$253K per Second, But Don't Panic

The Times visits Van Zeck, the Treasury official who manages the government's borrowing:

Last year alone, Mr. Zeck auctioned off $5.5 trillion of Treasury securities, to replace maturing debt and to meet new borrowing needs. Wall Street dealers expect the figure to exceed $8 trillion this year — an average of more than $253,000 every second.

In the first eight months of the current fiscal year, the government issued more Treasury bills, notes and bonds than in all of last year. Mr. Zeck expects to conduct more than 280 auctions this year, up from 263 last year and about 220 a year from 2004 to 2007.

Of course, that scary number is gross borrowing, not net (i.e., it includes refinancing), but the net picture isn't pretty either. The CBO and OMB will release updated estimates of the federal deficit tomorrow - the OMB's estimate for this year's deficit will be $1.58 trillion, and $9 trillion over the next decade. Stan Collender says not to panic:

[T]his is not the time for the administration to propose deficit reductions. Assuming that the current economic forecasts are as correct as they increasingly seem to be, that should happen when the president sends his fiscal 2011 budget to Congress next January or February. Proposing them now would unnecessarily complicate the politics of every issue being dealt with currently and that is likely the primary motivation for those who call for a deficit reduction effort between now and the end of the the year.

And Paul Krugman notes that the projected debt to GDP ratio is not historically unprecedented:

[T]he debt outlook is bad. But we’re not looking at something inconceivable, impossible to deal with; we’re looking at debt levels that a number of advanced countries, the US included, have had in the past, and dealt with.

Keynes as Conservative

In his Forbes column, Bruce Bartlett makes the case that Keynes was a "conservative." He wasn't in the contemporary American political usage of the word, but in the term applies in a more literal sense. Keynes saught to protect the capitalist system from the more radical alternatives of fascism and communism, which were real threats at the time. Bartlett writes:

Indeed, the whole point of The General Theory was about preserving what was good and necessary in capitalism, as well as protecting it against authoritarian attacks, by separating microeconomics, the economics of prices and the firm, from macroeconomics, the economics of the economy as a whole. In order to preserve economic freedom in the former, which Keynes thought was critical for efficiency, increased government intervention in the latter was unavoidable. While pure free marketers lament this development, the alternative, as Keynes saw it, was the complete destruction of capitalism and its replacement by some form of socialism.

That comes to my attention via Mark Thoma. For related thoughts, see this earlier post.

This Week in Econ Navel-Gazing, II

In the FT, Roger E.A. Farmer writes:

The economic history of the twentieth century is one of the struggle between classical and Keynesian ideas. Two events have transformed the history of economic thought since 1900. The first was the Great Depression of the 1930s. The second was the stagflation of the 1970s. We are now experiencing a third: the 2008 stock market crash and the ensuing Great Recession.

The economics of the 1920s was the economics of Adam Smith. Markets work well and the business cycle is self-stabilising. The economics of the 1950s was that of Keynes. Markets mess up sometimes and government must get in there and fix them. In the 1980s we had a resurgence of classical ideas with simpler content but harder mathematics.

Each of the two previous transformational events saw the death of a great idea. After the Great Depression it was the demise of Say’s law, the idea that supply creates its own demand. After stagflation in the 1970s, economists ditched the Philips curve; the idea that there is a stable exploitable trade-off between unemployment and inflation.

So far, so good... He continues:

Which great idea will economists topple next? The next casualty of economic history will be the natural rate hypothesis. I make that case in two forthcoming books and in two recent NBER working papers.

Given the various criticisms of macroeconomics that have been seen lately, perhaps I shouldn't be surprised, but it certainly had not occurred to me to think the natural rate might be in trouble. Though it is problematic to pin down empirically (and therefore of limited use as a guide to policy), I had thought it was a pretty useful concept, rightfully enshrined in "textbook" macro.

The original and best explanation is in Milton Friedman's 1968 presidential address [JSTOR] to the American Economic Association:

At any moment of time, there is some level of unemployment which has the property that it is consistent with equilibrium in the structure of real wage rates. At that level of unemployment, real wage rates are tending on the average to rise at a "normal" secular rate, i.e., at a rate that can be indefinitely maintained so long as capital formation, technological improvements, etc., remain on their long-run trends. A lower level of unemployment is an indication that there is an excess demand for labor that will produce upward pressure on real wage rates. A higher level of unemployment is an indication that there is an excess supply of labor that will produce downward pressure on real wage rates. The"natural rate of unemployment," in other words, is the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is imbedded in them the actual structural characteristics of the labor and commodity markets, including market imperfections, stochastic variability in demands and supplies, the cost of gathering information about job vacancies and labor availabilities, the costs of mobility, and so on.

That idea is part of the problem, according to Farmer:

The fact that central bankers believe this theory is important because it will lead them to conclude that high unemployment after the Great Recession is inevitable. That is why the Obama administration is psychologically preparing the public for the possibility that we will see double digit unemployment. If the natural rate of unemployment goes up by 5 per cent, get used to it. Economists have a name for it: A jobless recovery.

But a jobless recovery is not inevitable. We do not need to accept the immense human misery that goes with permanent job losses. The natural rate of unemployment is not like the gravitational constant. It depends on the confidence of all of us and it can be influenced by policies that we can and should adopt.

A jobless recovery is a real problem, and Farmer is right that we should not accept it (or any theory that says it is inevitable). But the natural rate concept is a strange culprit - I have not heard of anyone interpreting the increase in unemployment as a sudden, massive rise in the natural rate (though probably there is some hardcore new classical economist out there who is).

The natural rate is sometimes taken as synonymous with the "non accelerating inflation rate of unemployment" [NAIRU] - i.e., the unemployment rate consistent with stable inflation. Interpreting it this way, I also do not see any sign that the Fed is acting under the belief that they need to hold back because inflation might take off if the unemployment rate falls.

The problem is that we are struggling to figure out how to get aggregate demand back to the point where we're close to some reasonable equilibrium in the labor market. This does point to some deficiency in our thinking (or policymaking), and I think Farmer's ideas are interesting in this regard, but I'm somewhat befuddled by his framing it as a failure of the natural rate hypothesis. I guess I need to read the book once it comes out.

This Week in Econ Navel-Gazing

Robert Lucas - who has probably had more influence than anybody over the direction macroeconomics has taken since the 1970's - has responded to The Economist's critique of macro and financial economics (which I discussed recently) with a guest column. Lucas writes:

One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.

Or, as Bill Easterly puts it in his defense of economics: "[E]conomists did something even better than predict the crisis. We correctly predicted that we would not be able to predict it."

Lucas also argues that Ben Bernanke and former Fed governor Ric Mishkin did indeed see the potential for crisis in 2007, but:

[R]ecommending pre-emptive monetary policies on the scale of the policies that were applied later on would have been like turning abruptly off the road because of the potential for someone suddenly to swerve head-on into your lane. The best and only realistic thing you can do in this context is to keep your eyes open and hope for the best.

The Economist's Free Exchange blog has an interesting "roundtable" of responses to Lucas. One of the participants, Brad DeLong, notes that Lucas was against Bernanke before he was for him.

Elsewhere - in the FT - Keynes' biographer Robert Skidelsky argues that macroeconomics needs to be radically reconstructed. He writes:

The reconstruction of economics needs to start with the universities. First, degrees in the subject should be broadly based. They should take as their motto Keynes’s dictum that “economics is a moral and not a natural science”. They should contain not just the standard courses in elementary microeconomics and macroeconomics but economic and political history, the history of economic thought, moral and political philosophy, and sociology. Though some specialisation would be allowed in the final year, the mathematical component in the weighting of the degree should be sharply reduced. This is a return to the tradition of the Oxford Politics, Philosophy and Economics (PPE) degree and Cambridge Moral Sciences.

The point of this, Skidelsky says, is "to protect macroeconomics from the encroachment of the methods and habits of the mathematician." While I have some sympathy for his view that we need to broaden our thinking, I'm not convinced our methods are so fundamentally flawed. In this regard, Mark Thoma's post in the Lucas roundable gets it right:

Models are built to answer specific questions. When a theorist builds a model, it is an attempt to highlight the features of the world the theorist believes are the most important for the question at hand. For example, a map is a model of the real world, and sometimes I want a road map to help me find my way to my destination, but other times I might need a map showing crop production, or a map showing underground pipes and electrical lines. It all depends on the question I want to answer. If we try to make one map that answers every possible question we could ever ask of maps, it would be so cluttered with detail it would be useless, so we necessarily abstract from real world detail in order to highlight the essential elements needed to answer the question we have posed. The same is true for macroeconomic models.

But we have to ask the right questions before we can build the right models. The problem wasn't the tools that macroeconomists use, it was the questions that we asked.

Of course, we naturally prefer to ask questions that we think we can answer with the models we have...

I should add that, while I don't fully agree with Lord Skidelsky's assessment, I am looking forward to his forthcoming book, "Keynes: The Return of the Master" (the title causes me to imagine John Maynard Keynes, in silk pyjamas, taking out an army of new classical economists with badass ninja moves).

July Employment Report

The BLS reported a slight decrease in the unemployment rate in July to 9.4% (from 9.5% in June). That's the first decline since February 2008, when the unemployment rate was 4.8%.

Unemployment Rate

While an improvement in the headline number might be good for our animal spirits, the number of people working fell in July, though at a less alarming rate. The decreased unemployment rate was an artifact of people leaving the labor force (see Paul Krugman and Floyd Norris). The labor force participation rate fell to 65.5%.

Labor Force Participation Rate

Though I would not be surprised if the unemployment rate rises again - and it could if a recovering economy draws more people into the labor force - this does give some hope this recession will not break the postwar record of 10.8% set in late 1982.

At Economists' View, Mark Thoma rounds up reaction to the report. See also the Times story.

Hip (and remunerative) to be Square?

The Times reports that statistics is a hot occupation:

“I keep saying that the sexy job in the next 10 years will be statisticians,” said Hal Varian, chief economist at Google. “And I’m not kidding.”

The rising stature of statisticians, who can earn $125,000 at top companies in their first year after getting a doctorate, is a byproduct of the recent explosion of digital data. In field after field, computing and the Web are creating new realms of data to explore — sensor signals, surveillance tapes, social network chatter, public records and more. And the digital data surge only promises to accelerate, rising fivefold by 2012, according to a projection by IDC, a research firm.

Yet data is merely the raw material of knowledge. “We’re rapidly entering a world where everything can be monitored and measured,” said Erik Brynjolfsson, an economist and director of the Massachusetts Institute of Technology’s Center for Digital Business. “But the big problem is going to be the ability of humans to use, analyze and make sense of the data.”

Tax Cuts are Tricky

Jeff Frankel argues that the tax cut portions of the stimulus have not been effective, and notes an irony:

The Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 were both explicitly designed to boost saving — hence their focus on capital income and higher income brackets — and yet in both cases private saving fell in their aftermath. The tax cuts of January 2008 and February 2009 were both explicitly designed to boost consumption; yet private saving rose in their aftermath !

Of course, their effects really should be judged relative to a counter-factual...

Recession, Revised and Extended

Real GDP declined at an annual rate of 1% in the second quarter of 2009, according to the BEA's advance estimate. America's new-found frugality continued to be a drag: consumption decreased at a 1.2% rate, even as real disposable personal income rose at a 3.2% pace (presumably thanks largely to the tax cut). Investment continued to fall - nonresidential investment declined at a 8.9% rate, and residential (i.e. housing) at 29.3% (!). Exports fell at a 7% rate, much better than the 29.9% rate of decline in the first quarter. On the positive side, GDP was boosted by declining imports (down 15.1%) and increased government purchases (up 5.6%). Declining inventories showed up as a negative in the GDP numbers (by itself accounting for 0.83 percentage points of the 1% decline), but may bode well for the future as businesses may decide to increase output to re-stock.

Today's numbers came with a comprehensive revision of the entire GDP series. This changes our picture of the past a little bit. Validating the NBER's call of a business cycle peak in Dec. 2007, the new estimates have GDP declining at a 0.7% pace in the first quarter of 2008, compared to the previous estimate of a positive 0.9% growth rate (GDP did tick up in the second quarter of '08 - possibly with some help from the first stimulus, Floyd Norris reminds us - before beginning a sustained decline in the third quarter). Overall, the revisions make the recession look even worse, as the first three quarters of 2008 and the first quarter of '09 were all revised downward (though the fourth quarter of '08 was nudged upward).

The 2001 recession, already a "mild" one, is even shallower with the new numbers, according to the announcement:

For the contraction that lasted from the fourth quarter of 2000 to the third quarter of 2001, real GDP increased at an average annual rate of 0.1 percent in the revised estimates; in the previously published estimates, it had decreased by 0.2 percent.

The BEA is also revising its nomenclature: the "advance" estimates will now be followed by "second" and "third" estimates, rather than "preliminary" and "final." A further reminder, I suppose, that no estimate is ever truly final.

For more on the revisions, see Floyd Norris's article in the Times. On today's numbers, see also James Hamilton, who evokes some memories of my college days:

[S]ome folks are cheering today's news. Reminds me a little of how I've seen people in Minnesota take off their shirts for the first 40^oF day of spring, a little shocking to a traveler from San Diego.

[Rest assured, I didn't actually do that]

Zubin Jelveh highlights the "automatic stabilizer" role of declining imports, though Barry Ritholtz notes its hardly a sign of health. Josh Bivens and Dean Baker argue the numbers show the stimulus recovery act is helping. Real Time Economics rounds up the reactions of prognosticators.

Update (8/1): Andrew Samwick looks at the composition of GDP, which highlights the role that declining investment has played. I would add that the 11.2% share of investment in the 2nd quarter of 2009 is the lowest ever in the data series going back to 1947 (mainly due to housing, nonresidential fixed investment was 9.9% of GDP, which is lower than average, but not alarmingly so). At 70.6%, the share of consumption is the highest ever - even though consumption has fallen, output has fallen more.

Will Green Shoots Rise Quickly?

Writing for the FT, Tim Bond of Barclays Capital makes the case the recovery will be sharper than many expect (i.e., the recession is 'V-shaped'). One reason for this is that Asia is growing quickly already:

[A] strong Asian recovery is visible, with output, employment and demand all following V-shaped trajectories, and regional industrial production rapidly bouncing back above the previous peak. Yet this recovery is dismissed by western analysts, who appear unable or unwilling to believe the region is capable of endogenous growth. That 2009 will be the second year in a row in which the increase in Chinese domestic demand exceeds that of the US is a point roundly ignored.

(On China, see also The Economist's Free Exchange blog). Another reason is that, he argues, US firms overdid the layoffs:

[F]ew commentators consider the possibility that the large post-Lehman rise in US unemployment was a mistake on the part of panicky managements. Yet this is precisely what trends in labour productivity growth, not to mention common sense, tell us occurred. In the first half of 2008, labour productivity growth averaged 3.3 per cent, while the unemployment rate rose to 5.6 per cent. At that point, there was no evidence US companies were overstaffed. Thereafter, output collapsed, yet business productivity growth remained positive, registering an average yearly pace of over 2 per cent, as companies shed labour at a faster pace than they reduced output. Businesses, like markets, panicked after Lehman went under. Employment and output were both reduced far more than it turned out to be necessary, as businesses temporarily and understandably assumed a worst case scenario.

Just as global output is performing a V-shaped recovery, there is a big risk US employment will do the same, with monthly payrolls showing surprising growth by the end of 2009.

Usually, employment changes less than output during recessions - following a regularity known as Okun's law - which means that labor productivity falls. This recession appears to be breaking that pattern. Brad DeLong recently offered a more pessimistic interpretation (see also Robert Waldmann's response to DeLong).

While the widespread expectation of a 'jobless recovery' is consistent with the slow recoveries from the previous two US recessions in 1990-91 and 2001, Bond also notes that, historically, deeper recessions have been followed by sharper recoveries (a point I also made here). For example, 1983-84 was a particularly strong period of growth, coming out of the deep 1981-82 recession.

His article comes to my attention via Time's "Curious Capitalist" Justin Fox, who writes: "I find that awfully hard to believe, but perhaps that's because I work in an industry struggling with some major secular troubles as well as cyclical ones. In any case, it'd sure be fun if Bond turned out to be right."

Update: Krugman points out that Okun's Law looks better after the latest GDP revision.

In the Background, Rebalancing

The crisis we've had (I hope I'm not jinxing anything by using the past tense) was not the crisis that I was worried about. With the US running a large current account deficit - $803.5 bn (6.1% of GDP) in 2006 - international macro worrywarts could find plenty of reason to be concerned that US dependence on foreign purchases of our assets would end unpleasantly with a dollar rout and skyrocketing interest rates if foreign creditors rushed for the exit, as they often have done for emerging markets. As Brad DeLong put it:

The prevailing view was that the truly dangerous financial crisis would be one produced by the unwinding of "global imbalances"--a collapse in the dollar and a panicked flight not toward but away from dollar-denominated cash--that could not be handled by the Federal Reserve because in such a crisis the assets that it would create would be assets that nobody wanted to hold.

That was not the crisis we got, and, at times, the dollar has actually risen due to it's "safe haven" role in world financial markets (an irony noted in this earlier post). But, along the way, some of the global imbalances we were worried about have gotten considerably smaller. For the first quarter of 2009, the preliminary estimate of the seasonally adjusted US current account deficit was 2.9% of GDP. Brad Setser writes:

[T]here has been a major adjustment. The question is whether it will be sustained when the US recovers and US demand picks up.

That depends on the course of the dollar, to be sure. And of the course of the dollar depends on whether private demand for US assets picks up, as well as whether countries like China maintain dollar pegs. But it also depends on the nature of the global recovery – and the strength of stimulus policies other countries adopt. And their at least there is a bit of hope, at least so long as China sustains its current highly stimulative policies. China’s June surplus was lower than expected, in part because China’s imports picked up before China’s exports. That’s goods news for global adjustment.

There sometimes is a tendency to speak about the world’s macroeconomic imbalances as if nothing has changed. That increasingly strikes me as a mistake. The world’s imbalances haven’t gone away, but they have shrunk dramatically.

Japan is now running an external deficit. China’s surplus shrank, at least in q2. The US deficit is much smaller now than in the past. Europe’s internal imbalances also have shrunk.

The adjustment came the painful way – with sharp falls in exports and imports. But it was still adjustment. The trade deficit fell sharply. The rise in the public borrowing buffered an enormous fall in private borrowing, and private demand. It cushioned rather than stopped the adjustment. The challenge now is try to make sure the recovery doesn’t undo the adjustments that happened during the crisis.