A Hint of a Pulse

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The October employment report isn't really that good, but its soooo much better than what we've seen over the last few months... In particular, after falling for four consecutive months, nonfarm payroll employment rose by 151,000 in October.

The June-September reports looked so bad partly because the government was shedding workers (some of them temporary census workers). Because of this, some observers (and the White House) preferred to focus on private-sector payrolls, which have increased every month since January, albeit at a faltering pace. October's increase in private employment was 159,000, which was the best since April.

Of course, with 14.8 million unemployed, that's not nearly good enough to make a dent.  Essentially employment growth is back to a "treading water" pace, which only looks good after several months of drowning.

That is consistent with the headline number from the household survey: the unemployment rate was unchanged at 9.6% in October.  The underlying numbers aren't so hot - the number employed fell by 330,000 and the labor force participation rate fell from 64.7% to 64.5%.

Indeed, given the recent pace of real GDP growth (1.7% in the second quarter; 2% in the third, according to the advance estimate), we're lucky the unemployment rate hasn't risen, as Okun's law - which says that unemployment rises when growth is below 3% -  would imply.

Note that October is a month where the seasonal adjustment is downward; on a non-seasonally adjusted basis, payrolls increased 919,000 (private payrolls increased 409,000), and the unemployment rate fell to 9% (from 9.2% in September).

Paul Krugman refuses to be encouraged (of course):

So, we have a “strong” jobs report — with total employment still 7 1/2 million less than it was three years ago, we had job gains slightly higher than the number needed to keep up with population growth.
At this rate we’ll return to full employment around 2030 or so.

QE2 Sets Sail

Finally, quantitative easing (round 2), is here.  The Federal Open Market Committee announces:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability. 

That would represent a roughly 25% increase in Fed assets (currently about $2.3 trillion, including $838 billion of Treasuries); and a drop in the bucket relative to $8.6 trillion in US debt held by the public.

Will it work?  That has been the subject of considerable debate, which echoes an old-school Keynesian versus Monetarist scrap: Among the Keynesian skeptics are Paul Krugman and Mark Thoma and Joe Stiglitz, who would prefer more fiscal expansion. On the other hand, David Beckworth and Scott Sumner are more optimistic that QE can be effective.

The markets appear to be siding with the pro-QE camp.  Stock prices and the dollar are little changed today, which indicates that the announcement was pretty close to what was expected.  However, since Ben Bernanke raised the possibility of further expansion in a speech on Aug. 27, the stock market has headed up,

and the dollar has fallen (graph is the dollar price of a euro, so up indicates a relative dollar decline)

Also, a recent auction of TIPS (Treasury Inflation Protected Securities) suggests that inflation expectations are rising (see this NYT story, and this Jim Hamilton Econbrowser post).

One FOMC member is not on board: Thomas Hoenig of the Kansas City Fed.  According to the announcement:

Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.  

That is similar to the view expressed by Martin Feldstein in this FT op-ed. Another worry, expressed by Ambrose Evans-Pritchard, is that QE will start "currency wars," to which I say, "bring it on" (see this previous post).

More details on the policy are available from the New York Fed, which will implement it.

Update: Economix has a more comprehensive set of links to views on QE.  In his Times column, David Leonhardt explains how "dovish" monetary views have been vindicated.  Real Time Economics rounds up reaction from "economists and others" (Mike Pence, really?!).  In a Washington Post op-ed, Bernanke explains "What the Fed did and why."  See also: Free Exchange, Gavyn Davies, Scott Sumner, James Hamilton.

Actual Consols

Today's macroeconomics class arrived at the point where I needed explain how bond prices and yields are inversely related.  Fortunately for us economists, the British government has issued perpetual bonds - i.e., bonds which pay a fixed amount ("coupon"*) to the holder with no end date - known as "consols," which make the concept easy to illustrate.

If one pays £100 for a consol with a coupon of £5, the yield is 5% (5/100).  If market interest rates rise to 10%, the consol would only be worth £50 (since 5/50 = 0.10).

I was asked if the consols, which were first issued in the 18th century, still exist today.  A little internet "research" confirms that, indeed, these long-ago loans to the British government are still providing the descendents of the aristocracy with the income to cruise around Kensington in Rolls-Royces.

This wikipedia entry explains briefly the history of consols. According to the UK Debt Management office, there is £177 million worth of "2.5% consolidated stock" still outstanding (there are several other issues, too).  As of today, according to a British trading website, the 2.5% consol is trading at 56.52, which means a yield of 4.4% (2.5/56.52 = 0.044).  This post at the FT Alphaville blog has a graph of consol yields going back to 1729.

Hmm... perhaps I should buy some, so that next time the question comes up, I can say, "yes, I have some."

*I'm not sure "coupon" is good terminology for consols - it comes from bonds that included coupons that the owner would physically cut off and redeem for the interest payments.  That wouldn't work with a perpetual bond.

Naive and Sophisticated Friedman

My ten words or less version of monetarism is: "the Fed should maintain a constant rate of money growth."  By that standard, Milton Friedman would probably not be pleased with the Fed:

David Beckworth and William Ruger, who have a more sophisticated understanding of Friedman's views, come to a similar conclusion in an op-ed, "What Would Milton Friedman Say About Fed Policy Under Bernanke?" They write:

Friedman would likely make the case today for more aggressive monetary action. It is time for "Helicopter Ben" to earn his nickname.

Beckworth has more at his blog.

On a related note, Brad DeLong argues that neither Friedman nor Keynes would be pleased with the new British government's austerity policy.

QE2 Is Already Working!

I have some sympathy for worries that quantitative easing may not be very effective - that it will prove to be another incarnation of "pushing on a string" (see e.g., Annie Lowrey; Mark Thoma), but this Times story about tensions stemming from the declining dollar indicates its already having an impact:

The dollar’s decline is being driven by what everyone in global markets is now expecting: another round of so-called quantitative easing by the United States. In the next few weeks, the Federal Reserve is expected to inject vast sums of money into the economy in another attempt to spur growth....
Financial markets expect the Fed to announce at its meeting early next month that it will proceed with more quantitative easing, involving purchases of bonds, which reduces longer-term interest rates and puts further downward pressure on the dollar.
That worries other countries. A stronger United States economy is in everyone’s interest, but they fear that investors will flee America’s low interest rates and declining dollar and instead pour capital into their markets, overheating their economies and creating the types of asset bubbles in stocks and housing that burst with such devastating effects in the 1990s.
Already there is evidence of this: American investment in overseas stock funds, which was running at about $4 billion a month over the summer, has surged since Ben S. Bernanke, the Federal Reserve chairman, suggested the possibility of another round of quantitative easing at the end of August. About $19 billion has flowed into these funds since Aug. 1, according to TrimTabs, a funds researcher. 

The great thing about expectations is that a policy can have an effect before it is implemented - the mere fact that the Fed is expected to announce a new round of expansion in November has been enough to help get the dollar down after its summer spike due to the Euro crisis.

Zooming out to a five-year view, we can see that the effect of the rush to buy dollar assets in the financial crisis still hasn't fully reversed, but its getting there:

Exchange rate movements tend to have a significant lag in their effect on the economy, but if the decline in the dollar persists, it will benefit tradable goods sectors and improve the trade balance (i.e., increase the NX component of GDP).

So, while I am concerned about whether pushing down long-term interest rates really will do much to stimulate investment (I in GDP), anticipation of the policy is already building in a stimulative effect through the exchange rate channel (and, moreover, the markets are speaking).

So, what of the worries of those "other countries" that financial inflows will "overheat" their economies?  If they choose to hold their currencies down, that would be a problem; the solution is to allow them to rise.  As Jim Hamilton writes at Econbrowser:

If other countries want to prevent their exchange rates from appreciating, they should respond with easing of their own, which from my perspective would be a win-win outcome for everybody. If other countries feel that easing is contraindicated for their domestic situation, then isn't that part of the case why the dollar needs to depreciate relative to their currencies, given the current economic conditions in the U.S.?

Or, more bluntly, "the dollar may be our currency, but your problem."  That, of course, is what Nixon's Treasury Secretary John Connolly famously said in 1971, as the Bretton Woods system collapse.  While I doubt Tim Geithner would speak so directly today, perhaps we are indeed at the end of the so-called Bretton Woods II regime, as Tim Duy predicted recently (see also Ryan Avent and the amusingly hysterical Ambrose Evans-Pritchard).

Raise Greg Mankiw's Taxes, Please!

I should start out by saying that I'm a fan of Greg Mankiw.  He has written some important (and good!) papers that have made influential contributions to both business cycle and growth theory.  Moreover, he is a very good writer - his academic work is enjoyable to read (which is rare!) and he communicates well to a general audience (though sometimes his political biases - which are different from mine - do show through).  I've used several of his papers in classes I've taught, and I've been a (mostly) satisfied user of his intermediate macroeconomics textbook since I began teaching the course as a grad student back in 2003.

In a column for the NY Times, he uses himself as an example of how a change in marginal tax rates could reduce labor supply:

Suppose that some editor offered me $1,000 to write an article. If there were no taxes of any kind, this $1,000 of income would translate into $1,000 in extra saving. If I invested it in the stock of a company that earned, say, 8 percent a year on its capital, then 30 years from now, when I pass on, my children would inherit about $10,000. That is simply the miracle of compounding.

Now let’s put taxes into the calculus. First, assuming that the Bush tax cuts expire, I would pay 39.6 percent in federal income taxes on that extra income. Beyond that, the phaseout of deductions adds 1.2 percentage points to my effective marginal tax rate. I also pay Medicare tax, which the recent health care bill is raising to 3.8 percent, starting in 2013. And in Massachusetts, I pay 5.3 percent in state income taxes, part of which I get back as a federal deduction. Putting all those taxes together, that $1,000 of pretax income becomes only $523 of saving.

And that saving no longer earns 8 percent. First, the corporation in which I have invested pays a 35 percent corporate tax on its earnings. So I get only 5.2 percent in dividends and capital gains. Then, on that income, I pay taxes at the federal and state level. As a result, I earn about 4 percent after taxes, and the $523 in saving grows to $1,700 after 30 years.

Then, when my children inherit the money, the estate tax will kick in. The marginal estate tax rate is scheduled to go as high as 55 percent next year, but Congress may reduce it a bit. Most likely, when that $1,700 enters my estate, my kids will get, at most, $1,000 of it.

HERE’S the bottom line: Without any taxes, accepting that editor’s assignment would have yielded my children an extra $10,000. With taxes, it yields only $1,000. In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I turn down most of the money-making opportunities I am offered?

By contrast, without the tax increases advocated by the Obama administration, the numbers would look quite different. I would face a lower income tax rate, a lower Medicare tax rate, and no deduction phaseout or estate tax. Taking that writing assignment would yield my kids about $2,000. I would have twice the incentive to keep working.

So, if Mankiw's marginal tax rate reverts to its Clinton-era levels as scheduled under current law, when his editor calls to tell him its time for a new edition of his textbook, he would decline?

If we're doing a social cost-benefit analysis of changing Greg Mankiw's marginal taxes, we should account for externalities, positive and negative.  Following Mankiw's lead, I'll use myself as an example, and explain a benefit to reducing Mankiw's labor supply that should be accounted for in his analysis.

I would be better off if he decided the marginal benefit of an cranking out eighth edition was less than the marginal cost, and so would my students.  The churning of textbook editions (and this isn't Mankiw's fault, to be sure) is a real headache to instructors, and helps keep the cost high for students.  Though I'm sure it was well-intentioned (and thoroughly focus-grouped) a number of the changes from the sixth to seventh edition of his textbook made it worse from my point of view.  For example, I rather liked his discussion of New Keynesian and Real Business Cycle theory, which were supplanted by a "dynamic aggregate demand and supply" chapter that I'm not inclined to mess with.  And don't tell me I need my book "updated" for "current events." One of the fun things about teaching macroeconomics is that the world is always giving us interesting new examples to talk about.  But I can handle that quite well without some new "economics in the news" sidebars grafted into the textbook.

However, while the theoretical case that marginal tax rates can change behavior is clear, I'm not convinced, as an empirical matter, that Mankiw's would actually change.  After all, his book was first published in 1992, and he issued new editions in 1994 and 1997 when higher marginal tax rates on high levels of income (and capital gains and estates) were in effect.

Mark Thoma and Brad DeLong suggest some other possible shortcomings in his argument.

September Employment Report

According to the BLS, in September the economy lost 95,000 jobs, and the unemployment rate held steady at 9.6%.  Neither of those headline numbers is pleasant, but the first is more discouraging than the second - I suppose the choice of which one to emphasize depends on whether one sees the glass 10% full or 90% empty.

In this case, the reason for the discrepancy is the fact that the jobs number comes from a survey of businesses while the unemployment rate is calculated from a separate survey of households.  (Another potential explanation would be a decline in labor-force participation, but in September it remained unchanged.)  According to the household survey, the number of people employed actually increased by 141,000 (the payroll number from the establishment survey is usually preferred because it has a larger sample).

The decline in payrolls of 95,000 is the sum of an increase in 64,000 in private-sector jobs and a loss of 159,000 government jobs.  Federal government employment fell by 76,000 (77,000 temporary census jobs ended), state government employment fell by 7,000 and local government employment fell by 76,000 (of which 49,800 were in education).

So, ironically enough, the headlines from the last BLS report before the election will probably give a little more momentum to those who think "government spending" is the problem, even though the report shows that cuts in government spending are already acting as a drag on the economy.

One potential bit of good news from the bad news is that the gloomy report provides another piece of evidence to support the case within the Fed for more aggressive quantitative easing ("asset purchases").

The headline numbers are all seasonally adjusted to remove regular fluctuations that occur during the year.  On a non-seasonally adjusted basis, the unemployment rate fell from 9.5% to 9.2% (i.e., the seasonal adjustment factor raises the unemployment rate in September).  Also, non-seasonally adjusted payrolls rose 428,000 - including an increase of 865,800 in the "local government-education" category, so I think the correct interpretation of the government job loss is that fewer teachers and education workers were hired this year than usual.  Also, non-seasonally adjusted private payrolls fell by 412,000, so the seasonally-adjusted gain of 64,000 means that the private sector did not shed as many jobs as usual for this time of year.

See also: Economix, Free Exchange, Calculated Risk and RTE's round up of reactions.

The Output Gap

The Washington Post's Neil Irwin has a nice slide show to illustrate the output gap under several scenarios.  Check it out!

TARP: A Failure to Communicate

The Times reports that the estimated cost of TARP (a.k.a. "the bank bailout") has been revised downwards yet again:

Treasury reckons that taxpayers will lose less than $50 billion at worst, but at best could break even or even make money. Its best-case assumptions, however, assume that A.I.G. and the auto companies will remain profitable and that Treasury will get a good price as it sells its corporate shares in coming years. 

The Treasury has come out ahead on the money invested in the banking system - for example, it is making a profit on its investment in Citigroup.  The losses, if there are any, will come from the investments in the auto industry, and in AIG (which has announced a plan for unwinding its government ties).

The reality is certainly far different from the widespread perception that the government simply gave away $700 billion to Wall Street.  The failure to get the facts through people's thick skulls out appears to have had significant political consequences - would there be a "tea party" without this persistent misconception?  The Times story provides an example of the political consequences of this ignorance:

Among those who voted for the program in 2008, several Republicans have lost nominating contests for re-election or for another office, and others are on the defensive in fall races. Senator Robert F. Bennett of Utah was “Bailout Bob” to Republicans who refused to re-nominate him for a fourth term.
“For those who were screaming at me — and screaming was the operative word — ‘You’ve just saddled our children and grandchildren with $700 billion,’ I said, ‘No, I haven’t,” Mr. Bennett said in an interview.
“My career is over,” he added. “But I do hope that we can get the word out that TARP, number one, did save the world from a financial meltdown and, number two, did so in a manner that, I believe, won’t cost the taxpayer anything. And even if it did not all get paid back, it was still the thing to do.”

However, it should be noted that, while the financial cost of TARP will be much less than people think, the taxpayer is on the hook for some other costs because of the takeover of Fannie Mae and Freddie Mae (an indirect bank bailout).  The real cost, Simon Johnson argues, is that TARP (and the Dodd-Frank financial regulation bill) failed to create an incentive structure that will prevent financial crises.  He writes:

The first draft of its history, looking back over the past two years, may be this: TARP was an essential piece of a necessary evil – that is, it saved the American financial system from collapse — but it was implemented in a way that was excessively favorable to the very bankers who had presided over the collapse. And this sets up exactly the wrong incentives as we head into the next credit cycle.

He may be right.  But, for now, we are getting most of the money back, and our politics would be significantly different if people understood that much.

Inflation Above (Official) Target

Among its other benefits, a policy regime of inflation targeting, where a central bank has a clear primary focus of keeping inflation as close as possible to a certain level, has a pleasing clarity.  For example, the Bank of England Act of 1998 states:

In relation to monetary policy, the objectives of the Bank of England shall be –
(a) to maintain price stability, and
(b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.  

Compared to the mushy "dual mandate" of the Federal Reserve Act,

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.  

Matthew Yglesias finds the unambiguity of the Bank of England's regime refreshing:

The genius of this is that you now don’t need to have monetary policy matters be the subject of debates on op-ed pages and blogs with various board members giving interviews and speeches. If 2 percent inflation is too much inflation, well that’s on the heads of the politicians who set the target. If inflation is over 2 percent, then the Bank of England needs to tighten. And if inflation is below 2 percent, then the Bank of England needs to expand. Consequently, when faced with a giant downturn the Bank of England has had none of the self-induced paralysis of the Fed, the ECB, or the Bank of Japan. 

Yes, but... the Bank of England has been missing its target lately:

I think the BofE deserves great credit for being aggressive in its response to the economic crisis, but the inflation targeting regime forces it into making awkward excuses, like this from its inflation report:

CPI inflation remained well above the 2% target, elevated by temporary effects stemming from higher oil prices, the restoration of the standard rate of VAT to 17.5% and the past depreciation of sterling.  And the forthcoming increase in the standard rate of VAT to 20% will add to inflation throughout 2011.  As these effects wane, downward pressure on wages and prices from the persistent margin of spare capacity is likely to pull inflation below the target.  But the pace and extent of that moderation in inflation are impossible to predict precisely.  

The FT's Money Supply blog notes that the IMF approves of Britain's current loose monetary/tight fiscal policy mix (see also Free Exchange's comments).  But it is not clear that the inflation target has been helpful... indeed, the risk is that, by allowing inflation exceed the target, the Bank of England is damaging the "credibility" that inflation targeting was designed to buy.  Considering the circumstances, I'm inclined to believe that's a risk worth taking, it does raise questions about the whole inflation targeting concept. 

Inflation targeting is still relatively new. New Zealand was the first country to implement it, in 1988. The current global slump is inflation targeting's first real test, and, after the dust settles it will be interesting to evaluate how it performed.