Pearlstein's Rule

Steven Pearlstein:

As a general rule, whenever you hear special-interest groups using near-hysterical language to warn that some proposal will destroy jobs, snuff out innovation and end free-market capitalism as we know it, you can generally assume that progress is being made.

The rest of his Washington Post column is about internet regulation.

Krugman: Bernanke v. Bernanke

In his Times column, Paul Krugman applies Ben Bernanke's 1999 critique of the Bank of Japan to the Fed today. He writes:

At the time, the Bank of Japan faced a situation broadly similar to that facing the Fed now. The economy was deeply depressed and showed few signs of improvement, and one might have expected the bank to take forceful action. But short-term interest rates — the usual tool of monetary policy — were near zero and could go no lower. And the Bank of Japan used that fact as an excuse to do no more.

That was malfeasance, declared the eminent U.S. economist: “Far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.” He rebuked officials hiding “behind minor institutional or technical difficulties in order to avoid taking action.”

Who was that tough-talking economist? Ben Bernanke, now the chairman of the Federal Reserve. So why is the Bernanke Fed being just as passive now as the Bank of Japan was a decade ago?

Krugman has more - including a link to Bernanke's paper - in this blog post.

The Fed does seem to be overly-cautious, though its recent decision not to contract its balance sheet as planned is a baby step in the right direction. It could be worse: as new FT econ blogger Gavyn Davies explains, the Fed and Bank of England have been much more aggressive than the "hard currency mob" at the European Central Bank and (still) the Bank of Japan.

July Employment Report

I'd say "treading water," but I think that implies that one's head is above the surface...

According to the latest from the BLS, employment fell by 131,000 in July. Private-sector payrolls increased by 71,000, but the government shed 202,000 jobs (143,000 of which were temporary census workers). The unemployment rate held steady at 9.5%, mainly because labor force participation ticked downward again.The 48,000 decline in state and local government employment reminds us why the state aid bill that just passed the Senate is necessary (but insufficient!).

The report also included a downward revision in June payrolls to a loss of 221,000 (from 125,000); the June gain in private-sector employment now stands at 31,000 (versus 83,000 originally estimated).

As always, Economix has a good write-up; Calculated Risk has nice pictures, and RTE has a roundup of Wall Street reaction. On the politics, Ezra Klein asks "what is the White House thinking?"

Curve Bent!

Summary of the Social Security and Medicare Trustees' annual report, 2010:The red line represents Medicare (HI: Hospital Insurance and SMI: Supplemental Medical Insurance) and the blue line is Social Security (OASI: Old Age and Survivors Insurance and DI: Disability Insurance).

That looks much better than the same chart last year:The difference is due to the health care reform bill passed earlier this year (the Affordable Care Act, or ACA), as this year's report explains:

Much of the projected improvement in Medicare finances is due to a provision of the ACA that reduces payment updates for most Medicare goods and services other than physicians’ services and drugs by measured total economy multifactor productivity growth, which is projected to increase at a 1.1 percent annual rate on average. This provision is premised on the assumption that productivity growth in the health care sector can match that in the economy overall, rather than lag behind as has been the case in the past. This report notes that achieving this objective for long periods of time may prove difficult, and will probably require that payment and health care delivery systems be made more efficient than they are currently. To facilitate this outcome, the ACA establishes a broad program of research on innovative new delivery and payment models to improve the quality and cost-effectiveness of health care for Medicare — and, by extension, for the nation as a whole. The improvement in Medicare’s finances projected in this report highlights the importance of making every effort to make sure that ACA is successfully implemented. If health care efficiency cannot be substantially improved through productivity gains or other measures, then over time the statutory Medicare payment rates would become inadequate. In that situation, the payment update reductions might be suspended, in which case actual long-range costs would be larger than those projected under current law.

That's what President Obama and other reform advocates meant by "bending the curve." If it holds up over time, it represents a huge step towards improving the government's long-term financial picture - i.e., the health care reform bill was a tremendous act of "fiscal responsibility."

The other takeaway from the chart is that, in general, the fiscal situation of the main "entitlement" programs isn't nearly as dire as some would have you believe. Social Security looks to level off at roughly 6% of GDP, which is quite manageable, and now, thanks to the reform, Medicare may do the same.

Richard on Dodd-Frank

In the Hartford Courant, my colleague Richard Grossman discusses the recently enacted financial regulation bill. Overall, he thinks it strikes a good balance:

Reimposing Depression-era constraints on banking would be the equivalent of setting a 25 mph speed limit on I-95. The accident rate would surely fall, but cost to commuters would be enormous.

Our best hope of avoiding a recurrence of the financial turbulence of the last few years is an improved regulatory structure, which the Dodd-Frank legislation will deliver if the new regulators adopt sensible rules, combined with effective and sustainable macroeconomic policies.

Of course, that's a big if...

About That "Hastily Prepared Fiscal Blueprint"

In the Times, former Reagan budget director David Stockman writes:

This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts.

In 1981, traditional Republicans supported tax cuts, matched by spending cuts, to offset the way inflation was pushing many taxpayers into higher brackets and to spur investment. The Reagan administration’s hastily prepared fiscal blueprint, however, was no match for the primordial forces — the welfare state and the warfare state — that drive the federal spending machine.

Ahh, yes... three decades ago....

THE underlying problem of the deficits first surfaced, to Stockman's embarrassment, in the Senate Budget Committee in mid-April, when committee Republicans choked on the three-year projections supplied by the nonpartisan Congressional Budget Office. Three Republican senators refused to vote for a long-term budget measure that predicted continuing deficits of $60 billion, instead of a balanced budget by 1984.

Stockman thought he had taken care of embarrassing questions about future deficits with a device he referred to as the "magic asterisk." (Senator Howard Baker had dubbed it that in strategy sessions, Stockman said.) The "magic asterisk" would blithely denote all of the future deficit problems that were to be taken care of with additional budget reductions, to be announced by the President at a later date. Thus, everyone could finesse the hard questions, for now.

"Hastily prepared"?! To be fair, Stockman himself was an anti-government ideologue rather than a supply-side true believer, and the Reagan administration did change course and the tax cuts were partially reversed. But, nonetheless, three decades ago he entered into an alliance of convenience with the supply-siders and one can trace a pretty direct line between the policies he helped usher in and the nonsense he now laments. Of course, a return now to pre-Reagan Republican balanced budget dogma, as Stockman is calling for today, would be another kind of pernicious stupidity....

The quote above is from William Greider's famous 1981 Atlantic article "The Education of David Stockman." Stockman later wrote a book about his experience in the Reagan White House, which was reviewed by Michael Kinsley for the Times.

Update (8/6): Bruce Bartlett, who as a staffer for Congressman Jack Kemp also played a supporting role in the 1981 tax cuts, considers Stockman's "eclectic ideological journey."

The Great Growth Recession?

According to the BEA's advance estimate, the US economy continued to grow in the April-June quarter, but at a not-very-fast 2.4% annual rate. That's not fast enough to bring the unemployment rate down. Since output growth has been positive for a year now, we can't really say we're in a "recession," but with growth too slow to reduce unemployment, the word "expansion" doesn't really feel right. An informal term for this positive-but-slow growth state is "growth recession." While we shouldn't read too much into one quarter's (preliminary) data, it does raise the question of whether or not the "great recession" will be followed by the "great growth recession."

On a more optimistic note, nonresidential fixed investment growth (i.e., the part of investment that is not houses or inventories) accelerated to a 17% rate. So businesses are adding equipment and software again... if only we could get them to hire workers, too!

Consumption was sluggish - growing at a 1.6% rate as households continued to increase savings.

Net exports made a big negative contribution to the overall total - export growth of 10.3% was swamped by imports rising at a 28.8% rate. After decreasing sharply during the recession, the US trade deficit is headed back up:It remains to be seen how much of a "rebalancing" effect we'll ultimately get out of this slump. This suggests that the US hasn't entirely relinquished the "demander of last resort" role in the global economy, especially with Europe hobbling (ahem, Germany). The flight-to-safety spike in the dollar in 2008 did not help (in general, the effect of exchange rate movements on trade tends to occur with a significant lag).

The BEA release also included revisions of past data which were downward for 2007, 2008 and 2009 (Calculated Risk has a useful picture). In that light, the horrific job numbers make more sense. First quarter 2010 growth was revised upward from 2.7% to 3.7%.

See also Catherine Rampell's Times story and reaction to the report from: James Hamilton, Free Exchange, Mark Thoma and RTE's Wall Street round up.

Update (8/3): New inventory data give reason to expect a downward revision when the second estimate comes out Aug. 27.

The Postulates of the Classical Economics

At Project Syndicate, Keynes biographer Robert Skidelsky writes:

The chief task that John Maynard Keynes set himself in writing his General Theory of Employment, Interest, and Money was to uncover the deep axioms underlying the economic orthodoxy of his day, which assumed away the possibility of persistent mass unemployment. The question he asked of his opponents was: “What must they believe in order to claim that persistent mass unemployment is impossible, so that government ‘stimulus’ to raise the employment level could do no good?” In answering this question, Keynes reconstructed the orthodox theory – and then proceeded to demolish it.

He goes on to provide a nice quick sketch of Keynes' critique of "classical" economic assumptions; the original argument, which is well worth reading today, is found in chapter 2 and chapter 12 of the General Theory.

Effective Protectionism

One of the lessons in international trade class is that tariffs on input goods harm upstream domestic industries - e.g, a tariff on steel would put domestic automakers at a disadvantage by raising their costs relative to foreign competitors. To account for this, economists use a measure known as the "effective rate of protection" which calculates the net effect from the tariffs on the final product that protect an industry and the input tariffs that harm it.

Economists have a strong reflex to sigh when we see a headline like "House Passes Tariff Bill to Help Manufacturers," so it was a relief to read beneath it:

The House of Representatives approved a bill on Wednesday to help U.S. manufacturers by suspending import duties on hundreds of raw materials they use to make finished goods.

That is, the House is increasing the effective rate of protection by lowering tariffs. Perhaps they're more clever than I thought...

Is 'It' Happening Here?

Inflation is very low, as the Consumer Price Index (Blue) and GDP Deflator (Red) indicate:
According to the BLS, the CPI fell in April and May (the "core" CPI, which excludes food and energy prices was flat in March and April and slightly positive in May). Moreover, the Atlanta Fed's Macroblog reminds us that the CPI tends to overstate inflation:

[I]n an article (available to all in its working paper version) appearing in the latest issue of the American Economic Review, Christian Broda and David Weinstein say the earlier estimates of the new goods/quality bias may be a bit understated. The authors examine prices from the AC Nielsen Homescan database and conclude that between 1996 and 2003, new and improved goods biased the CPI, on average, by about 0.8 percentage points per year. If this estimate is accurate, consumer price increases since last October would actually be around zero, or even slightly negative, once we account for the mismeasurement of the CPI caused by new and improved goods.

But (oh, you just knew there was going to be a "but" in here, right?) the authors also point out that, because new goods are introduced procyclically, this bias tends to be larger during expansions and smaller during recessions. In other words, given the severity of the recession and the modest pace of the recovery, there may not be a whole lot of innovation going on right now in consumer goods. This is a bad thing for consumers, of course, but it would be a good thing for the accuracy of the CPI.

Why is deflation a problem? One eminent scholar of monetary theory and history explained it thus:

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous "cross of gold" speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America's post-Civil-War return to the gold standard. The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of "debt-deflation"--the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.

That's Ben Bernanke, in a speech titled "Deflation: Making Sure 'It' Doesn't Happen Here" given during our last deflation scare, in 2002. This one is far more serious because we have indeed reached the zero lower bound and are in recovering slowly from a severe recession.

Bernanke went on to explain that he believed monetary policy was far from powerless, even even after nominal interest rates had been driven down to zero:

U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Two Questions:

1. Do we have a "determined government"?

Its hard to tell, sometimes, but this Washington Post report was moderately encouraging:

Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.

With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns -- massive infusions of cash, such as those undertaken during the depths of the financial crisis -- but would reconsider if conditions worsen.

Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.

"If the economic situation changes, policy should react," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. "You shouldn't sit on your hands. . . . I think there's plenty more we could do if we had to."

2. Would more aggressive Fed action really work?

Perhaps, but the worry is that, while the Fed can create money, it can't force people to spend it. Mark Thoma says "Don't Expect Miracles from Monetary Policy" and Bruce Bartlett reminds us that any increase in money supply can be offset by a decline in money velocity.

Update (7/11): From Paul Krugman, evidence on a trend toward deflation; see also his Times column.