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Wednesday, December 19, 2012

Inflation is Caused by Monopoly Power?

Why would a reputable economist endorse nonsense like this from Mickey Kaus (you know who you are):

If increased concentration lets ”corporations use their growing monopoly power to raise prices” couldn’t that be, you know, inflationary? But Krugman’s spent another trillion pixels lecturing us about how inflation is not a threat. Discuss.

One possible answer, Krugman Derangement Syndrome. [There's more nonsense where that came from, and not just in this article, but I just can't link the Daily Caller in good conscience.]

    Posted by on Wednesday, December 19, 2012 at 09:55 AM in Economics, Inflation, Market Failure | Permalink  Comments (28) 

    'Central Banks Can Phase in NGDP Targets without Damaging the Inflation Anchor'

    Jeff Frankel urges central banks to adopt a nominal GDP target:

    Central banks can phase in nominal GDP targets without damaging the inflation anchor, by Jeffrey Frankel, Vox EU: The time is right for the world’s central banks to reconsider the framework they use in conducting monetary policy. The US Federal Reserve and the ECB are still grappling with sustained economic weakness, despite years of low interest rates. In Japan, Shinzō Abe, the new prime minister from the Liberal Democratic Party (LDP), was elected on the promise of a new, more expansionary monetary policy (Financial Times 2012). In the UK, Mark Carney, the incoming Governor of the Bank of England, is open to new thinking.

    Monetary policymakers would do well to consider a shift toward targeting nominal GDP; Carney is evidently considering precisely this. They could phase in such a switch in two steps, in such a way as to preserve credibility with respect to inflation.

    A number of monetary economists pointed out the robustness of nominal GDP targeting after monetarist rules broke down in the 1980s.1 “Robustness” refers to the target’s ability to hold up in the long term under various shocks. The context at that time was the need in advanced countries for an explicit anchor to help bring expected inflation rates down. The status quo regime to achieve this, during the heyday of monetarism, was a money growth rule. Relative to the money growth rule, the advantage of nominal GDP targeting was robustness with respect to velocity shocks in particular.

    These days, both the presumptive nominal anchor and cyclical context are very different than they were in the 1980s. The popular regime is inflation targeting. The advantage of a nominal GDP target relative to a CPI target is robustness, in particular, with respect to supply shocks and terms of trade shocks. For example, a nominal GDP target for the ECB could have avoided July 2008’s mistake: the ECB responded to a spike in world oil prices by raising interest rates to fight consumer price inflation, just as the economy was going into recession. A nominal GDP target for the US Federal Reserve might have avoided the mistake of excessively easy monetary policy during 2004-6, a period when nominal GDP growth exceeded 6%.

    The return of nominal GDP targeting

    Why have proposals for nominal GDP targeting been revived at this particular juncture, after two decades of obscurity? The motive, in large part, is to deliver monetary stimulus and higher growth – needed in the US, Japan, UK and the Eurozone – while still maintaining a credible nominal anchor.2 For a country teetering on the fence between recovery and recession, such as the Eurozone, a target for nominal GDP that constituted a 4 or 5% increase over the coming year would in effect supply as much monetary ease as a 4% inflation target.

    Some economists, such as IMF Chief Economist Olivier Blanchard (2010), have proposed responding to recent high unemployment by setting a target for expected inflation above the traditional 2% – say, 4% – as a way of reducing real interest rates in the presence of the “zero lower bound” on nominal interest rates. They like to remind Fed Chairman Ben Bernanke of similar recommendations that he made to Japan in the past.

    Little support for high inflation target

    Many central bankers are strongly averse to countenancing inflation rate targets of 4%, or even 3%. They do not want to abandon the hard-won 2% number that has succeeded in keeping inflation expectations well-anchored for so many years. Economists can say that the upward change in the inflation target would be made explicitly temporary, but central bankers worry that to target a higher number even temporarily would do permanent damage to the credibility of the long-term anchor.

    This is also a reason why these same central bankers are wary of the current proposals for nominal GDP targeting.3 Fed governors, for example, worry that to set a target for nominal GDP growth of 5% or more in the coming year would naturally be interpreted as setting an inflation target in excess of 2%, and thus again would damage the credibility of the anchor, permanently. Their reluctance to give up on 2% is unlikely to change. But it doesn’t have to.

    A nominal GDP target

    The practical solution for overcoming these worries entails phasing in a nominal GDP target in two steps.

    One of the main communications devices currently used by the US Federal Reserve is the Summary of Economic Projections. The governors and regional presidents give their forecasts of real growth rate and inflation rates for each of the next three years and for the long run – as well as for interest rates. The press interprets these as policy statements, even if they are only labeled projections.

    My proposal is to start, in Phase I, by:

    • Omitting near term projections for real growth and inflation.

    Do keep the longer-run projection, and keep it at the setting where it is, 2% – formerly 1.5-2% – for the US. But add a longer run projection for nominal GDP growth as well, which should be around 4-4.5% to avoid any discontinuous jumps. That number would imply a long-run real growth rate of 2-2.5%, the same as now. Nobody could call such a move inflationary. For Japan, the targets for nominal and real GDP growth would have to be set at lower levels, due in part to the absence of population growth.

    A few months later, in Phase II:

    • Add projections for nominal GDP growth for the next three years.

    These numbers should be greater than 4% – perhaps 5% in the first year, rising to 5.5% after that – but with the long run projection unchanged at 4 or 4.5%. Much public speculation would ensue, as to how the 5.5% breaks down between real growth and inflation. The truth is that the central bank has no control over that – monetary policy determines the total but not the breakdown – and thus doesn’t know what the answer is any more than anyone else does. But the nominal GDP target would insure that either real growth will accelerate, as we hope, or if real growth falls short, there will be an automatic decline in the real interest rate which will push up demand. The targets for nominal GDP growth could be chosen so as to put the level of nominal GDP on an accelerated path back to its pre-recession trend. In the long run, when nominal GDP is back on its path of 4-4.5%, real growth will be back at its potential, say 2.5%, and inflation back at 1.5%-2%.

    This way of phasing in nominal GDP targeting delivers the advantage of some stimulus now, when it is needed, while satisfying central bankers’ reluctance to abandon their cherished low inflation target.


    Bean, C (1983), “Targeting Nominal Income: An Appraisal”, The Economic Journal, 93, 806-819.

    Bernanke, B, (2000), “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” Chapter 7 in Ryoichi Mikitani and Adam S. Posen (eds.) Japan’s Financial Crisis and Its Parallels to U.S. Experience, pp. 149-166, Institute for International Economics.

    Blanchard, O, G Dell’Ariccia and P Mauro (2010), “Rethinking Macroeconomic Policy”, IMF Staff Position Note, 12 February.

    Financial Times (2012), “Monetary policy moves to forefront in Japan”, December 17.

    Frankel, J (1995), "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking 27, 2, May, 318-334.

    Frankel, J (2012), “Inflation Targeting is Dead. Long Live Nominal GDP Targeting,” VoxEU.org, 19 June.

    Feldstein, M and J Stock (1994), “The Use of a Monetary Aggregate to Target Nominal GDP” in N Gregory Mankiw (ed.) Monetary Policy, NBER, University of Chicago Press).

    Hall, R E and N G Mankiw (1994), “Nominal Income Targeting”, in N Gregory Mankiw, ed., Monetary Policy, (University of Chicago Press), 71-93.

    Hatzius, J (2011), “The Case for a Nominal GDP Level Target,” US Economics Analyst, issue 11/41, Goldman Sachs, October.

    Krugman, P (2011), “A Volcker Moment Indeed (Slightly Wonkish),” blog, 30 October.

    Krugman, P (2012a), “Two per cent is not enough”, The New York Times, 26 January.

    Krugman, P (2012b), “Earth to Bernanke”, The New York Times, 24 April.

    McCallum, B T and E Nelson (1998), “Nominal Income Targeting in an Open-Economy Optimizing Model,” Journal of Monetary Economics, 43(3), 553-578.

    Meade, J (1978), “The Meaning of Internal Balance”, The Economic Journal, 88, 423-435.

    Romer, C (2011), “Dear Ben: It’s Time for Your Volcker Moment,” The New York Times, 29 October.

    Woodford, M (2012) “Methods of Policy Accommodation at the Interest-Rate Lower Bound,” presented at the Jackson Hole symposium, August, Federal Reserve Bank of Kansas City.

    1 James Meade (1978), followed by Bean, Hall, McCallum, West, Feldstein, Stock, Frankel, McKibbin.

    2 The new proponents show up on the left, the right, and the center of the political spectrum: Romer (2011), Krugman (2011); on the Left; Scott Sumner (at Money Illusion), Lars Christensen (at Market Monetarist), David Beckworth (at Macromarket Musings) on the Right; Goldman Sachs (2011) and Woodford (2012) in the center.

    3 Central bankers have long had some other concerns as well about nominal GDP targeting. (1) One is that the public doesn’t know the difference between nominal GDP, real GDP and inflation. But communications clarity is not a reason to go with a complicated function of inflation and real growth (as in the ubiquitous Taylor rule) as opposed to the simpler nominal income target. Furthermore, the financial markets do understand the difference. (2) Central bankers also worry they may not be able to achieve the target. Needless to say, the margin around the target could and should be wide, though there is no reason why it has to be wider than the bands around the old M1 targets or the more recent inflation targets, and there are reasons to think the width of a nominal GDP band could be a bit less. Moreover, under current conditions, the shift in policy need be nothing more than a commitment to keep monetary policy easy so long as nominal GDP falls short of the target. It would thus serve a purpose similar to the Fed’s December 12, 2012, announcement that it would keep interest rates low so long as the unemployment rate remains above 6.5% - but it would not suffer the imperfections of the unemployment number (particularly its inverse relationship with the labor force participation rate and its tendency to lag other measures of expansion).

      Posted by on Wednesday, December 19, 2012 at 12:33 AM in Economics, Monetary Policy | Permalink  Comments (122) 

      Links for 12-19-2012

        Posted by on Wednesday, December 19, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (62) 

        Tuesday, December 18, 2012

        Galbraith: Change of Direction

        Via Roger Strassburg, a talk by Jamie Galbraith (there is also an accompanying interview, I'll post it tomorrow):

        Change of Direction, IG Metall Conference – Berlin, Germany Professor James K. Galbraith December 6, 2012 [audio]: My friends, it is a pleasure and honor to be asked to speak to you this morning. And I want to begin by congratulating you for taking up a theme that I think is a common theme around the world – the idea of the good life.
        I suppose I first encountered this theme a year or so ago at a meeting to discuss the future of development in Ecuador. And it reflects a little bit of the concerns my father had late in his life when he wrote a book entitled, “The Good Society.”
        I think it is a right and resonant theme for the future as we grapple with the problems that we face today. But first we must indeed deal with these problems —with the dark matters and imminent dangers that are before us now. And so I will focus my remarks on the first two words in the title of this conference, the question of changing course.
        Five years ago when the great financial crisis broke into public view, those who claimed falsely that no one could have predicted it also claimed that our economies would recover. Standard forecasts foretold rapid growth and high employment within five years. Banks in America would start lending again. Confidence would return in Europe. Those of us who said no, that there would be no return to normal, were for the most part ignored. Yesterday we heard Professor Nouriel Roubini give a magisterial and very high speed tour of the world situation making it clear of course that the promised recovery has not occurred. But if Nouriel is Sir Isaiah Berlin’s fox, who knows many things, let me try this morning to be the hedgehog who knows one big thing, and that one big thing is that what we are experiencing is a single, unified, global crisis of the economy and of the financial system. It is not a cluster of distinct and separated events; a subprime crisis in the United States; a public debt crisis in Greece; a bank crisis in Iceland; a real estate bust in Ireland and Spain; nor are there distinct U.S. and European crises, nor can the financial be separated from the real, nor is Germany a country to which crisis has not yet come with the suggestion that there might be some separate way out. There is one crisis, only one crisis, a deeply interconnected crisis of the world system. This crisis has, I think, three deep sources going back not twenty years but forty years to the early 1970s and the end of what we sometimes call the “golden age,” the “glorious thirty” years in the immediate aftermath of the second World War.
        The first of the three deep sources is, I think, the rising real cost of the resources that we use, of energy and of everything that we use energy for. This was a problem that emerged in the 1970s and was then submerged again; it was deferred by new discoveries, by the geopolitical situation, and by the financial power of the western countries, which because of the debt crisis in much of the rest of the world had the effect of suppressing demand for these core resources. But this is a problems that can no longer be avoided or deferred. The cost of energy is roughly twice of what it was a decade ago and the future is far more uncertain. Both of these factors, cost and uncertainty, place a squeeze on the surplus or profitability in regions, continents, and countries that are importers of these resources. And as we confront, as we must, the problem of climate change and as we begin, as we must, to pay the price of climate change this problem is going to become more difficult. That’s just an economic reality that we have to cope with as we face the imperative before us.
        The second great underlying issue it seems to me is technical change, the particular character of which in our time is quite different from what is was before. If you take the digital revolution together with globalization, the ease of transnational manufacturing and also to some degree the outsourcing of services, we find we live in an era where technology is radically labor-saving. It supplants workers. One thing that we can say without too much exaggeration is that the computer and the many associated technologies that have derived from it are now doing to the office worker what a century ago the internal combustion engine did to the horse.
        And the third great source of our problem is ideological. It is the neo-liberal idea that has given us deregulation and de-supervision; that has given us the notion that markets can function on their own without breaking down or blowing up. It is this notion as applied especially to finance. This is the great illusion of the last generation, and it fostered a form of economic growth that was intrinsically unstable and unsustainable. Why? Because it was based on declining standards for loans and on lax accounting of the proceeds of those loans. Or to put it in simple terms, it was based upon financial fraud, on the most massive wave of financial fraud that the world has ever seen. And the world has seen a lot of financial fraud. It was known to be such to the lenders at the time. This was true of housing loans in the United States made by the tens of millions that were known to the lenders as “liar’s loans,” as “ninja loans,” no income, no job, no assets; as “neutron loans” destined to explode leaving the building intact but destroying the people. This was known at the time. These were loans that had to be refinanced or they would default.
        It was also true of loans to the public sector, for example Greece. The fact that Greece had a weak public sector and a weak tax system was not a state secret before the crisis. It was something that was known on both sides of these transactions. This was equally true of commercial real estate in Ireland and of housing in Spain. You simply had to go and observe what was going on. Not to mention the acquisitions of the Icelandic Banks. It’s a fundamental fact, I think, that’s visible everywhere you look but not spoken of in polite society especially when economists address audiences of bankers. I trust you will indulge me since I am addressing an audience of unionists and friends and speaking this frankly to you, as I think it is very important.
        Rising inequality is often linked to these phenomena. But I think we should be clear about what the linkage is. It is not the case that inequality rose and people compensated for it by borrowing more so they could have a higher standard of consumption. This is not what happened. It certainly did not happen in the United States. What happened was, is that the lenders went out to find new markets often fostering fraudulent loans on low-information borrowers, poor borrowers, inner city home owners, for example, forcing those loans to be refinanced so that the recipient only saw a fraction of the debt with which they were ultimately saddled. And the inequality arose from the booking of fees on those loans. This is how bankers get rich. They make their money in this way. And you can see this in their tax statements and you can see it in the geographical distribution of income gains in the United States.
        And when the extent of the fraud could no longer be concealed then there was panic and collapse. This happened both in the United States and Europe and it did damage to the financial structure that was, let me suggest to you, essentially irreversible. It destroyed the underlying basis for economic growth that had sustained us for some time. That is to say it destroyed the housing finance market in the U.S. and it destroyed the sovereign credit market in Europe. And because in Europe it destroyed the sovereign credit market, the effects fell on public services and on dependent populations. Millions of jobs of course were also lost in both continents. That was the collateral damage.
        These matters have not gone away. And if you wish to ask why we did not experience the predicted recovery over the last five years, I think the answer is because they didn’t go away and will not go away.
        So we need to ask, how do we deal with them? And the basic choice is between two principles. It’s between all-in-it-together or everyone-for-themselves. That’s the choice. So while all of the wealthy resource-using, computerized finance-capitalist economies have been hit by the same forces, they have not all been hurt in the same way. The institutions that are available do matter, they have an effect. Here I want to say something you may find surprising, which is that actually my country, the United States, has enjoyed a certain advantage.
        And what was it? People have often said that the U.S. has a flexible labor market. This was not it at all. In the United States real wages did not fall in the crisis, actually in the first year they went up. Labor markets did not adjust. We did not restore employment. The employment population ratio was five percentage points lower than it was a decade ago. No, what happened in the U.S. was something quite different.
        This is actually my real voice, I’m not sure water will do any good. [Laughter]
        What happened in the United States was that we had a very flexible and effective system of public transfer payments which rose rapidly in the crisis. Unemployment insurance, early retirement under social security, disability, lower tax collections, and then on top of that, the expansion package, the stimulus package, the Keynesian policy that came into effect very quickly. And these things broke the fall in incomes and preserved living standards to a very substantial degree.
        Now this was also true in parts of Europe as it was I’m sure here. The automatic stabilizers came into effect. It was true in northern Europe. I was in Finland two days ago and they said basically they had a large fall in output but no fall in income. But it was not true everywhere in Europe.
        And the second key fact lies in the difference in the underlying debts. In the United States these were largely private debts. And private debts are either paid down -- mortgages are amortized – or they are defaulted, in which case people have to leave their homes but they leave their debts with their homes. They are not pursued afterwards by and large. In one way or another, those debt problems are resolved over time—painfully—but over time they tend to diminish. But with public debt, with sovereign debt, it’s not so easy and that of course is the issue here in Europe. Sovereign debts are perpetual until they are forgiven and written off, that is to say, until there is a meeting of minds between the debtors and the creditors on what has to be done. And we’ve had this experience in the United States with Latin America. It’s not news to us.
        It is fashionable to say that the U.S. is a free market economy with practically no welfare state. I am sure you have heard that many times, but the facts are actually otherwise. If you look at the numbers, we spend about six percent of our personal income on public pensions. I guess it’s about seven percent on public healthcare and another ten or so, on the private side. Overall in 2008, public transfer payments were about fifteen percent of personal income and they went up rapidly in the crisis. So my point is that in this respect the United States, which is a very large continental economy, is as an economy not entirely like Germany but more like Germany than like Greece or Spain.
        We do have a system that can sustain and that we can finance. Notwithstanding all you hear about budget deficits, that’s obvious. The United States government does not have a financing problem. The simplest evidence for this is the long-term interest rate which is at an historic low in spite of the size of the deficit and the public debt. And again that worked to break the shock of the crisis. We did not recover but we did not fall apart. Why not? Because fundamentally we are working with national institutions that were built a long time ago in the New Deal and the Great Society, and fundamentally those institutions are still there. Deposit insurance, social security, Medicare, Medicaid, and grants-in-aid from the federal government to the states and cities. It’s a tested model and it works.
        Now what is the situation in Europe? In Europe of course you have national institutions that were built, very strong ones, on essentially the same tradition of social solidarity and social insurance, and that of course is especially true in northern Europe. It is the critical tradition of any successful society in the modern world—of the ability to react to stress. But it’s not the case for your continental institutions which were built later in a different time. Those institutions are neo-liberal. I regret to say they are built on ideas that were exported from the United States to a large degree. I apologize to you for that. Your problem was that you accepted the exports and you’re paying for them now. You impose arbitrary budget and debt ceilings. You gave your central bank a monetarist price stability charter straight out of the University of Chicago, very different from the one, the dual mandate for full employment and price stability, which is in the legal statutes governing the U.S. Federal Reserve. I mention that all the time because I was a very young member of the staff of the House Committee on Banking when that statute was written and I was actually the person who drafted it.
        And you also allowed your banks to over-leverage under the disastrous Basel II arrangements, relying on alleged capital buffers to provide stability. What’s wrong with that? Straightforwardly, if the capital buffers are not backed by accurate accounting, they don’t exist. And if you aren’t supervising the accounting you don’t know what’s there and what’s not.
        But most of all, your politics imposes a dysfunctional austerity on the debtors who cannot pay and cannot escape their debts. And your leaders, Europe’s leaders, justify this by confusing surpluses with virtue and deficits with vice, an easy transfer to economics from religion, pretending that one can exist without the other, which actually if you were Catholic you would know is not the case. In fact, in economics deficit and surplus are simply the accounting counterparts of each other and you cannot erase the deficits without also erasing the surpluses. In Germany, you, even a few years ago wrote the so-called “debt brake” into your constitution—a balanced budget except in times of severe economic crisis. What is that? It's a constitutional provision that you will always have a severe economic crisis. What a foolish thing to have done, I have to say. [Applause]
        I was going to say I was sorry to have to be harsh in those remarks but I can see that’s not necessary.
        Now in the U.S., as well, these core social institutions are under threat. They have been under threat for years and that threat is acute at the moment. We have the so-called fiscal cliff, a contrived crisis, a reactionary device to force cuts in the programs that have so far survived thirty years of Reaganism-- cuts in Social Security, Medicare and Medicaid, as well as other public spending. But it has not happened yet and there is actually some good political news. I think the reelection of the President by a decisive margin and the results in the Senate were a defeat delivered by the American public to the neo-liberal vulture capitalist ethos. And the President, who was perhaps not as brave as some of us would have liked in his first term – okay that is a very kind remark – has already moved to assert some moral leadership in these matters which he had not done before. The battle is a matter of defense; the case is very clear cut; the people have spoken. I will not predict victory but the position is much better on these core issues than it was a month ago.
        But you in Europe, and especially you my friends in Germany, have a much harder task. Europe is moving from stop gap to stop gap, from hypocritical half measure to hypocritical half measure, from false assurance to false assurance as the situation gets worse. Eventually the debtors-turned-victims will rebel but they lack moral standing, political power, and the economic capacity to save Europe. That can only come from here. Solidarity is the prerogative of the strong.
        In 1919 in a book entitled, “The Economic Consequences of Peace,” John Maynard Keynes addressed his countrymen. He wrote, “If the European civil war is to end with France and Italy abusing their momentary victorious power to destroy Germany, and Austria Hungary now prostrate, they invite their own destruction also being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds.” And again much later in the book, “The policy of reducing Germany to servitude for a generation of degrading the lives of millions of human beings and of depriving a whole nation of happiness should be abhorrent and detestable. Abhorrent and detestable, even if it were possible, even if it enriched ourselves, even if it did not sow the decay of the whole civilized life of Europe.”
        I make no defense of the government in Greece, nor of the property speculators in Spain, Ireland, or the banks in Iceland or anything else you might name. But the flaws and follies at these agencies as I said before were not secret. They were known to those who lent to them just as the fraudulence of the housing loans were known in America to those who were making them. It was common currency. Responsibility is joint, mutual and sustained.
        And we know because we have seen it elsewhere, everywhere from 19th century Germany to 20th century American to post-war Europe and the 21st century in China, that economic integration concentrates economic activity, particularly high income activity. Successful banks, advanced technology, machinery making, don’t occupy all that much space. This is the principle of increasing returns. Germany is a big beneficiary of this principle inside Europe and indeed in the whole world. You yourself are representative of the world’s most successful industrial activity. You’re the architects of that. But we also know that relations between a wealthy exporter and a less wealthy importer cannot be regulated on commercial banking terms indefinitely. Nor can surpluses be maintained while deficits are exorcised. It’s a mathematically impossibility. The rules of double entry bookkeeping are known to every shopkeeper and cannot be ignored by political leaders.
        So what is the alternative? It must first involve a comprehensive restructuring of the debts. There is the Yanis Varoufakis-Stuart Holland “Modest Proposal” which I think is a very good starting place. It insists on three elements. They are: first, a common pool of Maastricht-compliant bonds; second, an European Investment Bank- funded New Deal program—an investment program—a reconstruction program, let us call it a Green New Deal and marry the challenge of economic reconstruction to the challenge of dealing with our larger energy and climate problems; and third a common, an independent banking authority with the authority to supervise and the authority to restructure, as required, including to downsize and rationalize the financial sector. This is something that we should have done in the United States when we had the political opportunity in 2009.
        Now, these matters are necessary but I don’t think they go all the way to addressing the needs.
        I think that the statement made by the Executive Board of IG Metal on the 9th of October, “Change of Course in European Solidarity,” is a marvelous document that sets out basic principles that are required for going further to develop a sustainable architecture. So you already know the answer on how to change course, but let me give you some ideas.
        Professor Rubery yesterday offered an excellent proposal: A common unemployment insurance fund for Europe. That would support those people who specifically are the most damaged victims of the crisis. Why not?
        Let me add to this another idea. A pension union—a European Pension Union to ensure that people who have worked their entire lives, retire decently on the standard of Europe as a whole and not on the past productivity of their own impoverished countries. Perhaps, later on, there could be a topping up scheme for wages on the model of the earned income tax credit in the United States; maybe a continental minimum wage. These are low-impact, easy-to-administer, old-fashioned devices, and they bypass weak and ineffective governments in the periphery. They stabilize incomes, employment, and purchasing power. They can work to save your markets even as they save the countries in which they have their most important effects.
        Your document shows that you, as unionists, understand how the principle of solidarity works. It states in general terms what reforms are required and that you are ready to act on the great challenges of inequality, energy, and climate that face and plague us all.
        Let’s look at this problem with a very hard eye. What will happen if we do not succeed? I think there is a model. It’s not so long ago; it’s not so very far away. It’s Yugoslavia, which was in its day, a very successful middle income country. My brother, as it happens, served as the first United States Ambassador to Croatia from 1993-1998. He told me early on this was not age old ethnic conflict, but new crimes committed for political and economic reasons. That’s what kicked off those wars. And when the violence starts in an advanced, in a developed country, it moves quickly and the fractures are not clean. And I can assure you that if you talk to people in certain parts of Europe, and Greece particularly, you can hear already the anxieties that you could have heard in Yugoslavia in the early 1990s.
        If you don’t like that model, and of course none of us can possibly stand to see this happen, well there’s another one also not far away, not long ago, that’s the Czechoslovak model-- a civilized, orderly, negotiated divorce. It would be better. But I have to ask, does any country anywhere in the world enjoy the sane, secure, farsighted moral leadership that Czechoslovakia happened to have had at that time?
        So I think you came to the right judgment in this document. You came to the right judgment that Europe must be saved.
        Let me thank you again for inviting me and for your patience in listening to my remarks. I make them to you again as leaders of one of the world’s great unions because the union movement rests on solidarity and courage. And I do so in the spirit of remarks made by Abraham Lincoln to the United States Congress in December of 1862, when he wrote, “I trust you will perceive no want of respect yourselves in any undue earnestness I may seem to prescribe.”
        Lincoln went on, by the way, to close with what is one of the great texts of American political history. So if you will permit me I’ll read just a little more of it. He wrote, “We can succeed only by concert. The dogmas of the quiet past are inadequate to the stormy present. As our case is new, so we must think anew and act anew. We must disenthrall ourselves, and then we shall save our country...
        “Fellow-citizens, we cannot escape history. We will be remembered in spite of ourselves. No personal significance or insignificance can spare one or another of us. The ...trial through which we pass, will light us down, in honor or dishonor, to the latest generation... We say we are for the Union. The world will not forget that we say this. We know how to save the Union. The world knows that we do know how to save it. We—even we here—hold the power, and bear the responsibility. The way is plain, peaceful, generous, just—a way which, if followed, the world will forever applaud.”
        It is your Union of course that is at issue today, but it is yours, you created it. It may be lost. It will not be saved on its own. I congratulate you again on the leadership you are showing and will continue to show. And I wish you well and I thank you again.

          Posted by on Tuesday, December 18, 2012 at 10:59 AM in Economics | Permalink  Comments (94) 

          What have Monetary and Fiscal Policymakers Learned from the Great Recession?

          New column:

          What have monetary and fiscal policymakers learned from the Great Recession?

          Not enough, particularly fiscal policymakers, but maybe there's a way to do better.

            Posted by on Tuesday, December 18, 2012 at 09:27 AM in Economics, Fiscal Policy, Fiscal Times, Monetary Policy | Permalink  Comments (54) 

            Is Macro Rotten?

            Paul Krugman, quoted below, started this off (or perhaps better, continued an older discussion) by claiming the state of macro is rotten. Steve Williamson, also quoted below, replied and this is Simon Wren-Lewis' reply to Williamson (remember that, as Simon Wren-Lewis notes below, he has defended the modern approach to macro).

            This pretty well covers my views, and I think this part of the Wren-Lewis rebuttal gets at the heart of the issue: "You would not think of suggesting that Paul Krugman is out of touch unless you are in effect dismissing or marginalizing this whole line of research." I am also very much in agreement with the "two unhelpful biases" he notes in the last paragraph, and have been thinking of writing more about the first, "too much of an obsession with microfoundation purity, and too little interest in evidence," particularly the lack of interest in using empirical evidence to test and reject models. (Though there are ways to get around this problem, it may be that such tests have fallen out of favor in macro since we only have historical data to work with, and it's folly to build a model with knowledge of the data and then test to see if the model fits. Of course it will fit, or at least it should. That would explain why there appears to be a greater reliance upon logic, intuition, and consistency with micro foundations than in the past. It seems like today models are more likely to be rejected for lack of internal theoretical consistency than for lack of consistency with the empirical evidence):

            The New Classical Revolution: Technical or Ideological?, by Simon Wren-Lewis:
            Paul Krugman: The state of macro is, in fact, rotten, and will remain so until the cult that has taken over half the field is somehow dislodged
            The cult here is freshwater macro, which descends from the New Classical revolution. In response
            Steve Williamson: “At the time, this revolution was widely-misperceived as a fundamentally conservative movement. It was actually a nerd revolution.” “What these people had on their side were mathematics, econometrics, and most of all the power of economic theory. There was nothing weird about what these nerds were doing - they were simply applying received theory to problems in macroeconomics. Why could that be thought of as offensive?”
            The New Classical revolution was clearly anti-Keynesian..., but was that simply because Keynesian theory was the dominant paradigm? ...
            I certainly think that New Classical economists revolutionized macroeconomic theory, and that the theory is much better for it. Paul Krugman (PK) and I have disagreed on this point before. ...

            But this is not where the real disagreement between PK and SW lies. The New Classical revolution became the New Neoclassical Synthesis, with New Keynesian theory essentially taking the ideas of the revolutionaries and adapting Keynesian theory to incorporate them. Once again, I believe this was a progressive change. While there is plenty wrong with New Keynesian theory, and the microfoundations project on which it is based, I would much rather start from there than with the theory I was taught in the 1970s. As SW says “Most of us now speak the same language, and communication is good.” ...
            I think the difficulty that PK and I share is with those who in effect rejected or ignored the New Neoclassical Synthesis. I can think of no reason why the New Classical economist as ‘revolutionary nerd’ should do this, which suggests that SW’s characterization is only half true. Everyone can have their opinion about particular ideas or developments, but it is not normal to largely ignore what one half of the profession is doing. Yet that seems to be what has happened in significant parts of academia.
            SW likes to dismiss PK as being out of touch with current macro research. Lets look at the evidence. PK was very much at the forefront of analyzing the Zero Lower Bound problem, before that problem hit most of the world. While many point to Mike Woodford’s Jackson Hole paper as being the intellectual inspiration behind recent changes at the Fed, the technical analysis can be found in Eggertsson and Woodford, 2003. That paper’s introduction first mentions Keynes, and then Krugman’s 1998 paper on Japan. Subsequently we have Eggertsson and Krugman (2010), which is part of a flourishing research program that adds ‘financial frictions’ into the New Keynesian model. You would not think of suggesting that PK is out of touch unless you are in effect dismissing or marginalizing this whole line of research.[2]
            I would not describe the state of macro as rotten, because that appears to dismiss what most mainstream macroeconomists are doing. I would however describe it as suffering from two unhelpful biases. The first is methodological: too much of an obsession with microfoundation purity, and too little interest in evidence. The second is ideological: a legacy of the New Classical revolution that refuses to acknowledge the centrality of Keynesian insights to macroeconomics. These biases are a serious problem, partly because they can distort research effort, but also because they encourage policy makers to make major mistakes.[3]
            [1] The clash between Monetarism and Keynesianism was mostly a clash about policy: Friedman used the Keynesian theoretical framework, and indeed contributed greatly to it.

            [2] It may be legitimate to suggest someone is out of touch with macro theory if they make statements that are just inconsistent with mainstream theory, without acknowledging this to be the case. The example that most obviously comes to mind is statements like these, about the impact of fiscal policy.

            [3] In the case of the UK, a charitable explanation for the Conservative opposition to countercyclical fiscal policy and their embrace of austerity was that they believed conventional monetary policy could always stabilize the economy. If they had taken on board PK’s analysis of Japan, or Eggertsson and Woodford, they would not have made that mistake.
            Update: Noah Smith also comments.

              Posted by on Tuesday, December 18, 2012 at 09:24 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (15) 

              Links for 12-18-2012

                Posted by on Tuesday, December 18, 2012 at 12:06 AM Permalink  Comments (79) 

                Monday, December 17, 2012

                'Can't Obama Play This Game?'

                One more from Brad DeLong, a comment on the negotiations over the fiscal cliff, and it's not good news:

                Can't Obama Play This Game?: This Is a Lousy Fiscal Cliff Deal Weblogging: "Chained-CPI" is code for "let's really impoverish some women in their 90s!" It's a bad policy. It should be off the table. Failing to extend the payroll tax cut is bad policy. It should be off the table. Failing to boost infrastructure spending is bad policy. It should be off the table.
                This deal would still be on the table in January. And odds are Obama could get a much better deal than this come January...

                  Posted by on Monday, December 17, 2012 at 01:21 PM in Economics, Politics | Permalink  Comments (40) 

                  Brad DeLong: Are Your Wages Set in Beijing?

                  Brad DeLong answers the question: Are Your Wages Set in Beijing?

                  This is I think an argument from my old teacher Richard Freeman, about how in the eighties and nineties effectively 2 billion workers were added to the potential global manufacturing work force. Developments in communication and trade, the coming of the container, the coming of the Deng Xiaoping policy reforms in China, reform in India, confidence these policy changes would persist--all these meant that businesses all around the world wondering where to locate manufacturing could be confident that they could if they wanted to, if it made sense, draw on a labor force that was 2 billion bigger than it had been in the 1970s.
                  In that context, the fact that the United States had a lot of highly-skilled manufacturing workers who had an immense productivity edge was no longer an effective factor in world production. Thus the claim is that an awful lot of the rise in inequality in the United States between 1980 and today is the result of this global pressure on the American economy.
                  Back in the mid 1990s when I was working for the Clinton Administration, I wrote a bunch of memos about how this was then nonsense--that is, it was simply too small to matter.
                  Since the mid 1990s, this factor has become significantly larger.
                  But I’d say it’s still in fourth place as far as the increase in U.S. inequality is concerned.
                  First place has been the education factor--the fact the United States is no longer clearly the most educated country in the world, and the education system is no longer is putting downward pressure on wage inequality.
                  Second place is the shift in the tax and transfer system--the fact that our tax and transfer system as a whole is less progressive than it was a generation ago, and that in fact it’s regarded as Kenyan Muslim socialism to even return taxes on the rich back to their levels of the Clinton Administration. ...
                  Third are the social structural and economic changes that allow the princes of Wall Street and the plutocrat CEOs to successfully charge what they do charge. ...
                  Global pressures are fourth. They are there, but they are ... more like ten percent of the process.
                  And with that ten percent we should in fact be willing to deal. We still are the most favored nation by luck in history. We thus have responsibility to manage the international system as a whole. We have a responsibility to be the importer of last resort for countries that are trying to develop by building up their own industries.
                  I place more weight on "social structural and economic changes" than he does (with the words "economic and political power" tossed into the mix somewhere).

                    Posted by on Monday, December 17, 2012 at 01:10 PM in Economics, Income Distribution, International Trade | Permalink  Comments (59) 

                    'Master Computer Controls Universe?'

                    I can't resist this one (via Boing Boing):
                    Master computer controls universe?, The Times of India: Scientists are conducting experiments to discover whether the universe exists within a Matrixstyle computer simulation created by super computers of the future.
                    The experiments being conducted by University of Washington could prove that we are merely pawns in some kind of larger computer game. However, it is unclear who created these super computers that may hypothetically power our existence.
                    "Imagine the situation where we get a big enough computer to simulate our universe, and we start such a simulation on our computers," said professor Martin Savage, a physicists working on the project. "If that simulation runs long enough, and have same laws as our universe, then something like our universe will emerge within that simulations, and the situation will repeat itself within each simulation," he said. ...
                    Explaining how the experiment works, physicists claim that finite computer resources mean that space time is not continuous but set on a grid with a finite volume, designed to create maximum energy subatomic particles. The direction these particles flow in will depend on how they are ordered on the grid. They will be looking at the distribution of the highest energy cosmic rays in order to detect patterns that could suggest that universe is the creation of some futuristic computer technology. And if it does turns out that we are mere players in some sort of computer program, they suggested that there may be a way to mess with the program, and play with the minds of our creators. "One could imagine trying to figure out how to manipulate the code, communicate with the code and questions that appear weird to consider today," he said.

                    If you like this stuff, you might enjoy The hidden reality: parallel universes and the deep laws of the cosmos by Brian Greene. One of the chapters (which explore different ways a multiverse might arise) is on this topic. A big problem in this literature is finding ways to test these various theories empirically, so this is interesting from that perspective as well.

                      Posted by on Monday, December 17, 2012 at 11:53 AM in Economics, Science | Permalink  Comments (28) 

                      Will the Unemployment Rate "Stay Around 8% as Late as Mid-2014"?

                      An Economic Letter from the SF Fed warns that, as discouraged workers return to the workforce with improving economic conditions:

                      ...the unemployment rate could stay around 8% as late as mid-2014, despite continued job growth. Progress in reducing the unemployment rate is a key factor in keeping consumer confidence and spending high enough to sustain recovery. And policymakers use the unemployment rate as a gauge of economic progress. A stall in reducing the unemployment rate would undoubtedly be viewed as a significant disappointment.

                        Posted by on Monday, December 17, 2012 at 10:59 AM in Economics, Unemployment | Permalink  Comments (21) 

                        Is the Fed Risking "Dangerous Side Effects"?

                        Robert Samuelson:

                        The Fed rolls the dice, by Robert J. Samuelson, Commentary, Washington Post: It was big news last week when the Federal Reserve announced that it wants to maintain its current low-interest rate policy until unemployment, now 7.7 percent, drops to at least 6.5 percent. The Fed was correctly portrayed as favoring job creation over fighting inflation, though it also set an inflation target of 2.5 percent. What was missing from commentary was caution based on history: the Fed has tried this before and failed — with disastrous consequences.
                        By “this,” I mean a twin targeting of unemployment and inflation. In the 1970s, that’s what the Fed did. Targets weren’t announced but were implicit. The Fed pursed the then-popular goal of “full employment,” defined as a 4 percent unemployment rate; annual inflation of 3 percent to 4 percent was deemed acceptable. The result was economic schizophrenia. Episodes of easy credit to cut unemployment spurred inflation... By 1980, inflation was 13 percent and unemployment, 7 percent. ...
                        Today’s problem is similar. Although the Fed has learned much since the 1970s ... its economic understanding and powers are still limited. It can’t predictably hit a given mix of unemployment and inflation. Striving to do so risks dangerous side effects, including a future financial crisis. ...
                        It’s seductive to think the Fed can engineer the desired mix of unemployment and inflation. And the motivation is powerful. About 5 million Americans have been jobless for six months or more. The present job market represents, as Bernanke said, “an enormous waste of human and economic potential.” But the Fed is bumping against the limits of its powers. Are potential short-term benefits worth the long-term risks? It’s a close call.

                        What does he think a dual mandate means if not the "twin targeting of unemployment and inflation"? That's not unique to the 1970s, it's essentially the Taylor rule (the Taylor principle comes into play as well, but I want to focus on something else). Anyway, he is trying to tell the story about shifting Phillips curve due to rising inflationary expectations, but he misses a key part of the story. A popular explanation for problems in the 1970s, one I think has a lot of veracity, is that the Fed was shooting at the wrong unemployment target (you can find this story in most textbooks, e.g. see Mishkin's text on demand-pull inflation). The Fed was shooting at a 4 percent unemployment target, but because of a large influx of new workers from the baby boom and women entering the workforce, the natural rate of unemployment was actually much higher than 4 percent (new workers tend to have high frictional unemployment rates, and there were also structural changes going on within the economy that led to a higher natural rate of unemployment as well). All told, it's not unreasonable to think of the natural rate had drifted as high as 7 percent, maybe even higher. It eventually came down to closer to 4 percent as the surge of new workers ended and structural change abated somewhat, but for awhile it was elevated above the Fed's 4 percent target. Unfortunately, the Fed didn't not realize this.

                        Here's how the story goes. The Fed, seeing unemployment drifting toward its natural rate of, say, 7 percent responded to its full employment mandate by using more aggressive policy to create inflation. In the short-run, the policy worked, unemployment did fall due to the inflationary surprise, but as soon as people adjusted their inflationary expectations (and demanded higher wages, etc.), the Phillips curve shifted and we ended up with the inflation we wanted, but the employment gains were lost as the unemployment rate moved toward its natural rate of 7 percent. At that point the Fed says to itself, we must not have been aggressive enough, we need a second round of stimulus and it pumps up the inflation rate even further. Again, this works so long as the inflation is a surprise, unemployment falls in the short-run, but as soon as inflationary expectations adjust once again the employment gains are eliminated, but the inflation remains. As this continues, inflation continues to drift upward until eventually we end up with double-digit inflation and nothing whatsoever to show for it in terms of employment gains.

                        The fundamental problem here is a miscalculation of the natural rate of the natural rate of unemployment. So the question is, has the Fed made this mistake again? Is the natural rate of unemployment a lot higher than 6.5 percent so that shooting for this target is likely to end up with double-digit, 1970s type inflation?

                        No for several reasons. First, the Fed is fully aware of this past mistake, and many opposed more stimulus for precisely this reason (e.g. Narayana Kockerlakoata would not support more stimulus until Bernanke convinced him in a series of phone calls that the employment problem was largely cyclical, not structural). If they are shooting at the wrong target, then the policy will not work and they will not continue doing so as they did in the 1970s. They are much more aware of the signs to look for that indicate they've made this mistake. Second, there has been considerable effort to measure the structural/cyclical/frictional unemployment mix for precisely this reason, and the estimates, for the most part, point to a mostly cyclical problem. We didn't have this type of information in the 1970s, in fact we weren't even asking this question. We simply assumed that full employment meant 4 percent and set policy accordingly. Finally, there is an inflation threshold of 2.5 percent, a relatively low level of tolerance for mistakes of this type. If the Fed is wrong about the structural rate, we'll see inflation, and if it the projected inflation rate drifts above 2.5 percent, the program will be reversed. I have no doubt that the Fed is serious abut pulling the plug if inflation rises above 2.5 percent. That's true even if unemployment is still above 6.5 percent.

                        Samuelson can worry all he wants, he's good at playing the Very Serious Person role (inflation is coming!, the debt will cause interest rates to spike!, there could even be "dangerous side effects, including a future financial crisis"!), but the Fed is not risking a repeat of the 1970s, not even close.

                        Update: Dean Baker comments on the Samuelson article.

                          Posted by on Monday, December 17, 2012 at 09:51 AM in Economics, Inflation, Monetary Policy, Unemployment | Permalink  Comments (51) 

                          Paul Krugman: That Terrible Trillion

                          Deficit scolds long for "frickin' sharks with frickin' laser beams attached to their frickin' heads" to use against "programs that shield both poor and middle-class Americans from harm":

                          That Terrible Trillion, by Paul Krugman, Commentary, NYTimes: ...I find myself in a lot of discussions about U.S. fiscal policy, and the budget deficit in particular. And there’s one thing I can count on..: At some point someone will announce, in dire tones, that we have a ONE TRILLION DOLLAR deficit.
                          No, I don’t think the people making this pronouncement realize that they sound just like Dr. Evil in the Austin Powers movies.
                          Anyway, we do indeed have a ONE TRILLION DOLLAR deficit,... actually $1.089 trillion. ... What the Dr. Evil types think, and want you to think, is that the big current deficit is a sign that ... a debt crisis is just around the corner, although they’ve been predicting that for years and it keeps not happening. ... But more often they use the deficit to argue that we can’t afford ... programs like Social Security, Medicare and Medicaid. So it’s important to understand that this is completely wrong. ...
                          So, let’s talk about the numbers. The first thing we need to ask is what a sustainable budget would look like. The answer is that in a growing economy, budgets don’t have to be balanced to be sustainable. ... Right now, given reasonable estimates of likely future growth and inflation, we would have a stable or declining ratio of debt to G.D.P. even if we had a $400 billion deficit. You ... should take $400 billion off the table right away.
                          That still leaves $600 billion or so. What’s that about? It’s the depressed economy — full stop.
                          First of all, the weakness of the economy has led directly to lower revenues ... by at least $450 billion. Meanwhile, the depressed economy has ... temporarily raised spending ... by at least $150 billion.
                          Putting all this together, it turns out that the trillion-dollar deficit isn’t a sign of unsustainable finances at all. ... We do indeed have a big budget deficit, and other things equal it would be better if the deficit were a lot smaller. But other things aren’t equal; the deficit is a side-effect of an economic depression, and the first order of business should be to end that depression — which means, among other things, leaving the deficit alone for now.
                          And you should recognize all the hyped-up talk about the deficit for what it is: yet another disingenuous attempt to scare and bully the body politic into abandoning programs that shield both poor and middle-class Americans from harm.

                            Posted by on Monday, December 17, 2012 at 12:33 AM in Budget Deficit, Economics, Fiscal Policy, Politics | Permalink  Comments (47) 

                            Links for 12-17-2012

                              Posted by on Monday, December 17, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (56) 

                              Sunday, December 16, 2012

                              Summers: How to Fix Our Costly and Unjust Tax System

                              Larry Summers:

                              How to fix costly and unjust US tax system, by Lawrence Summers, Commentary, Financial Times: Sooner or later the American tax code will be reformed. ...
                              So far, the debate has focused on scaling back provisions of the tax code that have favored activities traditionally deemed to be valuable..., reducing reliefs for charitable contributions, taxes paid to state and local governments, home mortgages, employer-provided health insurance and many less important provisions. There are reasonable arguments ... in each case. But taking only the “limit tax incentives” approach to tax reform has several major defects. [lists] ...
                              What is needed is an additional element, one that has largely been absent to date: the numerous exclusions from the definition of adjusted gross income... There are far too many provisions that favor a small minority of very fortunate taxpayers. ... it should not be possible to accumulate and transfer large fortunes while avoiding taxation almost entirely. Yet this is all too possible today. ... [lists several ways] ...
                              I believe it is plausible to raise $1tn over the next 10 years by going after provisions that cause what adds to wealth and spending not to be regarded as income.
                              It has been observed that the greatest scandals are not the illegal things that people do but the things that are fully legal. This is surely true with respect to a tax code in urgent need of reform.

                              [If you can't get to the article, it usually appears on the Washington Post's editorial page later in the day, though sometimes the editing is slightly different. Update: It's here.]

                                Posted by on Sunday, December 16, 2012 at 12:36 PM in Budget Deficit, Economics, Equity, Taxes | Permalink  Comments (30) 

                                'Mistaking Models for Reality'

                                Simon Wren-Lewis takes issue with Stephen Williamson's claim that "there are good reasons to think that the welfare losses from wage/price rigidity are small":

                                Mistaking models for reality, by Simon Wren-Lewis: In a recent post, Paul Krugman used a well known Tobin quote: it takes a lot of Harberger triangles to fill an Okun gap. For non-economists, this means that the social welfare costs of resource misallocations because prices are ‘wrong’ (because of monopoly, taxation etc) are small compared to the costs of recessions. Stephen Williamson takes issue with this idea. His argument can be roughly summarized as follows:

                                1) Keynesian recessions arise because prices are sticky, and therefore 'wrong', so their costs are not fundamentally different from resource misallocation costs.

                                2) Models of price stickiness exaggerate these costs, because their microfoundations are dubious.

                                3) If the welfare costs of price stickiness were significant, why are they not arbitraged away?

                                I’ve heard these arguments, or variations on them, many times before.[1] So lets see why they are mistaken...

                                But I want to focus on this. How useful are representative agent models, e.g. New Keynesian models, for examining questions such as the costs of unemployment?:

                                Lets move from wage and price stickiness to the major cost of recessions: unemployment. The way that this is modeled in most New Keynesian set-ups based on representative agents is that workers cannot supply as many hours as they want. In that case, workers suffer the cost of lower incomes, but at least they get the benefit of more leisure. Here is a triangle maybe (see Nick Rowe again.) Now this grossly underestimates the cost of recessions. One reason is  heterogeneity: many workers carry on working the same number of hours in a recession, but some become unemployed. Standard consumer theory tells us this generates larger aggregate costs, and with more complicated models this can be quantified. However the more important reason, which follows from heterogeneity, is that the long term unemployed typically do not think that at least they have more leisure time, so they are not so badly off. Instead they feel rejected, inadequate, despairing, and it scars them for life. Now that may not be in the microfounded models, but that does not make these feelings disappear, and certainly does not mean they should be ignored.

                                It is for this reason that I have always had mixed feelings about representative agent models that measure the costs of recessions and inflation in terms of the agent’s utility.[2] In terms of modeling it has allowed business cycle costs to be measured using the same metric as the costs of distortionary taxation and under/over provision of public goods, which has been great for examining issues involving fiscal policy, for example. Much of my own research over the last decade has used this device. But it does ignore the more important reasons why we should care about recessions. Which is perhaps OK, as long as we remember this. The moment we actually think we are capturing the costs of recessions using our models in this way, we once again confuse models with reality.

                                What does me mean by confusing models with reality?:

                                The problem with modeling price rigidity is that there are too many plausible reasons for this rigidity - too many microfoundations. (Alan Blinder’s work is a classic reference here.) Microfounded models typically choose one for tractability. It is generally possible to pick holes in any particular tractable story behind price rigidity (like Calvo contracts). But it does not follow that these models of Keynesian business cycles exaggerate the size of recessions. It seems much more plausible to argue completely the opposite: because microfounded models typically only look at one source of nominal rigidity, they underestimate its extent and costs.

                                I could make the same point in a slightly different way. Lets suppose that we do not fully understand what causes recessions. What we do understand, in the simple models we use, accounts for small recessions, but not large ones. Therefore, large recessions cannot exist. The logic is obviously faulty, but too many economists argue this way. There appears to be a danger in only ‘modeling what we understand’ that modelers can go on to confuse models with reality.

                                Let me add that while this is a good argument for why the measured costs only establish a minimum bound for the total costs, I am not sure we can be confident they do that. The reason is that I am not convinced that wage and price rigidities as modeled in the New Keynesian framework adequately capture the transmission mechanism from shocks to real effects that propelled us into the Great Recession. That is, do we really think that wage and price rigidities of the Calvo variety (or of the Rotemberg variety) are the main friction behind the downturn and struggle to recover? If prices were perfectly flexible, would our problems be over? Would they have never begun in the first place? More flexibility in housing prices might help, but the problem was a breakdown in financial intermediation which in turn caused problems for the real sector. Capturing these effects requires abandoning the representative agent framework, connecting the real and financial sectors, and then endogenizing financial cycles. There is progress on this front, but in my view existing models are simply unable to adequately capture these effects.

                                If this is true, if existing models do not adequately capture the transmission of financial shocks to changes in output and employment, if our models miss a fundamental mechanism at work in the recession, why should we believe estimates of fiscal multipliers, welfare effects, and so on based upon models that assume shocks are transmitted through moderate price rigidities? I think these models are good at capturing mild business cycles like we experienced during the Great Moderation, but I question their value in large, persistent, recessions induced by large financial shocks.

                                [For more on macro models, see Paul Krugman's The Dismal State of the Dismal Science and the links he provides in his discussion.]

                                  Posted by on Sunday, December 16, 2012 at 10:33 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (78) 

                                  Links for 12-16-2012

                                    Posted by on Sunday, December 16, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (56) 

                                    Saturday, December 15, 2012

                                    'Inequality: Power vs. Human Capital'

                                    Chris Dillow:

                                    Inequality: power vs human capital, by Chris Dillow: David Ruccio points to labor's falling share of income in the US and says:

                                    We need to talk much more about profits and who owns capital. And, in addition, who appropriates and distributes the surplus and to whom that surplus is subsequently distributed.

                                    This is like saying a man should put his trousers on before leaving the house. It's good advice, but it shouldn't need saying.

                                    A nice new paper by Amparo Castello-Climent and Rafael Domenech at the University of Valencia supports his point. They point out that there's no correlation between inequality of human capital and inequality of incomes. This is true across time.. And it's true across countries... This is a challenge for the neoclassical view that income inequality is due to inequality of marginal productivities. ...

                                    Instead, the more obvious possible reason for the lack of link between human capital and income equality is simply that inequality reflects not differences in productivity but differences in power which themselves arise from institutional differences. Inequality is higher in south America than in Japan or South Korea simply because south America has extractive institutions which enable a small minority to exploit the masses, whereas Japan and South Korea do not.

                                    Institutional differences in power also help explain another fact: why does the return to university education differ so much (pdf) across European nations of similar income? It is higher in the UK than in Germany or Nordic countries, for example. It's hard to explain this by technical change or globalization, as these factors should have affected countries reasonably similarly. A more plausible possibility, surely, is that institutional factors - the power of capital over labor - allow (some) graduates greater access to the economic surplus in the UK than it allows them in the Nordic countries.

                                    Although I'm speaking here in macroeconomic terms, the point holds at a micro level too. Why did Rebekah Brooks get a £10.9m payoff from Murdoch? It's not because she has obvious greater marginal productivity or technical human capital than the rest of us. It's because (for reasons we needn't consider) she had privileged access to the surplus.

                                    Inequality, then, is better explained by power than by human capital or marginal productivity.

                                    This is not a novel thought, or the first time I've made this point, but more and more it seems that we shouldn't think of these as competing explanations for inequality, but rather as complementary explanations that are mutually reinforcing.

                                      Posted by on Saturday, December 15, 2012 at 11:10 AM in Economics, Income Distribution, Politics, Productivity, Technology | Permalink  Comments (102) 

                                      'Why the Social Security Trust Fund is Real'

                                      pgl at Econospeak:

                                      Kevin Drum on Why the Social Security Trust Fund is Real, by pgl: Kevin Drum has a short and sweet analogy for the position that the assets in the Social Security Trust Fund are real:

                                      Now, suppose this surplus had been invested in corporate bonds. What exactly would that mean? It means that workers would be giving money to corporations, who would turn around and spend it. In return, the Social Security trust fund would receive bonds that represent promises to repay the money later out of the company's cash flow. In effect, it gives workers a claim on the cash flows of the company at a later date in time. When that time comes, the company would have to pay up, which would make it less profitable. If the company was already unprofitable, it would make their deficit even worse. If that's what had happened, there would be no confusion about the trust fund. Everyone agrees that corporate bonds are real things, and that the corporations who sell them have an obligation to pay them back, even though it means less money for shareholder dividends.

                                      He then substitutes treasury bonds for corporate bonds and draws the same conclusion. QED! While I agree, let me try to offer the rightwing rebuttal, which begins with the proposition that the general fund is essentially bankrupt. Is it and why? Well – it is true that the Reagan years cut taxes on the very rich just as it raised payroll taxes. It is also true that President Reagan increased defense spending. Although we had the peace dividend and some reversals of those tax cuts during the 1990’s, George W. Bush put us back on the path of high defense spending and low taxes on the rich in 2001. The Republican Party seems to believe that we must forever have high defense spending and low taxes on the rich. Well if that is true, it is analogous to paying high dividends to corporate shareholders even as corporate profits are well below the dividend policy. But do we really have to accept this Republican belief system? No we can honor these promises to pay Social Security benefits if we as a nation are willing to tell the rich to pay higher taxes and tell the military industrial complex that it gets less largesse. But I guess some Republicans see the promises of low tax rates for the rich and continuing largesse for the military industrial complex as sacrosanct, which of course leads them to conclude that the problem is those promises to Social Security beneficiaries.

                                      The tax cuts can also be viewed as a loan from the Social Security Trust Fund that didn't pay off as promised.

                                        Posted by on Saturday, December 15, 2012 at 09:34 AM in Economics, Politics, Social Insurance, Social Security | Permalink  Comments (38) 

                                        Links for 12-15-2012

                                          Posted by on Saturday, December 15, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (56) 

                                          Friday, December 14, 2012

                                          'The Height of Fiscal Folly'

                                          Laura Tyson echoes the message at the end of the post below this one (here too):

                                          The Trade-Off Between Economic Growth and Deficit Reduction, by Laura D’Andrea Tyson, Commentary, NY Times: ...After three years of recovery, the economy is still operating far below its potential and long-term interest rates are hovering near historic lows. Under these circumstances, the case for expansionary fiscal measures, even if they increase the deficit temporarily, is compelling.
                                          A recent study by the International Monetary Fund finds large positive multiplier effects of expansionary fiscal policy on output and employment under such circumstances. ... The rationale for expansionary fiscal policy is particularly compelling for federal investment spending in areas like education and infrastructure...
                                          The economy does not need an outsize dose of fiscal austerity now; it does need a credible deficit-reduction plan to stabilize the debt-to-G.D.P. ratio gradually as the economy recovers. As I contended in an earlier Economix post, the plan should have an unemployment-rate target or trigger that would postpone deficit-reduction measures until the target is achieved. ...
                                          The goal of deficit reduction is to ensure the economy’s long-term growth and stability. It would be the height of fiscal folly to kill the economy’s painful recovery from the Great Recession in pursuit of this goal.

                                            Posted by on Friday, December 14, 2012 at 01:53 PM in Budget Deficit, Economics, Fiscal Policy, Unemployment | Permalink  Comments (72) 

                                            'Trillion-Dollar Deficits are Sustainable for Now'

                                            John Makin of the American Enterprise Institute says that "trillion-dollar deficits are sustainable for now, unfortunately." I don't agree with everything he says -- the "unfortunately" in the title for one, his fear of inflation and the increase in debt servicing costs that come with it for another (though he is not saying inflation is just around the corner like some others have claimed) -- but I appreciate that he is trying to play it straight rather than support the nonsense other Republicans have tried to foist upon the public:

                                            Trillion-dollar deficits are sustainable for now, unfortunately, by John H. Makin: Congress is attempting, unsuccessfully, to reduce “unsustainable” deficits and debt accumulation by engineering “crises” that are meant to force politically challenging action on spending cuts (entitlements) and tax increases (loophole closing, higher tax rates on the “rich”). The mid-2011 debt-ceiling crisis fiasco and the upcoming year-end “fiscal cliff” are striking examples of this dangerous tactic. ...
                                            The tactic of threatening to go over the fiscal cliff will fail ... because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen. Interest rates have not soared as promised... Two percent inflation means that the real inflation-adjusted cost of deficit finance averages –1.5 percent...
                                            The debt-to-GDP ratio is not a reliable guide for gauging the sustainability of deficits, notwithstanding the Reinhart and Rogoff warning...
                                            The United States Is NOT Greece ... The hyperbolic claim that the United States is becoming Greece because of the absence of dramatic progress on deficit and debt reduction is unfortunately ridiculous. ...
                                            The real danger facing American policymakers is, contrary to the cries of imminent “crisis” and “unsustainable” deficits and debt accumulation, the sustainability of trillion-dollar deficits. Eventually, probably much later than most pundits claim if the experience of Japan is any guide, the Federal Reserve’s monetary accommodation of US government debt accumulation, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth, will cause inflation to rise. ...
                                            Once inflation rises and the Fed is forced to tighten, borrowing costs for both the government and private sectors will rise. Growth measured in real, constant-dollar terms will fall relative to real, inflation-adjusted interest rates along with tax revenues, and the US debt-to-GDP ratio will rise rapidly. ...

                                            We certainly disagree on how to solve the problem, i.e. whether to rely upon tax increases or cuts to important social programs, and on the pace of deficit reduction (though he calls for more gradual reduction than most), but I appreciate his willingness to acknowledge, as Krugman noted today, that "We are not having a debt crisis."

                                            (I should also note, yet again, that with a "real inflation-adjusted cost of deficit finance [that] averages –1.5 percent," we ought to be investing heavily in critical infrastructure to stimulate output and employment, and to increase our future growth prospects.)

                                              Posted by on Friday, December 14, 2012 at 10:10 AM in Budget Deficit, Economics, Politics, Social Insurance, Taxes | Permalink  Comments (81) 

                                              Fed Watch: Solid Bounce in Industrial Production

                                              Tim Duy:

                                              Solid Bounce in Industrial Production, by Tim Duy: Industrial production posted a solid gain in November, more than offsetting the Sandy-impacted October decline:


                                              This means that what had been the best clear top in a recession indicator is a lot less clear. A solid blow to ECRI Co-Founder Lakshman Achuthan's claim that the US slipped into recession in the middle of the year.

                                              I noticed this quote from Bloomberg:

                                              “There is this continued tug of war for manufacturing,” said Aneta Markowska, chief U.S. economist at Societe Generale in New York, who forecast a 1.2 percent gain in manufacturing output. “Consumer spending is still looking pretty good so that’s helping support production. On the other hand, business demand for things like capital equipment, machinery is pausing.”

                                              That vexing consumer spending question again - pretty good, on shaky grounds, or a pillar of strength? I would say the middle ground holds, as least on the basis of core retail spending in November:


                                              Of course, on a year-over-year basis, the deceleration from the earlier this year remains evident:


                                              It is worth remembering that at least one consumer sector that is an important element of manufacturing activity remains solid:


                                              I have trouble imagining IP rolling over and heading downward in any meaningful fashion when auto sales are still on the upswing. Moreover, improving residential construction activity will provide support to suppliers of related manufactured goods:
                                              Not to say the economy is growing gangbusters, but I think that Markoswka is broadly correct. The external sector and domestic business spending are a drag on some sectors of manufacturing, but other sectors are still growing. The upshot is that the decline in core manufacturing orders has yet to manifest itself in a broad decline in industrial production:


                                              Bottom Line: Weaker than we would like to see, but news of the economy's demise remains premature.

                                                Posted by on Friday, December 14, 2012 at 09:34 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (9) 

                                                Paul Krugman: The G.O.P.’s Existential Crisis

                                                The GOP's intense frustration over the collapse of its a "decades-long project" to dismantle the welfare state could be immensely damaging:
                                                The G.O.P.’s Existential Crisis, by Paul Krugman, Commentary, NY Times: We are not having a debt crisis.
                                                It’s important to make this point, because I keep seeing articles about the “fiscal cliff” that do, in fact, describe it ... as a debt crisis. But it isn’t. The U.S. government is having no trouble borrowing to cover its deficit. In fact, its borrowing costs are near historic lows. ...
                                                No, what we’re having is a political crisis, born of the fact that one of our two great political parties has reached the end of a 30-year road. ... Since the 1970s, the Republican Party has fallen increasingly under the influence of radical ideologues, whose goal is nothing less than the elimination of the welfare state... From the beginning, however, these ideologues have had a big problem:... Americans ... strongly support Social Security, Medicare, and even Medicaid. So what’s a radical to do?
                                                The answer, for a long time, has involved two strategies. One is “starve the beast,” the idea of using tax cuts to reduce government revenue, then using the resulting lack of funds to force cuts in popular social programs. ...
                                                Arguably more important in conservative thinking, however, was the notion that the G.O.P. could exploit other sources of strength — white resentment, working-class dislike of social change, tough talk on national security — to build overwhelming political dominance, at which point the dismantling of the welfare state could proceed freely. Just eight years ago, Grover Norquist ... looked forward cheerfully to the days when Democrats would be politically neutered: “Any farmer will tell you that certain animals run around and are unpleasant, but when they’ve been fixed, then they are happy and sedate.”
                                                O.K., you see the problem: Democrats didn’t go along with the program... And look at where we are now in terms of the welfare state: far from killing it, Republicans now have to watch as Mr. Obama implements the biggest expansion of social insurance since the creation of Medicare.
                                                So Republicans have suffered more than an election defeat, they’ve seen the collapse of a decades-long project. ... It’s a dangerous situation. The G.O.P. is lost and rudderless, bitter and angry, but it still controls the House and, therefore, retains the ability to do a lot of harm, as it lashes out in the death throes of the conservative dream.
                                                Our best hope is that business interests will use their influence to limit the damage. But the odds are that the next few years will be very, very ugly.

                                                  Posted by on Friday, December 14, 2012 at 12:33 AM in Economics, Politics | Permalink  Comments (67) 

                                                  Links for 12-14-2012

                                                    Posted by on Friday, December 14, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (65) 

                                                    Thursday, December 13, 2012

                                                    'That was a Bad Idea'

                                                    Jon Chait:

                                                    Even as they grudgingly have come to accept that they can’t prevent the expiration of the Bush tax cuts for the rich, Republicans have increasingly started explaining this pitiable state of affairs to themselves as the product of President Obama’s unique malevolence. The operating theory here is that Obama is not demanding higher taxes on the rich because it advances his public policy goals. No, his goal, writes Karl Rove today, is to “kick off a Republican civil war.” This odd theory has likewise found expression from Charles Krauthammer (“Obama’s objective in these negotiations is not economic but political: not to solve the debt crisis but to fracture the Republican majority in the House,”) Peter Wehner, and other luminaries of the right.

                                                    ... It’s certainly true that Republicans are undergoing some internal strife right now over the tax issue. Daniel Henninger,... on the Journal editorial page, mourns that the president is “dismantle[ing] their party by letting its most basic conservative principles disappear.” But how this is Obama’s fault, I can’t quite figure out. It was Republicans who elevated the unpopular cause of low income tax rates for the rich to a sacred principle, built an entire party theology around punishing even the slightest dissent from that principle, and then enacted the sacred agenda through a rickety budget mechanism that caused it all to expire after a decade. That was a bad idea. Since Republicans are at least considering how to rebuild their party at the moment, my advice would be to do something else next time.

                                                      Posted by on Thursday, December 13, 2012 at 07:09 PM in Economics, Politics | Permalink  Comments (5) 

                                                      The Fed and Long-Run Expectations

                                                      Paul Krugman on the Fed:

                                                      Bernanke’s Non-Stupidity Pact: So, how big a deal was yesterday’s Fed announcement? Philosophically, it was pretty major; in terms of substantive policy implications, not so much.
                                                      What the Fed did was pledge not to raise rates until unemployment is considerably lower than it is now, or inflation is running significantly above the 2 percent target. One fairly important wrinkle I haven’t seen emphasized: the inflation criterion was couched in terms of the inflation projection, rather than past inflation. This would let the Fed hold rates low even in the face of a blip caused by, say, a sharp rise in commodity prices.
                                                      It’s fairly clear — although not explicitly stated — that the goal of this pronouncement is to boost the economy right now through expectations of higher inflation and stronger employment than one might otherwise have expected. ...

                                                      What do we know about the expectations channel? Larry Ball via Greg Mankiw:

                                                      Interpreting the Fed: My friend and sometime coauthor Larry Ball sends me his quick analysis of the Federal Reserve's recent announcement:

                                                      I think the FOMC announcement is big news: for the first time, the Fed clearly says it will be more dovish in the future than the pre-crisis Taylor Rule (TR) dictates. ...

                                                      This deviation from the TR has not happened since the TR was discovered. In particular, the Fed was NOT more dovish than the TR in 2003. ...

                                                      It is not clear whether the Fed’s announcement of future dovishness will have significant effects today. The efficacy of announcements about future monetary policy is unproven.

                                                      There are two expectations channels here. One is expected inflation (the traditional channel), the other is "stronger employment than one might otherwise have expected" due to interest rates staying lower for a longer period of time than might have otherwise been expected (this is the channel that many at the Fed are relying upon). We have little evidence on this latter channel. As for the traditional channel, it may be difficult to move inflation expectations now that they "are almost perfectly anchored" (there is much more background and explanation in the article):

                                                      Inflation Expectations Have Become More Anchored Over Time, Economic Letter, by J. Scott Davis, FRB Dallas: The Organization of Arab Petroleum Exporting Countries imposed an oil embargo on the United States in October 1973 in response to U.S. support of Israel during the Yom Kippur War. The embargo was lifted in March 1974, and although it lasted less than six months, the effects on inflation and inflation expectations in the United States would persist for a decade.
                                                      Oil prices spiked, increasing by more than 350 percent from June 1973 to June 1974, propelling a sharp increase in U.S. inflation (Chart 1). Consumer prices jumped 12 percent in 1974, from a 3 percent rise in 1972. Although the 1973 oil price shock was transitory—the price of oil declined over the next two years—inflation proved more persistent. After exceeding 5 percent in 1973, it didn’t fall below that level again until 1982.
                                                      The experiences of the 1970s show that when inflation expectations become unanchored, they may become self-fulfilling, or in the words of former Federal Reserve Chairman Paul Volcker, “inflation feeds in part on itself.” This helps explain how a transitory oil price spike in 1973—along with a second oil shock in the late 1970s (associated with the 1979 Iranian Revolution)—could lead to a decade of high inflation. Over the past 30 years, Federal Reserve policy has succeeded in better anchoring inflation expectations, producing diminished expectations that a short-term shock leads to sustained high inflation. ...
                                                      Measuring Inflation Anchoring
                                                      One way to gauge such anchoring is calculating the responsiveness of expected inflation in the next few years to a shock to current inflation. If expectations are well-anchored, the response will be minimal. ...
                                                      A plot of the changes in the five-year-ahead, five-year-forward expected inflation rate shows that during the early part of the 1983–2011 period, long-run inflation expectations were quite variable and highly correlated with unexpected inflation (Chart 3). For instance, in early 1984, when inflation turned out to be almost 1 percentage point higher than expected, the expectation of long-run inflation also increased by nearly 1 percentage point. A few years later, in 1986, when inflation turned out to be 3 percentage points lower than expected, people reduced their expectations of long-run inflation by 1 percentage point.
                                                      The chart shows that over this nearly 30-year sample, long-run inflation expectations became less volatile and less responsive to surprises in current inflation. For example, between 2008 and 2011, unexpected inflation fluctuated: 3 percent in 2008, negative 5 percent in 2009, 3 percent in early 2010, negative 2 percent later in 2010 and 3 percent in 2011—yet, long-run inflation expectations over this period, as measured by revisions in the five-year-ahead, five-year-forward rate, barely moved.
                                                      The statistical methodology of ordinary least-squares regression allows analysis of the relationship between two or more variables. This “averaging” tool helps measure how short-run surprises affect long-term inflation expectations. For example, if inflation over the past year is 1 percentage point higher than expected, the least-squares regression results show that people tend to raise their long-run expectations by some number γ of percentage points—for 1983–2011, γ is 0.11 (Table 1). This means that, on average over the period 1983 to 2011, a 1 percentage point surprise in the inflation rate raised long-term inflation expectations by 0.11 percentage points. The smaller the value of γ, the more anchored are long-run inflation expectations—if γ is not significantly different from zero, then long-run expectations are perfectly anchored.


                                                      Anchoring of inflation expectations over the past 30 years has changed markedly, as shown by the results in the bottom half of Table 1. In the 1980s, confronted with a 1 percentage point higher-than-anticipated inflation rate, people boosted their expectations for long-run inflation by 0.28 percentage points. However, since 2000, people raise their expectations by about 0.03 percentage points following a similar surprise, suggesting that long-run expectations are almost perfectly anchored.
                                                      As few as 30 years ago, long-run inflation expectations were quite responsive to short-term shocks. Over the ensuing period, the Fed has been better able to anchor such expectations so that now long-run expectations barely change following a series of dramatic, but ultimately transitory, inflation surprises. ...

                                                        Posted by on Thursday, December 13, 2012 at 10:42 AM in Economics, Inflation, Monetary Policy, Unemployment | Permalink  Comments (27) 

                                                        Fed Watch: Gas Prices Falling

                                                        Tim Duy:

                                                        Gas Prices Falling: Gas prices continued to decline last week, falling to the bottom of the roughly $3.50-$4.00 range of the past two years:


                                                        Ever notice that when gas prices rise, Fed critics starting jumping up-and-down and screaming inflation, but never say a word about deflation when gas prices fall?

                                                          Posted by on Thursday, December 13, 2012 at 09:10 AM in Economics, Fed Watch, Inflation | Permalink  Comments (15) 

                                                          Links for 12-13-2012

                                                            Posted by on Thursday, December 13, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (115) 

                                                            Wednesday, December 12, 2012

                                                            Video: David Leonhardt Interviews Paul Krugman

                                                              Posted by on Wednesday, December 12, 2012 at 06:34 PM in Economics, Video | Permalink  Comments (10) 

                                                              Just Sayin': It May Already Be Too Late

                                                              Tim Haab:

                                                              Just sayin': I was thinking of writing a lengthy post about climate change denial being completely unscientific nonsense, but then geochemist and National Science Board member James Lawrence Powell wrote a post that is basically a slam-dunk of debunking. His premise was simple: If global warming isn’t real and there’s an actual scientific debate about it, that should be reflected in the scientific journals.
                                                              He looked up how many peer-reviewed scientific papers were published in professional journals about global warming, and compared the ones supporting the idea that we’re heating up compared to those that don’t. What did he find? This:

                                                              Powell-Science-Pie-Chart[1]The thin red wedge.   Image credit: James Lawrence Powell

                                                              Maximillian Auffhammer at the Berkeley blog:

                                                              Doha schmoha: On Saturday (Dec. 8) another wildly unsuccessful round of climate negotiations, in Doha, Qatar, concluded with applying a band aid to solve the rapidly accelerating climate problem. The 1997 Kyoto accord was extended to 2020. If you think this is a good thing, you are severely mistaken. China, the US and the other usual suspects made no significant concessions. Further,  the climate leader — the EU — is internally in disagreement over what reductions should be agreed to. ...
                                                              While academics have proposed a number of interesting avenues for further studies of so called architectures for future agreements, time is slowly running out. It is simply too difficult to get 200+ countries to agree and then stick to a binding agreement. So what to do?
                                                              I think a simple handshake between the U.S. and China would be a good start. Each agrees to a carbon tax which is collected fairly far upstream. Any country wanting to sell its goods into the U.S. or Chinese markets could either pay a carbon tariff at the border or start charging its own equivalent carbon tax and be exempt from the tariff.
                                                              Is this going to happen? Maybe not...
                                                              But one thing is for sure: We are becoming richer as a species and we will want to consume more energy services. Unless we start pricing carbon, that energy will largely come from coal. And if that happens, limiting warming to 2 degrees is a pipe dream. In fact, it may already be too late.

                                                                Posted by on Wednesday, December 12, 2012 at 05:06 PM in Economics, Environment, Market Failure, Taxes | Permalink  Comments (66) 

                                                                Fed Watch: FOMC Projections and the Press Conference

                                                                Two more from Tim Duy on the Fed's decision today:

                                                                FOMC Projections

                                                                The Press Conference

                                                                  Posted by on Wednesday, December 12, 2012 at 01:35 PM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (16) 

                                                                  The Fed Adopts Numerical Thresholds for Inflation and Unemployment

                                                                  Here's my reaction to today's announcement from the Fed:

                                                                  The Fed Adopts Numerical Thresholds for Inflation and Unemployment

                                                                  One point is that the Fed adopted thresholds, not triggers, and that matters.

                                                                    Posted by on Wednesday, December 12, 2012 at 11:40 AM in Economics, Monetary Policy | Permalink  Comments (12) 

                                                                    'More Bond Buying and Thresholds'

                                                                    I'll have a post up soon at MoneyWatch on today's announcement from the Fed. I'll link as soon as it leaves editing and is posted. While I wait, here's Tim Duy's response:

                                                                    More Bond Buying and Thresholds, by Tim Duy: The FOMC statement was released this morning. Key points are that Operation Twist will be converted one-for-one to an outright purchase program and the long-debated issue of thresholds became a reality. First thoughts:

                                                                    On the current situation:

                                                                    Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions. Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.

                                                                    Slow and steady, taking into account Hurricane Sandy, with a special nod to weak investment numbers. Inflation both low in near-term and longer-term inflation expectations remain anchored. Nothing too surprising here as it seems broadly consistent with the tenor of recent speeches by Fed speakers.

                                                                    Next, the outlook:

                                                                    Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.

                                                                    Slow and steady is not enough to generate the improvement in labor market the Fed believes is necessary within the context of the dual mandate. They continue to see strains in global financial markets...although this seems odd, as it seems that financial markets have calmed considerably in recent months. The FOMC reaffirms its commitment to long-term price stability.

                                                                    Bond buying, key addition:

                                                                    The Committee also will purchase longer-term Treasury securities after its program to extend the average maturity of its holdings of Treasury securities is completed at the end of the year, initially at a pace of $45 billion per month.

                                                                    I am not surprised, but I was cautious that the Fed would choose to pull the trigger on a complete conversion of Operation Twist to an outright purchase program. I think the St. Louis Federal Reserve President James Bullard is right when he notes that this is a more dovish policy. The Fed has more than doubled the pace of the balance sheet expansion, a much more stimulative stance - unless, of course, we are deep into the territory of diminishing marginal returns.

                                                                    We all knew thresholds were coming, but in general did not expect it this meeting:

                                                                    To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee views these thresholds as consistent with its earlier date-based guidance. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

                                                                    The expiration date of low-interest rate policy is replaced with economic thresholds, which I believe is a more appropriate communications strategy. The baseline expectation is that as long as unemployment remains above 6.5%, the Fed will tolerate an inflation forecast as high as 2.5% in the near term, assuming that long-term expectations remain anchored, before considering to raise rates. In other words, all bets are off if the Fed judges that long-term expectations are accelerating even if unemployment and near-term inflation forecasts remain within their respective bounds. The Fed is also taking pains to explain that policy depends on more than just two variables, and may act on the basis of that additional information. Also, the Fed does not believe the move to thresholds changes policy relative to the date-based guidance; it only changes the communications strategy.

                                                                    Finally, a dissent:

                                                                    Voting against the action was Jeffrey M. Lacker, who opposed the asset purchase program and the characterization of the conditions under which an exceptionally low range for the federal funds rate will be appropriate.

                                                                    Not surprising in the least.

                                                                    Bottom Line: The Fed delivered an early Christmas present to the economy by acting above expectations with not only a one-for-one conversion of Operation Twist to outright asset purchases, more than doubling the pace of balance sheet expansion, but also shifting the communications strategy to thresholds. The latter ties policy explicitly to outcomes rather than dates, which I think is the appropriate direction for policy.

                                                                      Posted by on Wednesday, December 12, 2012 at 10:47 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (31) 

                                                                      'Cautionary Details on U.S. Manufacturing Productivity'

                                                                      Awhile back I asked Tim Taylor if it would be okay to reprint a post occasionally in full or in part, and he quickly and graciously said I could. As he notes, this is an important addendum to the standard story on manufacturing, productivity, and employment. The bottom line is that "the condition of U.S. manufacturing looks more ominous than the standard story" would have us believe:

                                                                      Cautionary Details on U.S. Manufacturing Productivity: Susan Houseman, by Tim Taylor: There's a basic and often-told story about output and employment in the U.S. manufacturing sector: I'm sure I've told it a time or two myself. The story begins by pointing out that the total quantity of U.S. manufacturing output has actually held up fairly well over recent decades, although it hasn't grown as quickly as the services sector. However, productivity growth in manufacturing has been rising quickly enough that productivity growth. However, manufacturing productivity has been rising quickly enough that, even though manufacturing output has remained fairly strong, the number of jobs has been falling. The standard historical analogy is that just as rising agricultural productivity meant that fewer U.S. farmers were needed, now rising manufacturing productivity means that fewer manufacturing workers are needed.

                                                                      That story isn't exactly wrong, at least not over the long-run, but Susan Houseman has been digging down into the details and finding arguments which suggests that it is a seriously incomplete version of what's happening in the U.S. manufacturing sector. Houseman presented some of these arguments in a paper written with Christopher Kurz, Paul Lengermann, and Benjamin Mandel, called  "Offshoring Bias in U.S. Manufacturing," which appeared in the Spring 2011 issue of my own Journal of Economic Perspectives. (Like all articles in JEP back to the first issue in 1987, it is freely available courtesy of the American Economic Association.) In turn, their JEP paper was a revision of a more detailed Federal Reserve working paper in 2010, available here. However, Houseman offers a nice overview of her arguments in an interview recently published in fedgazette, a publication of the Federal Reserve Bank of Minneapolis. ...
                                                                      After reading Houseman, when you hear the standard story about how high productivity in manufacturing is leading to reduced employment, the following thoughts should rattle through your head:

                                                                      1)  Most of the productivity growth in manufacturing is computers. Houseman: "First, a very important fact, but one I find most people don’t know—including some people who write a lot about the manufacturing sector—is that manufacturing growth in real [price-adjusted] value added and productivity wasn’t that strong without the computer and electronics industry. The computer industry is small—it only accounts for about 12 percent of manufacturing’s value added....  But we find that without the computer industry, growth in manufacturing real value added falls by two-thirds and productivity growth falls by almost half. It doesn’t look like a strong sector without computers."

                                                                      2) Most of the productivity growth in manufacturing computers is because computers are becoming so much faster and better over time, and government statistics count that a productivity growth, not because an average worker is producing a dramatically greater quantity of computers. Houseman: "The standard argument is that the rapid productivity growth in computers is coming from product innovation. This year’s computers and semiconductors are faster and do more than last year’s models. And that product innovation essentially gets captured in the price indexes the government uses to deflate computer and semiconductor shipments. The price indexes for most products increase over time—that’s inflation. But, for example, the price indexes used to deflate computer shipments have actually fallen by a whopping 21 percent per year since the late 1990s. Those rapid price declines largely reflect adjustments for the growing power of computers. And that extraordinary decline in computer price indexes translates into extraordinary growth in real value added and productivity in the computer industry as measured in government statistics. So, in some statistical sense, today’s computer may be the equivalent of, say, 13 computers in 1998. ... The reason jobs in computers have been lost is not because productivity growth has crowded them out; not at all. It’s because much of the production has gone overseas...."

                                                                      3)  A sizeable share of what looks like growth in manufacturing productivity is actually from importing less expensive inputs to production. Houseman: "[T]here’s been a lot of growth in manufacturers’ use of foreign intermediate inputs since the 1990s, and most of those inputs come from developing and low-wage countries where costs are lower. We point out that those lower costs aren’t being captured by statistical agencies, and so, as a result, the growth of those imported inputs is being undercounted. ...  Suppose an auto manufacturer used to buy tires from a domestic tire manufacturer. Then it outsources the purchase of its tires to, say, Mexico, and the Mexicans sell the tires for half the price. That price drop—when the auto manufacturer switches to the low-cost Mexican supplier—isn’t caught in our statistics. And if you don’t capture that price drop, it’s going to look like, in some statistical sense, the manufacturer can make the same car but only needs two tires. ... Our statistical agencies try to measure price changes, but they miss them when the price drops because companies have shifted to a low-cost supplier. So because we don’t catch the price drop associated with offshoring, it looks like we can produce the same thing with fewer inputs—productivity growth. It also looks like we are creating more value here in the United States than we really are."

                                                                      4) If productivity in manufacturing rises because of automation, then those gains in productivity may benefit the owners of the machines--that is, benefit capital rather than labor. Houseman: "And then another standard story has to do with automation. Basically, capital is substituting for labor. Automation can lead to job losses. And the returns from automation, or higher capital use, won’t necessarily be shared with workers."

                                                                      5) If low-wage labor-intensive manufacturing tasks are now more likely happen overseas, an higher-wage tasks remain in the U.S., then it may appear as if the productivity of an average U.S. manufacturing worker is higher--but it's just a shift in the composition of U.S. manufacturing workers. Houseman: "Then, finally, there’s probably been some shifting in the sorts of production that occur here. In particular, less of the labor-intensive production is done in the United States, and that would result in job losses and higher labor productivity. Again, the gains from that productivity growth aren’t necessarily going to be shared with remaining workers. So part of the answer to the puzzle is that even if productivity gains are real, there’s really nothing that guarantees those gains will be broadly shared by workers."

                                                                      Add all these factors up, and the condition of U.S. manufacturing looks more ominous than the standard story of high productivity and resulting job losses. For more on the future of global and U.S. manufacturing, see this November 30 post on "Global Manufacturing: A McKinsey View."

                                                                        Posted by on Wednesday, December 12, 2012 at 09:07 AM in Economics, Productivity, Technology, Unemployment | Permalink  Comments (23) 

                                                                        For Lobbyists, It's 'Who You Know'

                                                                        What's the value of a lobbyist?:

                                                                        Economists calculate true value of 'who' you know, rather than 'what' in US politics, EurekAlert: Economists at the University of Warwick have calculated the true value of US political lobbyists, proving the old adage 'it is not what you know, but who you know'.
                                                                        In a paper published this month in the American Economic Review Mirko Draca, from the University of Warwick's Department of Economics, looked at the role of lobbyists in the US. He found their revenue falls by 24% when their former employer leaves government office.
                                                                        The study examined the so-called 'revolving door' of politics, which refers to the movement of people from government service into lobbying positions.
                                                                        Mr Draca said: "We investigated how the revenues of lobbyists who had previously worked in the offices of a member of US Congress were affected when their former employers left office. This allowed us to look at the value of 'what' and 'who' because we evaluated situations in which knowledge did not change, but connections did."
                                                                        The paper, co-authored by Jordi Blanes i Vidal, London School of Economics, and Christian Fons-Rosen from Universitat Pompeu Fabra, found the24% fall in revenue was immediate and long-lasting. The relative pay of lobbyists depends on the seniority and committee assignments of the congressional politicians they have worked for in the past.
                                                                        Mr Draca said: "Our work quantifies, I believe for the first time, the value of personal connections to elected officials for lobbyists in Washington, rather than relying on anecdotal evidence." ...

                                                                          Posted by on Wednesday, December 12, 2012 at 08:10 AM in Economics, Politics | Permalink  Comments (6) 

                                                                          Links for 12-12-2012

                                                                            Posted by on Wednesday, December 12, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (107) 

                                                                            Tuesday, December 11, 2012

                                                                            Fed Watch: The Debt-Ceiling Gamble

                                                                            One more from Tim Duy:

                                                                            The Debt-Ceiling Gamble, by Tim Duy: Ezra Klein reports that the White House is drawing a line in the sand on the debt-ceiling, and they really, really mean it:

                                                                            The Obama administration is utterly steadfast on this point: They will not suffer a repeat of 2011, when they conducted negotiations over whether the United States should default. If Republicans go over the cliff and try to open up talks for raising the debt ceiling, the White House will not hold a meeting, they will not return a phone call, they will not look at the e-mails.

                                                                            The Administration is looking to take the debt ceiling off the table forever. This is good policy; that Congress should be able to pass laws authorizing spending but not authorizing the required debt is beyond ridiculous. Also ridiculous - and irresponsible - is the willingness of the Republicans to use the debt ceiling to hold the economy hostage. Ending this travesty should be a priority for the White House.

                                                                            Klein adds that the White House is ready for the fight now while their strength is up:

                                                                            Boehner and the Republicans don’t want to give up the leverage of the debt ceiling forever, or for 10 years, or even, as John Engler, head of the Business Roundtable and a former Republican governor suggested, for five years. But the White House isn’t very interested in compromising on this issue, as they figure that if there needs to be a final showdown over the debt ceiling, it’s better to do it now, when they’re at peak strength, then delay it till 2014 or 2015, when their own vantage might have ebbed.

                                                                            I would add another advantage. Better - from a political point of view - to have a recession at the beginning of President Obama's second term that can be blamed entirely on the Republicans. A recession in the first half of 2013 means that, most likely, the Democratic presidential nominee can run on the back of an improving economy by 2016. Alternatively, they run the risk that this recovery, anemic as it is, gets long in the tooth by 2016. Even worse would be that they agree to let the Republicans once again hold the economy hostage two years from now. Politically, if I had to pick between a recession now or closer to the next election, I would pick now.

                                                                              Posted by on Tuesday, December 11, 2012 at 01:28 PM in Budget Deficit, Economics, Fed Watch, Politics | Permalink  Comments (23) 

                                                                              Fed Watch: Disappointing Trade Report

                                                                              Tim Duy:

                                                                              Disappointing Trade Report, by Tim Duy: Today's international trade report confirms that sluggish global growth is taking a toll on the US economy. Exports are now barely up compared to last year:


                                                                              Calculated Risk notes the wider goods deficit with the Eurozone. I would add that this is clearly on the back of weaker exports (imports are up slightly). On the plus side, exports of services were up 4.3 percent, while goods exports were down slightly, a story consistent with the divergent ISM manufacturing and services surveys.
                                                                              Also note the negative year-over-year growth around 1998, the time of the Asian Financial Crisis, which means that even a significant external shock does not necessarily induce a US recession. That said, the softer external sector does leave the economy more vulnerable to negative internal shocks. In the late 1990's, the US experienced a positive internal shock, mitigating the impact of the Asian Financial Crisis. In the near-term, such a positive shock does not look as likely this time around. 
                                                                              I take little comfort from the import data:


                                                                              Flat to negative numbers are typically consistent with recession as they reflect periods of negative domestic demand. We can't write off the slightly negative reading as simply a reflection of falling oil imports (down $625 million); non-petroleum imports (down $792 million) also fell slightly compared to a year ago. Unless the pace of import-substitution is happening very quickly, this data seems like something of a red flag.  Something to be cautious of as we head into 2013.
                                                                              Bottom Line: While I do not believe the US economy is in recession by any stretch of the imagination, I am under no illusions about the lack of underlying momentum. Slow and steady, in my opinion. But slow also means more vulnerable; there was more room to absorb an external hit in the late 1990's than today. Which again leaves me wary about the impact of tighter fiscal policy, and I am not alone. I question the belief that the clarity-induced confidence of a deal will be sufficient to offset the impact of tighter policy. Just as the Federal Reserve has committed to asset purchases until labor markets are substantially and sustainably stronger, fiscal policymakers should commit to easy policy until those conditions are met as well. Instead, we are poised for another austerity experiment. For now, the plan is to squeeze through the choppy first part of 2013 to the restorative powers of improved private sector balance sheets at the end of 2013. Hopefully we make it there relatively unscathed.  

                                                                                Posted by on Tuesday, December 11, 2012 at 11:32 AM in Economics, Fed Watch, International Trade, Monetary Policy | Permalink  Comments (1) 

                                                                                'Jobs, Productivity, and the Great Decoupling'

                                                                                This is not starting off as the greatest day ever. Grrr. A quick one on inequality while I sort things out:

                                                                                Jobs, Productivity and the Great Decoupling, by Erik Btynjolfsson and Andrew McAffee, Commentary, NY Times: ...For several decades after World War II ... G.D.P. grew, and so did productivity... At the same time, we created millions of jobs, and many of these were the kinds of jobs that allowed the average American worker, who didn’t (and still doesn’t) have a college degree, to enjoy a high and rising standard of living. ...


                                                                                But as shown by the accompanying graph, which was first drawn by the economist Jared Bernstein, productivity growth and employment growth started to become decoupled from each other at the end of that decade. Bernstein calls the gap that’s opened up “the jaws of the snake.” They show no signs of closing. ... Wages as a share of G.D.P. are now at an all-time low, even as corporate profits are at an all-time high. The implicit bargain that gave workers a steady share of the productivity gains has unraveled.
                                                                                What’s going on? ... There are several explanations, including tax and policy changes and the effects of globalization and off-shoring. We agree that these matter but want to stress another driver of the “Great Decoupling” — the changing nature of technological progress. ...
                                                                                The Great Decoupling is not going to reverse course... And this should be great news for society. Digital progress lowers prices, improves quality, and brings us into a world where abundance becomes the norm.
                                                                                But there is no economic law that says digital progress will benefit everyone evenly. ... Designing a healthy society to go along with such an economy will be the great challenge, and the great opportunity, of the next generation. ...

                                                                                As I've stressed in the past many, many times, I believe the growth in economic power and the political power that comes with it is also a factor, and this has distorted the distribution of income away from working class households (the market power and technological progress explanations aren't mutually exclusive, and may be complementary -- I should also mention political factors as well, e.g. the politics behind the demise in unions, as another cause even though I think of this as part of the economic/political power explanation).

                                                                                  Posted by on Tuesday, December 11, 2012 at 10:11 AM in Economics, Income Distribution, Market Failure | Permalink  Comments (123) 

                                                                                  'What Does the New CRA Paper Tell Us?'

                                                                                  Mike Konczal:

                                                                                  What Does the New Community Reinvestment Act (CRA) Paper Tell Us?, by Mike Konczal: There are two major, critical questions that show up in the literature surrounding the 1977 Community Reinvestment Act (CRA).
                                                                                  The first question is how much compliance with the CRA changes the portfolio of lending institutions. Do they lend more often and to riskier people, or do they lend the same but put more effort into finding candidates? The second question is how much did the CRA lead to the expansion of subprime lending during the housing bubble. Did the CRA have a significant role in the financial crisis?   There's a new paper on the CRA, Did the Community Reinvestment Act (CRA) Lead to Risky Lending?, by Agarwal, Benmelech, Bergman and Seru, h/t Tyler Cowen, with smart commentary already from Noah Smith. (This blog post will use the ungated October 2012 paper for quotes and analysis.) This is already being used as the basis for an "I told you so!" by the conservative press, which has tried to argue that the second question is most relevant. However, it is important to understand that this paper answers the first question, while, if anything, providing evidence against the conservative case for the second. ...
                                                                                  "the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis." ...

                                                                                    Posted by on Tuesday, December 11, 2012 at 09:42 AM in Academic Papers, Economics, Financial System | Permalink  Comments (8) 

                                                                                    'The Political Economy of Inequality'

                                                                                    In light of the recent attention on the importance of capital ownership as source of inequality, Arin Dube reminds me of this piece in the Economists' Voice from March 2012 that he published along with Ethan Kaplan ("Occupy Wall Street and the Political Economy of Inequality"). They argue that upper tail income inequality is best understood through the lens of increasing power of those owning capital. Here is an excerpt provided by Arin: 

                                                                                    ... During the 1990s and 2000s, most economists viewed the growth in the upper-tail inequality as largely representing the same phenomenon as the growth in wage inequality elsewhere—primarily a change in the demand for skills through technological change, with some role for policy ...  Missing from all this was a discussion about how upper-tail earnings inequality could be better understood as an increase in the power of those with control over financial and physical capital. The exceptions were mostly outside of mainstream economics (e.g., Duménil and Lévy 2004). 
                                                                                    Consider three pieces of evidence. First, there has been a broad decline in the labor share of income from around 66 percent in 1970 to 60 percent in 2007. Moreover, as measured, labor income includes compensation going to top executives—the modern day equivalent of the nineteenth century capitalist. The exclusion of their compensation would show a substantially greater drop in labor’s share. Additionally, most of the growth in executive compensation has been capital-based, i.e., through stock options but appears in national accounts as labor income (Frydman and Molloy 2011).
                                                                                    Second, based on tax data, the majority of income at the top comes from capital-based earnings (capital gains, dividends, entrepreneurial income and rent). In 2007, this proportion was 62 percent and 74 percent for the top 1 percent and 0.1 percent, respectively (Figure 1).
                                                                                    Third, the biggest driver of upper-tail inequality—both in terms of capital and wage based income—was finance, the sector which governs the allocation of capital. Between 2002 and 2007, 34 percent of all private sector profits came from the financial sector. Meanwhile, studies of financial sector pay setting suggest that the exorbitant finance premium in earnings was driven by financial sector profits (Philippon and Resheff 2009, Crotty 2011).
                                                                                    Overall, a focus on the 1 percent concentrates attention on the aspect of inequality most clearly tied to the distribution of income between labor and capital. This type of inequality is seen as being the least fair, as economic rents and returns to wealth are often perceived as unearned income (Atkinson 2009). ...

                                                                                      Posted by on Tuesday, December 11, 2012 at 09:07 AM in Economics, Income Distribution, Market Failure | Permalink  Comments (32) 

                                                                                      Links for 12-11-2012

                                                                                        Posted by on Tuesday, December 11, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (97) 

                                                                                        Monday, December 10, 2012

                                                                                        Fed Watch: Wobbly Consumers?

                                                                                        Tim Duy:

                                                                                        Wobbly Consumers?, by Tim Duy: This morning's Wall Street Journal contains a front page story on the state of the American consumer:

                                                                                        U.S. consumer spending, a rare pillar of economic strength in recent months, is showing signs of weakening.

                                                                                        American consumers helped carry the economy through a spring slowdown and appeared to power a summer resurgence in growth. But in recent weeks government data have shown spending was slower over the summer than previously believed, and it has started off the final three months of the year on an even weaker footing.

                                                                                        This, I think, is a charitable interpretation of the consumer situation up until now. I am not sure who exactly believed that the US consumer is a "rare pillar of economic strength," but I suspect they were somewhat delusional and perhaps overemphasizing the importance of consumer confidence surveys. I don't think the consumer is falling off the cliff, fiscal or otherwise, just yet, but household spending hasn't been exactly a source of strength for several months now. The fragility of the sector is not new.

                                                                                        Begin with a quick look at core retail sales:

                                                                                        The October figure can be discounted as a artifact of Sandy. And even if not, by itself the decline is hardly out of line with monthly fluctuations in the series. On a three month basis, core sales have also been within their past range:


                                                                                        The soft spot earlier this year, however, did put in place a more worrisome trend:


                                                                                        On this basis, consumer spending lost momentum in April. So why is spending believed to be an economic pillar? I think the rebound of consumer sentiment fostered this view. From the article:

                                                                                        On Friday, a preliminary December measure of consumer sentiment from the University of Michigan tumbled to its lowest level since August after four months of gains.

                                                                                        "It was a dramatic drop," said Jacob Oubina, senior U.S. economist for RBC Capital Markets. "The consumer's not all of a sudden going to pick up the baton."

                                                                                        But as I have explained previously, at best sentiment rose to where it would be expected to be based on its past relationship with spending:


                                                                                        Sentiment has not been an accurate indicator of spending since 2010, consistently lower than would be expected. Note also that real PCE lost momentum at the beginning of 2011, much earlier than core retail sales. Of course, "momentum" is a matter of opinion. Spending never came close to regaining its pre-recession trend:


                                                                                        By major component:


                                                                                        Of the three components, durable goods has most closely regained its previous growth rate, but not the trend. And even its growth rate is in question as the replacement cycle for cars and light trucks comes to end; sales are closing in on the pre-recession levels in the auto sector.
                                                                                        So why isn't spending surging? Why aren't low interest rate powering spending? After all, by some measures households are more capable of supporting additional debt than they have been in years:


                                                                                        But households remain in a deleveraging phase:


                                                                                        As part of that deleveraging, note that home mortgage withdraw remains sharply negative - see Calculated Risk. With households still deleveraging, spending is dependent on job and wage growth. And we pretty much know that neither of those two factors are supporting runaway consumer spending anytime soon.
                                                                                        So I think consumer vulnerability has been evident for months, that this is not in any way a recent event, and that it will continue until deleveraging comes to a halt or if job and wage growth suddenly surge. And that vulnerability is aggravated by the fiscal cliff concerns. One way or another, fiscal policy will be tighter next year. Congress is debating the shape and depth of that tightening. Another way to think about it is that fiscal policy will turn toward deleveraging while the household sector continues to delever. I think fiscal policy should refrain from deleveraging until the private sector is ready to relever. When will that be? Jan Hatzius of Goldman Sachs expects that releveraging to begin in the second half of 2013 - see his interview with Joe Weisenthal. If so, then the first half of 2013 will be stormy, but the sky will clear toward the end of the year and into 2014.
                                                                                        Of course, the alternative is that the combination of fiscal and household deleveraging is more severe than anticipated. Perhaps fiscal mutlipliers are greater than expected, as just might be the case at the zero bound. Then the first half of 2013 is much choppier than anticipated, undermining stronger growth forecasts for the second half of the year. In which case the turn to fiscal austerity will be deemed ill-timed at best.
                                                                                        Bottom Line: I don't think that consumer spending has suddenly decelerated, but I never thought it suddenly accelerated either. It has been vulnerable for many months, and will remain vulnerable for many more. Vulnerable does not mean apocalyptic; all else equal, I would expect consumer spending to grind along as it has been for much of the year. That said, even grinding along is at risk in the face of fiscal austerity.

                                                                                          Posted by on Monday, December 10, 2012 at 02:33 PM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (11) 

                                                                                          'The Distributional Issue ... is Extremely Important'

                                                                                          Dean Baker responds to inconsistent worries about robots displacing labor and the ability of a smaller number of workers per retiree to support Social Security:

                                                                                          ... we seem to be seeing rapid improvements in productivity growth ... that are drastically reducing the demand for labor. Yet all the gains from these improvements seem to be going to owners of capital as the labor share of output has been falling sharply.

                                                                                          The distributional issue ... is extremely important, both for workers who are not seeing gains in living standards, and also for the economy as a whole, since a continual upward redistribution of income will lead to stagnation as a result of inadequate demand. However, it is worth noting that the concern that rapid productivity growth will lead to less demand for labor is 180 degrees at odds with the often repeated concern that productivity growth will be inadequate to sustain rising living standards in the future.

                                                                                          ... If you are concerned that a falling ratio of workers to retirees is going to make us poor then you are not concerned that excessive productivity growth will leave tens of millions without jobs.
                                                                                          It is possible for too much productivity growth to be a problem, if the gains are not broadly shared. It is also possible for too little productivity growth to be a problem as a growing population of retirees impose increasing demands on the economy. But, it is not possible for both to simultaneously be problems. ...

                                                                                          I'm not worried about low productivity growth and stagnation. Since we are in the midst of it, it's hard to see the full impact of the digital revolution, but I believe it's a bigger force for productivity growth than we realize. There are big changes in our future as robots/machines become better and better at displacing people. However, that growth will be more unequal than ever, and it's the distribution of the gains from growth that I worry about.

                                                                                          In the future, we'll have the ability to produce enough stuff, and that ability won't stop growing. The problem will be distribution, and our inherently selfish nature makes it an extremely difficult problem to solve.

                                                                                            Posted by on Monday, December 10, 2012 at 09:21 AM in Economics, Income Distribution, Productivity | Permalink  Comments (67) 

                                                                                            Paul Krugman: Robots and Robber Barons

                                                                                            I have been arguing for some time now "that we have paid too little attention to the growing economic and political power of our largest firms," and that this is a factor in the "maldistribution" of income, so it's nice to see this issue get more attention:

                                                                                            Robots and Robber Barons, by Paul Krugman, Commentary, NY Times: The American economy is still, by most measures, deeply depressed. But corporate profits are at a record high. How is that possible? It’s simple:... profits have been rising at the expense of workers in general, including workers with the skills that were supposed to lead to success in today’s economy.
                                                                                            Why is this happening? As best as I can tell, there are two plausible explanations, both of which could be true to some extent. One is that technology has taken a turn that places labor at a disadvantage; the other is that we’re looking at the effects of a sharp increase in monopoly power. Think of these two stories as emphasizing robots on one side, robber barons on the other.
                                                                                            About the robots: there’s no question that in some high-profile industries, technology is displacing workers of all, or almost all, kinds. ... What’s striking ... is that many of the jobs being displaced are high-skill and high-wage; the downside of technology isn’t limited to menial workers. ...
                                                                                            What about robber barons? We don’t talk much about monopoly power these days; antitrust enforcement largely collapsed during the Reagan years and has never really recovered. Yet Barry Lynn and Phillip Longman of the New America Foundation argue, persuasively in my view, that increasing business concentration could be an important factor in stagnating demand for labor, as corporations use their growing monopoly power to raise prices without passing the gains on to their employees.
                                                                                            I don’t know how much of the devaluation of labor either technology or monopoly explains, in part because there has been so little discussion of what’s going on. I think it’s fair to say that the shift of income from labor to capital has not yet made it into our national discourse.
                                                                                            Yet that shift is happening — and it has major implications. For example, there is a big, lavishly financed push to reduce corporate tax rates; is this really what we want to be doing at a time when profits are surging at workers’ expense? Or what about the push to reduce or eliminate inheritance taxes; if we’re moving back to a world in which financial capital, not skill or education, determines income, do we really want to make it even easier to inherit wealth?
                                                                                            As I said, this is a discussion that has barely begun — but it’s time to get started, before the robots and the robber barons turn our society into something unrecognizable.

                                                                                              Posted by on Monday, December 10, 2012 at 12:33 AM in Economics, Income Distribution, Market Failure | Permalink  Comments (100) 

                                                                                              Fed Watch: Is The US Already in Recession?

                                                                                              Tim Duy:

                                                                                              Is The US Already in Recession?, by Tim Duy: Via a recent media blitz, ECRI Co-Founder Lakshman Achuthan insists that the US is already in recession, apparently as of July. I would be very skeptical that this was in fact the case. I think the preponderance of evidence weighs in favor of ongoing expansion, disappointing as the pace of that expansion may be.

                                                                                              Actually, Achuthan loses credibility quite quickly by claiming there is a strict definition of recession based upon peaks of production (Achuthan apparently views "production" as "industrial production"), income, jobs, and sales. In contrast, according to the NBER business cycle dating committee:

                                                                                              The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve's index of industrial production (IP). The Committee's use of these indicators in conjunction with the broad measures recognizes the issue of double-counting of sectors included in both those indicators and the broad measures. Still, a well-defined peak or trough in real sales or IP might help to determine the overall peak or trough dates, particularly if the economy-wide indicators are in conflict or do not have well-defined peaks or troughs.

                                                                                              Dating a recession, it would seem, is something of an art. And note that Achuthan appears to ignore the role of GDP and GDI in the determination of a recession. Taking a quick look at those two series:


                                                                                              Both GDP and GDI gained in the third quarter. I would imagine that the NBER would need to see at least one of these indicators clearly turn downward before the issue of recession would even be worth the slightest consideration. Onto the jobs picture:


                                                                                              No, nothing to see here. Unless you expect some very, very significant revisions, nothing in the jobs picture should lead you to believe that a recession began in July. I find it very hard to believe that the NBER would find cause to declare a recession began in July when the economy added jobs for the next four months. How about real income?


                                                                                              Arguably, there is a peak in July. There was, however, also a peak at the end of 2010 as well, and real income moved sideways for almost a year, yet no recession was identified in 2011. In other words, recent behavior in this series is not inconsistent with that seen during the current expansion.
                                                                                              Together, I don't think these four indicators even begin to pass the sniff test for dating a recession beginning in July 2012. Beyond what the NBER believes to be the key elements in identifying recessions comes secondary data that does not cover the entire economy. Start with industrial production:


                                                                                              There is clear evidence that manufacturing softened in recent months, consistent with the July near-term peak in industrial production. As the NBER notes, however, a downturn in one sector does not define a recession. A recession is a broad-based downturn in activity; industrial production may be an element in dating a cycle, but is not itself a recession. Next up is real manufacturing and trade sales, only available through September:


                                                                                              I would be hard pressed to call July a peak. It looks like this series rolls over quickly in a recession, coincident with a jobs downturn. And that, I believe, is the key - you don't see widespread declines of activity without widespread job losses. And when job losses mount, sales roll over. I very much doubt sales will roll over in the presence of ongoing job growth. They may bounce along sideways - see 2006. But decline substantially and persistently? Doubtful, in my opinion. Watch, however, for recession watchers to take an October, Katrina-impacted decline as recession evidence.
                                                                                              I think that even a cursory glance of all the data the NBER cites as elements in recession dating, even ignoring the important issue of first identifying broad-based indicators, would lead one to be very skeptical about a July recession call on the basis of "eyeball econometrics" alone. Moving on to something more sophisticated, Chauvet and Piger (1998) use the four variables identified by Achuthan to estimate recession probabilities:


                                                                                              When first released, this measure stirred up some excitement as some interpreted the original 20% estimate for August to be a clear signal of recession. As Jeremy Piger notes on his website:

                                                                                              Historically, three consecutive months of smoothed probabilities above 80% has been a reliable signal of the start of a new recession, while three consecutive months of smoothed probabilities below 20% has been a reliable signal of the start of a new expansion.

                                                                                              In any event, the estimate was subsequently revised downward, and now indicates only marginal probability of recession.

                                                                                              Bottom Line: Lakshman Achuthan is in the media claiming the US is already in recession as of July. I don't think even a cursory examination of the data supports that contention.

                                                                                                Posted by on Monday, December 10, 2012 at 12:24 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (15) 

                                                                                                Links for 12-10-2012

                                                                                                  Posted by on Monday, December 10, 2012 at 12:06 AM in Economics, Links | Permalink  Comments (33) 

                                                                                                  Sunday, December 09, 2012

                                                                                                  'State Costs of the 2008 Icelandic Financial Collapse'

                                                                                                  [Three quick ones before hitting the road.] Is Iceland an exception when it comes to bailing out banks?:

                                                                                                  State Costs of the 2008 Icelandic Financial Collapse, by Thorolfur Matthiasson & Sigrun Davidsdottir: Outside Iceland it is widely believed that the collapse of the Icelandic financial sector in October 2008 came at no expense to Icelandic taxpayers. This contrasts with taxpayers in Ireland, the UK, Greece, Spain and Portugal, who have recapitalized their banking sectors. However, based on a recent estimate of public funds put into the financial sector since the collapse, we calculate that the cost accruing to the Icelandic State amounts to 20 to 25% of GDP – which means that Iceland cannot be taken as an example of a country that did not bail out any banks. This is of some interest since Iceland is now a popular comparison for economists studying crisis-stricken European countries.

                                                                                                    Posted by on Sunday, December 9, 2012 at 10:59 AM in Economics, Financial System | Permalink  Comments (22) 

                                                                                                    'Globalization is Not the Answer to the Lesser Depression'

                                                                                                    Paul Krugman:

                                                                                                    Dean Baker catches David Ignatius suggesting that trade liberalization can provide enough economic boost to offset the effects of austerity. As Dean says, the arithmetic is totally off — almost two orders of magnitude off. ...
                                                                                                    First, there’s an especially strong tendency to mythologize the power of free trade. Not that open world markets are a bad thing; they’re definitely a force for good, especially for small, poor countries. But my experience is that the less somebody knows about international trade, the more likely he or she is to imagine that modest moves toward or away from protectionism will have huge effects. Trade economists, who have actually worked with the models, have a much less grandiose view.
                                                                                                    Second, even to the extent that trade liberalization would raise the efficiency of the world economy, it is not, repeat not, a route to overall job creation. Yes, everyone would export more; they would also import more. There is no reason at all to assume that the jobs gained from export creation would exceed the jobs lost to import competition.
                                                                                                    Globalization is not the answer to the Lesser Depression.

                                                                                                      Posted by on Sunday, December 9, 2012 at 10:59 AM in Economics, International Trade, Unemployment | Permalink  Comments (23)