Tuesday, March 30, 2010

Misplaced Rectitude

In the FT, Jeffrey Sachs and George Osborne argue that governments need to deal with their budget woes sooner rather than later:
Virtually all policy analysts agree that the path to renewed prosperity in Europe and the US depends on a credible plan to re-establish sound public finances. Without such a plan, the travails which have hit Greece and which are threatening Portugal and Spain will soon enough threaten the UK, US, and other deficit-ridden countries. In the recent duel of macro-economists, one camp has called for early budget consolidation, followed by further measures over five years. We agree. Others want more fiscal stimulus, delaying deficit reduction. We believe delaying the start of deficit reduction would put long-term recovery at risk. Such an approach misjudges politics, financial markets, and underlying economic realities.

Blaming our predicament on financial markets, as some in the second camp do, ignores the awkward truth that governments have enabled, if not enthusiastically promoted, recklessness, through chronic deficits and lax financial regulation. Our predicament, in this sense, is a political crisis at least as much as a financial one. We can’t expect “credibility” by succumbing to temptation just one more time. What politicians like to present as saving the world economy from financial markets is in many cases simply responding to past errors while continuing to operate on a time horizon no longer than the next election.

Count me with the "others" in the "second camp." In the case of the US, there is still little evidence of a problem. If markets were losing their appetite for US government debt, it would be reflected in rising Treasury yields, which are not apparent (unless you read alot into that tick at the end): That's not to say that their concern is irrational. If government finances don't eventually improve, at some point borrowing costs will rise, and crowd out private investment. We're not there yet, but it would make sense to think about what we'll do before we get there.

A couple of things to bear in mind:

  • The government budget will get somewhat better when the economy recovers, and spending cuts or tax increases now would serve to slow the recovery.
  • In the US, the long term federal budget problem is driven by projected increases in health care costs, so the bill just signed by the president is a step in the right direction, to the extent it helps control cost growth.
Sachs and Osborne seem to think that any policy would not be "credible" - i.e., would not influence expectations about future borrowing - if it does not inflict some pain today. They may be right, but I don't think so. If enacted today, a tax reform that projected to yield revenues closer to spending at "full employment" (i.e., once cyclical effects are taken out) would be a significant step to pre-empting the problem, even if the current deficit remains large because of the downturn. This would be true even if the reforms were phased in or scheduled to take effect in a few years. Indeed, some of the tax changes could be written to be contingent on recovery. But, while we should take future deficits seriously, we should not lose sight of the fact that, right now, a large deficit is exactly what we need to help make up the shortfall in private demand.

At Economist's View, Mark Thoma has a similar opinion to mine.

Friday, March 26, 2010

Health Care Reform and Inequality

In the Times, David Leonhardt argues that the health care reform just passed by Congress (!!) can be understood as part of President Obama's effort to reverse - or at least lean against - the trend of widening income inequality in the US. He writes:
The bill that President Obama signed on Tuesday is the federal government’s biggest attack on economic inequality since inequality began rising more than three decades ago.

Over most of that period, government policy and market forces have been moving in the same direction, both increasing inequality. The pretax incomes of the wealthy have soared since the late 1970s, while their tax rates have fallen more than rates for the middle class and poor.

Nearly every major aspect of the health bill pushes in the other direction. This fact helps explain why Mr. Obama was willing to spend so much political capital on the issue, even though it did not appear to be his top priority as a presidential candidate. Beyond the health reform’s effect on the medical system, it is the centerpiece of his deliberate effort to end what historians have called the age of Reagan.

Tax Time

From the instructions to form 1040:
Certain whaling captains may be able to deduct expenses paid in 2009 for Native Alaskan subsistence bowhead whale hunting activities.
Learn something new every day.

Friday, March 19, 2010

Did JP Morgan Save the Dollar?

In the 1890s, the ability of the US to maintain a fixed exchange rate came into question and it was threatened by an international financial crisis similar to those experienced in recent decades by many "emerging markets." In this instance, the exchange rate peg was to the gold standard, which meant grinding deflation as money growth, limited by the pace of gold production, failed to keep pace with output. This hit debtors particularly hard as it raised real interest rates - imagine a farmer facing fixed interest payments while the price of his crops falls year after year. Populists and silver mining interests campaigned for the monetization - "free coinage" - of silver, which would have led to inflation and devaluation.

With the commitment to gold under threat in the 1890s, the Treasury faced a drain on gold reserves and US bonds carried a risk premium over UK gilts. Nowadays, a country in such a predicament might seek the aid of the International Monetary Fund. Since the IMF did not exist at the time, the US instead turned to JP Morgan.

At the American Heritage website, John Steele Gordon has an interesting description of JP Morgan's 1895 "bailout" of the US Government. He concludes:
Morgan’s rescue of the dollar, despite intense criticism from the Left, changed the country’s economic mood, and a strong recovery from the depression began. The next year the 36-year-old William Jennings Bryan would win the Democratic nomination with a promise that the moneyed classes “shall not crucify mankind upon a cross of gold.” It was one of the most famous speeches in American history, but his far less eloquent opponent, William McKinley, trounced him by running on a slogan of “sound money, protection, and prosperity.”

The election proved to be the start of the revival of Republican dominance in American politics that would last until 1932.

While the Morgan loan did give the Treasury some breathing space, if deflation had continued, no doubt populism would have continued to gain strength. What really did in the "free silver" movement was the end of deflation due to an increase in world gold supplies:

For academic studies, see Milton Friedman, "The Crime of 1873" (Journal of Political Economy, 1990 [JSTOR]) and Hallwood, MacDonald and Marsh, "Realignment Expectations and the US Dollar, 1890-1897: Was There a 'Peso Problem'?" (Journal of Monetary Economics, 2000).

Monday, March 15, 2010

Hardball with China?

A useful article by Keith Bradsher in the Times points out a weakness in international economic governance - while the WTO provides a system of rules and an enforcement mechanism for trade, the IMF does not have the power to do the same for exchange rate policies. China has made use of this asymmetry, he writes:
Seeking to maintain its export dominance, China is engaged in a two-pronged effort: fighting protectionism among its trade partners and holding down the value of its currency.

China vigorously defends its economic policies. On Sunday, Premier Wen Jiabao criticized international pressure on China to let the currency appreciate, calling it “finger pointing.” He said that the renminbi, China’s currency, would be kept “basically stable.”

To maximize its advantage, Beijing is exploiting a fundamental difference between two major international bodies: the World Trade Organization, which wields strict, enforceable penalties for countries that impede trade, and the International Monetary Fund, which acts as a kind of watchdog for global economic policy but has no power over countries like China that do not borrow money from it.

Paul Krugman argues that it is time for the US to confront China over its exchange rate policies:

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”

But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

The Economist offers a more cautious view:

Will the administration’s new tough talk move things in the right direction? Those who argue in favour of sabre-rattling do so on two grounds: first, that it is likely to shift China’s position, and second, that a stronger stance against China’s currency from the White House will diffuse protectionist sentiment in Congress. Both are dubious. China’s reactions so far suggest that American complaints make an imminent currency shift less, not more, likely. And a row could spur rather than diffuse anti-China action in Congress.

Rather than raising a bilateral ruckus, America would be far better off convincing other big economies in the G20 to press together for a yuan appreciation as part of the world’s exit strategy from the crisis. Cool and calm multilateral leadership will achieve more, with fewer risks, than a Sino-American currency spat.

Dani Rodrik, on the other hand, has suggested China's policy is a defensible development strategy.

Speaking of hardball and China, the Economist reports they're not taking to it.

Update: More on Krugman's blog. Free Exchange is harshly critical of his column, and he responds, and is answered. Scott Sumner also disagrees with Krugman. See also Ambrose Evans-Pritchard, who sees China spoiling for a fight it won't win.

Grad School Advice

From Greg Mankiw. Among other things, he says:
Talk with the graduate students who are now in the programs you are considering. Are they happy?
Hmm.... yes, its definitely a good idea to talk to graduate students before choosing a program, but "happy" might be a bit too much to expect. (And if you do meet graduate students who are "happy," do them a favor and don't report them to the director of graduate studies).

My advice on grad school is here.

Update: Chris Blattman adds to Mankiw's list.

Sunday, March 7, 2010

February Employment Report

Given the fears about the impact of the blizzards that hit during the survey period (see this earlier post), the BLS estimate that unemployment held steady at 9.7% in February was good news.

Some of the other numbers from the household survey were encouraging, as both the labor force participation rate and the employment-population ratio both ticked up slightly. The numbers from the establishment survey were not as positive - nonfarm payroll employment fell by 36,000, and the average workweek fell by 0.1 hours.

U.S. Unemployment Rate (Seasonally Adjusted)
On the impact of the weather, the BLS said:
In the establishment survey, the reference period was the pay period including February 12th. In order for severe weather conditions to reduce the estimate of payroll employment, employees have to be off work for an entire pay period and not be paid for the time missed. About half of all workers in the payroll survey have a 2-week, semi-monthly, or monthly pay period. Workers who received pay for any part of the reference pay period, even one hour, are counted in the February payroll employment figures. While some persons may have been off payrolls during the survey reference period, some industries, such as those dealing with cleanup and repair activities, may have added workers.

In the household survey, the reference period was the calendar week of February 7-13. People who miss work for weather-related events are counted as employed whether or not they are paid for the time off.
At Economist's View, Mark Thoma has a roundup of reactions to the BLS report.

Net Stimulus

The theory behind the recovery act ("stimulus") is for government spending to prop up demand by making up for the fall in private consumption and investment spending. While the federal government has been trying to do that, state and local governments are pushing in the opposite direction by cutting spending in order to balance budgets in the face of collapsing tax revenues.

From the standpoint of the government purchases component of GDP, state and local spending is a big deal - in 2009, state and local government purchases were $1790 billion, compared to $377 billion in nondefense federal government spending. To the extent that federal government is "big" it is because of military spending ($794 bn), transfers ($2139 bn), and interest payments ($272 bn).

Much of the recovery act was explicitly designed to reduce states' needs to cut back, but it didn't prove to be enough to completely offset state budget problems. Joshua Aizenman and Gurnain Kaur Pasricha have performed the useful exercise of calculating the "net stimulus" - the combined change in government purchases at the federal and state and local levels. They find that the net stimulus was only slightly positive. At Vox, they write:
[S]o far, the federal fiscal expenditure stimulus has mostly compensated for the negative state and local stimulus associated with the collapsing tax revenue and the limited borrowing capacity of the states. While this is a significant accomplishment, the net effect is that the consolidated fiscal expenditure stimulus is small relative to the sharp fall in private aggregate demand. Consumption plus gross investment expenditures of all levels of the US government were only $47.6 billion higher in 2009 than in 2008 whereas total expenditures (which include transfers) were $330 billion higher. Thus, the fiscal expenditure stimulus did not manage to provide a viable cushion for the negative stimulus associated with private sector’s declining demand. This observation is pertinent in explaining the anaemic reaction of the overall US economy to the alleged “big federal fiscal stimulus”.
That provides a useful sense of perspective (and another bit of evidence for those who would argue the stimulus was too small). It is worth noting that, because they focus solely on government purchases, they are leaving out the effects of the tax cut components, which were about one-third of the recovery act.