroblog: The CPI Report By The Numbers
              Angry Bear: Inflation Check

              If you can only read one of the three, that is unfortunate, but if so, read the first one on the list. For news reports (I'd still recommend reading the post at macroblog first) go to The Washington Post, NY Times, CNN/Money, and Bloomberg.

                Posted by on Wednesday, November 16, 2005 at 01:58 PM in Economics, Inflation | Permalink  TrackBack (0)  Comments (0) 


                Senate Panel Approves Bernanke's Nomination

                The Senate Banking Committee approved Ben Bernanke's nomination and sent it to the full senate for a vote, but it wasn't unanimous. It should have been:

                Senate Panel Approves Bernanke for Fed, by William Branigin, Washington Post: The Senate Banking Committee today approved the nomination of top White House economic adviser Ben S. Bernanke to be the next chairman of the Federal Reserve, recommending his confirmation to the full Senate. ... The 20-member committee approved the nomination by a voice vote in executive session, with only one dissenting "nay." The lone opponent was Sen Jim Bunning (R-Ky.), a Greenspan critic who complained that Bernanke has not demonstrated independence from the outgoing Fed chairman. ...[E]ight Republicans and six Democrats ... were present for the vote ... The nomination now goes to the full Senate for a vote that has not yet been scheduled. Bernanke ... is expected to win easy confirmation.

                  Posted by on Wednesday, November 16, 2005 at 01:28 PM in Economics, Monetary Policy, Politics | Permalink  TrackBack (0)  Comments (2) 


                  Effective Marginal Tax Rates on Labor Income

                  The CBO released a report this month looking at effective marginal tax rates and how they will change if recent tax cuts are not extended. The report is signed by CBO director Douglas Holtz-Eakin who, as Brad DeLong notes, announced he is leaving at the end of the year. Here is a summary of the findings:

                  Effective Marginal Tax Rates on Labor Income, November 2005:

                  • Provisions of tax law, such as the different tax rate brackets and the phasing in and out of various credits and deductions, interact with taxpayers’ individual characteristics to create a wide range of effective marginal tax rates on labor income. Moreover, marginal rates can vary substantially for taxpayers with comparable incomes...
                  • In terms of federal individual income taxes, most taxpayers face effective marginal rates of 15 percent or less. Less than one-fifth face rates of more than 25 percent, and about 7 percent of taxpayers face rates in excess of 30 percent. Taxpayers who are subject to higher rates tend to be disproportionately high earners: the one-15th of taxpayers with marginal rates above 30 percent account for one-fifth of total earnings, whereas the two-thirds with marginal rates of 15 percent or less account for just one-third of earnings.
                  • Payroll taxes and state income taxes significantly raise effective marginal rates. For example, the median marginal federal income tax rate is 15 percent, but the median rate including payroll and state income taxes is more than twice as high: 31.6 percent. (Payroll taxes account for most of the difference.)
                  • If tax provisions enacted in 2001, 2003, and 2004 expire as scheduled over the next five years, marginal rates will increase across most of the income distribution. Compared with a fully phased-in version of existing law, expiration would raise effective marginal tax rates by an average of almost 3 percentage points. Roughly half of taxpayers would face higher marginal rates; most other taxpayers would see no change in their marginal rates.

                  Here's a graph of marginal and average effective tax rates broken down by income:

                  Here's another graph showing how the 3% average increase in taxes mentioned in the summary would be distributed if the 2001, 2003, and 2004 tax provisions are not extended:

                  Interesting. The graphs pretty much speak for themselves so I think I'll leave it at that.

                    Posted by on Wednesday, November 16, 2005 at 12:45 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (19) 


                    Explicit Inflation Targets and Flexibility

                    Fed Chair nominee Ben Bernanke reaffirmed his support of explicit inflation targets or ranges in today's confirmation hearing and one of the main questions concerning inflation targeting is how it affects flexibility. This is not a new question. Here's former Fed Governor Laurence H. Meyer at the University of California at San Diego Economics Roundtable,  July 17, 2001 with a common view on this topic:

                    Inflation Targets and Inflation Targeting, by Fed Governor Laurence Meyer: Retaining Flexibility with the Dual Mandate The key issue for me is whether setting an explicit inflation target would reduce the flexibility of policymakers to pursue a dual mandate and select the preferred point along the tradeoff between output and inflation variability. ... Specifically, would implementing an explicit inflation target inevitably also raise the response parameter on the inflation gap relative to that on the output gap? In my view, the answer is that this need not be the case, but I agree that there is some risk of this outcome. It seems to me, however, that it is less likely if the move to an explicit inflation target is taken in the context of a reaffirmation of the dual mandate.

                    Quoting Bernanke in his opening statement today on implementing explicit inflation targets:

                    I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment.

                      Posted by on Wednesday, November 16, 2005 at 12:42 AM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (1)  Comments (4) 


                      Chicago Fed's Moskow: U.S. Economic Outlook

                      Here's more from the Fed today in addition to the testimony by Bernanke and the speeches by Fed governors Olson and Ferguson. This next speech is from Chicago Fed President Michael H. Moskow. Unlike the other two speeches which do not address current policy, he is fairly specific about his view of the economic outlook and where interest rates are headed in the future. The economic outlook is the standard view heard in recent Fed speeches:

                      • GDP is somewhat above potential growth
                      • Much of the slack in the economy has been eliminated
                      • There are two risks to growth, a slowing of the housing market and high energy prices
                        • He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
                        • He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
                      • Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward

                      The bottom line for policy: It will likely entail further removal of accommodation (code for rates are going up), and if expectations of inflation show signs of increasing, a stronger response may be needed. But like other recent speeches, there does seem to be the sense that an end is in sight even if the timing is not yet clear. Note also the key phrase "As we move into 2006 and try to determine whether we have removed enough accommodation..." implies a rate increase in December is fairly certain in his mind:

                      U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: Over the last two years real Gross Domestic Product has been growing an average of 3.7 percent each year. This is somewhat faster than potential, or the rate of GDP growth that can be sustained without creating inflation pressures. ... [M]uch of the slack has been eliminated. The unemployment rate has fallen to 5 percent; ... a level ... roughly consistent with an economy operating at potential. In addition, the capacity utilization rate in manufacturing is only slightly below its historical average. This indicates that there may be some slack remaining in manufacturing, but probably not much. Finally, core inflation has changed little in recent months. Currently we're not seeing the kinds of disinflationary forces that would be associated with a substantial degree of resource slack ...

                      As we move into 2006 and try to determine whether we have removed enough accommodation, the FOMC will have to answer two critical questions: One, will the economy continue growing near its potential? And, two, will there be persistent pressures on core inflation? ... Abstracting from the effects of the storms, current economic growth appears to be self-sustaining because the underlying economic fundamentals continue to be sound. ... According to the Blue Chip consensus, GDP is expected to grow by 3.5 percent in 2005 and by 3.3 percent in 2006—numbers on the high side of recent estimates for potential. ... While this forecast is good, there certainly are risks. One relates to home prices. ...[M]any analysts warn that housing is overvalued. ... I am starting to hear more anecdotes ... and seeing more reports that home prices are increasing at a slower rate. If housing does prove to be overvalued and home prices fall, residential construction would be adversely affected. But history suggests that the impact on overall consumer spending would be more modest. Moreover, the changes in wealth ... likely would be gradual. ...[I]t seems likely that these gradual aggregate changes would allow time for any appropriate recalibration of policy... But, it's far from certain what will happen to home prices. ...

                      Another risk to the outlook relates to energy prices. ... Higher energy prices have had some effect on growth in the U.S., but to date, it's been relatively modest. ... [because] solid productivity growth and accommodative monetary policy have offset some of the negative effect of rising oil prices. ..., the increase in crude prices, after adjusting for inflation, is smaller than during the 1970s, and the level remains well below the peak reached in 1980 ..., [a]nd ..., the U.S. economy is less dependent on oil today. ...

                      In addition to the risk to growth, rising energy prices are a risk to the outlook for inflation. ... The latest reading of the core price index for personal consumer expenditures, the Fed's preferred measure of inflation, shows an increase of 2 percent over the last 12 months. This is at the upper end of the range that I feel is consistent with price stability. One question about inflation is whether businesses will pass through the recent increases in energy costs to the prices ... [U]nless energy costs continue to rise, such pass-through would just result in a one-time increase in prices and a temporary spike in the core inflation rate, not a sustained higher rate of core inflation. ... Furthermore, although energy prices are still high, they have been falling recently... There is another worry however. If we indeed start to see a string of higher inflation numbers, then people may begin to expect permanently higher inflation. Such expectations could become self-fulfilling ... And this would have adverse effects on longer term economic performance. Fortunately, current financial market data and consumer surveys suggest that long-run inflation expectations remain contained.

                      Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations well contained. For me, at this time such policy likely entails further removal of policy accommodation. And if inflation expectations did become unhinged, this might require a stronger response. ...

                        Posted by on Wednesday, November 16, 2005 at 12:31 AM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (0) 


                        Asset Prices and The Great Moderation

                        Ben Bernanke's wasn't the only person talking about monetary policy today. There were also two Fed speeches (neither addresses the future course of monetary policy). The first speech by Fed Vice Chair Roger W. Ferguson looks at whether recent declines in GDP and inflation volatility have increased asset values or decreased their volatility and notes that it's hard to find a solid connection between macroeconomic fundamentals and changes in the level or volatility of asset prices. Variation in the discount rate shows up as a much more important factor. The reasons for the Great Moderation and its effects on variables such as asset prices are not settled areas and the speech has quite a few useful references on these topics. The references are included in the continuation frame below:

                        Asset Price Levels and Volatility: Causes and Implications, by Fed Vice Chairman Roger W. Ferguson: The variability of real activity and inflation in the United States has declined substantially since the mid-1980s--a development often termed the Great Moderation. ... [T]he decline does not appear to be the result of a long-term downward trend but appears to conform more to a structural break around the mid-1980s. The moderation is substantial: The standard deviation of the quarterly growth rate of real gross domestic product from 1985 to 2004 ... is only about one-half its standard deviation from 1960 to 1984. ... A variety of explanations for this Great Moderation have been put forth, ... First, the U.S. economy might have been lucky, ... Another explanation is that firms may have adopted information technologies that allow them to more efficiently manage their inventories ... Better conduct of monetary policy could also lead to lower inflation and economic volatility ... Finally, financial innovations, such as risk-based loan pricing and expanded securitization, may have enhanced the ability of households to borrow, which would make them less sensitive to fluctuations in income... Importantly, equity valuation ... has been higher in the past two decades than in the two decades before that. ... The rise in equity valuations at the same time that macroeconomic volatility fell is circumstantial evidence of a link between the two. ...

                        Does volatility of real activity affect the level of asset prices? ... [A]lthough the data are suggestive, tests based on asset pricing models have not firmly established an empirical link between reduced macroeconomic volatility and higher asset prices. ... A more concrete finding is that the decline in macroeconomic volatility has not led to a decline in asset price volatility. ... Rather, existing research suggests that asset price volatility remains largely a reflection of variation in investors' discount rates rather than of changes in forecasts of fundamentals. On a micro level, financial innovations and new types of market participants appear to have led to greater market efficiency and liquidity. ...

                        The second speech is by Governor Olson and discusses the development and unification of the payments system within the U.S. and where it is headed in the future. If you are interested in this topic, there is a lot of useful information and detail in the linked speech:

                        Perspectives on the Development of a Unified National Payments System in the United States, by Fed Governor Mark W. Olson: ...This morning, I would like to discuss the development of a unified national payments system, or single payments area, in the United States. I will sketch the foundations of the contemporary U.S. payments system and remark on the history of U.S. banking. ... I will then discuss some of the challenges in the U.S. experience, as well as some thoughts on the future of the U.S. payments system. The overarching theme of my remarks is that the United States has evolved toward an increasingly unified national payments system, through both market-driven development and some specific public-sector actions. ...

                        Continue reading "Asset Prices and The Great Moderation" »

                          Posted by on Wednesday, November 16, 2005 at 12:06 AM in Economics, Fed Speeches, Financial System | Permalink  TrackBack (0)  Comments (0) 


                          Tuesday, November 15, 2005

                          Ben Bernanke's Opening Statement

                          In Ben Bernanke's opening statement at his confirmation hearing before the Committee on Banking, Housing, and Urban Affairs, he emphasizes:

                            • Continuity from Greenspan
                            • Maintaining independence and non-partisanship
                            • Long-term price stability as an important goal
                            • Flexibility as reflected, e.g., in the risk management approach
                            • Explicit inflation targets, but he won't move in that direction immediately or without a broad consensus
                            • Maintaining stability and equity in financial markets

                          Statement of Ben S. Bernanke before the Committee on Banking, Housing, and Urban Affairs United States Senate November 15, 2005:... I recently testified before this Committee in my capacity as Chairman of the President’s Council of Economic Advisers. Today, however, I appear before this Committee in a different capacity, as the President’s nominee to lead the Federal Reserve System. In this prospective new role, I would bear the critical responsibility of preserving the independent and nonpartisan status of the Federal Reserve--a status that, in my view, is essential to that institution’s ability to function effectively and achieve its mandated objectives. I assure this Committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve’s mandate from Congress and by the public interest. 

                          With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority. ... First, central bankers in the United States and around the world have come to understand that ensuring long-run price stability is essential for achieving maximum employment and overall economic stability. In recent decades, the variability of output and employment has decreased markedly, and recessions have been less frequent and less severe. ... If I am confirmed, I am confident that my colleagues on the Federal Open Market Committee (FOMC) and I will maintain the focus on long-term price stability ...

                          Second, monetary policy at the Fed has been executed with both careful judgment and flexibility. ... Chairman Greenspan’s risk-management policy approach ... approach requires sophisticated judgments about possible risks to the economy as well as the flexibility to respond quickly to new information or unexpected developments. Risk analysis of this type is a necessary component of successful monetary policymaking. ... Monetary policy is most effective when it is as coherent, consistent, and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.

                          Finally, under Chairman Greenspan, monetary policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support. ... One possible step toward greater transparency would be for the FOMC to state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long-term price stability ... I have supported this idea in my academic writings and in speeches as a Board member. Providing quantitative guidance about the meaning of “long-term price stability” could have several advantages, including further reducing public uncertainty about monetary policy and anchoring long-term inflation expectations even more effectively. ... I assure this Committee that, if I am confirmed, I will take no precipitate steps in the direction of quantifying the definition of long-run price stability. This matter requires further study at the Federal Reserve as well as extensive discussion and consultation. I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment. 

                          My comments so far today have focused on monetary policy. Of course, the Federal Reserve’s responsibilities extend well beyond this area. Since its founding, the Federal Reserve has been given substantial responsibility for protecting the stability of the nation’s financial system, which is a precondition for stability of the broader economy. ... If I am confirmed, I will work to enhance the stability of the financial system and to ensure that the resources, procedures, and expertise are in place as needed to respond to any threats to stability that may emerge. The Federal Reserve, along with other regulators, is also engaged in trying to ensure that consumers are treated fairly in their financial dealings: that their privacy is protected, that they receive clear and understandable information about the terms of financial agreements, and that they are not subject to discriminatory or abusive lending practices. ... These are important responsibilities and, if I am confirmed, I will give them my close attention and active support. ...

                          Let me conclude by offering special thanks to Chairman Greenspan for his collegiality and support ... One may aspire to succeed Chairman Greenspan but it will not be possible to replace him...

                          [Link to video, Hearing transcript]
                          [Washington Post, NY Times, Bloomberg, CNN/Money]

                            Posted by on Tuesday, November 15, 2005 at 09:17 AM in Economics, Monetary Policy, Politics | Permalink  TrackBack (0)  Comments (7) 


                            King Kong vs. Godzilla

                            All economics all the time gets boring you say? Something else then:

                            SciAm Observations: King Kong vs. Godzilla: First came a new report on Gigantopithecus, a huge prehistoric ape that inevitably invites comparisons to King Kong because of the imminent release of the film remake by the same name. And now comes the discovery of Dakosaurus andiniensis, a monstrous species of 135-million-year-old aquatic crocodile that has been nicknamed "Godzilla." The synchronicity of these reports can mean only one thing:

                            People of Tokyo, run for your lives.

                            Continue reading "King Kong vs. Godzilla" »

                              Posted by on Tuesday, November 15, 2005 at 02:06 AM in Science | Permalink  TrackBack (0)  Comments (3) 


                              Taking Better Aim at Overshooting?

                              New Economist alerts us to a recent entry in the debate over the Dornbusch overshooting hypothesis:

                              New Economist: Dornbusch's overshooting hypothesis revisited: ...Rudiger Dornbusch’s (1976) well known exchange rate overshooting states that the nominal exchange rate immediately appreciates with the increase in nominal interest rates, in line with uncovered interest parity (UIP). The problem is, many recent studies suggest otherwise. As Hilde C. Bjørnland of the University of Oslo writes:

                              Instead they have found that following a contractionary monetary policy shock, the real exchange rate either depreciates, or, if it appreciates, it does so for a prolonged period of up to three years, thereby giving a hump-shaped response that violates UIP. These results have been so persuasive that the puzzles themselves are now about to be considered consensus, of which many recently developed DSGE models seek to replicate.

                              In Norges Bank working paper 2005/11, Monetary policy and the illusionary exchange rate puzzle, she argues there is a major problem with ...[the] models used. They ignore the immediate effects of a monetary shock on the exchange rate... [T]he Dornbusch hypothesis can be reconciled with the empirical data if one "...leaves the contemporaneous relationship between the interest rate and the exchange rate unaltered". ...

                              Allowing for full simultaneity between monetary policy and the exchange rate, I find striking results; Contrary to the recent “consensus”, a contractionary monetary policy shock has a strong effect ... consistent with the Dornbusch overshooting hypothesis. Furthermore, the ensuing movement of the exchange rate is with few exceptions consistent with UIP. Hence, I have found no evidence of the typical hump-shaped response found in the empirical literature...

                                Posted by on Tuesday, November 15, 2005 at 01:19 AM in Academic Papers, Economics, International Finance | Permalink  TrackBack (0)  Comments (0) 


                                The Grass is Always Greener at Home ... But I'm Biased

                                Federal Reserve Chair Alan Greenspan discusses the current account balance and the role that two factors, a decline in home bias and a relative increase in U.S. productivity, have played in allowing such a large deficit to persist. Noting that the growth in the deficit cannot persist indefinitely and adjustment will occur at some point, he believes the key to a smooth adjustment is economic flexibility. Economic flexibility, which requires a hands off approach from government, gives economies the best chance to withstand shocks and to provide the stability needed for economic growth:

                                Stability and Economic Growth: The Role of the Central Bank, by Fed Chair Alan Greenspan: International finance presents us with a number of intriguing anomalies, but the one that seems to bedevil monetary policy makers the most as they seek stability and growth ... is the seemingly endless ability of the United States to finance its current account deficit. To date, despite a current account deficit exceeding 6 percent of our gross domestic product (GDP), we ... are experiencing few difficulties in attracting the foreign saving required to finance it... Of course, deficits that cumulate to ever-increasing net external debt ... cannot persist indefinitely. At some point investors will balk at further financing. ...

                                In all instances, a current account balance is essentially the product of a wide-ranging interactive process ... To the extent that an economy harbors elements of inflexibility, so that prices and quantities are slow to respond to new developments, the deficit-adjustment process is likely to adversely affect the levels of output and employment. ... The rise of our deficit and our ability to finance it appears to coincide with ... a major acceleration in U.S. productivity growth and the decline in what economists call home bias, the parochial tendency to invest domestic savings in one's home country. ...[S]tarting in the 1990s home bias began to decline discernibly. ... The decline in home bias reflects a number of recent factors that ... lessen restraints on cross-border financial flows as well as on trade in goods and services. ... [T]he advance of information and communication technologies has effectively shrunk the time and distance that separate markets around the world. ... Technological innovation and ongoing deregulation and tariff reductions have driven the globalization process by ... lowering the cost of transacting across borders. The effect of these developments has been to markedly increase the willingness and ability of financial market participants to reach beyond their national borders to invest in foreign countries...

                                The decline in home bias has clearly enlarged sources of finance for the United States. ...  How much further home bias can decline is obviously conjectural, ... Federal Reserve staff studies indicate that ... U.S. and foreign portfolios still exhibit marked home bias. ... Presumably, well before the practical lower limits of home bias are reached, effective constraints on deficit funding, and hence on the deficit itself, are likely to come from foreign investors' fear of portfolio concentrations of claims on the residents and government of the United States. Concentration and other risks in holding dollar balances seem to have become a consideration at least for some investors. ... What could be the potential consequences should the dollar's status as the world's reserve currency significantly diminish...? Most analysts would contend that U.S. interest rates were lowered by the world's accumulation of dollars. Accordingly, in the event of a significant diminishing of the dollar's reserve currency status, U.S. interest rates would presumably rise. ...

                                [T]here are ... lessons to be learned from the experience of sterling as it faded as the world's dominant currency. ... Many wartime controls were maintained ... immediately after World War II. ... The experience of Britain's then extensively regulated economy provides testimony to the costs of structural rigidity in times of crisis. Any diminution of the reserve status of the dollar ... is likely to be readily absorbed by a far more flexible U.S. economy than existed in Britain immediately following World War II. ... Governments today ... are rediscovering the benefits of competition and ... beginning to recognize an international version of Smith's invisible hand in the globalization of economic forces. ... We appear to be revisiting Adam Smith's notion that the more flexible an economy, the greater its ability to self-correct after inevitable, often unanticipated disturbances. ... Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset. The impressive performance of the U.S. economy over the past couple of decades ... offers the clearest evidence of the benefits of increased market flexibility. ...

                                Flexibility is most readily achieved by fostering an environment of maximum competition. A key element in creating this environment is flexible labor markets. Many working people equate labor market flexibility with job insecurity. Despite that perception, flexible labor policies appear to promote job creation. An increased capacity of management to discharge workers without excessive cost, for example, apparently increases companies' willingness to hire without fear of unremediable mistakes. ... Protectionism in all its guises ... does not contribute to the welfare of workers. At best, it is a short-term fix for a few workers at a cost of lower standards of living for a nation as a whole. Increased education and training for those displaced by creative destruction is the answer, not a stifling of competition. ...

                                See Kash at Angry Bear for more comments. I would also add that sometimes government intervention is required to make markets work. Does anyone doubt that the protection of property rights by the government is necessary for markets to flourish? It's hard to bring goods to market if they are stolen along the way. Monopolies are easy to create if the most powerful can block the gates to the market. Governments and other institutions make markets work in both obvious and subtle ways, a lesson learned most recently by formerly socialist countries attempting to transform to market economies.  As we go down the path to less government regulation, a path justified in most cases, we should be careful not to undermine rather than promote competition.

                                  Posted by on Tuesday, November 15, 2005 at 12:15 AM in Economics, Fed Speeches, International Finance, Monetary Policy | Permalink  TrackBack (0)  Comments (4) 


                                  Is High European Unemployment Due to Labor Market Rigidities?

                                  Recently, a paper by Olivier Blanchard on European Unemployment was posted here and at Brad DeLong's. This paper by James K. Galbraith and Enrique Garcilazo, which arrived through comments (thanks anne) provides countervailing evidence to the claim that high and persistent unemployment rates in Europe are the result of labor market rigidities arising from policies at the national level. Instead, the paper finds that a large amount of the excess unemployment in Europe can be explained by changes common across countries since the Union such as the policies of the European Central Bank and the convergence criteria for the Euro:

                                  Unemployment, Inequality and the Policy of Europe: 1984-2000, by James K. Galbraith and Enrique Garcilazo, UTIP WP 25: Abstract: This paper reconsiders the problem of unemployment in Europe ... We employ a panel structure that permits us to separate regional, national and continental influences on European unemployment. Important local effects include the economic growth rate, relative wealth or poverty, and the proportion of young people in the labor force. ... [W]e find that higher pay inequality in Europe is associated with more, not less, unemployment, and the effect is stronger for women and young workers. ... [D]istinctive effects at the national level are few, perhaps indicating that national labor market institutions are not the decisive factor in the determination of European unemployment. Changes in the European macro-environment are picked up by time fixed effects, and these show a striking pan-European rise in unemployment immediately following the introduction of the Maastricht Treaty, though with some encouraging recovery late in the decade.

                                  I. Introduction ...[T]he literature on unemployment in Europe tends to concentrate on national characteristics and national unemployment rates. The predisposition is to blame unemployment on labor market “rigidities” -- and then to search for particular culprits, generally in the fields of national unemployment insurance, job protections, and wage compression. Periodic movements to reform national labor markets sweep aside the careful qualifications found in empirical work such as Nickell (1997) and Blanchard and Wolfers (1999), and presuppose that greater wage flexibility is the established cure for European unemployment. ... In a recent paper, Baker, Glyn, Howell and Schmitt (2002) provide a comprehensive review of the national-institutions approach to explaining European unemployment. They find only one robust result, namely that coordinated collective bargaining and (perhaps) union density are associated with less unemployment in Europe. Of course, this interesting finding is inconsistent with the rigidities framework. ...

                                  In this paper, we try a different approach. Instead of the nation, our smallest unit of analysis is the region. ... We specify just four regional “labor market” variables that, we find, account significantly for the variation in regional unemployment rates. ... We identify two regional factors that influence the demand for labor. First is the strength of economic growth at any given time – an obvious determinant of construction and investment jobs, and a consequence of the local effects of macroeconomic policies and regional fiscal assistance. The second is a measure ... of the average wage rate of the region relative to the average for Europe as a whole. Our thinking is that regions with higher average wages should tend to have stronger tax bases, more public employment, and also more open (and therefore taxed) employment in services. On the supply side, we also identify two factors. The first is the relative size of the population of very young workers – an obvious measure of the difficult-to-employ. The second is a measure of the inequality of the wage structure. To acquire this measure, we construct, for the first time, a panel of European inequalities at the regional level, comparable both across countries and through time.

                                  Our hypothesis that regional pay inequalities should be placed on the supply side of the labor market is an innovation. ... [I]n this analysis we take the regional wage structure as a datum facing individual workers. We consider that this datum affects how long they choose to search for employment. The greater the differential between high and low-paid jobs in the local setting, the longer a rational person will hold out for one of the better jobs, accepting unemployment if necessary. This theoretical position is well-known in neoclassical development economics, ... The general concept, that inequality creates an incentive to search, has not been applied to Europe or to any developed-country setting so far as we know. But there is no compelling reason why it should not be. In practice, we find that pay inequality is a strong determinant especially of cross-sectional variation in European unemployment, ...

                                  The time effects are striking for all population groups. They show a sharp rise in unemployment common to all regions beginning in 1993. This is an interesting break-point in view of the introduction of the Maastricht Treaty on European Union at the start of that year. The effect continues through the 1990s, and suggests that a substantial part of European excess unemployment – generally between two and three percentage points–reflects policy conducted at the European level since the Union. In this regard, the monetary policy of the European Central Bank and the convergence criteria for the Euro come to mind as leading suspects.

                                    Posted by on Tuesday, November 15, 2005 at 12:09 AM in Academic Papers, Economics, Unemployment | Permalink  TrackBack (0)  Comments (4) 


                                    Monday, November 14, 2005

                                    Not So Transparent Reasons for Discontinuing M3

                                    Many have asked about the Fed's decision to stop reporting M3:

                                    Discontinuance of M3: On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.

                                    Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).

                                    The Big Picture has been tracking this story closely and it was through a post at that site that I first became aware of this notice (he was kind enough to quote me in his latest). My assumption is that the Fed believes this is no longer an informative aggregate and has decided that its potential to confuse by sending misleading signals outweighs its value.

                                    Unfortunately, the Fed has been silent about its reasons for the discontinuance and that is my biggest complaint. This is not how transparency works. There are all sorts of conspiracy stories about (e.g. the Fed wants to hide the rapid growth of liquid assets so it's burying the information) and all the confusion could have been easily avoided by a simple explanation for the discontinuance posted on the Fed's web site. If it's there, I couldn't find it.

                                    I am waiting to hear more on this decision from our newly transparent Fed, and as I find out more about the Fed's reasons I will update this post. William Polley has indicated he will post on this later as well. [Update: Institutional Economics also comments. Prudent Investor has lots to say as well. Graphs of M1, M2, and M3.]

                                    [Update: David Altig at macroblog comments and is unconcerned.]

                                      Posted by on Monday, November 14, 2005 at 06:00 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (2) 


                                      Fed Watch: Headed for More of the Same

                                      Here's Tim Duy with his latest Fed Watch:

                                      I believe this is something of a dangerous time for a Fed watcher.  At the moment, the data and Fedspeak can be described as “monotonous” – it consistently points to higher rates, as dutifully reported by David Altig.  The danger here is twofold.  One is that the Fedwatcher gets complacent and fails to recognize shifts in sentiment at the Fed or in the economy.  Two, that in the need to feel like they are doing something new, he/she begins predicting the inevitable pause.  I have committed the first sin in the past, and came, in my opinion, close to committing the second in my last post

                                      Little has come to my attention in the past couple of weeks to change my underlying outlook – the Fed will continue to raise rates until they see a clear shift in real activity. In this case, “clear” means “evident in the data,” not anecdotal evidence (I will comment on housing later in this piece). 

                                      We are not seeing such clear data. The 3rd quarter GDP report was strong enough to keep the Fed on path, not withstanding the likely push and pull from revisions due to the September inventory and trade reports.  And while commentators such as Kash at Angry Bear have highlighted some weaknesses in the employment repots, the Fed will respond to the payroll weakness as hurricane distorted data, while the wage gains will be interpreted as signs of incipient inflation pressures. That is the interpretation that Fedspeak leads us to.

                                      To be sure, inflation expectations appear to be dropping off. And some might see this as supporting a pause in rates. But the Fed is worried not so much about the rise in headline inflation (actual and expected), they are worried about pass through to core. As Mark Thoma reports, the pass through will only happen with a lag. Along these lines, note the story in Saturday’s WSJ reporting on growing signs of rising pricing power among firms.

                                      I see that Fed St. Louis President William Poole declared that a hard landing, at least on the basis of internal imbalances, is highly unlikely.  Truly a dangerous statement. I vividly remember a Fed official (sorry, I don’t kiss and tell) assuring me in 2000 that “there is no way the US economy can have a hard landing.”  The basic idea was that the equity bubble was fundamentally confined to a small segment of the economy, and consequently the impact of its bursting would be confined as well. But whether or not you agree that the downturn was “hard” or “soft,” the Fed’s frantic rate cutting in 2001 suggests that they were caught off guard by the drop in activity. 

                                      Incidentally, that little insight into policymaker psychology allowed me to call the Fed’s hardline approach through 2000 as I recognized the Fed was considerably less concerned than the bond market.  But I also became complacent, not to mention stubborn, and subsequently failed to look for the January 2001 intermeeting easing.

                                      The lesson here is that the Fed can be heavily influence by prior beliefs; but also that those beliefs can change rapidly when the data hits some critical mass.

                                      What prior beliefs might be at play? Indirectly, housing is a significant factor here.  I noticed some comments on William Polley’s site regarding our Econoblog discussion on the Wall Street Journal online. Some were surprised that we did not comment more on the housing “bubble.” Bill and I appear to share the same opinion on this:  The “bubble” itself is not driving policy. It is the incipient inflationary pressures that are the Fed’s concern, a position that stands in contrast to many commentators (thank you, David).

                                      Greenspan & Co., however, recognize that tightening will likely work via a housing slowdown.  Does this mean a slowdown in housing will be enough to shift the Fed’s stance? Maybe – if the slowdown is sharp enough.  The anecdotal evidence so far, while interesting and though provoking, is too thin to hang policy on. Likewise with the data religiously monitored by Calculated Risk.  While these could be the precursors to a significant slowdown, I tend to believe that we will have to see an impact on consumers in the data for the Fed to be confident that overall activity is slowing to trend.  This is likely on the mind of Cleveland Fed President Susan Pianalto:

                                      "As we start to see an increase in interest rates will that cause the consumer problems?" she asked rhetorically in response to a question. "I think it depends on whether that's gradual and how consumers adjust to that."

                                      "In the past several years consumers ... have been very diligent in managing some of their debt in terms of refinancing to lower rates, but we'll have to ... keep our eye on this situation as the conditions change," Pianalto said.

                                      My interpretation of Pianalto’s statement is that she expects consumer spending to weaken, but not rapidly or catastrophically.  Consequently the first signals of a slowdown will be events that match her expectations. If I am reading all this correctly, the Fed will not react until it sees significant stress on the consumer (assuming that is the correct channel of transmission) – again, in the data, not anecdotally. Note that such a point could still be months away:  A housing slowdown will need to become evident, then spread into consumption, and then show up in the data. 

                                      Of course, consumption is just an example – an example that the Fed appears to be watching – of bearish signals. Another signal could be a swing in investment. Considering the conventional wisdom that recessions are investment driven events, I think that a slowdown in investment would be grounds to think about actual easing, whereas a consumer slowdown would be reason to pause. In any event, the hawkish rhetoric will ease only slowly, I suspect, until some critical mass of data is reached.

                                      Overall, I come to the point where I find myself repeating the party line:  The Fed will continue to raise interest rates to keep inflation expectations in line. Monotonous. But while I repeat the line, I take care to watch the data (and rhetoric) to find that shift in policy sentiment. After all, as I noted last week, the tightening will have an impact at some point.

                                      For public consumption, I offer this outlook for next year that I presented on October 18, prior to the latest GDP report (I underestimated Q3 growth).  You will notice that I play close to the razor edge of Okun’s law – I tend to be neither excessively optimistic nor pessimistic. I based my high estimate of aid relief for Katrina on news reports (numbers that ranged from $500 million to $2 billion per day). I am sympathetic to the prediction that housing market will curtail consumer spending next year. You may also notice that I expect the Fed to stop raising interest rate in early 2006, with the possibility of a cut at the end of next year.  I had March for the last rate hike in the back of mind when I wrote this.

                                      Overall, I believe it is a reasonable baseline…but time and data will tell how much I adjust my outlook in the months ahead. I wrote this in September (the publishing department needs some lead time); currently, data suggests to me that the rate peak may be farther out than I anticipated. I am not wedded to this outlook; it simply represents the baseline in my mind.  Consistent with my anticipation of how the Fed will behave, I will adjust this forecast to any notable change in data or any perception of a change in the Fed’s outlook. Complacency is dangerous, and arrogance and stubbornness can lead you stick to a story long after its time has past.  Humbleness is a virtue in Fed watching – you are only as good as your last call.

                                      [All Fed Watch posts.]

                                        Posted by on Monday, November 14, 2005 at 12:24 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (8) 


                                        Paul Krugman: Health Economics 101

                                        It's nice to have Paul Krugman discuss a question that has been addressed repeatedly at this site, market failure in the provision of health and social insurance due to moral hazard and adverse selection:

                                        Health Economics 101, by Paul Krugman, NY Times: ...[W]e rely on free markets to deliver most goods and services, so why shouldn't we do the same thing for health care? .... It comes down to three things: risk, selection and social justice. First, about risk: ... In 2002 a mere 5 percent of Americans incurred almost half of U.S. medical costs. If you find yourself one of the unlucky 5 percent, your medical expenses will be crushing, unless you're very wealthy - or you have good insurance. But good insurance is hard to come by, because private markets for health insurance suffer from ... the economic problem known as "adverse selection," in which bad risks drive out good. To understand adverse selection, imagine what would happen if ... everyone was required to buy the same insurance policy. In that case, the insurance company could charge a price reflecting the medical costs of the average American, plus a small extra charge for administrative expenses. But in the real insurance market, a company that offered such a policy ... would lose money hand over fist. Healthy people, who don't expect ... high medical bills, would go elsewhere, or go without insurance. ... [T]hose who bought the policy would be a self-selected group of people likely to have high medical costs. And if the company responded to this selection bias by charging a higher price for insurance, it would drive away even more healthy people.

                                        That's why insurance companies ... devote a lot of effort and money to screening applicants... This screening process is the main reason private health insurers spend a much higher share of their revenue on administrative costs than do government insurance programs like Medicare, which doesn't try to screen anyone out. ... [P]rivate insurance companies spend large sums not on providing medical care, but on denying insurance to those who need it most. What happens to those denied coverage? Citizens of advanced countries ... don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action... Some ... are covered by Medicaid. Others receive "uncompensated" treatment, ... paid for either by the government or by higher medical bills for the insured. ...

                                        At this point some readers may object that I'm painting too dark a picture. After all, most Americans ... have private health insurance. So does the free market work better than I've suggested? No: to the extent that we do have a working system of private health insurance, it's the result of huge though hidden subsidies. ... [C]ompensation in the form of health benefits... isn't taxed. One recent study suggests that this tax subsidy may be as large as $190 billion per year. And even with this subsidy, employment-based coverage is in rapid decline.

                                        I'm not an opponent of markets. ...  I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semiprivate system supported by large government subsidies. That system is now failing.  And a rigid belief that markets are always superior to government programs - a belief that ignores basic economics as well as experience - stands in the way of rational thinking about what should replace it.

                                        For similar comments on Social Security insurance, see  Social Security is about insurance, not savings, The Need for Social Insurance, and Optimizing Social Security through Poverty Insurance and Retirement Saving. And from Paul Krugman, see Passing the Buck.

                                        Update: Tyler Cowen at Marginal Revolution notes:

                                        Marginal Revolution: Paul Krugman, circa India: Here is yesterday's column on health care; I am not sure if the The Hindu will be carrying them all on-line.  Arnold Kling offers excellent commentary.  Thanks to Eswaran for the pointer.

                                        Previous (11/11) column: Paul Krugman: The Deadly Doughnut
                                        Next (11/18) column: Paul Krugman: A Private Obsession

                                          Posted by on Monday, November 14, 2005 at 12:15 AM in Economics, Health Care, Market Failure | Permalink  TrackBack (0)  Comments (7) 


                                          Are Programs to Help Dislocated Workers Effective?

                                          This paper talks about the effectiveness of job retraining programs for displaced workers. It is a fairly long paper so I've cut quite a bit out of it to present the highlights. If you are interested in this topic, I encourage you to read the entire paper (and also "Does job training pay off?" cited below):

                                          Just how effective is our expanding public system for helping dislocated workers?, by Ronald A. Wirtz, Minneapolis Fed: Take two aspirin, and find a new job in the morning. Historically, that's been the advice to workers facing layoffs. Grab your bootstraps. Pound the pavement. Good luck. ... But as globalization continues apace, so has society's anxiety over the job dislocation commonly associated with it. ... Layoffs are “very traumatic” for workers ... and many are having trouble adjusting to new realities of employment. After being laid off, some workers will “sit on unemployment waiting for the world to snap back to normal.” It rarely does, and many workers find themselves ill-equipped to compete for new jobs that come close to replacing their old salaries. ... Is this gut-punch a fatal blow ... While the immediate effect of layoffs on individual households is surely great, most economists argue that such job dislocations are actually a backdoor wellspring of economic growth. Layoffs allow the economy to reallocate resources (including labor) from mature, declining firms and industries to growing, healthy ones. This job churn—the many jobs lost, and new ones found—ultimately makes the U.S. economy more competitive and, in turn, prosperous.

                                          But that claim rests on a matter that doesn't get a lot of attention: our ability to rechannel dislocated workers ... to new job opportunities that are advantageous for both new employer and dislocated worker. Traditionally, dislocated workers have had to find their own way to the next job opportunity. But as the economy's job churn has increased over the last decade, ... What's evolving slowly ... is a public system of job-matching services for those workers not able to do it on their own. Government programs for these workers appear to be improving ... But they've also been hit with stinging and evidently well-founded criticisms about their tepid performance and questionable long-term effects. Equally important, ... redundancy becomes an issue: Public programs are offering services already available from a rapidly growing and sophisticated job-matching industry in the private sector.

                                          Continue reading "Are Programs to Help Dislocated Workers Effective?" »

                                            Posted by on Monday, November 14, 2005 at 12:11 AM in Economics, Policy, Unemployment | Permalink  TrackBack (0)  Comments (42) 


                                            Sunday, November 13, 2005

                                            Googling Innovation

                                            After talking about changes in the the rate of innovation in the U.S. in the post below this one, this story about Google reveals one strategy to create a work environment that promotes maximum creativity. The term "disruptive innovation" used in the article is interesting given the quote in the linked post that "Creative people, whether artists or inventive engineers, are often nonconformists and rebels. Indeed, invention itself can be perceived as an act of rebellion against the status quo." Also, I didn't realize how much data about me and my searches that Google collects, organizes, and uses. And that's not all:

                                            What Lurks in Its Soul?, by David A. Vise, Washington Post: The soul of the Google machine is a passion for disruptive innovation. Powered by brilliant engineers, mathematicians and technological visionaries, Google ferociously pushes the limits of everything it undertakes. The ... goal: to organize all of the world's information and make it universally accessible, whatever the consequences. Google's colorful childlike logo, its whimsical appeal and its lightning-fast search results have made it the darling of information-hungry Internet users. ... But these friendly features belie Google's ... voracious appetite for aggressively pursuing initiatives to bring about radical change. ... Consider the wide-ranging implications of the activities now underway at the Googleplex, the company's campuslike headquarters in California's Silicon Valley. Google is ... scanning millions of books without traditional regard for copyright laws; tracing online searches to individual Internet users and storing them indefinitely; demanding cell phone numbers in exchange for free e-mail accounts (known as Gmail) as it begins to build the first global cell phone directory; saving Gmails forever on its own servers, making them a tempting target for law enforcement abuse; inserting ads for the first time in e-mails; ...

                                            Google has also created a new kind of work environment. It serves three free meals a day to its employees (known as Googlers) so that they can remain on-site and spend more time working. It provides them with free on-site medical and dental care and haircuts, as well as washers and dryers. It charters buses with wireless Web access between San Francisco and Silicon Valley so that employees can toil en route to the office. To encourage innovation, it gives employees one day a week -- known as 20 percent time -- to work on anything that interests them. To eliminate the distinction between work and play -- and keep the Googlers happily at the Googleplex -- they have volleyball, foosball, puzzles, games, rollerblading, colorful kitchens stocked with free drinks and snacks, bowls of M&Ms, lava lamps, vibrating massage chairs and a culture encouraging Googlers to bring their dogs to work. (No cats allowed.) The perks also include an on-site masseuse, and extravagant touch-pad-controlled toilets with six levels of heat for the seat and automated washing, drying and flushing without the need for toilet paper.

                                            Meanwhile, the Googlers spend countless hours tweaking Google's hardware and software to reliably deliver search results in a fraction of a second. Few Google users realize, however, that every search ends up as a part of Google's huge database, where the company collects data on you, based on the searches you conduct and the Web sites you visit through Google. The company maintains that it does this to serve you better, and deliver ads and search results more closely targeted to your interests. But the fact remains: Google knows a lot more about you than you know about Google. ...

                                            Google ... has grander plans. The company is quietly working with maverick biologist Craig Venter and others on groundbreaking genetic and biological research. ... Venter and others say that the search engine has the ability to deal with so many variables at once that its use could lead to the discovery of new medicines or cures for diseases. Sergey Brin says searching all of the world's information includes examining the genetic makeup of our own bodies, and he foresees a day when each of us will be able to learn more about our own predisposition for various illnesses, allergies and other important biological predictors by comparing our personal genetic code with the human genome, a process known as "Googling Your Genes." ...

                                            From Madison Avenue to Microsoft, Google's rapid-fire innovation and growing power pose a threat of one kind or another. Its ad-driven financial success has propelled its stock market value to $110 billion, ... Its simplified method of having advertisers sign up online, through a self-service option, threatens ad agencies and media buyers who traditionally have played that role. Its penchant for continuously releasing new products and services in ... test form... has sent Microsoft reeling. ... Microsoft also worries that Google is raiding the ranks of its best employees. ... [I]t grew worse when Google opened an outpost in the suburbs of Seattle, just down the road from Microsoft headquarters, and aggressively started poaching. Microsoft finally sued Google for its hiring of Kai-Fu Lee, a senior technologist who once headed Microsoft's Chinese operations. Lee is now recruiting in Asia for Google, despite a court order upholding aspects of a non-compete clause that Lee signed while at Microsoft. ...

                                            Google's distinctive DNA makes it an employer of choice for the world's smartest technologists because they feel empowered to change the world. And despite its growing head count of more than 4,000 employees worldwide, Google maintains the pace of innovation in ways contrary to other corporations by continuing to work in small teams of three to five, no matter how big the undertaking. Once Google went public and could no longer lure new engineers with the promise of lucrative stock options, Brin invented large multi-million-dollar stock awards for the small teams that come up with the most innovative ideas. ...

                                            Despite all that has been achieved, Google remains in its infancy. Brin likes to compare the firm to a child who has completed first grade. ... Quietly, they have been buying up the dark fiber necessary to build GoogleNet, and provide wireless Web access for free to millions or billions of computer users ... potentially disruptive to phone and cable companies that now dominate the high-speed Internet field. Their reasoning is straightforward: If more people globally have Internet access, then more people will use Google. ... Supremely confident, the biggest risk that Brin, Page and Google face is that they will be unable to avoid the arrogance that typically accompanies extraordinary success...

                                            [Update: Brad DeLong has more on Google.]

                                              Posted by on Sunday, November 13, 2005 at 01:35 AM in Economics, Technology | Permalink  TrackBack (0)  Comments (4) 


                                              Are Innovations in Inventiveness Slowing for U.S. Innovators?

                                              Are we losing our lead in science and technology and as a consequence are we in danger of losing our economic leadership in the world? What is the secret to innovation? How are creators created?

                                              Are U.S. Innovators Losing Their Competitive Edge?, by Timothy L. O'Brien, NY Times: ...Inventors have always held a special place in American history and business lore, embodying innovation and economic progress in a country that has long prized individual creativity and the power of great ideas. In recent decades, tinkerers and researchers have given society microchips, personal computers, the Internet, balloon catheters, bar codes, fiber optics, e-mail systems, hearing aids, air bags and automated teller machines, among a bevy of other devices. Mr. West [an award-winning research professor at Johns Hopkins University. ... who has secured 50 domestic and more than 200 foreign patents on inventions] stands firmly in this tradition - a tradition that he said may soon be upended. He fears that corporate and public nurturing of inventors and scientific research is faltering and that America will pay a serious economic and intellectual penalty for this lapse.

                                              A larger pool of Mr. West's colleagues echoes his concerns. "The scientific and technical building blocks of our economic leadership are eroding at a time when many other nations are gathering strength," the National Academy of Sciences observed in a report ... "Although many people assume that the United States will always be a world leader in science and technology, this may not continue to be the case inasmuch as great minds and ideas exist throughout the world. We fear the abruptness with which a lead in science and technology can be lost - and the difficulty of recovering a lead once lost, if indeed it can be regained at all." ...

                                              To spur American innovation, [a committee of leading scientists, corporate executives and educators] recommends enhanced math and science education in grade school and high school, a more hospitable environment for scientific research and training at the college and graduate levels, an increase in federal funds for basic scientific research and a mix of tax incentives and other measures to foster high-paying jobs in groundbreaking industries. The report cites China and India among a number of economically promising countries that may be poised to usurp America's leadership in innovation and job growth. "For the first time in generations, the nation's children could face poorer prospects than their parents and grandparents did," the report said. "We owe our current prosperity, security and good health to the investments of past generations, and we are obliged to renew those commitments." ...

                                              While tipping their hats to the scores of breakthroughs that have emerged from corporate labs, inventors also say they are concerned that bottom-line pressures at many companies may cause pure research to be eclipsed by innovation tied to rapid commercialization - leading to routine refinements of existing products rather than to breathtaking advances. ... Robert S. Langer, a research scientist at the Massachusetts Institute of Technology and a biotechnology pioneer, says that he shares the concerns raised in the National Academy of Sciences report but that he remains confident about the country's prospects. "While I think we can always do better, I am optimistic about the spirit of innovation in this country," he said. "I think we hold a lead, but no lead is unassailable."

                                              That is closest to my view, cautiously optimistic. If we do the best we can do, and we can do better than we are doing now, then inventions elsewhere in the world help all of us. I want more people working hard to find solutions to difficult problems. As the rest of the world develops the gap will close in any case, I just don't want the gap to close faster because our rate of innovation slows unnecessarily. On that point, there is more pessimism in some quarters:

                                              "The inventiveness of individuals depends on the context, including sociopolitical, economic, cultural and institutional factors," said Merton C. Flemings, a professor emeritus at M.I.T. who holds 28 patents and oversees the Lemelson-M.I.T. Program for inventors. "We remain one of the most inventive countries in the world. But all the signs suggest that we won't retain that pre-eminence much longer. The future is very bleak, I'm afraid." Mr. Flemings said that private and public capital was not being adequately funneled to the kinds of projects and people that foster invention. The study of science is not valued in enough homes, he observed, and science education in grade school and high school is sorely lacking. But quantitative goals, he said, are not enough. Singapore posts high national scores in mathematics, he said, but does not have a reputation for churning out new inventions. In fact, he added, researchers from Singapore have studied school systems in America to try to glean the source of something ineffable and not really quantifiable: creativity. "In addition to openness, tolerance is essential in an inventive modern society," a report sponsored by the Lemelson-M.I.T. Program said last year. "Creative people, whether artists or inventive engineers, are often nonconformists and rebels. Indeed, invention itself can be perceived as an act of rebellion against the status quo." ...

                                              [Update: Michael Mandel at Economics Unbound comments.]

                                                Posted by on Sunday, November 13, 2005 at 12:32 AM in Economics, Technology | Permalink  TrackBack (1)  Comments (8) 


                                                Saturday, November 12, 2005

                                                Criticism of Chinese Economists

                                                A fairly harsh view, too harsh I think, of Chinese economists from Professor Ding Xueliang, a sociologist from the Hong Kong University of Science and Technology:

                                                Qualified Chinese economists no more than five?, by Hector Lee (mranti), China Daily: 2005 is an eventful year for Chinese's mainstream economists, who have been plunged into stern criticism both from the public and on the Internet. Reflection on the current status of China's economics may lead to a retrospect of China's reform and policy. Therefore China Business Times (CBT) had an interview on Oct 26 with Professor Ding Xueliang, a sociologist from the Hong Kong University of Science and Technology.

                                                CBT: During the past two decades, it seems that only economists have been playing in the intellectual arena, compared with other disciplines. They seem to have an exclusive edge to affect our government's policy and become the limelight in the China's opening-up and reform process. What's your comment on this?

                                                Ding: In the past quarter century, we implemented our reform and policy without considering sustainable development and a harmonious society. We always stick to one subject and ignore others at the same time; this easily causes us go astray. Some interest groups have emerged that are hard to ignore. The cost will be expensive if we want to make things up. During the past two decades, many people believed it was the economists' responsibility to develop the economy, and economists were the only ones who could speak out among the "silent majority." However, this is far from the truth. In a mature and sustainable society, developing the economy is a systematic project. Disciplines like law, sociology and political science all play their own part in the policy-making process. Their impact may not be overwhelming, but they cannot be replaced. Sociology focuses on social structure and fairness. Law emphasizes procedure and justice. Political science concerns the government's efficiency and cost. Each discipline has its own approach, so there should not be a dominant discipline that muffles the others. You've seen the English term "social studies?" The term is plural rather than singular. We need different voices; we need dialogue and argument based on a normal environment. Policy making should be a systematic project and should be made by comprehensively understanding the essence of various disciplines.

                                                CBT: How do you judge China's contemporary economics?

                                                Ding: In those western countries whose economics are advanced and developed, these disciplines are deeply professionalized, like physics and mathematics. Their topics are professional and profound. How could economics become such a communal discipline? China's economics are too popular. Too many people claim to be economists, and they dare to talk about everything. This means China's economics are still young and far from being a serious discipline, let alone a science. True science can't be so popular.

                                                CBT: what do you think of the misleading policies made by economists, like those in education reform?

                                                Ding: Over a long period, a couple of so-called economic problems were not real economics problems; they belonged to another area in international practice. But experts from other areas were silenced while economists become talkative. And since China's economics were still young, many un-economic solutions and arguments which pretend to be economic led to more leeway in policy-making.

                                                CBT: During the past two years, more and more mainstream economists have been blamed in public and on the Internet. How do you explain that?

                                                Ding: This is complicated. One important reason is those mainstream economists spend too much time on speaking for a certain interest group and too little time studying. You can find many interest group spokesmen among Chinese economists. Yes, it is true that there are also western economists who play such roles, but they are few. And the most distinctive western economists never do such things. They may be hired by banks and investment banks to study industrial economics. Most so-called Chinese economists act like economic analyzers in a western bank; they only speak for their employer's industry. But in terms of professional quality, they cannot even be compared with an economic analyzer. The best western economists are professors and researchers in top university economics departments.

                                                CBT: Are there any qualified economists in China?

                                                Ding: I think there are no more than five. Some of the most famous Chinese economists are not even qualified to be postgraduates in the world's top 50 economics departments. Some economists long for the Nobel Prize, but they contribute nothing. A real economist should make academic research the first priority, not personal wealth, fame and rank. In western society, some economists become officials in government and big banks, but only after they have made distinguished and independent research achievements. And one day, they expect to return to their original field and resume research. Wealth, fame and rank are not their goals.

                                                  Posted by on Saturday, November 12, 2005 at 03:39 PM in China, Economics | Permalink  TrackBack (0)  Comments (10) 


                                                  Minneapolis Fed Interview with Robert Barro

                                                  This is an interview with Robert Barro that appears in the Minneapolis Fed's The Region. The interview is somewhat long, but covers deficit spending, Social Security and Medicare/Medicaid, the economics of religion, inflation targeting, the equity premium puzzle, Europe's monetary union, economic growth, inequality and growth, the future of macroeconomics, and the IMF:

                                                  Interview with Robert Barro, The Region, Minneapolis Fed: The staircase that leads to Robert Barro's second-floor office at Harvard spirals like a helix; on the wall above these steps hang large photos of renowned Harvard economists. ... Schumpeter, Hansen, Kuznets, Leontief... In the early 1970s, Barro followed this lineage faithfully, publishing several significant papers along Keynesian lines. But ... Barro broke with tradition in 1974 with a powerful critique of Keynesian thought. ... His articles are among the most often cited in economics...

                                                  DEFICIT SPENDING

                                                  Region: The Ricardian equivalence hypothesis, which you brought to prominence in 1974, might be taken to suggest that deficit spending isn't inherently harmful since rational people, expecting to pay higher taxes in the future to pay off government debt, will save more, so private savings will balance out the public deficit. Does that imply that concerns about “irresponsible” levels of debt are unfounded? ...

                                                  Barro: Let me say first that I think the Ricardian equivalence idea is basically right as a first-order proposition. However, people get confused as to exactly what it says. ... To illustrate the potential pitfalls in what Ricardian equivalence says and does not say, one can consider the famous quote attributed to Vice President Cheney to the effect that President Reagan proved that budget deficits don't matter. The Cheney quote is often interpreted to mean that the level of government expenditure does not matter, and that surely is not what Ricardian equivalence says. The Ricardian proposition is about the consequences of paying for a given amount of public expenditure in different ways. Specifically, does it matter ... whether the government pays for its spending with current taxes or with current borrowing, which entails higher future taxes?

                                                  So, a central part of the proposition is that the amount of public expenditure—today and tomorrow—is being held constant. ... As a first-order proposition, it is right that it matters little whether you pay for government spending with taxes today or taxes tomorrow, which is basically what a fiscal deficit is. ... The method of public finance is an important question, but it is less important than the question of how big the government is and what activities it should carry out. Taxing now versus taxing later is ... a public-finance topic. This view moves the analysis away from pure Ricardian equivalence to the optimal tax perspective, which brings in the principle of tax smoothing. The idea is that ... optimal public finance dictates having tax rates ... that are similar from one year to another. ... erratic movements in tax rates ... are highly distorting. From that standpoint, it is not desirable to have a very low tax rate today, financed by a fiscal deficit, followed by much higher tax rates in the future. ...

                                                  Region: I'd like to follow that with an empirical question, if I might. By some measures, U.S. personal savings rates are quite low. What does this say about people's anticipation of having to pay higher taxes in the future?

                                                  Barro: National savings rates are not constant over time in the United States, and they are not the same across countries. ... However, economists have not demonstrated empirically for the U.S. or across countries that there is a regular relation between fiscal deficits or the size of the public debt and the level of the national saving rate. The idea that fiscal deficits drive down national saving is often claimed, but it is mainly proof by repetition. No one has actually shown convincingly that the U.S. national saving rate relates in a systematic way to the size of the fiscal deficit or the stock of public debt, both measured in relation to GDP. ...

                                                  SOCIAL SECURITY AND MEDICARE/MEDICAID

                                                  Region: Social Security and Medicare/ Medicaid are two major government expenditures, of course. Are you concerned about future spending for those programs?

                                                  Barro: I should say, in general, that the Bush administration has been a real failure with respect to fiscal discipline, especially during its early years. I mean this with respect to the level of federal expenditure, not about fiscal deficits per se. Particularly in the first term, there was a tendency to increase spending across the board—a very different pattern from most of the Clinton period, although Clinton did become less disciplined at the end of the 1990s. ... The expansion of Medicare, in terms of coverage for prescription drugs, is one important aspect of the lack of discipline, and this “generosity” will have long-term adverse consequences for the federal budget. So, although I am not particularly concerned about the current fiscal deficit, I am worried about the growth of federal outlays under Bush. ...

                                                  Of course, the legacy of deficits and debt came from Reagan and the first President Bush; that is, they involved what economists now call “strategic budget deficits.” I think this Reagan-Bush strategy actually worked to promote discipline on the federal spending side in the 1990s. ... Unfortunately, the spending discipline coming from fiscal deficits did not seem to work during Bush's first term. ... Anyway, I agree that the longer-term expenditure problems related to Social Security and Medicare are significant. But there is also a broader, short-run problem with regard to federal spending across the board. President Bush really should try vetoing a spending bill sometime.

                                                  ECONOMICS OF RELIGION

                                                  Region: Most economists will not expound on religion... You're an exception to that rule. In your work with your wife [Harvard scholar] Rachel McCleary on the associations between religion and growth, you're trying to tease out not just correlations but causality. Can you tell us what you've found?

                                                  Barro: I'm excited about this research project. It's on the interplay between religion and political economy, so there's a two-sided interplay here. One is about religion having influence on beliefs, values, traits like honesty, work ethic, thrift and so on... In this context, we are studying the impact of religion on economic growth and productivity, and also on political institutions, including democracy. These effects represent one direction of causation. The other effect, a big part of the literature on the sociology of religion, is that economic development and government policies influence the levels of religiosity in society. For example, one idea is that as nations get richer and better educated, they tend to become less religious.

                                                  Region: The “secularization” of society?

                                                  Barro: That's the secularization hypothesis, exactly. And though that hypothesis has lost favor, I think the empirical evidence supports it. ... A related idea is that what governments do in terms of having official state religions or regulating the market—either subsidizing or suppressing religion—has an impact. Communist countries were particularly focused on antireligion policies ... that is, if we do not count communism as its own religion. ...

                                                  Region: Could you explain your concept of “religious capital”?

                                                  Barro: The general idea is analogous to investing in education to accumulate human capital. Or, alternatively, one can think of investing in networks and friendships to form social capital. Analogously, you can invest in spirituality and beliefs to form a kind of religion capital. Rachel and I think of this influence as working through beliefs, not so much through networking, or going to church and meeting lots of people. That would be more like social capital. ... These beliefs matter ... if they support certain traits and values, such as honesty, work ethic, thrift and hospitality to strangers. These traits then influence productivity and work effort, which ultimately affect economic growth. ... The other thing I might mention is that I find that whenever I give a seminar on this topic, I inevitably get a question about whether I'm personally religious. The attitude seems to be that if I'm studying this topic it must come from some individual set of beliefs or commitment to a particular religion. It's curious because people studying other aspects of social science do not tend to get analogous questions. [University of Chicago economist] Gary Becker studied the economics of crime, and (as far as I know) nobody ever asked him if he was a criminal ...

                                                  Region: If I'm not mistaken, Gary Becker got his idea about crime and economics when he was thinking about parking illegally. ...

                                                  Continue reading "Minneapolis Fed Interview with Robert Barro" »

                                                    Posted by on Saturday, November 12, 2005 at 12:31 AM in Budget Deficit, Economics, Macroeconomics, Monetary Policy, Social Security | Permalink  TrackBack (0)  Comments (11) 


                                                    Joseph Stiglitz Questions Greenspan's Record and the Independence of the Fed

                                                    Joseph E. Stiglitz is a Nobel laureate in economics, a Professor of Economics at Columbia University, and he was Chairman of the Council of Economic Advisers for President Clinton and Chief Economist and Senior Vice President at the World Bank. He has some harsh words for Alan Greenspan, particularly his role in promoting tax cuts, and he wonders if central bank independence is an illusion:

                                                    Is central bank independence all it’s cracked up to be?, by Joseph Stiglitz, Daily Times, Pakistan: Alan Greenspan attained an almost iconic status as Governor of the Federal Reserve Board. ... Few central bank governors have the kind of hagiography lavished upon them, especially in their lifetime... But what makes for a great central bank governor ... great institutions or great individuals? ...[T]here is little doubt that those “managing” the economy receive more credit than they deserve, if sometimes less blame.  ... So ... while no central bank governor can ensure economic prosperity, mismanagement can cause enormous harm. Many of America’s post-World War II recessions were caused by the Fed hiking interest rates too fast and too far. There is little doubt that Greenspan had great moments... These successes ... reinforced Greenspan’s exalted status. But they also led many to forget less successful moments. ...

                                                    [T]he real problem for Greenspan’s legacy concerns what happened to the American economy in the last five years, for which he bears heavy responsibility. Greenspan supported the tax cuts of 2001 with the most specious of arguments – that unless something was done ... the national debt would be totally paid off within, say, ten to fifteen years. According to Greenspan, immediate action needed to be taken to avert this looming disaster, which would impede the Fed’s ability to conduct monetary policy! It says a great deal about the gullibility of financial markets that they took this argument seriously. More accurately, tax cuts were what Wall Street wanted, and financial professionals were willing to accept any argument that served that purpose... Greenspan’s irresponsible support of that tax cut was critical to its passage. ...

                                                    But soaring deficits did not return the economy to full employment, so the Fed did what it had to do – cut interest rates. Lower interest rates worked, but not so much because they boosted investment, but because they led households to refinance their mortgages, and fueled a bubble in housing... [A]s Greenspan departs, he leaves behind an American economy burdened with high household and government debt and fragile balance sheets – a legacy that is already contributing to global financial instability. It is still not clear what led Greenspan to support the tax cut. Was it a massive economic misjudgment, or was he currying favor with the Bush administration? The most likely explanation is a combination of the two, for he and Bush were pursuing the same “starve the beast” political strategy...

                                                    The traditional argument for an independent central bank is that politicians can’t be trusted to conduct monetary and macroeconomic policy. Neither, evidently, can central bank governors, at least when they opine in areas outside their immediate responsibility. Greenspan was as enthusiastic for a policy that led to soaring deficits as any politician ... engendering support from some who otherwise would have questioned its economic wisdom. This, then, is Greenspan’s second legacy: growing doubt about central bank independence. Macroeconomic policy can never be devoid of politics: it involves fundamental trade-offs ... Unemployment harms workers, while the lower interest rates needed to generate more jobs may lead to higher inflation, which especially harms those with nominal assets whose value is eroded. Such fundamental issues cannot be relegated to technocrats, particularly when those technocrats place the interests of one segment of society above others. Indeed, Greenspan’s political stances were so thinly disguised as professional wisdom that his tenure exposed the dubiousness of the very notion of an independent central bank and a non-partisan central banker. Unfortunately, many countries have committed themselves to precisely this illusion, and it may be a long time before they take heed of Greenspan’s most important lesson. Stressing the new Fed chief’s “professionalism” may only delay the moment when this lesson is learned again.

                                                    I share these views, but my own take is more tempered. The chair is designed to bring political influence to the FOMC, the four year appointment and the ability to be reappointed make political considerations important. But on the FOMC, the chair has become a dominant voice leading to questions about how well other interests are represented in the deliberations and outcome of monetary policy decisions. To me, that is where the problem begins. To the extent that FOMC decisions will be driven less by the wishes of a single person under Bernanke, that will be a welcome change.

                                                      Posted by on Saturday, November 12, 2005 at 12:12 AM in Budget Deficit, Economics, Monetary Policy | Permalink  TrackBack (2)  Comments (12) 


                                                      Friday, November 11, 2005

                                                      Stock Returns and Expected Business Conditions

                                                      I haven't had chance to read this closely yet, but it looks like a paper worth passing along as it connects expected business conditions to excess stock returns, shows that expected business conditions are linked to standard predictors of excess returns, amd reinforces recent evidence that expected returns are countercyclical:

                                                      Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence, by Sean D. Campbell, Francis X. Diebold, NBER WP 11736, November 2005: Abstract ...[U]sing half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwise standard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R-squared. Expected business conditions retain predictive power even after controlling for ... the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion. [Free versions here and here.]

                                                        Posted by on Friday, November 11, 2005 at 09:27 AM in Academic Papers, Economics | Permalink  TrackBack (0)  Comments (1) 


                                                        Paul Krugman: The Deadly Doughnut

                                                        Paul Krugman looks at Medicare's new prescription drug benefit and asks whose interests are served by the legislation that created it:

                                                        The Deadly Doughnut, by Paul Krugman, NY Times: Registration for Medicare's new prescription drug benefit starts next week. Soon millions of Americans will learn that doughnuts are bad for your health. ... [L]et's look at how the Medicare drug benefit will work... At first, the benefit will look like a normal insurance plan, with a deductible and co-payments. But if your cumulative drug expenses reach $2,250, ... you'll suddenly be on your own. The Medicare benefit won't kick in again unless your costs reach $5,100. This gap in coverage ...[is] the "doughnut hole." (Did you think I was talking about Krispy Kremes?)  ... [T]his will place many retirees on a financial "roller coaster." People with high drug costs will have relatively low out-of-pocket expenses for part of the year... Then, suddenly, they'll enter the doughnut hole, and their personal expenses will soar. ...

                                                        How will people respond when their out-of-pocket costs surge? ...[B]ased on experience from H.M.O. plans with caps on drug benefits, ... it's likely "some beneficiaries will cut back even essential medications while in the doughnut hole." ... [T]his doughnut will make some people sick, and for some people it will be deadly. The smart thing to do... would be to buy supplemental insurance that would cover the doughnut hole. But guess what: the bill ... specifically prohibits ... buying insurance to cover the gap...

                                                        [B]ear in mind that I've touched on only one of the bill's awful features. There are many others... Why is this bill so bad? The probable answer is that the Republican Congressional leaders who rammed the bill through ... weren't actually trying to protect retired Americans... In fact, they're fundamentally hostile to the idea of social insurance... Their purpose was purely political: to be able to say that President Bush had honored his 2000 campaign promise to provide prescription drug coverage... Once you recognize that the drug benefit is a purely political exercise..., the absurdities ... make sense. For example, the bill offers generous coverage to people with low drug costs, who have the least need for help, so lots of people will get small checks in the mail and think they're being treated well. Meanwhile, the people who are actually likely to need a lot of help ... were deliberately offered a very poor benefit. According to a report issued along with the final version of the bill, people are prohibited from buying supplemental insurance to cover the doughnut hole to keep beneficiaries from becoming "insensitive to costs" ... A more likely motive is that Congressional leaders didn't want a drug bill that really worked for middle-class retirees. Can the drug bill be fixed? Yes, but not by current management. ... We won't have a drug benefit that works until we have politicians who want it to work.

                                                         Next (11/14) column: Paul Krugman: Health Economics 101

                                                          Posted by on Friday, November 11, 2005 at 12:33 AM in Economics, Health Care, Politics | Permalink  TrackBack (0)  Comments (27) 


                                                          Bernanke and Budget Deficits

                                                          Senator Schumer says he has been assured by Bernanke that he will speak out on the budget deficit issue:

                                                          Nominee for Fed Chief Wins Backing of Schumer, by Edmund L. Andrews, NY Times: A leading Senate Democrat ... endorsed President Bush's nomination of Ben S. Bernanke to become chairman of the Federal Reserve. "I think he's going to be an outstanding Fed chairman, and I think he's going to be in the mold of Alan Greenspan," said Senator Charles E. Schumer of New York, a member of the Senate Banking Committee, after a 45-minute meeting with Mr. Bernanke. ... Mr. Schumer's emphatic endorsement means that Democrats are likely to clear the path for an easy confirmation. "I think the only people who might not like him are on the far right or the far left," ... Mr. Schumer said he had received assurances from Mr. Bernanke that he would follow the lead of Mr. Greenspan and speak out about fiscal policy and about the need to reduce deficits. That is a shift for Mr. Bernanke, who ... initially told lawmakers and others that he would avoid commenting on fiscal policy if he became Fed chairman. But Democrats are hoping that Mr. Bernanke will echo the view of Mr. Greenspan that tax cuts should be paid for with savings in other areas. ...

                                                          I thought a criticism of Greenspan was that he didn't speak out forcefully enough on the deficit issue, and I'm not sure that's an accurate reflection of what Democrats want. In other deficit news:

                                                          G.O.P. Dissension Delays Vote on Budget-Cutting Bill, by Carl Hulse, NY Times: Facing defeat, House Republican leaders on Thursday abruptly called off a vote on a contentious budget-cutting bill in a striking display of the discord and political anxiety running through the party's ranks. Despite making major concessions to moderate Republicans, the House leadership failed to win enough converts to the budget plan and surrendered in mid-afternoon. Leading Republicans said they would try again next week to find a bare majority for more than $50 billion in spending cuts and policy changes. ... It was a stunning retreat for a Republican majority that has prided itself on iron party discipline and an ability to consistently win even the most difficult floor votes ... And the fiscal fight is not limited to the House. Also on Thursday, Senate Republicans on the Finance Committee had hoped to approve a bill .... But they were forced to postpone a vote after failing to win over a key dissident, Senator Olympia Snowe, Republican of Maine, despite two hours of closed door talks. ... In the House, .... top Republicans said a main impediment was the unity of the Democrats...

                                                            Posted by on Friday, November 11, 2005 at 12:22 AM in Budget Deficit, Economics, Monetary Policy, Politics | Permalink  TrackBack (1)  Comments (3) 


                                                            The Response of the CPI and Core CPI to Energy Shocks

                                                            I'm supposed to be getting ready to present a paper to our macro research group tomorrow. So, to procrastinate and really put the pressure on later, I decided to estimate an impulse response function from a VAR model to answer a question I've been wondering about. What's a VAR model? It doesn't matter. Here's what it does. I wanted to know how long it takes a shock to energy prices to bleed through to core inflation.  So I downloaded monthly data from FRED for 1957:1 through 2005:09 and calculated inflation rates for the CPI, core CPI (CPI less food and energy), and the PPI for energy (PPIENG, the price index for fuels and related power, chosen mainly because it is a longer time-series than other energy indexes). Then, using these three variables I estimated a three lag VAR model and used it to forecast how the CPI and core CPI will change in response to a one-time shock to energy prices. Here's the graph of the results (I'll show results for two lags as well to check robustness, and I also  estimated other lag lengths, checked serial correlation statistics, etc., and  two lags, certainly three, eliminates serial correlation):

                                                            The main thing to notice is the delay between the time the shock hits and the subsequent rise in core inflation. For the first month after the shock, the CPI rises, but core CPI rises very little. At the end of two months the effect on core inflation is much larger but the peak effect does not occur until three months after the shock. After the peak at three months, core inflation slowly declines through the end of the year. Remember, the shock to energy prices lasts only one month yet the effects are drawn out over a much longer period of time. The two lag model is similar, but shows a little less persistence and the response of core inflation occurs a bit earlier. But there is still a delay between the response of the CPI and the subsequent response of core inflation.

                                                            Okay, enough for now. I should caution that with more time I would want to build a much better model than this. Real variables such as consumption, investment, GDP, and wages might be included and an interest rate, perhaps the federal funds rate, is another candidate variable. There are trend and co-integration issues to worry about, whether to include levels or changes (or both, or gaps) of some variables, I would want to find a better energy index, check robustness to ordering and alternative structural assumptions, ...

                                                              Posted by on Friday, November 11, 2005 at 12:11 AM in Economics, Inflation, Macroeconomics, Monetary Policy, Oil | Permalink  TrackBack (0)  Comments (3) 


                                                              Thursday, November 10, 2005

                                                              "The Rabbit is Indeed in the Middle of the Python"

                                                              The theme of the next few posts is global imbalances, so let's start things off with two articles about China. First, The Financial Times wonders if China's rapidly aging population will cause slower economic growth in the future:

                                                              Why China stands to grow old before it gets rich, by David Willetts, Commentary, Financial Times: ...One reason for China’s stellar growth is that it is at a demographic sweet-spot. The massive reduction in infant mortality achieved by China’s barefoot doctors in the 1960s and 1970s is now yielding a surge of young workers – an extra 10m working-age adults per year. China’s challenge now is just to absorb them into the labour force. ... There are few pensioners and there are not many children either. The rabbit is indeed in the middle of the python. As early as 2015, China’s working age population will actually start falling. By 2040, today’s young workers will be pensioners – in fact the world’s second largest population, after India, will be Chinese pensioners. ... The desperate rush for economic growth is fuelled by fears that China could grow old before it grows rich. ... Imposing the one-child policy ... is having an extraordinary effect. If you can have only one child it becomes highly desirable to have a boy. The rule is not as strictly enforced as it was, but you can now see its effect on the second child, which in the eyes of many Chinese really is the last chance to have a boy. For every 100 female second children, there are 152 males. Overall, there are now about 120 boys for every 100 girls in China. ... China is going to have to attract large-scale female immigration or many of its young men will leave. ... So China is going to be full of old people and rather earnest, frustrated young men. It will be one of the most dramatic and unusual demographic changes the world will have seen for a very long time, and Chinese leaders now would do well to plan for such a future.

                                                              Next The Los Angeles Times discusses how economic insecurity, lack of an effective social security system, underdeveloped financial and mortgage markets, and high educational costs cause the high savings rate in China:

                                                              Anxiety Drives Chinese Fixation on Frugality, by Don Lee, LA Times: ...China's economic reforms have vastly improved living standards, but the last two decades also have seen a dismantling of the socialist "iron rice bowl" that provided basic health and welfare from cradle to grave. The result is that many Chinese today feel more insecure about their future than their parents' generation did. Chinese families are saving about half of their income. ... [M]ost experts expect China's savings rate to stay high for years to come because of the need to prepare for a large dependent elderly population. ... China, like other nations in East Asia, has a long tradition of thrift. Analysts say it may be linked to Confucian values that encourage thrift and production rather than consumption. China's propensity to save also reflects its agrarian society, where people face more risks of fluctuating incomes and their long work hours leave them with little leisure time to consume. ... pensions, for those who have them, tend to be modest. China's healthcare system is broken; insurance is inadequate for most everybody. Many employers in China don't provide insurance ... In the event of a serious ailment, ... "even an entire life savings may not be enough. So they dare not spend." Zhuo Yunbao recently had a scare when his father was hospitalized with a stroke. He says his father may need a pacemaker, but that's not covered by the state insurance for the elderly. The family is saving for more than a rainy day. They want to buy a car. A few years from now, Zhuo says, maybe they'll look at moving into a bigger home. ... More than anything else, though, the Zhuos are squirreling away for their son's education. ... Like many young Chinese parents, the Zhuos want to send their son abroad for college. They have their sights on England or the U.S., where four years of tuition could reach $125,000. The family has saved a little more than 10% of that. "We have a long way to go," Zhuo says.

                                                                Posted by on Thursday, November 10, 2005 at 12:54 AM in China, Economics, International Finance, Saving | Permalink  TrackBack (0)  Comments (18) 


                                                                William Poole: A Hard Landing is Unlikely

                                                                St. Louis Fed president William Poole looks at the the likelihood that growing global imbalances will cause a hard landing for the U.S. His view is that so long as the U.S. pursues sound monetary and fiscal policy, a hard landing is unlikely. The reason, Poole argues, is that any adjustment is self-limiting because the U.S. is in the unique position of having most of its debt denominated in dollar terms rather than in a foreign currency and this changes the equation relative to a typical financial crisis. That is, because 95% of U.S. debt is denominated in dollar terms, a declining dollar will not increase the U.S. debt obligation to any substantial degree and thus will not precipitate a crisis. In addition, because the majority of U.S. assets held abroad are denominated in foreign currencies, these investments appreciate in dollar terms as the dollar declines further undermining the chance of a hard landing:

                                                                How Dangerous Is the U.S. Current Account Deficit?, by William Poole, St. Louis Fed President: The U.S. current account deficit has attracted considerable attention from academics, policymakers and market participants. So also has the U.S. international investment position—the difference between U.S.-owned assets abroad and foreign-owned assets in the United States. The net position has become increasingly negative as current account deficits have accumulated over time. ... [A] situation in which the U.S. net international investment position becomes ever more negative as a percentage of GDP is inconsistent with long-run equilibrium. So, the question is not whether the U.S. current account deficit will fall in the future but whether the inevitable adjustment is likely to be painful and disruptive of U.S. economic growth and stability—a hard landing. My answer is that a hard landing is very unlikely provided that U.S. monetary and fiscal authorities maintain sound policies. ...

                                                                It is sometimes said that the United States has become a “net debtor” nation, and that this situation increases the risk that currency depreciation might lead to financial crisis. Indeed, ... some have drawn comparisons with countries such as Argentina, Brazil, Mexico and other countries that at times have experienced severe balance-of-payments crises. I consider it highly unlikely that such a crisis will befall the United States. ... In fact, about 95 percent of international claims on the United States are denominated in dollars. A country with most of its debt denominated in its own currency is in a very different situation from one whose debt is denominated in other currencies. The familiar crises experienced by several Asian countries ..., by Mexico ..., and by numerous other countries have all involved situations in which the impacted countries have had large external debts denominated in foreign currencies. ... Consider what typically happens to a country suffering a balance-of-payments crisis. As the foreign exchange value of its currency depreciates, the value of its foreign liabilities ... increases, as does the burden of servicing its international debt. Recognizing this implication of a crisis, international investors respond by paring back their positions further, engendering even greater currency depreciation. Hence, the combination of foreign-denominated debt and a depreciating currency has proven to be something of a vicious circle—compounding and accelerating a crisis.

                                                                The U.S. situation is completely different. To the extent that the foreign exchange value of the dollar declines, ... Dollar-denominated U.S. liabilities remain unchanged in domestic value, which means that debt service in dollars and relative to the size of the U.S. economy does not change. Moreover, holdings of U.S. investors abroad, about two-thirds of which are denominated in foreign currencies, appreciate in dollar terms. The composition of the U.S. international investment account, therefore, contributes to stability rather than to instability. ... If the capital markets view is correct—and I obviously think it is—the ... transition to a sustainable long-run path [will not] necessarily require wrenching adjustments in domestic or international markets or in exchange rates. ... The United States has created for itself a comparative advantage in capital markets, and we should not be surprised that investors all over the world come to buy the product.

                                                                Finally, for those looking for a statement about the future course of interest rates, Bloomberg reports remarks made after the speech:

                                                                Federal Reserve Bank of St. Louis President William Poole said the risk of inflation is still ''skewed toward the high side'' after 12 consecutive interest- rate increases. ... ''I would put a higher probability on an upside surprise than on a downside surprise,'' he told reporters today following a speech... ''That in my mind calls for the Federal Reserve to make sure that policy is risk-averse with respect to that outcome.'' ...

                                                                And Cleveland Federal Reserve Bank President Sandra Pianalto, as reported by Reuters, remarked after her speech today (discussed here):

                                                                The Federal Reserve does not have a set goal for how high it wants to push up short-term U.S. interest rates and will be guided by economic conditions... "There is no numerical target because where ... we adjust it to ... depends on economic conditions," ... Pianalto... noted the Fed has been taking stimulus away from the economy... "Our statement says we are continuing to remove that accommodation," she said... "Where we determine we are no longer accommodative again depends on economic conditions." ... Pianalto also ... acknowledged ... that households could face a harder time servicing debts as rates rise. "As we start to see an increase in interest rates will that cause the consumer problems?" she asked rhetorically in response to a question. "I think it depends on whether that's gradual and how consumers adjust to that." "...we'll have to ... keep our eye on this situation as the conditions change," ...

                                                                  Posted by on Thursday, November 10, 2005 at 12:18 AM in Economics, Fed Speeches, International Finance, Monetary Policy | Permalink  TrackBack (0)  Comments (11) 


                                                                  Explaining the Global Pattern of Current Account Imbalances

                                                                  New Economist presents a Federal Reserve Board working paper that attempts to explain the pattern of current account imbalances. In the process, it provides positive evidence for the idea that institutional strength in the financial sector and strong economic growth have attracted foreign investment into the U.S. as Poole suggests in his analysis of the probability of a hard landing, but there is still much to learn in this area:

                                                                  New Economist: The Fed's explanation of global current account imbalances: it's not all glut: A new Federal Reserve Board working paper, Explaining the Global Pattern of Current Account Imbalances, makes a thoughtful attempt to explain the global current account imbalances that have emerged in recent years... As Fed economists Joseph W. Gruber and Steven B. Kamin note, a variety of reasons for this imbalance have been put forward:

                                                                  There is no consensus explanation for the current pattern of international capital flows, and many hypotheses have been put forward: U.S. fiscal deficits; declines in U.S. private saving; the surge in U.S. productivity growth; increases in global financial intermediation; a global savings glut; a rash of emerging market financial crises; and exchange rate pegs by our trading partners. However, many of these factors are quite amorphous, and it has been difficult to muster support for one explanation against another.

                                                                  Though the authors don't quite manage to square the circle, their modelling gets some of the way there. Here's a summary:

                                                                  Based on the approach developed by Chinn and Prasad (2003), we ... estimate panel regression models for the ratio of the current account balance to GDP. We find that a model that includes as its explanatory variables the standard determinants of current accounts proposed in the literature - per capita income, relative growth rates, the fiscal balance, demographic variables, and economic openness - can account for neither the large U.S. deficit nor large Asian surpluses of the 1997-2003 period. However, when we include a variable representing financial crises, ... the model explains much of developing Asia’s swing into surplus since 1997. Even so, the model cannot explain why the capital outflows associated with Asia’s current account surpluses were channeled primarily into the U.S. economy. Observers have pointed to strong growth performance and a favorable institutional environment as elements attracting foreign investment into the United States, and we found strong evidence that good performance in these areas significantly reduces the current account balance. ... [A] model incorporating these factors still fails to predict the large U.S. current account deficit...

                                                                  Both advocates and critics of the 'global savings glut' hypothesis will be interested in their findings. On the Asian surplus side, they find support:

                                                                  First, our work provides support for at least half of the global savings glut hypothesis: the half suggesting that the U.S. deficit owes partly to an autonomous rise in the quantity of saving made available to the United States... In particular, our estimation results indicate that financial crises systematically lead to higher current account imbalances, and ... especially in East Asia, contributed to their shift into current account surplus. This finding tends to undercut a related explanation for the East Asian surpluses, that they reflect the rational development strategy of East Asian governments and can be expected to persist for a long time ... In fact, our sense is that, with much of developing Asia’s surpluses explained by prior financial crises, these surpluses will likely dissipate as adjustments following those crises are completed. ... consistent with standard theory.

                                                                  That conclusion is likely true of non-Chinese Asian current account surpluses. Kamin provided some plausible reasons why in another recent paper of his: The Revived Bretton Woods System: Does It Explain Developments in Non-China Developing Asia? But China's large and growing surplus is due to other factors, and cannot be expected to dissipate anytime soon.

                                                                  As to the large US current account deficit, it is less easily explained by the savings glut hypothesis:

                                                                  Second, for the global saving glut story to explain the large U.S. current account deficit, however, some explanation must be posited for why the increase in global savings availability was tapped primarily by the United States. Our research provides mixed support for the explanations that have been advanced (some of which, in principle, could operate even without an autonomous rise in foreign saving).

                                                                  The expansion of the U.S. budget deficit ..does not appear to explain the U.S. current account deficit, at least for the 1997-2003 period; not only is the estimated pass-through of the fiscal balance to the current account quite small, at about 0.1, but the average budget balance during this period was relatively positive by international standards. The view that current account deficits can be caused both by strong economic performance ..and by a market-friendly institutional environment ..was well-supported by our research; we found that the pace of output growth generally exerted a significant negative effect on the current account.

                                                                  ...

                                                                    Posted by on Thursday, November 10, 2005 at 12:10 AM in Economics, Financial System, International Finance, International Trade | Permalink  TrackBack (0)  Comments (1) 


                                                                    Cleveland Fed's Pianalto: Education is a Key Factor for Economic Flexibility

                                                                    Sandra Pianalto, president of the Cleveland Fed, discusses how to minimize the negative consequences of structural change. For example, the Cleveland Fed District has experienced a decline in manufacturing activity and other changes related to globalization. How can the region overcome this decline? The key, according to president Pianalto, is innovation. And what is the key to innovation? Continuing a recent theme from Fed officials (e.g., Chicago Fed), and a recurring theme at this site, the key is education. With all the recent post on this topic, this may be a bit repetitive, but it's an important topic, I've been trying to document most Fed speeches by governors and presidents, and the it gives an indication of how policy makers are thinking about this problem:

                                                                    The Role of Innovation in Economic Transformation, by Sandra Pianalto, Cleveland Fed President, November 9, 2005: At the Federal Reserve Bank of Cleveland, we spend a lot of time thinking about what factors drive economic growth and prosperity. We have found that innovation is one of the key factors in creating the kind of economic conditions that will benefit all of our citizens. Today, I would like to share my thoughts on the role of innovation in economic transformation. ...[I]n Northeast Ohio ... After a century of relying on the heaviest types of traditional industry — such as coal, steel, autos, and rubber — we have been deeply affected by global trends including rapidly changing technology and increased international trade. As I am sure you know, these trends have led to a decline in manufacturing jobs and a growing wage differential between high-school and college graduates. ... Economists call this process “creative destruction.” It is a natural part of our economic development... Economic change is as relentless as the tides, and this change will direct resources to wherever they are most productive. ... [O]ur region’s transition does not necessarily mean we have to live in a world with downsized dreams, or less productive industry, or less prosperous communities. ... Every sector of society — public and private; for-profit and non-profit; philanthropic and academic — can participate in fostering a growing regional economy in the future. The key to our shared success, I am convinced, will be our ability to foster and sustain innovation. ... I don’t think it is any exaggeration to say that innovation is the mainspring for economic renewal. ... The task now... is to educate a new generation of inventors and entrepreneurs, to encourage their creativity, to invest in their potential, and to promote their access to worldwide markets. ... To create a dynamic economy that promotes innovation in Northeast Ohio, we must find a way to do a few important things well (bullets added for emphasis):

                                                                    • We must fund academic research...
                                                                    • [W]e must support business startups to move innovations from the labs to production sites.
                                                                    • We must build on our existing strengths — using the industrial knowledge and workplace skills from older industries and applying them to new tasks. ...
                                                                    • But there is one more important thing that we need to do well, and that is educating our workforce for the future. In a global economy that grows more competitive every day, the words “education” and “opportunity” are becoming increasingly synonymous. Creating a civic culture that supports education is the most promising pathway to creating a base for innovation. ... Investments in education today ... can generate dramatic new productivity growth tomorrow. The fact is that Northeast Ohio lags behind many other regions of the country in levels of educational attainment, and nowhere is that more evident than in our large cities.

                                                                    Making effective investments in our people must be among our foremost priorities. Investments, after all, come in many forms. ... As we look ahead, our prospects depend on our commitment to invest in intellectual capital: the knowledge base of our students, the technological skills of our workers, and the imaginative power of our inventors. ... Instead of resisting change, we must prepare for new opportunities by rethinking our approaches, retraining our workforce, and investing in new initiatives. ...

                                                                    "Economic change is as relentless as the tides." As I've said before many times here, we will not stop globalization, the economic tide will move where it wants to move - but we can do a whole lot better helping those who, through no fault of their own, have the costs of globalization thrust upon them, and a key component of that effort is education.

                                                                      Posted by on Thursday, November 10, 2005 at 12:03 AM in Economics, Fed Speeches, Universities | Permalink  TrackBack (0)  Comments (5) 


                                                                      Wednesday, November 09, 2005

                                                                      Structural Change and Declining Output Volatility

                                                                      This Research Discussion Paper from the Reserve Bank of Australia provides a follow up to the interesting paper by Blanchard on "European Unemployment: The Evolution of Facts and Ideas", in particular the ideas about how labor market reform is related to output volatility. It is also interesting because it gives more credit for the decline in volatility to monetary policy reform and other structural changes such as declining product and labor market regulation than does most previous work:

                                                                      Declining Output Volatility: What Role For Structural Change?, by Christopher Kent, Kylie Smith and James Holloway, RDP 2005-08 Abstract The decline in output volatility in a number of countries over the past few decades has been well-documented, though less agreement has been reached about the causes of this decline. In this paper, we use a panel of data from 20 OECD countries to ... suggest that reforms in product and labour markets can reduce volatility of aggregate output by encouraging productive resources to shift more readily in response to differential shocks across firms and sectors. In contrast to other studies, we include direct measures of product market regulations and monetary policy regimes as indicators of structural reform. We find that less product market regulation and stricter monetary policy regimes have played a role in reducing output volatility...

                                                                      And from the conclusion, what is different about these results as compared to previous work, and why we should believe the decline in output volatility is permanent:

                                                                      Studies that have used structural models to identify various demand and supply shocks find that most of the decline in output volatility is due to a decline in the magnitude of shocks, with a limited role for structural reforms and monetary policy. In comparison, our atheoretical approach accounts for the possibility that smaller shocks may themselves be the result of structural changes. The finding of a significant role for increased efficacy of monetary policy and less regulated markets ... has an important implication for future output volatility. Namely, while any decline in global shocks that has been driven solely by good fortune cannot (by definition) continue indefinitely, the benefit of significant structural reforms is likely to limit the extent of any future rise in output volatility.

                                                                        Posted by on Wednesday, November 9, 2005 at 12:52 AM in Economics, Macroeconomics, Monetary Policy, Technology | Permalink  TrackBack (1)  Comments (2) 


                                                                        Amber Tidal Waves of Grain

                                                                        This will surprise you. Subsidies cause overproduction:

                                                                        Mountains of Corn and a Sea of Farm Subsidies, by Alexei Barrionuevo, NY Times: ...[C]orn production by American farmers ... this year is estimated to reach a nationwide total of at least 10.9 billion bushels, second only to last year's 11.8 billion bushels. ... underscoring what critics call a paradox at the heart of the government farm subsidy program: America's efficient farmers may be encouraged to produce far more than the country can use, depressing prices and raising subsidy payments. ... [F]ederal spending on farm payments is closing in on the record of $22.9 billion set in 2000... If export sales stay weak, this year's subsidies could hit a new record. ...In response to pressure, the Bush administration said last month that the United States was prepared to cut its most trade-distorting farm subsidies by 60 percent over five years. The world's poor nations, which tend to be heavily dependent on agriculture, complain that American and European Union farm subsidies spur growers to produce gluts that depress crop prices throughout the world. ...

                                                                        Farmers are hardly shy about exploiting the government safety net provided by guaranteed loan-deficiency payments. "Everybody leans on the L.D.P.'s as much as they can," said Ash Kading, a farmer in western Iowa... "It is like opening up the federal Treasury. There were quite a few people this year that wish corn prices would go to zero because they would have a bigger L.D.P." ... This year grain piles are everywhere across Iowa and parts of Illinois, the two biggest corn-producing states. In Iowa, the amount of grain being stored on the ground for lack of storage is averaging more than 19 percent, its highest level in at least 25 years... Lately the giant piles have become the butt of jokes in farm country. They were spoofed in a fake picture... that showed a skier airborne atop West Central's biggest pile, with the caption that said "one thing you can do with a 3-million-bushel pile of harvested corn: Ski Iowa."

                                                                        Here's the Ski Iowa picture from Chicago Boyz. There seems to be general agreement that farm subsidies distort markets and should be eliminated. There also seems to be general agreement that to do so is political suicide. I do want to add one note. Maybe this will make farmers a little less ticked off at economists for calling for an end to the gravy train. Farming can lead to highly volatile incomes. Some years are great, others are awful. So as we cut subsidies, if we ever do, we should be careful to keep in place institutions that serve to smooth farm incomes over time. Though many believe market failures lead to an underprovision of this type of insurance and government intervention is needed to overcome them, it seems natural that farmers, politicians, and others in favor of privatization of Social Security would also favor this type of income insurance being provided by the private sector instead of the government, but I'm not sure that is generally the case.

                                                                          Posted by on Wednesday, November 9, 2005 at 12:17 AM in Economics, Policy, Politics | Permalink  TrackBack (0)  Comments (11) 


                                                                          The European Central Bank Pressures Nations to Reduce Fiscal Deficits

                                                                          In the eurozone, when banks want to borrow money from the European Central Bank (ECB), they must put up collateral. This gives the ECB powers over fiscal policy that the Fed does not have, or at least does not exercise. If the ECB refuses to accept a country's debt as collateral on these loans, and it is threatening to do just that in a few cases, it would make it harder for those countries to use deficit financing. Imagine the Fed exerting similar pressure by saying it will no longer accept US T-Bills when conducting open market operations because the deficit is out of control. The Fed can buy and sell any asset, not just T-Bills, to change the money supply, so it could do this in theory, but congress could also pass a law taking away the Fed's independence in response:

                                                                          ECB targets its problem nations, by Ralph Atkins and Mark Schieritz, Financial Times:  The European Central Bank will sharply step up pressure on Italy, Greece and other eurozone fiscal laggards by warning that it will refuse to accept their sovereign debt as collateral if their credit ratings slip. ...[T]he bank is to state that it will only accept bonds with at least a single A- rating from ... the main rating agencies as collateral in its financial market activities.... A refusal by the ECB to accept a government's bonds would amount to a humiliating swipe at that government's policies, and make its bonds harder to sell. ... The eurozone has been dogged by the failure of many countries to keep budget deficits under control... The ECB appears to hope that the market mechanism will help impose fiscal discipline where political pressure has failed. But the move will not put additional pressure on France and Germany which enjoy high credit ratings in spite of having broken EU rules on budget deficits. Jean-Claude Trichet, ECB president, last week described the outlook for the deficits of some eurozone countries as "a matter of great concern". ... The ECB's move is likely to divide finance ministries. Some are expected to regard it as a welcome embrace of market-based pricing mechanisms but others may worry about the increased importance given to ratings agencies. ... The convergence of bond spreads since the introduction of the euro in 1999 has meant that less fiscally disciplined governments have largely escaped punishment by the markets, although the ECB argues that investors have priced in different risks in recent months. ...

                                                                            Posted by on Wednesday, November 9, 2005 at 12:10 AM in Budget Deficit, Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0) 


                                                                            Senator Grassley: Social Security Reform Unlikely Before 2009

                                                                            Social Security reform is still in the news, but only to confirm that the reform effort is on its last legs and unlikely to come up again anytime soon:

                                                                            U.S. Social Security overhaul unlikely before 2009, by Donna Smith, Reuters: ... Charles Grassley, the chairman of the Senate Finance Committee, told a business group he is unable to win agreement for a Social Security overhaul even among his fellow Republicans on the tax writing panel. ... "I am very pessimistic about it in the future," Grassley told the U.S. Chamber of Commerce. "Probably the next bite at Social Security will come in 2009."  ... Bush still mentions Social Security in speeches, but has not devoted any public appearances solely to the private account proposal in months. ... Backers of private accounts hope to keep the issue alive by pushing a bill sponsored by Sen. Jim DeMint, a South Carolina Republican, ...[and a] second bill sponsored by Sen. Rick Santorum, a Pennsylvania Republican ... Aides to the two senators said the lawmakers enjoyed support of Senate Republican leaders and they hope to see a floor vote on the proposals before the end of the year. Grassley said he would support any effort to revive Bush's plan, but told reporters he was unsure how the drive for a vote by the two lawmakers would play out...

                                                                            So some will continue to push for a vote. And, as reported in CNN/Money:

                                                                            Grassley: no Social Security reform now, CNN/Money: ...Grassley said he will try to get his fellow committee members to act sooner than 2009, but those efforts may be hampered by next year's Congressional elections. "I'm pessimistic that it could come up before 2009," Grassley said. "Doesn't mean that I won't try to bring it up before 2009."

                                                                            Nevertheless, reform in the near term looks very unlikely.

                                                                              Posted by on Wednesday, November 9, 2005 at 12:05 AM in Economics, Politics, Social Security | Permalink  TrackBack (0)  Comments (19) 


                                                                              Tuesday, November 08, 2005

                                                                              Econoblog: Changing Times at the Fed

                                                                              The latest Econoblog at the Wall Street Journal featuring Tim Duy and William Polley is at:

                                                                              Econoblog: Changing Times at the Fed: Alan Greenspan will soon step down as chairman of the Federal Reserve and, if the Senate consents, hand the reins to former Fed governor and celebrated academic economist Ben Bernanke. But that's not the only change likely to be in store at the U.S. central bank.

                                                                              To be sure, Mr. Bernanke has vowed that he'll follow closely on the policy path marked by the Greenspan Fed. But he could bring along some new tools -- such as inflation targets -- to help him navigate. Further, Mr. Bernanke will be stepping to the helm as the Fed appears to be nearing the end of a long tightening cycle. Will he continue to raise interest rates, or apply the brakes to the central bank's long campaign to lift borrowing costs to a "neutral" level?

                                                                              The Wall Street Journal Online asked economist bloggers William Polley and Tim Duy to explore what the future might hold for the seat of U.S. monetary policy.

                                                                              I encourage you to read the discussion as well as William Polley's comments at his blog. Thanks to both for doing this. Also, the subscription wall is down this week at the WSJ so all content is free. Finally, here are all of Tim Duy's Fed Watch posts.

                                                                                Posted by on Tuesday, November 8, 2005 at 02:41 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0) 


                                                                                The Relationship between R&D and Successful Innovation

                                                                                As I continue to give others the floor tonight, here's Michael Schrage, a researcher at the Massachusetts Institute of Technology and Sweden’s Royal Institute of Technology on R&D spending and successful innovation:

                                                                                For innovation success, do not follow the money, by Michael Schrage, Financial Times: The “Chicken Littles” of Eurocompetitiveness are clucking in despair. The latest research shows that yet again, American and Asian companies have boosted their rates of research and development spending even as Europe’s own innovation investment has gone flat. ... Worse yet, Europe ranked last in the key global benchmark of “R&D intensity” – R&D spending as a percentage of sales. ... You can almost hear the Eurocrats crying: “The innovation is falling! The innovation is falling!” Is it perhaps time for some European soul-searching into the short-sighted and risk-averse nature of the continent’s industrial elite? Hardly. These global R&D budget numbers are an exercise in accurate rubbish. They simultaneously deceive and mislead.

                                                                                Any policymaker, chief executive or innovation champion who relies on R&D intensity and R&D budgets as a meaningful or usable metric to assess global competitiveness virtually guarantees shoddy analysis and distorted decisions. Few things reveal less about a company’s ability to innovate cost-effectively than its R&D budget. Just ask General Motors. ... “There is no correlation between the percentage of net revenue spent on R&D and the innovative capabilities of an organisation – none,” Bart Becht, chief executive of Reckitt Benckiser... said recently. The ... company reports an R&D intensity of 1 per cent. Nevertheless, Mr Becht’s company enjoys a reputation both for innovation and for relatively high margins... Similarly, Illinois Tool Works ... spends but 1 per cent of its revenues on R&D ... Yet the ... company is likewise regarded as a premier industry innovator that consistently ranks in the top 100 of US corporate patent recipients. Even Apple Computer defies the high-tech, high R&D intensity stereotype ... its ... R&D spending was a fraction of larger competitors such as Sony or Microsoft. Yet the iPod, iTunes and iBook enjoy breakthrough status as profitable innovations...

                                                                                This anecdotal evidence is not atypical. Last month, Booz Allen ... published a report confirming ... there was “no discernible statistical relationship between R&D spending levels and nearly all measures of business success including sales growth, gross profit, operating profit, enterprise profit, market capitalisation or total shareholder return”. In other words, more is not better. Econometricians may quibble over the survey’s methodological details but ... The simple fact is that R&D spending ... is an input, not a measure of efficiency, effectiveness or productivity. Ingenuity, invention and innovation are rarely functions of budgetary investment. ... [C]ompanies get far more design value for far less money from their information technology spending now than a decade ago. ... [by] doing more R&D in developing markets such as China and India where quality research is much cheaper... Consequently, comparisons between the corporate R&D intensities of today with the intensities of yesteryear become even less meaningful.

                                                                                R&D productivity – not R&D investment – is the real challenge for global innovation. Innovation is not what innovators innovate, it is what customers actually adopt. Productivity here is not measured in patents granted but in new customers won and existing customers profitably retained. ... Growing market competition, not growing R&D spending, is what drives innovation. A successful innovation policy is a competition policy where companies see innovation as a cost-effective investment to differentiate themselves profitably. ...

                                                                                If I were to take back the floor, I would note the existence of market failures requiring remedies such as government enforced patents and how such factors are related to the role of government and university research within this "free market" framework. Global enforcement of property rights and how that may affect innovation might also be discussed. And while it may be part of the solution, there are a lot more complicated issues to think about in this area beyond calling for increased competition as a means of increasing global innovative investment.

                                                                                  Posted by on Tuesday, November 8, 2005 at 12:52 AM in Economics, Market Failure, Technology | Permalink  TrackBack (0)  Comments (8) 


                                                                                  Krugman Responds in Money Talks

                                                                                  Paul Krugman responds to questions about two of his recent columns in Money Talks. In one response, he answers a question about converting Medicare to a national health insurance system:

                                                                                  On "Pride, Prejudice, Insurance," Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Lynne Koester, Yuba City, Calif.: Would it be feasible to convert Medicare into a national health insurance system? I realize that its present per-patient cost is high because of the age of those who qualify..., but if the pool were enlarged by including most all Americans, wouldn't the per-patient cost decrease? By eliminating the profits built into private health insurance companies, we could save even more money. Plus, when ill, many uninsured people presently use a hospital emergency room because they do not have medical insurance, but if they were covered by a national health insurance, they could be treated in a doctor's office, which is less costly than a hospital.
                                                                                  Paul Krugman: Yes, indeed. One way to implement national health care would simply be to expand Medicare to everyone. Of course, doing that would require additional funds, probably in the form of an increase in the payroll tax. And that would elicit howls from the right. But the apparent rise in tax rates would be an illusion: it would simply substitute an explicit tax for the implicit tax that companies and workers pay in the form of insurance premiums. Given international experience, I have no doubt that overall spending on health care would actually fall, and that job creation would actually rise, after the supposed tax increase. It's a simple solution, building on a program that we already know works. It would make the vast majority of Americans better off. And it's considered a complete non-starter politically. Now why is that?

                                                                                  In another response, Krugman answers questions from readers about where to get further information on international health care comparisons:

                                                                                  Notes on International Comparisons of Health Care, Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Some readers may want to follow up on my Nov. 7 column on international comparisons of health care. Here are a few useful links.

                                                                                  • Trends in employer-based insurance: The underlying data come from the Census. Here is a shorter, useful summary of the data.
                                                                                  • International comparisons of health spending: The Factbook of the Organization for Economic Cooperation and Development, an international research organization supported by member governments, is available at www.sourceoecd.org. It provides comparative data on many economic, environmental, and social trends. Data on health care spending per capita are ... adjusted for international differences in the cost of living. Two things stand out. First, the United States is off the scale in terms of the amount we spend per person. Second, the U.S. system is unique in its reliance on private spending.
                                                                                  • Quality of Health Care: “Taking the Pulse of Health Care Systems: Experiences of Patients With Health Problems in Six Countries,” is a new study published in Health Affairs. Check out Exhibits 6 and 7, in particular.
                                                                                  • Taiwan: A very interesting study, also online, is “Does Universal Health Insurance Make Health Care Unaffordable? Lessons from Taiwan.” Since it’s predictable that ... the usual suspects will attack my column by citing newspaper articles about runaway costs in Taiwan, it’s particularly interesting to read the paper’s discussion of how “political theater” – overstating the quite mild financial difficulties of the Taiwanese system – was used to sell a modest increase in premiums.

                                                                                  Finally, here's a comment Krugman included about his column on the role of the press:

                                                                                  On "Ending the Fraudulence," Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Bill Paoli, Oakland, Calif.: I liked your column but think it was too tepid. ... There are two factors that I think lead to our rotten press:

                                                                                  The first is laziness. Reporters seem to think that they have to have anonymous informants to get the news. They are unwilling to use their own eyes and ears and do the spade work necessary to get these stories. The obvious example of a muckraking journalist who avoided insiders and did not use anonymous sources was I.F. Stone. He never thought it was necessary to have drinks with the likes of a Karl Rove, for instance, something editor Bill Keller seems to favor. You mention the use of the interview as a favored device for reporting. Again, this is sheer laziness and it results in a journalistic product, not reporting.

                                                                                  Secondly, there is a complete lack of courage except for a few columnists here and there, including a few at your paper. There seems to be a status quo, common knowledge, everyone knows, undercurrent that blinds reporters to what would otherwise seem obvious. This is sometimes referred to as buying the party line... Of course this blindness also helps the old career along as well — no one is offended and everything is sweetness and light...

                                                                                    Posted by on Tuesday, November 8, 2005 at 12:21 AM in Economics, Health Care | Permalink  TrackBack (0)  Comments (15) 


                                                                                    Tax Reform Thoughts from Marginal Utility's Perspective

                                                                                    For reasons evident in the post below this one, I am going to let others do most of the talking, for the moment anyway. Tom Bozzo at Marginal Utility is reading the report from the Tax Reform Panel. I'm glad it's him and not me:

                                                                                    Marginal Utility: The Tax "Reform" Panel's Report: Some Thoughts: While tax "reform" may be deader than a dead dodo, in the spirit of teaching Democratic strategists a lesson from the other side's not-necessarily-evil behavior, I will not refrain from kicking it when it's down. This is in no way a comprehensive list, as I only have so much leisure time to devote to poring over the report.

                                                                                    1. Having Democrats around does matter: Had the panel recommended a consumption tax or a progressive wage tax a la the "X Tax" — thereby offering political cover to the right's goal of exempting investment income from taxation — a host of tax policy analysts from the AEI, Cato, Heritage, etc. would have been walking around resembling "Nail's Tales." Tom DeLay, I'm sure, would be describing the reforms as gilding the deck chairs on the Queen Mary 2 rather than re-arranging same on the Titanic. Some credit for this not happening must go to John Breaux, otherwise hardly a progressive's progressive, and other representatives of the center on the panel, who at least were not going to let zero rates for personal investment income fly.

                                                                                    2. Lies, damn lies, statistics, and marketing: Max Sawicky is right that the report is not only a policy analysis document. It's full of non-functional illustrations like this one, meant to dramatize how much better it will be to fill out the proposed 1040-SIMPLE than the existing 1040 (non-EZ, I presume):

                                                                                    Preying on fear of math may be effective, though doing so on page 107 of a several hundred page report overestimates the mean level of wonkery in the target audience.

                                                                                    The reality is, the existing income tax is not complicated at all for wage and salaries income, which accounts for the vast majority of income for the vast majority of taxpayers. Features like graduated tax rates don't count since tax tables turn the calculation (not advanced math to begin with) into a simple lookup, and anyway there are these things called computers and e-filing initiatives have driven the price of tax software effectively to zero.

                                                                                    The Simplified Income Tax alternative, meanwhile, introduces new complexity — e.g., regionally variable limits on the mortgage interest credit — and retains other forms, such as preferential treatments of some investment income. This provision may look simple:

                                                                                    (p. 108) Exclude 100% of dividends of U.S. companies paid out of domestic earnings.

                                                                                    Quick, define U.S. companies and domestic earnings! Does the former include tax-avoiding expatriates? Can you figure the latter while decreasing (other things equal) the level of employment in the transfer pricing business?

                                                                                    3. Dept. of "Are you kidding me?": The report does, early on, express a touching bit of concern for the possibility that tax rates distort labor supply decisions. When I was a student, some conservative economics professors actually were concerned about such things, before the obsession with capital market distortions took over. This, however, has to be the worst example ever:

                                                                                    (p.6) Let’s say you are just offered a great job at $120,000 a year. You are married with one child and your current salary is $80,000. You take the job, right? Not necessarily. The increase in salary might cause you to lose some of the child credit – and subject you to other provisions that increase your total tax bill even more, such as the alternative minimum tax. In all, the pre-tax jump in your new salary may be $40,000, but it could end up costing you an extra $9,203 in tax – meaning that your salary would rise by 50 percent while your tax liability would increase by 140 percent. Not surprisingly, some workers figure this out quickly and avoid taking on work... simply because of how the tax code penalizes that extra effort.

                                                                                    Forget for a moment that $120,000 is in a sufficiently high percentile of the wages-and-salaries distribution that relatively few people will have the problem of making the decision. Those percentages are highly misleading. Yes, tax increases more than income since the marginal rate on the extra $40,000 is higher than the average rate on the previous $80,000. But let's rephrase the problem. Define "great job" how you will. Would you forego the after-tax $30,797? (If yes, really? Why?) More later...

                                                                                      Posted by on Tuesday, November 8, 2005 at 12:12 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (1) 


                                                                                      Monday, November 07, 2005

                                                                                      FRB Survey on Bank Lending Practices

                                                                                      This analysis will have less teeth than usual. I had a broken and unrepairable tooth dug out while under a general anesthetic just under an hour ago and now it's time to start loading up on a few more pain pills. Should I blog in this condition? Why of course! When else can I say whatever I want and blame it on legally ingested drugs. I'm too self-conscious when I blog anyway. I told the oral surgeon there would be someone here to look out for me, but there won't be as I live alone, and even if there was I don't think stopping me from driving the heavy equipment that constitutes my computer is part of the deal anyway. So, about this Bush guy and his economic policies. Let me get a few things off my chest....

                                                                                      More seriously, I want to make you aware of a Fed survey on bank lending practices. These are just a few of the tables from the report, there's an accompanying analysis, but in all honesty given my current state of mind, I started to read it and dozed off almost immediately so I will set it aside for later or for others to report on (CR perhaps on the residential stuff?). There do appear to be some interesting tidbits here and there just from scanning it.

                                                                                      Here are the tables. A few very quick notes: (1) banks appear to be, surprisingly, easing credit standards in the residential loan market over the last three months. (2) demand appears to have weakened over the last three months, (3) the size of loans and length to maturity has increased moderately, and terms appear to have eased in general, (4) If I'm reading it right, a necessary qualifier right now, the last table says that banks did not change at all in response to the May 16, 2005, joint guidance on home-equity lines of credit issued by Federal regulators. This leads to speculation that recent talk of a stepped up regulatory response under Bernanke to events such as housing bubbles may not produce the desired decline in risky mortgages, at least not the type of regulatory response implemented in May:

                                                                                      Senior Loan Officer Opinion Survey on Bank Lending Practices, The Federal Reserve Board: ... Questions 9-12 ask about residential mortgage loans at your bank. ... If your bank's credit standards have not changed over the relevant period, please report them as unchanged even if the standards are either restrictive or accommodative relative to longer-term norms. If your bank's credit standards have tightened or eased over the relevant period, please so report them regardless of how they stand relative to longer-term norms. Also, please report changes in enforcement of existing standards as changes in standards.

                                                                                      9. Over the past three months, how have your bank's credit standards for approving applications from individuals for mortgage loans to purchase homes changed?

                                                                                      All Respondents Large Banks Other Banks
                                                                                      Banks % Banks % Banks %
                                                                                      Tightened considerably 0 0.0 0 0.0 0 0.0
                                                                                      Tightened somewhat 3 5.6 2 6.3 1 4.5
                                                                                      Remained basically unchanged 46 85.2 25 78.1 21 95.5
                                                                                      Eased somewhat 5 9.3 5 15.6 0 0.0
                                                                                      Eased considerably 0 0.0 0 0.0 0 0.0
                                                                                      Total 54 100.0 32 100.0 22 100.0

                                                                                      10. Apart from normal seasonal variation, how has demand for mortgages to purchase homes changed over the past three months? (Please consider only new originations as opposed to the refinancing of existing mortgages.)

                                                                                      All Respondents Large Banks Other Banks
                                                                                      Banks % Banks % Banks %
                                                                                      Substantially stronger 0 0.0 0 0.0 0 0.0
                                                                                      Moderately stronger 5 9.3 3 9.4 2 9.1
                                                                                      About the same 32 59.3 19 59.4 13 59.1
                                                                                      Moderately weaker 17 31.5 10 31.3 7 31.8
                                                                                      Substantially weaker 0 0.0 0 0.0 0 0.0
                                                                                      Total 54 100.0 32 100.0 22 100.0

                                                                                      11. Over the past two years , how have the following terms changed for mortgage loans to purchase homes originated by your bank? (Please assign each term a number between 1 and 5 using the following scale: 1=tightened considerably, 2=tightened somewhat, 3=remained basically unchanged, 4=eased somewhat, 5=eased considerably.)

                                                                                      All Respondents Large Banks Other Banks
                                                                                      Mean Mean Mean
                                                                                      Maximum size of primary mortgage 3.40 3.41 3.40
                                                                                      Maximum size of second mortgage 3.31 3.35 3.24
                                                                                      Maximum maturity 3.15 3.09 3.24
                                                                                      Maximum loan-to-value ratio including all outstanding loans for that property 3.26 3.28 3.24
                                                                                      Loan origination fees (higher fees=tightened, lower fees=eased) 3.11 3.03 3.24
                                                                                      Spreads of mortgage rates over an appropriate market base rate (wider spreads=tightened, narrower spreads=eased) 3.28 3.34 3.19
                                                                                      Maximum length of extended interest-rate locks 3.08 3.00 3.19
                                                                                      Maximum debt-service ratio including all other debt payments 3.19 3.22 3.14
                                                                                      Minimum required credit score 3.09 3.16 3.00
                                                                                      Other (please specify) 3.00 3.00 3.00
                                                                                      Number of banks responding 53 32 21

                                                                                      12. Because of rapid growth in home equity lending that has involved products with higher embedded risk, federal bank regulators released, on May 16, 2005, joint guidance on home-equity lines of credit (SR 05-11). In light of the concerns expressed in the supervisory letter, how has your bank changed its lending standards and terms for home equity lines of credit? (Please assign each term a number between 1 and 5 using the following scale: 1=tightened considerably, 2=tightened somewhat, 3=remained basically unchanged, 4=eased somewhat, 5=eased considerably.) Note: The text of the letter is available from the Board's public website:

                                                                                      All Respondents Large Banks Other Banks
                                                                                      Mean Mean Mean
                                                                                      Credit standards 2.95 2.97 2.92
                                                                                      Price-related terms (higher fees and wider spreads=tightened; lower fees and narrower spreads=eased) 2.91 2.90 2.92
                                                                                      Non-price-related terms 2.95 2.94 2.96
                                                                                      Number of banks responding 55 31 24

                                                                                        Posted by on Monday, November 7, 2005 at 03:42 PM in Economics, Housing, Regulation | Permalink  TrackBack (0)  Comments (6) 


                                                                                        A Drunk and Her Dog: An Illustration of Cointegration and Error Correction

                                                                                        Some of you will surely want to scroll past this post to the post on Krugman's column about health care or perhaps the next post on Blanchard's discussion of European unemployment, or further down to something, anything, but econometrics. I was asked about the connection between cointegration and error- correction models, terms used frequently in macroeconomics and time-series econometrics. This explanation is fairly intuitive and will, hopefully, help to clarify these terms (the equations can be skipped). It's from Michael P. Murray, "A Drunk and Her Dog: An Illustration of Cointegration and Error Correction," The American Statistician, Vol. 48, No. 1. (Feb., 1994), pp. 37-39:

                                                                                        Update: Open link to paper - Thanks Paul.

                                                                                          Posted by on Monday, November 7, 2005 at 12:25 AM in Academic Papers, Economics | Permalink  TrackBack (0)  Comments (3) 


                                                                                          Paul Krugman: Fixing Health Care

                                                                                          With so many companies such as General Motors and Delphi reducing medical benefits, with Wal-Mart's recent plans to cut healthcare costs by screening out high medical cost job applicants, with recent discussions about reducing the government's role in economic security, including healthcare, and with demographic realities in front of us, Paul Krugman examines the most efficient means of satisfying our health needs of the future, and what it will take to get there. He sees two factors standing in the way, prejudice that does not allow us to get over mistaken ideology that the private sector is always more efficient than the government, and the inability to overcome our pride and admit that other countries may have better ideas than we do in this area:

                                                                                          Pride, Prejudice, Insurance, by Paul Krugman, NY Times: ...Employment-based health insurance is the only serious source of coverage for Americans too young to receive Medicare and insufficiently destitute to receive Medicaid, but it's an institution in decline. ... The funny thing is that the solution - national health insurance ... - is obvious. But to see the obvious we'll have to overcome pride - the unwarranted belief that America has nothing to learn from other countries - and prejudice - the equally unwarranted belief, driven by ideology, that private insurance is more efficient than public insurance. Let's start with the fact that America's health care system spends more, for worse results, than that of any other advanced country. In 2002 the United States spent $5,267 per person on health care. Canada spent $2,931; Germany spent $2,817; Britain spent only $2,160. Yet the United States has lower life expectancy and higher infant mortality than any of these countries.

                                                                                          But don't people in other countries sometimes find it hard to get medical treatment? Yes ..but so do Americans. ... The journal Health Affairs recently published ... a survey of the medical experience of "sicker adults" in six countries, including Canada, Britain, Germany and the United States. ... It's true that Americans generally have shorter waits for elective surgery ... although German waits are even shorter. But Americans ... find it harder ... to see a doctor when we need one, and our system is more, not less, rife with medical errors. Above all, Americans are far more likely than others to forgo treatment because they can't afford it. ...

                                                                                          Why does American medicine cost so much yet achieve so little? ...[W]e treat access to health care as a privilege rather than a right. And this attitude turns out to be inefficient as well as cruel. The U.S. system is much more bureaucratic, with much higher administrative costs, ... because private insurers and other players work hard at trying not to pay for medical care. And our fragmented system is unable to bargain with drug companies and other suppliers for lower prices. Taiwan... offers an object lesson in the economic advantages of universal coverage. In 1995 less than 60 percent of Taiwan's residents had health insurance; by 2001 the number was 97 percent. Yet ... this huge expansion in coverage came virtually free: it led to little if any increase in overall health care spending ... The economic and moral case for health care reform in America... is overwhelming. One of these days we'll realize that our semiprivatized system isn't just unfair, it's far less efficient than a straightforward system of guaranteed health insurance.

                                                                                          I agree. As discussed extensively at this site, there are important market failures in the provision of social insurance, moral hazard is one problem, adverse selection is another, the inefficiencies from fighting over who pays the bills identified by Krugman is yet another, that make the private sector provision of social insurance less efficient than public sector provision.

                                                                                          [See this NBER paper for more on the insurance value of government provided health insurance. See "Passing the Buck" for more from Krugman on this topic.]

                                                                                            Posted by on Monday, November 7, 2005 at 12:06 AM in Economics, Health Care, Market Failure | Permalink  TrackBack (0)  Comments (20) 


                                                                                            Sunday, November 06, 2005

                                                                                            Blanchard: "European Unemployment: The Evolution of Facts and Ideas"

                                                                                            This is a timely paper on unemployment in Europe that, with the appropriate degree of humility, asks what we do and don't know about persistently high average unemployment rates in Europe:

                                                                                            European Unemployment: The Evolution of Facts and Ideas, by Olivier Blanchard, NBER WP 11750, November 2005: Abstract In the 1970s, European unemployment started increasing. It increased further in the 1980s, to reach a plateau in the 1990s. It is still high today, although the average unemployment rate hides a high degree of heterogeneity across countries. The focus of researchers and policy makers was initially on the role of shocks. As unemployment remained high, the focus has progressively shifted to institutions. This paper reviews the interaction of facts and theories, and gives a tentative assessment of what we know and what we still do not know. [free September Version] [free October version] See also "Explaining European Unemployment."

                                                                                            The paper is worth reading for more than this particular point, but given the increasing job insecurity arising from globalization and other forces, I want to highlight an important distinction Blanchard makes between protecting jobs and protecting workers:

                                                                                            6 Do We Know Enough to Give Advice? At the end of this tour, one may ask whether we know enough to give advice to policy makers about how to reduce unemployment. I believe we do—with the proper degree of humility. ...

                                                                                            6.1 A General Story Line Going back over the last thirty years, there is little question that the initial increase in unemployment in Europe was primarily due to adverse and largely common shocks, from oil price increases to the slowdown in productivity growth. There is not much question that different institutions led to different initial outcomes. ... There is not much question, ... that the increase in unemployment led... most countries.. to changes in institutions... to limit the increase in unemployment through employment protection, and to reduce the pain of unemployment through more generous unemployment insurance. There is not much question that, since the early 1980s... most governments have partly reversed the initial change in institutions. But this reversal has been partial, and sometimes perverse. The different paths chosen may well explain the differences in unemployment rates across European countries today. ...

                                                                                            6.2 Which Institutions? It is one thing to say that labor market institutions matter, and another to know exactly which ones and how. Humility is needed here, and there is no better reminder than the comparison between Portugal and Spain. Both experienced revolutions and wage explosions in the 1970s ... both have, at least on the surface, rather similar institutions, including high employment protection. Yet, Spanish unemployment has been very high, exceeding 20% in the mid–1990s, whereas Portuguese unemployment has remained low, with a high of 8.6% in the mid–1980s, and a decrease thereafter. Many researchers, including myself, have tried to trace the differences to differences in shocks or institutions ... I am not sure that our explanations are much more than ex-post rationalizations. ... Nevertheless, even if one cannot pretend to have much confidence about the optimal overall architecture, much has been learned ... We know much more about the incentive aspects of unemployment insurance on search intensity and unemployment duration... We know more about the effects of decreasing social contributions on low wages ... We know more about the effects of employment protection, ... From both the macro evidence and this body of micro–economic work, a large consensus—right or wrong—has emerged:

                                                                                            • It holds that modern economies need to constantly reallocate resources, including labor, from old to new products, from bad to good firms.
                                                                                            • At the same time, workers value security and insurance against major adverse professional events, job loss in particular. While there is a trade-off between efficiency and insurance, the experience of the successful European countries suggests it need not be very steep.
                                                                                            • What is important in essence is to protect workers, not jobs.
                                                                                            • This means providing unemployment insurance, generous in level, but conditional on the willingness of the unemployed to train for and accept jobs if available.
                                                                                            • This means employment protection, but in the form of financial costs to firms to make them internalize the social costs of unemployment, including unemployment insurance, rather than through a complex administrative and judicial process.
                                                                                            • This means dealing with the need to decrease the cost of low skilled labor through lower social contributions paid by firms at the low wage end, and the need to make work attractive to low skill workers through a negative income tax rather than a minimum wage.

                                                                                            This consensus underlies most recent reforms or reform proposals ... These measures are probably all desirable. If they were to be implemented, would they be enough to eliminate the European problem? I see ... reasons to worry. ... these reforms deal only with a subset of the institutions that govern the labor market. ...

                                                                                              Posted by on Sunday, November 6, 2005 at 11:39 AM in Academic Papers, Economics, Social Security, Unemployment | Permalink  TrackBack (1)  Comments (26) 


                                                                                              Keeping Up With the Experiential Joneses

                                                                                              This just might be crazy enough to be correct:

                                                                                              Material riches fail the happy test, by Henry Tricks, Financial Times: Rich people are likely to find more happiness scuba-diving or going to a concert than buying that Ferrari, global investors were told on Friday. According to what many in financial circles will regard a heretical piece of research by Dresdner Kleinwort Wasserstein, materialistic goals may even cause dissatisfaction with life and mental disorders such as paranoia. The report by James Montier, DrKW global equity strategist, comes a year after he shocked clients with ... another jaw-dropping suggestion, that money and happiness shouldn't be equated. Building on the theme, he said on Friday that there was a mass of evidence to suggest that spending on experiences, such as walking the Machu Picchu trail in Peru, rather than possessions, such as “flash watches”, seemed to make people happier, provided their basic needs were satisfied. This notion applied to people once they were earning more than $25,000. “This doesn't mean you have to give your wordly possessions away, although there may be a lot to say for this,” he told clients. Explaining the benefits of experiences over possessions, he said they tended to be unique, whereas a house or car is likely to become the norm very quickly. He urged readers to avoid a keep-up-with-the-Joneses syndrome. However, other experts believe that is a pipe dream. “Human beings have to look over their shoulder before they decide how happy they feel,” said Andrew Oswald, professor of economics at Warwick University.

                                                                                              So, like he says, avoid those paranoia inducing materialistic goals. Instead, grab that new scuba gear made possible by the home equity loan, take advantage of those expensive diving lessons, and enjoy yourself! Just don't drive there in a Ferrari.

                                                                                                Posted by on Sunday, November 6, 2005 at 12:48 AM in Economics | Permalink  TrackBack (1)  Comments (14) 


                                                                                                Charitable Tax Write-Offs and Social Insurance

                                                                                                Reigning in improper tax write-offs for charitable donations is a good idea, though it will dissuade people from giving to private sector non-profits at a time when charities are expected to satisfy a larger share of the need for social insurance. The proposal by senator Santorum to allow people to cash in their IRAs and give the proceeds to charity would offset this fall in donations. However, I don't see any reason to give people an incentive to save less for retirement and then expect non-profits to use the donated IRA money to bail out those with insufficient saving down the road. I must be missing something. Why is encouraging people to cash in their IRAs a good idea?:

                                                                                                Tax-Bill Provisions Would Limit Charity Write-Offs, by Jacqueline L. Salmon, Washington Post: ... This week, senators are expected to propose rules that would limit a number of charitable write-offs. ... Last year, Congress tightened rules for donations of vehicles and gifts of intellectual property. This week, Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) is expected to propose amendments to the tax-reconciliation bill ... that would ... would tighten rules on appraisals of non-cash charitable donations, such as art, land and closely held stock. Another would limit deductions for donations of easements that protect the outward appearance of historic buildings... And those who donate clothing and household goods to charities will no longer be able to guess at their value. Under a Grassley proposal, they would have to consult a guide, to be published by the Internal Revenue Service, to determine the value of the items. ... The news isn't all grim for charities and their contributors. Sen. Rick Santorum (R-Pa.) is expected to offer a proposal allowing taxpayers to withdraw money from their individual retirement accounts and donate it to charities, a provision long sought by nonprofit organizations. ... In the coming months, it is expected to consider proposals that would expand disclosure requirements for charities and modify the way they govern themselves.

                                                                                                  Posted by on Sunday, November 6, 2005 at 12:21 AM in Economics, Social Security, Taxes | Permalink  TrackBack (0)  Comments (4) 


                                                                                                  How Much Will Google Enhance Competition?

                                                                                                  In order for competition to flourish in the marketplace, consumers must be fully informed. It does no good to have many sellers of a good if consumers do not know where they are located, the prices they are charging, the quality of their product, and so on. This article discusses ways in which Google and other search engines will allow consumers to access such information in the future. How much of a a decline in market power will occur if consumers can begin to do the types of refined and informed searches discussed in this article? How this will change how firms compete?  The potential is large in many industries and it won't be surprising to see firms opposing Google's attempts to allow consumers access to the types of information that would take away advantages based upon imperfect information:

                                                                                                  Just Googling It Is Striking Fear Into Companies, by Steve Lohr, New York Times: Wal-Mart, the nation's largest retailer, often intimidates its competitors and suppliers. ... But there is one company that even Wal-Mart eyes warily these days: Google... In Google, Wal-Mart sees both a technology pioneer and the seed of a threat... The worry is that by making information available everywhere, Google might soon be able to tell Wal-Mart shoppers if better bargains are available nearby. Wal-Mart is scarcely alone in its concern. ... Businesses already feeling the Google effect include advertising, software and the news media. Apart from retailing, Google's disruptive presence may soon be felt in real estate and auto sales. ... And ever-smarter software... will cull and organize larger and larger digital storehouses of news, images, real estate listings and traffic reports, delivering results that are more like the advice of a trusted human expert. Such advances... would be an unsettling force for all sorts of industries and workers. But it would also reward consumers with lower prices and open up opportunities for new companies. ...

                                                                                                  Among the many projects being developed and debated inside Google is a real estate service, according to a person who has attended meetings on the proposal. The concept... would be to improve the capabilities of its satellite imaging, maps and local search and combine them with property listings. The service... could make house hunting far more efficient...  Search engines, combined with other technologies, have the potential to drive comparison shopping down to the shelf-by-shelf level. Cellphone makers, for example, are looking at the concept of a "shopping phone" with a camera that can read product bar codes. The phone could connect to databases and search services and, aided by satellite technology, reveal that the flat-screen TV model in front of you is $200 cheaper at a store five miles away. ... Such services could lead to lower prices for consumers, but also relentless competition that threatens to break up existing businesses. ...

                                                                                                    Posted by on Sunday, November 6, 2005 at 12:18 AM in Economics, Market Failure, Technology | Permalink  TrackBack (0)  Comments (2) 


                                                                                                    Graphs Gathered from Blogs (October 2005)

                                                                                                    The collection of graphs is at Optimetrica:

                                                                                                    Graphs Gathered from Blogs (October 2005).

                                                                                                    There is also a directory of links to graphs from other months.

                                                                                                      Posted by on Sunday, November 6, 2005 at 12:09 AM in Economics, Graphs | Permalink  TrackBack (0)  Comments (0)