Not Fast Enough

According today's advance estimate from the BEA, US real GDP grew at a 3.2% annual rate in the first quarter.In normal times, that would be a respectable showing - pretty much in line with the historical average. But these are not normal times, and 3.2% growth is not fast enough to make much of a dent in unemployment. According to the rule of thumb known as Okun's Law, roughly 3% output growth is needed just to keep the unemployment rate from rising, because of increases in the labor force and productivity. At this rate, unemployment will be very high for a long time.

The last severe recession - 1981-82 - was followed by a rapid recovery; real GDP grew by 4.5% in 1983 and 7.2% in 1984, and unemployment fell from its postwar peak of 10.8% in Dec. 1982 to 7.3% two years later. This recovery, so far, looks like it may disappoint those of us who were hoping for a similar (or better) showing. It does at least appear to be a little stronger than the "jobless recoveries" in the wake of the relatively mild 1990-91 and 2001 recessions, where the unemployment rate actually continued to rise for some time after the business cycle trough.

Looking inside the numbers shows a couple of good signs: consumption grew at a 3.6% rate and investment in equipment and software increased at 13.4% rate, which suggests some business optimism. Inventory "investment" also added to growth, as, for the first time in a while, businesses actually added to inventories (last quarter it made a positive contribution because firms reduced inventories at a decreasing rate). However, construction continued to be a drag as investment in both structures and housing dropped (how low can they go?). Net exports made a negative contribution as imports grew faster than exports, and Europe's woes may hinder export growth in the future. The most troubling item is a negative contribution from government, because state and local spending was off 3.8%. That's a further reminder that, while the stimulus bill did include substantial money going to states, it wasn't enough. Washington should find a way to do more.

How Do You Say "Riesgo Pais" in Greek?

My international economics students have been reading And The Money Kept Rolling In (And Out), Paul Blustein's excellent chronicle of Argentina's 2001 financial crisis. Blustein tracks the "riesgo pais" (literally, country risk), the yield gap between Argentina's dollar-denominated debt and US Treasuries, which rises inexorably as confidence in Argentina's ability to maintain its Dollar peg and fully repay its debts ebbs.

This Times story on the Greek crisis included a graph of the extra yield on Greek relative to German government debt:Yikes!

Paul Krugman suggests that a Greek exit from the euro would be similar the end of Argentina's "convertibility" system. He writes:

[T]he Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.

And if Greece is in effect forced out of the euro, what happens to other shaky members?

I think I’ll go hide under the table now.

But R.A. of Free Exchange believes there is good reason to think the crisis will be defused:

The situation is troubling, but I think it's worth taking a step back and a deep breath. It is fairly easy to sketch out the ways in which the current crisis could develop into a real economic catastrophe. Sovereign debt and bank concerns in Greece and Portgual could generate pressure on borrowing costs for Italy and Spain and trouble for Italian and Spanish banks. Italy and Spain are big economies, however, and so the sums involved are quite large (in terms of potential bail-out sizes and debt exposure). Real trouble in Italy and Spain would place significant pressure on northern European political systems and economies, and on the euro zone. Depending on how the chips fall, Europe could face capital flight and a new wave of real economic pain. Given the size of the European economy, that would mean trouble for the global financial system and unpleasant headwinds for the global economy.

But things needn't turn out like that. Germany has behaved wildly irresponsibly over the course of this crisis, but its leaders may yet come to their senses (certainly IMF leaders are spinning doomsday scenarios for them, much as American officials laid out the apocalyptic potential of a defeat of the TARP legislation). A Greece restructuring is all but inevitable, but the cost associated with making Greek creditors whole is very small relative to the potential losses associated with continued chaos. While Greece is beyond the brink, other countries have room to rein in their deficits if given time; all that's needed is an effort to avert a liquidity crisis.

The risk is real, but the potential consequences are clear, and it is within the ability of the IMF and European finance ministers to avoid a disaster.

Furthermore, as noted by Matthew Yglesias, a "bailout" of Greece is really a bailout of Greece's creditors. As a side effect of its current account surpluses, many of those creditors are in Germany, so even though its tough politics, Chancellor Merkel now seems to recognize she has strong incentives to do something. See also Felix Salmon, who is not optimistic.

The Daily Show on Global Rebalancing

The reduction in the trade deficit means a shift in tradable goods production to the US. Or, as the Daily Show's Aasif Mandvi puts it: "you're telling me that we Americans have to make our own cheap plastic crap?"

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Wham-O Moves to America
www.thedailyshow.com
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Even before China's recent decision to allow the Yuan to resume appreciating, increasing costs due to higher inflation meant it was becoming less undervalued in real terms.

Looking at the factory in the background suggests that Wham-O's manufacturing in the US is very capital-intensive, as standard trade theory would predict since the US is, relative to China, a capital abundant country (however, this may be an example of a violation of the "no factor intensity reversals" assumption...).

See also this report on the Daily Show's visit from Wham-O's local paper.

Somebody's Watching Me

E-mail from big brother Borders:
Like Rockwell said.

Keynes on Casino Capitalism

In the Times, Roger Lowenstein considers "How Wall Street Became a Giant Casino," which, yet again, reminds me of ch. 12 of the General Theory, in which Keynes says:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism - which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object.

Bush Tax Cut Time Bomb Ticking Louder

The Times reports that Congress is preparing to deal with the scheduled expiration of the 2001 and 2003 tax cuts at the end of this year. That is, without congressional action, tax rates will increase to their pre-2001 levels (more detail in this previous post). President Obama wants to extend the cuts for households earning less than $250,000, but EconomistMom suggests he rethink his position:

For all the complaining you have done on your Senate campaign trail, and then your presidential campaign trail, and now even as President about how unaffordable and unfair and in general not very smart the Bush tax cuts were, why is it that the centerpiece of your–emphasis on your–tax policy thus far is the deficit-financed extension of the vast majority of these very same (not very smart) tax cuts?

Why do you spend over $2 trillion in your budget–the most you spend on any single policy item–on your predecessor’s tax policy, which you repeatedly explain is to blame for the deterioration and unsustainability of our nation’s fiscal outlook? Meanwhile, you took back your own ideas for new tax policy–such as the permanent extension of the Making Work Pay tax credit–because you decided to put higher standards on your own tax cuts and actually pay for them (offset their cost with offsetting revenue increases such as climate change revenues), and Congress (even your own Congress) therefore balked.

I have news for you: you’re in charge now! You aren’t stuck with the (not very smart) Bush tax cuts–not any part of them! You are the one who will have to sign an entirely new piece of legislation in order to keep any part of the Bush tax cuts after this year. You hold the reins. You don’t have to stay on the Bush path. You don’t even have to stay on the Bush tax policy horse. You can switch horses altogether and go down a better path on your better horse.

From a cyclical point of view, letting the cuts expire (i.e., increasing tax rates) next year would not be a good idea because it would reduce demand at a time when unemployment is still likely to be elevated. However, permanently extending the cuts contributes significantly to the long-term deficit (see the graph in this earlier post). A reasonable stopgap might be to extend the "sunset" of the tax cuts a couple of years while working out a "reform" that would bring revenues more in line with spending, and hopefully simplify the tax code, too. That is why I was encouraged by this, from the Times' story:

[T]he White House and Democrats in Congress have given some thought to limiting an extension of the popular middle-class tax cuts to a year or two in the hope that they can overhaul the tax code in the meantime. That also would have the effect, at least on paper, of making projected big deficits look smaller over the long run than if the tax cuts for the vast middle class were continued indefinitely — an important political consideration when the nation’s debt is building to what many economists consider dangerous levels.

On the politics, see Jonathan Chait.

NBER BCWC?

The Times reports on the NBER's Business Cycle Dating Committee:

A committee of economists, charged with determining the official turning points in the nation’s business cycles, certifies the beginnings and ends of recessions. But this time, the committee members say, the evidence is not so easy to decipher.

The committee plans to announce on Monday that it cannot yet declare an end to the recession that began in December 2007, several members indicated on Sunday. Such an acknowledgment is rare in the history of setting dates to business cycles and could affect the behavior of investors and consumers.

Despite a recent uptick in employment and income, the decision of the committee at a meeting on Friday reflects a lingering worry that the economy could turn downward again in a so-called double-dip recession.

Several economists on the committee, which has seven active members, said they considered such a turn to be unlikely. But, they said, the duration and severity of the contraction have made it hard to determine with authority that a recovery has begun.

Hmmm... sounds more like a Business Cycle Waffling Committee.

The NBER's official definition of recession is rather squishy:

[A] recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

That leaves quite a bit of room for subjectivity. As an economist, I'd like them to keep the data series as consistent as reasonably possible. A quick comparison with the previous two recessions, which were mild and short, but followed by "jobless recoveries," suggests that the consistent way to call it would be a trough (end of recession) date in mid-2009.

Indeed, FRED (the St. Louis Fed's great data tool that I used to make the graph) provisionally penciled in a trough of July, 2009, which explains the end of the "shaded area."

If things head back down, after at least two consecutive quarters of positive GDP growth (almost certainly three, if the first quarter of 2010 is reported positive as expected), and many other indicators having turned up, then the consistent way to describe it would be as two recessions. That is how the NBER treated the "double dip" of the Jan-July '80 and July '81-Nov '82 recessions. While a new downturn would really mean one prolonged period of economic awfulness, like the early '80s (or the depression, which was two recessions with a recovery in between), calling it as two separate recessions would be in keeping with the NBER's past practice.

Update (4/12): Here is the committee's statement:

The Business Cycle Dating Committee of the National Bureau of Economic Research met at the organization’s headquarters in Cambridge, Massachusetts, on April 8, 2010. The committee reviewed the most recent data for all indicators relevant to the determination of a possible date of the trough in economic activity marking the end of the recession that began in December 2007. The trough date would identify the end of contraction and the beginning of expansion. Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature. Many indicators are quite preliminary at this time and will be revised in coming months. The committee acts only on the basis of actual indicators and does not rely on forecasts in making its determination of the dates of peaks and troughs in economic activity. The committee did review data relating to the date of the peak, previously determined to have occurred in December 2007, marking the onset of the recent recession. The committee reaffirmed that peak date.

Update #2 (4/12): Via Economix, committee member Robert Gordon has offered a "dissenting opinion" (has that ever been done before?). He thinks they should have called the trough for June, 2009. Furthermore, "a double dip is implausible, if it were to occur in the future it would be classified as a new recession rather than a continuation of the 2007-09 recession." Another committee member, Jeff Frankel, declared the recession over on his blog last week.

Derivative Love

On the Times web site, Steven Strogatz offers a nice discussion of our friend the [calculus] deriviative:

Derivatives are all around us, even if we don’t recognize them as such. For example, the slope of a ramp is a derivative. Like all derivatives, it measures a rate of change — in this case, how far you’re going up or down for every step you take. A steep ramp has a large derivative. A wheelchair-accessible ramp, with its gentle gradient, has a small derivative.

Every field has its own version of a derivative. Whether it goes by “marginal return” or “growth rate” or “velocity” or “slope,” a derivative by any other name still smells as sweet. Unfortunately, many students seem to come away from calculus with a much narrower interpretation, regarding the derivative as synonymous with the slope of a curve.

Like many, I did not appreciate calculus in my first encounters with it, but it grew on me when I was in economics graduate school. I think its possible (though difficult) to make it as an economist without being a natural at math, but, at some point, you must learn to like it.

Stiglitz Says Chill Out on China

At Project Syndicate, Joseph Stiglitz argues that it would be counterproductive for the US to confront China over the exchange rate. He concludes:

Since China’s multilateral surplus is the economic issue and many countries are concerned about it, the US should seek a multilateral, rules-based solution. Imposing unilateral duties after unilaterally labeling China a “currency manipulator” would undermine the multilateral system, with little payoff. China might respond by imposing duties on those American products effectively directly or indirectly subsidized by America’s massive bailouts of its banks and car companies.

No one wins from a trade war. So America should be wary of igniting one in the midst of an uncertain global recovery – as popular as it might be with politicians whose constituents are justly concerned about high unemployment, and as easy as it is to look for blame elsewhere. Unfortunately, this global crisis was made in America, and America must look inward, not only to revive its economy, but also to prevent a recurrence.

Though he doesn't name names, he clearly seems to be answering Paul Krugman's recent column on the subject (discussed in this earlier post).

Update: Krugman responds.

Update #2: See also Martin Wolf, who agrees with Krugman.

Volcker Revisited

As bad as its been, it doesn't look like the current slump will match the postwar peak in the unemployment rate, 10.8% at the end of 1982. That recession was largely a result of the Volcker Fed's efforts to reduce inflation, which was quite painful - exactly as the Phillips curve implies. Since Paul Volcker seems to be back in vogue, Free Exchange asks a very good question:

The Fed began raising interest rates in 1977, and the American economy tipped into recession in 1980, at which point the central bank took its foot off the brakes. But inflation rates continued to rise, and so shortly after the economy recovered (briefly) in July of 1980, Mr Volcker orchestrated a series of interest rate increases that took the federal funds target from around 10% to near 20%.

What followed was an extraordinarily painful recession. Unemployment rose to near 11%. Manufacturing states were battered by the downturn; the near 17% unemployment rate in Michigan was worse than the state sustained in this latest recession. Mortgage lenders were devastated by high interest rates. The banking system was pushed to the point of insolvency. Things were quite bad. And while growth snapped back to trend rather quickly after the Fed took its foot offf the brake for good, there was considerable suffering through the recession, and the effects of unemployment, on health and earnings of sacked workers, persisted for years.

And yet, Mr Volcker is widely hailed as a hero for his total victory over inflation. This is understandable; inflation can be an extremely unpleasant phenomenon. It distorts consumption and investment decisions, and erodes faith in markets and government. But I found myself wondering yesterday whether the Volcker Recession was, after all, worth the pain. Was it a good decision to send the American economy into a debilitating recession for three years in order to whip inflation?

Their answer is worth reading. It leans heavily on the "supply shock" interpretation of the 1970s stagflation, suggesting that, in the absence of further oil shocks in the 1980s, inflation would have gotten at least somewhat better on its own. Hardcore believers in Milton Friedman's dictum that "inflation is always, everywhere a monetary phenomenon" would beg to differ.