Wednesday, January 30, 2008

The News Today, Oh Boy

A big day for macroeconomic news:

The BEA released its advance estimate of US output for 2007, reporting that real GDP grew by 2.2%, which is slower than the postwar average of 3.3%. The effect of the housing market implosion is evident in the 16.9% decrease in "residential fixed investment" which contributed -0.97% to overall GDP growth. With the aid of a declining dollar, exports increased by 7.9%, contributing 0.89% to the total (imports also rose, by a smaller amount, making for a total contribution of 0.55% from net exports).

The last quarter of the year was sluggish indeed, with an 0.6% annual growth rate. At that pace, growth is too slow to keep unemployment from rising, but as long as output growth is positive, we're not - technically - in a recession.

Inflation, as measured by the GDP deflator, came in at 2.7%, and the currently fashionable deflator for personal consumption expenditures excluding food and energy (i.e. "core PCE") increased 2.1% (and at a 2.7% pace in the 4th quarter.... is that a whiff of stagflation in the air?).

An important caveat - today's release was the "advance estimate," which will be followed by the "preliminary estimate" at the end of February and the final figure a month after that. (See also Krugman's observations, and James Hamilton's).

Later the same day...

The Federal Reserve announced announced a 50 bps (0.5%) cut in the target for the Federal Funds Rate, to 3.0%. This is only eight days after the surprise 0.75% cut last Tuesday (today was the regularly scheduled meeting for the FOMC). The Fed said:
Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

The Fed's short term concern is growth and employment, but it also has a mandate to keep inflation low (and, as ever, tension between those two goals). Even as the Fed pushes short-term rates down, the yield on 30-year US Treasury bonds has risen from 4.28% on Jan. 18 (before the 0.75% cut) to 4.44% today. Many things can influence rates, but this increase in the term component may be a sign that the Fed's apparent eagerness to keep growth growing with loose monetary policy has caused inflation expectations to tick upwards. Willem Buiter is not pleased:

By now, the neglect by the Fed of the price stability leg of its mandate no longer comes as a surprise. But even fully anticipated mistakes hurt. The US and the world economy will pay the price when, in due course, the Fed has to clean up the mess it is creating by its reckless pursuit of the maximum employment objective.
Also, Dean Baker makes an interesting point about the steepening of the yield curve.

Update (2/2): The Journal's Real Time Economics reports on the rise in inflation expectations, as measured by the yield on TIPS (Treasury Inflation Protected Securities) which are Treasury bonds whose value is indexed to inflation (see also Mankiw's comment).

Tuesday, January 29, 2008

Economist Smackdown

In Sunday's Washington Post, economist Steven Landsburg explained "Why the Stimulus Shouldn't Stimulate You" -
As a general rule, economic policies command bipartisan support only when they're incoherent. Take, for example, the fiscal stimulus package now bulldozing its way through the legislative process. It's poorly conceived, it's unlikely to work, and it's sure to do a lot of collateral damage.

The idea, we're told, is to stave off an all-out recession by stimulating both investment (through tax cuts for businesses) and consumption (through tax rebates to individuals). But hold it right there.

Investment and consumption are natural rivals.

Investment means converting resources into machines and factories; consumption means converting those same resources into TV sets and motorboats. In anything but the very short run, more of one means less of the other.

Ah, say the package's more honest proponents, that's exactly what we care about -- the very short run. And in the very short run, we can have more of everything if only we put more people to work.

Fine, but what makes you think that this package will put anyone to work? The idea behind the stimulus deal is to give people tax cuts so they'll feel richer and spend more. But government can't make people richer on average; all it can do is shuffle wealth around. To pay Peter, you must tax Paul (or at least promise to tax Paul in the future, when your debts come due). Peter spends more, but Paul spends less.

Landsburg's argument seems to be based on classical economic theory, which holds that changes in aggregate demand do not affect the level of output. That was prevailing economic wisdom 80 years ago, but we've figured some things out since then, as Paul Krugman explains:

The understanding that Say’s Law doesn’t work in the short run — that a fall in consumption doesn’t automatically translate into a rise in investment, but can lead to a fall in output and employment instead — is the central insight of Keynes’s General Theory. (My introduction to the new edition is here.) And we’re having a serious debate about economic policy that hinges on that insight.

Yet here we have an opinion piece published in a major newspaper 70 years after that profound insight, supposedly informing readers about economics, by someone who obviously just doesn’t get it.

Brad DeLong thinks its the "stupidest thing published by the Washington Post so far this year," and Mark Thoma is also critical.

Landsburg and Jason Furman are debating the stimulus in the LA Times (Hat tip: Greg Mankiw).

Friday, January 25, 2008

Migration and Global Poverty

Reason Magazine has a thought-provoking interview with Harvard Economist Lant Pritchett who argues the best way to improve the lives of the world's poor is to make it easier for them to move to rich countries. Pritchett says:
Being against migration to the United States is wrong for two reasons. One, I don’t think it gets the scale of the poverty in the United States vs. poverty in the rest of the world right. Second, if you are really concerned about inequality in the United States, there are many things you can do that would be better than blocking other people from coming to our country. I don’t want to say that people who are concerned about inequality in the U.S. aren’t right to be concerned about inequality in the U.S. But I think taking that concern and using it to keep people from coming to the United States is victimizing the world’s true victims in favor of people who happen to live closer to you.
An interesting argument, though clearly a political non-starter these days... Pritchett was also featured last year in the NY Times magazine. Hat tip to Free Exchange.

Thursday, January 24, 2008

Fiscal Graffiti

The administration and the House have agreed on a $150 billion "stimulus package" centered on tax rebates intended to increase aggregate demand. The effectiveness of such a policy depends, in part, on how it is distributed. According to the Congressional Budget Office:
Households are particularly likely to spend a greater share of a temporary reduction in taxes or additional transfer payments if they are credit constrained (that is, they have borrowed as much money as creditors will lend them). Given that these households would probably borrow additional money if given the opportunity, they are unlikely to save additional income. They are therefore likely to spend a greater proportion of a tax reduction or a transfer increase than other people who have access to credit. Lower-income households are more likely to be credit constrained and more likely to be among those with the highest propensity to spend. Therefore, policies aimed at lower-income households tend to have greater stimulative effects.
The initial proposal by the administration was (unsurprisingly) skewed more towards higher income taxpayers because it would only apply to households that pay income tax, and many low and moderate income families have no income tax liability (though they do pay the social security payroll tax). The Democrats negotiated for a package that would send checks to more low income households. The Washington Post reports:
Under the deal, nearly everyone earning a paycheck would receive at least $300 from the Internal Revenue Service. Workers who earned at least $3,000 last year -- but not enough to pay income taxes -- would be eligible for $300.

Overall, 117 million families would receive a rebate check, including 35 million with incomes too low to have qualified under the earlier Bush proposal. Those 35 million families would receive rebates totaling $28 billion.

Many will get more than the minimum $300: the payout is structured as a "rebate" of 10% of taxable income, with a maximum payout of $600 ($1200 for a married couple), plus $300 per child, and is phased out for people with incomes above $75,000 ($150,000 for married couples). There is also about $50 billion in additional tax deductions for business investments.

Unfortunately, the Democrats gave in on extending unemployment benefits and increasing food stamps, options that the CBO rated "large" for cost-effectiveness, "short" for lag time in impacting the economy and "small" for uncertainty of effects. If the downturn gets nasty, hopefully those provisions will be revisited (or maybe the Senate, which has yet to act, will put them in).

I'll take the deal as a glass half-full: the administration decided to refrain from using the issue to push extensions of the tax cuts currently scheduled to expire in 2011, the package is relatively clean and simple and will get checks into people's hands this spring or summer, and it is a minor miracle to get an agreement at all. Paul Krugman sees it as mostly empty:

[T]he stimulus bill will be a real disappointment. As I pointed out in an earlier post, economic theory — Milton Friedman’s theory! — suggests that if we want stimulus funds spent, they should go to people in temporary economic difficulty who are likely to be liquidity-constrained. But it appears that most of the measures that would do that — benefits to the unemployed, food stamps, aid to state and local governments — are being bargained away. Even the tax credit is apparently not fully refundable, so those who need it most, and are most likely to spend it, won’t get the full amount.

You can blame the Bush administration, whose hostility to helping those in need is now getting in the way of good economic policy. But I’m also disappointed with the Democratic leadership, for not standing up more forcefully.
Greg Mankiw believes the whole thing is dubious:
I am personally skeptical that the economic weakness is sufficient at this point to justify such a package...

In this environment, I would prefer to rely on monetary policy as the main source of macroeconomic stimulus. If there were a stronger case for a short-run demand-oriented fiscal stimulus, I would view the compromise package announced today as reasonable. But given where the economy is right now and the best forecasts of where it is heading, the fiscal package seems unnecessary as a short-run measure, while in the long run adding to the debt burden without doing anything to improve incentives for economic growth.
For more, see Howard Gleckman of the Tax Policy Center, and the White House's "Fact Sheet."

Update (1/25): Krugman has estimates on the distribution of the stimulus, which support the skeptical view.

Tuesday, January 22, 2008

Pushing Hard on the String

The Federal Reserve announced a cut of 75 basis points (0.75%) in the target for the Federal Funds Rate (the overnight rate for interbank loans). The move was unusual in both its size - the fed generally moves in 0.25% or 0.5% increments - and timing, coming a week ahead of the regularly scheduled meeting of the committee which sets the rate target. The Fed said:
The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

Willem Buiter slammed the move:

It is bad news when the markets panic. It is worse news when one of the world's key monetary policy making institutions panics....

This extraordinary action was excessive and smells of fear. It is the clearest example of monetary policy panic football I have witnessed in more than thirty years as a professional economist. Because the action is so disproportionate, it is likely to further unsettle markets.
In yesterday's Financial Times - before the latest bout of financial market freak out - Wolfgang Munchau looked at the channels through which monetary policy affects the economy and concluded that it is unlikely to be effective in the current situation:
It would therefore be unwise, to say the least, for policymakers to rely on monetary policy alone. By far the best policy response – though clearly limited in scope – is a well-targeted fiscal policy stimulus...

The best stimulus package would be one that could be agreed today, enacted tomorrow, targeted specifically at subprime families, and was only temporary. Back in the real world, where politicians run fiscal policy, this is obviously not going to happen. While the usual pork-barrel-type stimulus package that is now shaping up in the US is far from ideal, it is still marginally better than letting the central bank sort out this mess alone.

There is no such thing as a standard policy response to all recessions. There are recessions like the one in 2001, which respond well to a monetary policy stimulus. But not all do. This is going to be one of those.

Although the Keynesian model, as we teach it to our students, allows for both fiscal and monetary policy effects, the traditional Keynesian argument is that monetary policy is like a string - it can be easily pulled to slow down an "overheating" economy, but not effectively "pushed" to stimulate it. That is particularly true in the case of a "liquidity trap," which Paul Krugman believes Bernanke is trying to avoid:

What you probably should know is that Ben Bernanke, in his capacity as a professional economist, spent a lot of time worrying about Japan’s experience in the 1990s. (So did I.) What was so disturbing about Japan was the way monetary policy became ineffective; by the later 1990s the short-term interest rate was up against the ZLB — the “zero lower bound.” This is alternatively known as the “liquidity trap.” And once you’re there, conventional monetary policy can do no more, because interest rates can’t go below zero.

There was a lot of discussion of various unconventional monetary things you could do. But the best answer was not to get there in the first place. A 2004 paper co-authored by Bernanke argued that the ZLB could and should be avoided by “maintaining a sufficient inflation buffer and easing preemptively as necessary”.

And here we go.
Update: The Economist's Free Exchange has a roundup of reactions to the Fed's move.
Update #2: Stephen Cecchetti thinks Bernanke is the new sheriff in town.

Sunday, January 20, 2008

Our Economic Future

The American Enterprise Institute's Kevin Hassett suggests that we
think of our economic future as being a road trip in a 1971 Ford Pinto. Our car might burst into flames in the next instant, there might be a truck in our lane around the bend, or we just might make it all the way to California.
Hmmm... Hassett is trying to make a valid point - economic fluctuations are not so regular as the term "business cycle" might suggest. But there isn't that much uncertainty.

US real GDP, 1947-2007 (log scale):Ford Pinto:
In fairness, it should be noted that the tendency of Ford Pintos to burst into flame may have been exaggerated. According to Wikipedia:
[A] 1991 law review paper by Gary Schwartz, argued that the case against the Pinto was less clear-cut than commonly supposed. Only 27 people ever died in Pinto fires. Given the Pinto's production figures (over 2 million built), this was no worse than typical for the time.

Wednesday, January 16, 2008

Hold The Line

Fiscal stimulus isn't always on time, says Howard Gleckman of the Tax Policy Center:
Let’s say President Bush and Congress agree that the U.S. needs a fiscal boost to jump-start the sluggish economy. Let’s say they even reach a consensus on what to do (fantasy, perhaps, but bear with me). Could tax cuts and direct aid get to individuals, business, and states in time to forestall a recession?

History and the current political climate suggest the answer is “no.” Too often, the cash arrives long after the economy has bottomed out. That’s not necessarily all bad, of course. Sometimes such government assistance can still shorten a recession or cushion its impact. But late is not always better than never. Pumping unneeded money into an already-rebounding economy may do little more than provide people and companies with a windfall, complicate monetary policy, and pointlessly worsen long-term deficits.

But Jared Bernstein and Larry Mishel note, while the last two recessions have been short, by the NBER's reckoning, they have been followed by long "jobless recoveries," so the stimulus may not be too late after all:

The 1990-91 recession officially ended in March 1991, but unemployment kept rising for another fifteen months, until June 1992. That was also the birth of the jobless recovery, as employment growth stagnated over this same period. But that was nothing compared to the jobless recovery following the 2001 recession: between the official trough (recession end-date) and August 2003, we lost another 1.1 million jobs (in addition to the 1.7 million lost over the recession).

Since most families depend on their paychecks, not their stock portfolios, the weak job market translated into income losses for many in the middle-class on down. In both of the last two cases, real median family incomes fell not just in the recessions, but for the first three to four years of the recoveries.

On his blog, director Peter Orzag summarizes a CBO report on stimulus options. Paul Krugman looks at what the Presidential candidates are proposing - he prefers Clinton's and Edwards' proposals over Obama's (or any of the Republicans), but Brad de Long prefers Obama's because it is simpler and quicker, though he remains unconvinced fiscal stimulus is necessary:

I don't yet believe that the case for a fiscal stimulus is strong--although I may well change my mind in a month or two. Congress and the president have a role to play in stimulus only if monetary policy has shot its bolt--which it has not--or if unemployment is rising rapidly and it is important to get cash quickly into the hands of people who will spend it and so keep the rise in unemployment from being as large. We are not there yet--at least I don't think so--but we may be there in three months.
The Times reports that the man in charge of monetary policy apparently believes the Fed could stand a fiscal assist:

Ben S. Bernanke, chairman of the Federal Reserve, has told members of Congress that he can support tax cuts or spending measures to stimulate the economy, even if they temporarily increase the budget deficit, as long as the measures are quick and temporary.

But Mr. Bernanke, who is scheduled to testify before the House Budget Committee on Thursday, has also made it clear that he will refuse to comment on Republican calls to link a stimulus package with a permanent extension of President Bush’s tax cuts.

Democratic lawmakers who have spoken with Mr. Bernanke said the Fed chairman would not endorse any specific plan, but supported the general idea of propping up consumer spending and investment with temporary tax rebates or additional government spending.

Monday, January 14, 2008

Borrowing From The Poor

Notwithstanding all the hype, China remains a relatively poor country, as this International Herald Tribune story usefully reminds us:
When she gets sick, Li Enlan, 78, picks herbs from the woods that grow nearby instead of buying modern medicines.

This is not the result of some philosophical choice, though. She has never seen a doctor and, like many residents of this area, lives in a meager barter economy, seldom coming into contact with cash.

"We eat somehow, but it's never enough," Li said. "At least we're not starving."

In this region of southern Henan Province, in village after village, people are too poor to heat their homes in the winter and many lack basic comforts like running water. Mobile phones, a near ubiquitous symbol of upward mobility throughout much of this country, are seen as an impossible luxury. People here often begin conversations with a phrase that is still not uncommon in today's China: "We are poor."

China has moved more people out of poverty than any other country in recent decades, but the persistence of destitution in places like southern Henan Province fits with the findings of a recent World Bank study that suggests that there are still 300 million poor in China - three times as many as the bank previously estimated.

And yet China is lending the US hundreds of billions of dollars. In The Atlantic, James Fallows has an excellent look at the Chinese side US-China economic relationship. He writes:

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. But because of political tensions in both countries, and because of the huge and growing size of the imbalance, the arrangement now shows signs of cracking apart.

In terms of the national income accounts, it is quite simple - negative NX for the US means that C + I + G > Y, and the opposite is true for China. To the extent that China's low consumption reflects high investment, it is arguably doing some good for its future. The trade imbalance - and concomitant financial flow, as China receives financial assets in return for the goods it sells to the US - is harder to rationalize.

The concerns about inflation don't really make sense to me - inflation is (usually, mostly) a monetary phenomenon, and China's policy of keeping its currency weak entails inflationary printing of yuan to buy dollars (and in turn, they have to use "sterlization" to try to restrain the inflationary consequences). Allowing the yuan to rise more quickly would be deflationary, because it would lower the price of imported goods. It is true that a higher consumption share of GDP would increase demand for consumer goods and this would tend raise their prices, but it would also induce a shift of resources into producing these goods. If China let its currency appreciate more and increased consumption, the Chinese people would be able to enjoy more of the fruits of their own labor as well as more imported goods.

Hat tips: Fallows' article came to my attention via Brad Setser, and the IHT article from Managing Globalization.

Wednesday, January 9, 2008

The Doctoral Curriculum

The first year of an economics PhD program is notorious for its intensity (I'm still surprised I got through it..). At most schools, it is comprised of one-year sequences of microeconomics, macroeconomics, mathematics for economists and statistics/econometrics. A panel at the meetings last weekend in New Orleans revisited it. The Chronicle reports:
Doctoral programs in economics should radically redesign the grueling first-year course work known as "the core," several prominent scholars said on Friday during a panel here at the annual meeting of the American Economic Association.

Many elements of the core were set in stone shortly after World War II, and the courses have not always evolved to make room for emerging fields of study, the scholars said. They also complained that the courses tend to emphasize the abstract manipulation of equations, with little sustained attention given to real-world problems and data.

"The core needs to have a certain element of fun," said Bo E. Honoré, a professor of economics at Princeton University. "I think it's important that students come out of the first year with a sense of excitement about economics and excitement about doing research."

Looking back, I see the first year as a training camp of sorts, and though it wasn't pleasant, and often didn't seem to have much relation to what I thought of as "economics," it was useful in developing skills useful later in graduate school and in research. In particular, the drill of "abstract manipulation of equations" develops a kind of mental muscle memory for working through the problems economists deal with every day. It was hard to see the point at the time - just like Daniel-san did not understand why he was painting Mr. Miyagi's fence - and Honoré has a point about trying to motivate things better. However, we may not want to make the first year "fun" - some dedication and willingness to defer gratification are necessary to be successful, so its not a bad thing if we chase away some of the people who are not really committed.

One issue that came up at the session was the place of macroeconomics:

"It's not clear why macroeconomics is given an entire year in the core," said Susan C. Athey, a professor of economics at Harvard University and the winner of the 2007 John Bates Clark Medal, which is given biennially to a distinguished economist under the age of 40. "I think macro is very important, but it's not clear to me that monetary theory is more important for everyone to learn than, for example, theories about social-entitlement programs or international trade."

Most of the other five panelists agreed with Ms. Athey, though all conceded that macroeconomics has been a source of models and techniques that have shaped the entire discipline.

The task of defending macroeconomics was left to Michael Woodford, a professor of political economy at Columbia University. Mr. Woodford argued that all economists should learn the dynamic-modeling tools that are taught in macroeconomics courses. "A lot of students find that the macro sequence is the hardest part of the core," he said. "That makes me reluctant to believe that we could radically reduce the length of it and people would still get the important parts."

As a macroeconomist (I wasn't at the panel, because I was attending this session about macroeconomics), I hate to concede that Athey has a point, but I think she does. Although modern macroeconomics is grounded in "micro foundations," the reverse is not true. However, Woodford is correct that many of the dynamic tools taught in first-year macroeconomics have broader application, so some of it is ultimately useful to non-macro people.

One thing that is missing from graduate training is a critical perspective about methodology that would come from a sense of how economics has evolved. I was fortunate to have had some exposure to the history of economic thought as an undergraduate, but it rarely appears in graduate programs. It should. It is rather absurd that we "scholars" of economics know so little about our own intellectual history and never read Smith and Keynes. A core course on the subject might help get us to really think about what we're doing. If I were experimenting with revising "the core" I might reduce the macro to one semester and use the open slot for history of economic thought (which is not to be conflated with economic history - a crucial, under-valued field to be sure, but not one that needs to be in the first year).

Tuesday, January 8, 2008

Catching Up, Forging Ahead and Falling Behind

One of the big stories of late-19th/early-20th century economic history is the US catching up with and surpassing Britain as the global economic leader. This can be seen in the data from Angus Maddison's Historical Statistics for the World Economy, 1-2003 AD:

This year may see a role reversal. Heather Stewart of The Observer says "at least we've got one up on the Yanks" -
For the first time since Queen Victoria was on the throne and Britain still had an Empire, average living standards are now higher on this side of the Atlantic.

New calculations by consultancy Oxford Economics show that GDP will reach £23,500 per person in the UK in 2008, beating £23,250 in the US, and also topping the levels in both Germany and France by 8 per cent.

Those figures are not adjusted for purchasing power and partly reflect the strength of the pound/weakness of the dollar. Nonetheless, Britons have a reason to feel chuffed, if not cock-a-hoop.

Note: The title of this post is swiped from a classic 1986 Journal of Economic History paper by Moses Abramovitz.

Let's Get Fiscal

In recent years, countercyclical policy - the day-to-day "management" of aggregate demand - has largely come through monetary policy action by the Fed. However, current circumstances call for fiscal policy, says Lawrence Summers:
There is now a compelling case for the president and Congress to create a programme of fiscal stimulus to the US economy that could be signed into law in the next several months.

Given the market’s prediction of Fed policy actions, the debate now is not about whether or not to provide macro­economic stimulus. That question appears to be settled. The question is whether it is better for all the stimulus to come from discretionary monetary policy or for some of the stimulus to come from discretionary fiscal policy. A diversified policy approach seems clearly preferable in that (i) in a world where judging the impact of policy measures is difficult, the outcome is less uncertain with a diversified mix of stimulus measures; (ii) the proximate impact of fiscal policies is felt by the families bearing the brunt of recession, in contrast to monetary policies whose immediate impact is on financial institutions; (iii) use of fiscal policy reduces the amount by which interest rates have to be reduced, thereby reducing downward pressure on the dollar, which in turn contributes to upward pressure on US inflation and international instability; (iv) partial reliance on fiscal policy mitigates the various risks of bubble creation associated with excessively low interest rates.

Summers suggests that the government make equal payments to all income or payroll tax payers and increase unemployment insurance and food stamp benefits.

Of course, fiscal policy does not necessarily need to take the form of tax cuts, as Mark Thoma pointed out (about a month ago, in response to a similar argument from Martin Feldstein):

A tax cut creates an incentive for households to increase consumption, but there is no guarantee that they will, e.g. they could just retire debt instead. This is just the familiar split of a change in taxes and hence disposable income into a change in consumption and a change in saving, and most of the time consumption and hence aggregate demand will increase when taxes are cut, but we can't be sure in advance how a tax cut will be used. In addition, when the tax cut is temporary, as this one would be, the impact on consumption is generally lower than with a permanent change in taxes.

With government spending, however, the impact on aggregate demand is assured. A change in government spending impacts aggregate demand directly on a dollar for dollar basis so there is no uncertainty at all about whether or how much aggregate demand will increase with a change in fiscal policy. And, with all of our infrastructure needs, it's not as though we can't find places where government spending could increase output and employment and also improve our public capital (there are many other ways spending could help as well, infrastructure enhancement is not our only need).

One problem with fiscal policy is the time it takes (the "lags" we talk about in Econ 202) - it requires action by the Congress and President, and once the policy is implemented, it takes time to affect demand in the economy (also an issue with monetary policy). Moreover, recessions tend to be relatively short - the average postwar recession has been 10 months long (and the two most recent ones were eight months). If we take the gloomy December employment report as an indication that a recession began in late 2007, it is likely to be over by this fall (at least as the NBER defines recessions - the unemployment rate tends to remain elevated longer). It therefore is nearly impossible to time the "stimulus" correctly to precisely "fine tune" the economy.

For example, the stimulus package proposed at the beginning of the Clinton administration was defeated in April, 1993. In retrospect, that was for the best: the NBER subsequently dated the end of the recession in March, 1991, and the unemployment rate peaked in June, 1992.

The lags are likely worse with a spending program because it would take longer for the government to spend the money than to just mail out checks. However, the stimulus is likely to miss its moving target anyway, but we would at least get some roads and bridges out of a spending program...

The Washington Post reported that the Bush administration is considering a stimulus package. Real Time Economics reports on Barack Obama's proposal. Robert Reich had an interesting idea on the subject in December.

Saturday, January 5, 2008

Econ Rules!

Though most of the trash-talking here in New Orleans is between the LSU and Ohio State fans who are sharing the town with the big economics convention, the American Economic Association did post this on its web site:
During 2006 and 2007, the American Economic Review was the most widely consulted journal among all 775 scholarly journals that are archived in JSTOR.
That's right, among all scholarly journals. Take that, other academic disciplines!

Wednesday, January 2, 2008

Not Constantinople

At least, not yet... In the FT, Niall Ferguson has "An Ottoman Warning for Indebted America" (and it has nothing to do with getting our feet off the furniture):
[We are] living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US.

In the aftermath of the Crimean war, both the sultan in Constantinople and his Egyptian vassal, the khedive, had begun to accumulate huge domestic and foreign debts. Between 1855 and 1875, the Ottoman debt increased by a factor of 28. As a percentage of expenditure, interest payments and amortisation rose from 15 per cent in 1860 to 50 per cent in 1875. The Egyptian case was similar: between 1862 and 1876, the total public debt rose from E£3.3m to E£76m. The 1876 budget showed debt charges accounting for more than half of all expenditure.

The loans had been made for both military and economic reasons: to support the Ottoman military position during and after the Crimean war and to finance railway and canal construction, including the building of the Suez canal, which had opened in 1869. But a dangerously high proportion of the proceeds had been squandered on conspicuous consumption, symbolised by Sultan Abdul Mejid’s luxurious Dolmabahçe palace and the spectacular world premiere of Aïda at the Cairo Opera House in 1871. In the wake of the financial crisis that struck the European and American stock markets in 1873, a Middle Eastern debt crisis was inevit­able. In October 1875 the Ottoman government declared bankruptcy.

The crisis had two distinct financial consequences: the sale of the khedive’s shares in the Suez canal to the British government (for £4m, famously ad­vanced to Disraeli by the Rothschilds) and the hypothecation of certain Ottoman tax revenues for debt service under the auspices of an international Administration of the Ottoman Public Debt, on which European bondholders were represented. The critical point is that the debt crisis necessitated the sale or transfer of Middle Eastern revenue streams to Eur­opeans.

He sees a parallel to the growing accumulation of US assets by foreigners - particularly Asian and Middle Eastern sovereign wealth funds - including the recent sales of stakes in Bear Stearns, Citigroup, Merrill Lynch and Morgan Stanley.

[W]e need to recognise that these “capital injections” represent a transfer of the revenues from the US financial services industry into the hands of foreign governments. This is happening at a time when the gap between eastern and western incomes is narrowing at an unprecedented pace.

In other words, as in the 1870s the balance of financial power is shifting. Then, the move was from the ancient oriental empires (not only the Ottoman but also the Persian and Chinese) to western Europe. Today the shift is from the US – and other western financial centres – to the autocracies of the Middle East and east Asia.

The parallel is an interesting one, but somewhat strained. The US is the largest economy in the world, and near the top in terms of per capita output. The Ottoman empire occupied a very different relative position - according to Angus Maddison's estimates (in 1990 $), Turkey's per capita GDP in 1870 was $825 (and Egypt's $649), far below that of European countries like Germany ($1839) and Britain ($3190), as well as the US ($2445). Furthermore, the US debt situation has a long way to go before it becomes as severe as the Ottoman case. In terms of government debt, according to the CBO, of total federal outlays of $2655 billion in 2006, less than 10% ($227 bn) was spent on interest payments (the publicly-held debt is $4829 bn, and according to the BEA, $2215 bn of Treasuries are held by foreigners, so slightly less than half of the interest is going overseas). More broadly, according to the BEA, at the end of 2006, foreigners owned $16.2 trillion worth of US assets, and Americans owned $13.7 tr of foreign assets, making the US net position -$2.5 tr. Relative to GDP $13.2 tr, that is equivalent to a household with an income of $60,000 having a debt of $11,400.

Ferguson is no doubt correct that the "balance of financial power" is indeed shifting. Partly this reflects natural forces of economic growth (convergence), and partly it is due to US borrowing. A decline in the relative economic position of the US is to be expected as more of the world is catching up - China and India are growing faster, and contributing a larger share of world output - exactly as Solow's growth model tells us they should. Potentially more worrying is that, because our domestic saving is less than investment, the rest of the world is indeed accumulating financial claims on us. This may, in part, reflect some degree of profligacy and bad policy. Though Ferguson's Ottoman analogy is a bit of a stretch, perhaps we shouldn't be putting our feet up...