James Crabtree from NDN reports on a speech given today by Paul Krugman:
Paul Krugman’s Remarks at New America Foundation Economic Conference: DISCLAIMER: These notes were taken by NDN’s James Crabtree from Paul Krugman’s opening address to the New America Foundation’s “Back to the Economy” conference on Monday October 30th 2006. They are notes only, not a written speech circulated by Mr. Krugman. Any quotes taken should make clear that this is not a verbatim or official transcript.
Where is the economy? If you look at the last 6 years, the official history is misleading. We had a very brief recession in 2001, and the recovery began in November of that year. But in practice it didn’t feel that way. We had sluggish growth and lost jobs up to 2003. What felt like a recovery didn’t start until mid-2003.
Since then the expansion has been ok, but not great. The unemployment rate has fallen largely because the fraction of the adult population looking for a job has fallen. Wages are nowhere. Profits are spectacular. Top shares of income – best as we can tell – fell fairly steeply at the beginning of the decade, but came roaring back post 2003.
Lots of talk of tax revenue coming back up, much more quickly than anyone expected. There is a way to think about this. Look at the early years of the Bush economy, and revenue fell by much more than you can explain by the policies. The fall of revenue of was c4% of GDP, despite tax cuts being only 2%. We think this is mostly because of lower capital gains receipts. Now we have just made up that ground. So revenue is now a little bit below what you might have thought it would have been without the previous fall. Overall it isn’t that big a thing.
How did the tax receipts go up? Look at the CBO monthly budget report. What it says is that corporate profits taxes have gone up 28%. Nonwithheld individual income tax is up a lot too, at c17%. This is mostly capital gains on executive bonuses. On the other hand social insurance receipts are up only 5%, which is slower than usual. Basically there has been a large redistribution of income to the top.
In general economic terms we are off the map - in two ways on (1) housing and (2) the trade deficit. Because we are off the map, we are struggling to use our fundamental understanding of economics, and some dubious number crunching, to make sense of a situation that doesn’t look like anything we’ve seen before.
1. Housing. Adjusted for inflation house prices are up 50% by 2000. If this was the end of the story you could just about justify this in terms of lower interest rates and other things. But that isn’t the right comparison. It depends on where you look. 1/3rd of the US lives in areas of land scarcity and restrictive zoning. 2/3rds live elsewhere, where land is plentiful. In these “flat lands” the price of houses doesn’t respond to demand much. Home prices in Houston haven’t risen. In the rest of the nation, that 1/3rd. you find that house prices are up 80 – 100%. Here it really does look like a bubble. People have extrapolated from rising prices that things will keep rising. The result is a surge in housing demand, with huge impact on the economy. Residential constructions was up to 6.3% of GDP, up from c4%. This is clearly a bigger GDP stimulus than all of the bush tax cuts.
2. Trade Deficit. We finance our deficit by borrowing. This cannot go on indefinitely. Stein’s law – re: Herbert Stein – “if something cannot go on forever it will stop.” If this happens then any kind of scenario will have to involve a substantial fall in the dollar. And the markets are not taking this into account. Inflation adjusted bond rates seem incorrectly priced, compared to the EU or Japan. Some bonds are being bought by foreign based banks for non-market reasons. But many are not. So the market, if it took the dollar decline into account, would price this in. There will be a Wily Coyote moment. When? I would have said the answer was two years ago, so I’ve been wrong before. But it will happen at some point.
So here is the economic problem. We have a big trade deficit and a highly inflated housing sector. One result has been that we’ve lost a lot of manufacturing jobs – which are tradable – but we’ve made that up in domestically orientated employment. (Among other things this has included a c50% increase in real estate jobs.) Eventually this will slide back, and we’ll see more jobs in manufacturing if exports pick up. The thing is that the transition will be unlikely to be smooth.
What will happen? If you asked me a year ago I thought the Wiley Coyote moment would lead to a rise in interest rates, and then a collapse in the housing boom. Then the question would be could exports rise to take up the slack? But this hasn’t happened. What is actually happening is that housing is falling first, without any fall in the dollar. This is what is reflected in the GDP figures. The last quarter was pretty bad – and probably worse than the figures suggest. There are several parts of that report which look implausible. Automobile production, for instance, is unlikely to be going up at a 26% annual rate.
Where do we go from here? I’ve never seen economists disagreeing so much. Not about what will happen in 1 year, but what will happen in the 4th quarter, which we are half way through. Some people say rebounding. Some say worse is to come. The reason for this is conflicting trends. Housing is falling like a stone. Maybe it has hit bottom. But probably not. The fundamentals still look like housing has a long way down to go. The norm for housing construction is c4%, its now down to 5.7% down from above 6%. So I think housing will be much worse.
But as Larry Summers like to say “you don’t have to fill a flat tire through a hole.” There are reasons for optimism. Business investment is still good. Construction spending is up. (A lot of this is hotels.) Consumer spending is still going up, until and unless they revise the numbers down.
Overall, I’m with the pessimists. But I’m not sure how solid my ground is. It is really hard to say. The odds are that consumer spending will take a hit from current trends. Whether it is a formal recession or not, I don’t know. Meryl Lynch project a sharp rise in unemployment over the next year. Oddly, this is quite consistent with no fall in output. But it would feel like a recession.
The thing to be worried about is the difficulty of a policy response. We normally count on the Fed to respond. (Bernanke, on the whole, has had his judgment on rates vindicated.) But if this turns nasty, what will the Fed do? They will cut rates. And will this help? Where is the traction on the real economy? The problem is that rate cuts stimulate the economy mostly through the housing and construction market. In truth, business investment is not sensitive to the Fed and consumers don’t respond. Housing is where the rubber meets the road. So that is a worry.
Also, there is a hint at least in the latest data the productivity boom is losing steam. There is a hint that we had our big tech-driven productivity boom. If that is true, that will make everything more difficult in the decade ahead. A lot of people are saying that we might need to put potential growth down half a point.
I hope you will thank James for taking and transcribing these notes by visiting NDN's blog and reading the speech Rob Shapiro gave at the conference and also the remarks from James Crabtree on Krugman's comments.