Thursday, January 29, 2009

More Stimulus Guesstimates

The stimulus has passed the House and is now cooling in the senatorial saucer. The CBO has estimated its effects:
According to CBO’s estimates, with enactment of H.R. 1, the number of jobs would be between 0.8 million and 2.1 million higher at the end of this year, 1.2 million to 3.6 million higher at the end of next year, and 0.7 million to 2.1 million higher at the end of 2011 than under current law.
As this Times analysis nicely explains, the components vary in their speed and effectiveness - the spending has a higher multiplier than the tax cuts, but some of the spending will take longer to implement. The Tax Policy Center has graded the effectiveness of the tax provisions; they give a B+ to the centerpiece "making work pay" refundable tax credit of $500 for individuals and $1000 for couples, while the corporate tax breaks mostly get lower grades. At Econbrowser, Menzie Chinn plots the CBO's estimate of spending over time (bear in mind that the CBO's estimates are for the federal government's fiscal years, which begin in October, not January, so we're almost half way through FY 09).

A detailed outline of the bill has been posted by Speaker Pelosi's office.

The Roquefort Files

The Washington Post reports:
In its final days, the Bush administration imposed a 300 percent duty on Roquefort, in effect closing off the U.S. market. Americans, it declared, will no longer get to taste the creamy concoction that, in its authentic, most glorious form, comes with an odor of wet sheep and veins of blue mold that go perfectly with rye bread and coarse red wine.

The measure, announced Jan. 13 by U.S. Trade Representative Susan C. Schwab as she headed out the door, was designed as retaliation for a European Union ban on imports of U.S. beef containing hormones. Tit for tat, and all perfectly legal under World Trade Organization rules, U.S. officials explained.

Is it just me, or does this smell like a parting shot at cheese-eating surrender monkeys?

Update (2/1): The Economist's Free Exchange says: "Yes, while Europeans will be relishing delicious bleu cheese, Americans can eat hormone-injected beef with a side of stale freedom fries."

Old School

From Davos, of all places, the Times reports:Don't forget to include their running-dog lackeys.

Wednesday, January 28, 2009

Keynes and FDR

From an interesting Times article on the lessons of the depression:

In 1934, the British economist John Maynard Keynes visited Roosevelt in the White House to make his case for more deficit spending. But Roosevelt, it seems, was either unimpressed or uncomprehending. “He left a whole rigmarole of figures,” Roosevelt complained to his labor secretary, Frances Perkins, according to her memoir. “He must be a mathematician rather than a political economist.”

Keynes left equally disenchanted, telling Ms. Perkins that he had “supposed the president was more literate, economically speaking.”

A Crisis of Animal Spirits

In the WSJ, Yale's Robert Shiller argues for the relevance of the Keynes beyond the "textbook" Keynesian model:
The term "animal spirits," popularized by John Maynard Keynes in his 1936 book "The General Theory of Employment, Interest and Money," is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people...

But lost in the economics textbooks, and all but lost in the thousands of pages of the technical economics literature, is this other message of Keynes regarding why the economy fluctuates as much as it does. Animal spirits offer an explanation for why we get into recessions in the first place -- for why the economy fluctuates as it does. It also gives some hints regarding what we need to do now to get out of the current crisis...

The famous phrase comes from this passage in chapter 12 of the General Theory:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; - though fears of loss may have a basis no more reasonable than hopes of profit had before.

Tuesday, January 27, 2009

Krugman Debunks Stimulus Skeptics

In his Times column, Paul Krugman provides a useful rebuttal of some of the arguments being made against the stimulus proposal, including:
First, there’s the bogus talking point that the Obama plan will cost $275,000 per job created. Why is it bogus? Because it involves taking the cost of a plan that will extend over several years, creating millions of jobs each year, and dividing it by the jobs created in just one of those years.

It’s as if an opponent of the school lunch program were to take an estimate of the cost of that program over the next five years, then divide it by the number of lunches provided in just one of those years, and assert that the program was hugely wasteful, because it cost $13 per lunch. (The actual cost of a free school lunch, by the way, is $2.57.)

The true cost per job of the Obama plan will probably be closer to $100,000 than $275,000 — and the net cost will be as little as $60,000 once you take into account the fact that a stronger economy means higher tax receipts.

Emerging Markets, Foiled Again

Whatever happens in the world economy, developing countries always seem to get the worst of it. After the financial crises of the late 1990's, many "emerging market" countries sought to reduce their dependence on fickle financial inflows by building up reserves. This entailed running trade surpluses - selling goods in exchange for financial assets - with the perverse implication that low-income countries were net lenders to the US and other high-income "surplus" countries.

Initially, there was great hope that their fortunes had "decoupled" from the US, but, alas, they may be even in worse shape. Brad Setser puts it well:
Emerging economies who thought that they had protected themselves from sudden swings in capital flows by maintaining large reserves and running large external surpluses are discovering that their efforts to reduce their exposure to volatile global capital flows added to their exposure to a global slump in trade.

Saturday, January 24, 2009

Gov. Strickland, Hold that Axe!

And you, too, President Hodge. The Center on Budget and Policy Priorities has provided a useful state-by-state breakdown of some of the elements in the stimulus package proposed by the House Democrats designed to help states, education and low-income households. Here is what they estimate Ohio would get from certain provisions, over two years, with the national total in parenthesis:
  • Temporary increase in Federal share of Medicaid: $2.8bn ($82.5bn)
  • State education block grants: $1.4bn ($38.8bn)
  • Block grants for other state services: $0.9bn ($24.8bn, [+$15bn unallocated])
  • Other education spending: $1.7bn ($41bn)
  • Training and employment services: $0.2bn ($2.7bn, [+$1.3bn unallocated], over 1yr)
Those pieces alone add up to about $7bn for Ohio, and that is not including some of the other major elements, such as infrastructure spending and tax cuts. So it looks like the help from Washington could go a long way towards closing the state budget gap, which is projected to be $7.3bn for the 2010-11 fiscal year.

Do We Need An Insurer of Last Resort?

At Vox, MIT's Ricardo Caballero offers an interesting take on the financial crisis. He sees it as following from an increased global demand for safe (i.e., AAA-rated) assets:
For quite some time, but in particular since the late 1990s, the world has experienced a chronic shortage of financial assets to store value. The reasons behind this shortage are varied. They include the rise in savings needs by aging populations in Japan and Europe, the fast growth and global integration of high saving economies, the precautionary response of emerging markets to earlier financial crises, and the intertemporal smoothing of commodity producing economies.

The immediate consequence of the high demand for store-of-value instruments was a sustained decline in real interest rates. Conventional wisdom blames these low rates on loose monetary policy, but this position is difficult to reconcile with facts from the period of the so-called “Greenspan conundrum’’ – when tightening monetary policy had virtually no impact on long rates. In my view, the solution to the apparent conundrum is that low long rates were driven by the large demand for store-of-value instruments, not short-term monetary policy considerations.

That is, Bernanke's famous "savings glut," with an added tilt towards risk aversion. The "subprime" mess is a result of the attempts of the financial sector to manufacture assets to meet this demand:

Under this perspective, there is a more subtle angle on subprime mortgages than simply being the result of unscrupulous lenders. The world needed more assets and the subprime mortgages were helping to bridge the gap. So far so good.

However, there was one important caveat that would prove crucial later on. The global demand for assets was particularly for very safe assets – assets with AAA credit ratings. This is not surprising in light of the importance of central banks and sovereign wealth funds in creating this high demand for assets. Moreover, this trend toward safety became even more pronounced after the NASDAQ crash.

Soon enough, US banks found a “solution” to this mismatch between the demand for safe assets and the expansion of supply through the creation of risky subprime assets; the market moved to create synthetic AAA instruments. This consisted of pooling subprime mortgages on the asset side of a Structured Investment Vehicle (SIV), and to tranch (slice) the liability side to generate a AAA component buffered by the now ultra volatile “toxic” residual. The latter was then pooled again into Collateralized Debt Obligations (CDOs), tranched again, and then into CDO-squared, and so on. At the end of this iterative process, many new AAA assets were produced out of some very risky subprime mortgages.

In a second column, he argues the financial system is afflicted with "Knightian uncertainty" - the possibility of truly unknowable outcomes, as opposed to standard "risk" where economists and financiers can attach a probability distribution to a set of known outcomes. The appropriate policy solution, therefore, is for the government to step in and take an increased role as an insurer (like it did for Citi):

Essentially, the US (and other) financial markets are experiencing the modern version of a systemic run as we had not seen since the Great Depression. It used to be that depositors ran from banks. Some of this still happens, but runs in modern financial markets, to be systemic, have to involve a larger class of assets. A run against explicit and implicit financial insurance is essentially a run against virtually all private sector financial transactions but for those with the shortest maturities. Thus, the modern lender-of-last resort facility has to be a provider of broad insurance, not just deposit insurance. This is what it will take to get us back into a reasonable equilibrium where we can initiate a recovery from a (more) “normal” recession.
We will see if the second round of the TARP and future Fed improvisations incorporate more of an insurance component, which would involve the government taking on more contingent liabilities, rather than spending directly (which might be a way of getting around budget limits imposed by Congress, for better or worse). One thing we can be sure of is that the ballooning deficit means that the federal government will be making plenty of safe assets (Treasury bonds) available.

Thursday, January 22, 2009

And Now You Find Yourself in '82

The Times' David Leonhardt reminds us that the recession of the early 1980's was worse than the current one (so far):
The recession of the early 1980s doesn’t have a catchy name, and almost half of Americans are too young to have any real memory of it. But it was terrible — qualitatively different from the mild recessions of 1990-91 and 2001.

The first big blow to the economy was the 1979 revolution in Iran, which sent oil prices skyrocketing. The bigger blow was a series of sharp interest-rate increases by the Federal Reserve, meant to snap inflation. Home sales plummeted. At their worst, they were 30 percent lower than they are even now (again, adjusted for population size). The industrial Midwest was hardest hit, and the term “Rust Belt” became ubiquitous. Many families fled south and west, helping to create the modern Sun Belt...

So why are public opinion polls showing Americans to be even gloomier about the economy today than they were back then? I think there are two main reasons.

First, the economic expansion that just ended wasn’t as good as the 1970s expansions. The ’70s get a bad rap, and deservedly so in many ways. But median family income still rose 2 percent during the decade, after adjusting for inflation. Over the past decade, it has fallen.

Second, people seem to understand that the worst is yet to come — that the economy has not yet worked off its excesses.
I'd suggest another reason - the reduction in macroeconomic volatility after the mid-1980's (formerly) known as the "great moderation." There were only two recessions between 1982 and the current one, and they were both relatively short and minor, which means that we are much less accustomed to big economic swings now than we were 27 years ago. In 1982, however, the turbulence of the 1970's was still a fresh memory. The "double dip" recessions of 1980 and 1981-82 came only a few years after the severe 1973-75 recession, so perhaps it is not surprising people felt like this:

1982 also saw a bottoming out of the stock market, Floyd Norris recalls.

Monday, January 19, 2009

The (In)utility of Higher Education

Stanley Fish writes:
...I have argued that higher education, properly understood, is distinguished by the absence of a direct and designed relationship between its activities and measurable effects in the world.

This is a very old idea that has received periodic re-formulations. Here is a statement by the philosopher Michael Oakeshott that may stand as a representative example: “There is an important difference between learning which is concerned with the degree of understanding necessary to practice a skill, and learning which is expressly focused upon an enterprise of understanding and explaining.”

Understanding and explaining what? The answer is understanding and explaining anything as long as the exercise is not performed with the purpose of intervening in the social and political crises of the moment, as long, that is, as the activity is not regarded as instrumental – valued for its contribution to something more important than itself...

This ideal, he says ruefully, is on its way out:

Except in a few private wealthy universities (functioning almost as museums), the splendid and supported irrelevance of humanist inquiry for its own sake is already a thing of the past.
He goes on to discuss the argument of a new book, "The Last Professors: The Corporate University and the Fate of the Humanities," by Frank Donoghue. One of the main supporting pieces of evidence is the growing use of adjunct and temporary faculty. That may reflect shifting priorities, but I would partly attribute it to Baumol's cost disease - the relative cost of personally delivered services has tended to rise over time because their productivity growth is slow. That is, the price of professors relative to cars has risen, because the manufacture of cars requires much less labor than it did a generation or two ago, while teaching requires about the same amount of human effort.

I think the broader problem, what Fish describes as a "shift from a model of education centered in an individual professor who delivers insight and inspiration to a model that begins and ends with the imperative to deliver the information and skills necessary to gain employment," is more a consequence of the increasing college wage premium.

(figure swiped from Goldin and Katz). Because the gap in earnings between those who hold college degrees and those who don't has grown significantly over the past several decades, young adults (and their parents) have come to regard college as a stepping stone - or obstacle - to "success." It is not surprising that they therefore believe that universities should deliver some sort of "useful" job-specific knowledge.

Unfortunately, many people inside the university seem to make the same error. There are several reasons why they are wrong -

The economics argument would be that college is really a signaling mechanism, as Christopher Caldwell explained in the Times:

But the education kids are rewarded for may not be the same education their parents think they are paying for. Economists would say that a college degree is partly a “signaling” device — it shows not that its holder has learned something but rather that he is the kind of person who could learn something. Colleges sort as much as they teach. Even when they don’t increase a worker’s productivity, they help employers find the most productive workers, and a generic kind of productivity can be demonstrated as effectively in medieval-history as in accounting classes.

Another argument, that I have made before, is that liberal education develops broadly applicable skills, like critical thinking and writing.

But Fish's view is the one that I like best, that seeking to understand and interpret the world is an enterprise of intrinsic value. I hope someday the college wage premium will disappear, so we can overcome the confusion about what we are really here for.

Sunday, January 18, 2009

High Future Energy Prices Now, Please!

The Times reports from the Detroit auto show:
But the return of cheap gasoline has already dampened hybrid sales. Throughout the show, auto executives emphasized that stable fuel prices, or a coherent government energy policy, would help them anticipate what consumers would buy next. Because of wild swings in fuel prices, “Every six months we get called stupid for having the wrong products,” said Robert A. Lutz, G.M.’s vice chairman.

“Far be it for me to be the first auto executive to call for a gas tax,” Mr. Lutz said. “But right now, it’s like fighting obesity by requiring clothing manufacturers to make nothing but small sizes.”

Electric cars did generate the show’s central irony: the models that will most impress Detroit’s new overseers in Washington will also drag down the automakers’ bottom lines for several years.
The Post's Steven Mufson writes:
Goodness knows, President-elect Obama has his legislative hands full. Maybe that explains why he has taken the idea of increasing gasoline taxes off the table, saying that Americans had enough economic burdens at the moment. Nominees like Steven Chu, the Nobel Prize winning physicist who will become Energy Secretary, dutifully echoed Obama's view even though in Chu's case he has long supported higher fuel taxes.

But by failing to raise the gasoline tax, the president-elect risks complicating another problem: Fixing the U.S. automobile industry.

Here's the problem. Obama and leading members of Congress keep saying they want ailing automakers to make more fuel-efficient vehicles. But the automakers in the past made more money on the guzzlers; in the future, they will have trouble charging enough to make money on new cars using costly new technologies for plug-in or hybrid cars. So the car company of the future may be a money-losing operation, just like the car company of the present.

Raising the gasoline tax would increase consumer demand for more fuel-efficient vehicles. That could help automakers charge more for them and make more money on sales of plug-ins, hybrids or more efficient conventional engines. Not surprisingly, Ford and General Motors both belong to the U.S. Climate Action Partnership, which this week proposed a detailed blueprint for a cap-and-trade system for carbon dioxide emissions. Such a system would put a price on carbon and would effectively tax gasoline and all other fossil fuels.

After being burned last summer by sky-high gasoline prices, do Americans really need higher gasoline taxes to get them to buy fuel-efficient cars? Yes, actually. Americans have an astonishingly short memory about gasoline prices. Sales of the Toyota Prius have hit the skids now that gasoline prices are back below $2 a gallon. And sales of SUVs are relatively strong compared to many other models.

(Hat tip: Mankiw). The principle applies more broadly - the best way to induce investments in "green" technology would be policies that credibly ensure that the price of (non-renewable) energy will rise in the future, like a phased-in carbon tax. Done right, this could even have a positive effect on current investment by creating an incentive to replace inefficient equipment before the higher costs kick in. That is, a (future) tax increase could be a stimulus today... not to mention addressing a problem - global warming - that is ultimately far more serious than the recession.

Politically, it isn't an easy sell, but it should be less difficult now, in the wake of a fall in global energy prices, than it will be once they go back up. Chu's comments were not encouraging, but presumably a climate/energy proposal is in the works that will result, perhaps indirectly, in higher costs for transportation fuel. Still, I worry Matthew Yglesias may be right when he says: "my best guess is that Obama’s climate proposals are too ambitious to be enacted and too timid to avert catastrophe."

But if he's wrong, and we get the high energy prices we need, Bob Lutz has got me covered.

Wednesday, January 14, 2009

At Least We Have a TARP Over Our Heads

Washington Post columnist Steven Pearlstein says the financial sector bailout recapitalization (et cetera) has been a qualified success:
There's been a lot of grousing lately about the Treasury's $700 billion bailout program, which, according to its many critics, has accomplished nothing other than line the pockets of undeserving bankers and their shareholders.

Maybe I'm missing something, but I don't see how it's possible to rescue the banking system without rescuing banks. That's not because anyone thought banks or bankers were particularly deserving of public charity or even sympathy -- clearly they weren't. But by last summer, with investors, lenders and depositors running for the exits, there was a genuine fear that the banking system could collapse and bring the whole global economy down with it. To prevent that outcome, the Treasury asked for $700 billion that it could use not only to mount rescues of individual institutions, but also to try to get ahead of the crisis by taking proactive steps to shore up the financial system.

Sure, you can question how the money was used -- many of us have -- but you can't quarrel with the fact that a financial meltdown has been avoided as a direct result of the government's extraordinary interventions...
Indeed, Calculated Risk finds that some measures of credit market stress have improved considerably.

But, the Times reports, more will be needed...

Tuesday, January 13, 2009

Guesstimating the Stimulus

Although the details are still in flux, Christina Romer and Jared Bernstein (incoming CEA chair and chief economist for VP-elect Biden, respectively), have put out a rough estimate of the effects of the Obama administration stimulus package.Their estimates are based on a plan of $775 billion, spread over two years, including both spending and tax cuts. Paul Krugman says:
Kudos, by the way, to the administration-in-waiting for providing this — it will be a joy to argue policy with an administration that provides comprehensible, honest reports, not case studies in how to lie with statistics.

But the stimulus is not enough:

So this looks like an estimate from the Obama team itself saying — as best as I can figure it out — that the plan would close only around a third of the output gap over the next two years.
Here are the CBO's projections of the output gap (the difference between potential and actual GDP), assuming no stimulus:

(The graph is from these charts, which accompany the latest Budget and Economic Outlook)

Brad DeLong says:

I agree with Paul that this fiscal boost plan is too small, but I do want to admit that doing this well is harder than it looks. The tax-cut part does not look terribly effective as a stimulus--it is a step toward compensating for higher income inequality and a political play to make it more likely that Republicans will lose politically by trying to block the package rather than a significant boost to employment. Thus I do not think you would want to make the tax-cut part larger. And it is hard to find a lot of additional spending projects that can be ramped up quickly and do a lot of good--relatively soon in that endeavor the short-term fiscal multiplier falls below one. They are trying their best.
At Econbrowser, Menzie Chinn notes that, with the output gap expected to last for a while, we shouldn't be so concerned with the "lags" in implementing infrastructure spending (a point also made by Krugman in this column).

The implicit assumption here seems to be that the recovery will be slow, as it was following the 1990-91 and 2001 recessions. In both of those cases the unemployment rate continued to drift upward after the business cycle peak declared by the NBER. In terms of magnitude, it looks like we're now in a more serious recession, comparable to 1973-75 and 1981-82. Those recessions had bigger spikes in unemployment, but also much brisker recoveries. Unemployment peaked at 10.8% in December 1982 and fell to 8.3% at the end of 1983 - a decline of 2.5 percentage points in 1 year. The unemployment rate declined 1.6 points from May 1975 (9.0%) to May 1976 (7.4%). In both cases, the recoveries were quicker than what is envisioned by Romer and Bernstein or by the CBO.

It may indeed be that the 'jobless recovery' is the new 'normal' pattern. If the dynamics of earlier recessions were driven by manufacturing firms responding to unintended inventory accumulation, improvements in inventory management and the declining share of manufacturing might help explain the changing pattern. However, part of the reason economies can bounce back quickly (Milton Friedman once compared recessions to plucks of a guitar string) is that idle resources can be put back to work fast. And it looks like we will have no shortage of idle resources this time around.

Friday, January 2, 2009

The Celebrated Optimism of Economists

This NY Times headlinecalls to mind a favorite passage from ch. 3 of Keynes' General Theory:
But although the [classical] doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation; - a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

The "economists" featured in the Times story are mostly corporate forecasters, and, indeed, Candide-like:

They base their forecasts on computer models that tend to see the American economy as basically sound, even in the worst of times...

Those models also take as a given that the natural state of a market economy like America’s is a high level of economic activity, and that it will rebound almost reflexively to that high level from a recession...

“Most of our models are structured in a way that the economy is self-righting,” said Nigel Gault, chief domestic economist for IHS Global Insight, a consulting and forecasting firm in Lexington, Mass.
That said, though I haven't hazarded any forecasts, I have also been of the belief that the gloominess has been overdone. My reason for optimism is that we seem to be re-learning our Keynesian lessons quickly (most of us, anyway - there are some exceptions of course) and enough of the madmen in authority are on board that we can expect monetary and (soon) fiscal policy to be conducted with due regard for the principle of effective demand.

My Favorite Econ Goof

Marginal Revolution is soliciting nominations for the most famous mistakes of economics. My personal favorite is William Baumol's 1986 American Economic Review article "Productivity Growth, Convergence, and Welfare: What the Long Run Data Show" (link requires JSTOR subscription). In it, he finds that GDP data for 16 countries over the period 1870-1979 validates the convergence prediction of neoclassical growth models. That is, initially poor countries grow faster than rich ones, thereby catching up over time. Looks good, but as Brad DeLong pointed out in "Productivity Growth, Convergence and Welfare: Comment," (AER, 1988 [JSTOR]) the finding suffers from a selection problem. All of the countries in the sample are wealthy in 1979, so, of course, if they started out poor, they caught up. As a way around, with limited data, DeLong instead chooses a sample based on the initial level of income in 1870. Doing so adds several countries like Portugal and Argentina, that did not converge.Some of the nominees at MR have much more cosmic importance, but this case is a good example of how smart people - not just Baumol, but the editors and referees at AER, too - can make mistakes that seem obvious, but only in retrospect after another smart person points them out.

To be fair, it should be mentioned that Baumol did mention the potential issue in a footnote.