Bernanke on 60 Minutes

Euro Trouble

Another sign the euro is in trouble: this week's Economist has an article on how a member country might leave the currency union.  It concludes:

The cost of breaking up the single currency would be enormous. In the ensuing chaos and recrimination, the survival of the EU and its single market would be in jeopardy. But by believing that a break-up cannot happen, the euro zone’s authorities will always tend to stop short of the radical measures needed to hold the project together. Given the likely and devastating chaos, it would be a mistake for a country to choose to leave. But mistakes occur in times of stress. That is why some are beginning to contemplate the unthinkable.

Germany may be the country that walks - the Guardian reports:

At the Brussels dinner on 28 October attended by 27 EU heads of government or state, the presidents of the European commission and council, and the head of the European Central Bank, witnesses said Papandreou accused Merkel of tabling proposals that were "undemocratic".

"If this is the sort of club the euro is becoming, perhaps Germany should leave," Merkel replied, according to non-German government figures at the dinner. It was the first time in the 10 months since the euro was plunged into a fight for its survival that Germany, the EU's economic powerhouse and the lynchpin of the euro's viability, had suggested that quitting the currency is an option, however unlikely.

Much of the difficulty in Europe stems from German attitudes on monetary policy (though their deeply ingrained aversion to inflation is understandable) and their influence on the ECB.  Ryan Avent put it well last week:

A demonstration of commitment to Europe requires a little bit from everyone, and what it requires from the ECB is that it act like the European Central Bank, rather than just a Bundesbank that gets to impose unreasonably hard money on everyone in the single currency. Mr Trichet, who has had to earn his post by acting as German as a Frenchman can possibly be expected to act, seems to be realising that that's not actually what's required of the ECB.

The recent "bailout" of Ireland does not impress Barry Eichengreen:

The Irish “programme” solves exactly nothing – it simply kicks the can down the road. A public debt that will now top out at around 130% of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan.

According to the deal, not just interest but also principal is supposed to begin to be repaid after a couple of years. At that point, Ireland will be transferring nearly 10% of its national income as “reparations” to the bondholders, year after painful year.

This is not politically sustainable, as anyone who remembers Germany’s own experience with World War I reparations should know. A populist backlash is inevitable. The Commission, the ECB, and the German Government have set the stage for a situation where Ireland’s new government, once formed early next year, rejects the budget negotiated by its predecessor.

Even measures like this, which fall far short of what would be necessary to end the crisis, are tough to get the Germans to sign off on.  Though its not surprising that loans to Greece and Ireland are bad politics in Germany, it needs to be remembered that the problems of some of the peripheral countries are due, in part, to the fact that ECB policy, which placed more weight on Germany (because its bigger) was too loose for them. This helped create the bubbles that have now burst.  Moreover, much of the debt involved is owed to German (and other European) financial institutions, so this is really a "bailout" of Germany's banks.

Europe faces both sovereign debt and monetary policy problems.  Some of the countries have too much debt, and a restructuring is probably in order.  But if they're going to avoid that - and they seem determined to (though don't they always?) - a more expansionary monetary policy would help them grow (and inflate) their way out of trouble.  Without more inflation, the peripheral countries really need not just loans, but fiscal transfers from those that are in better shape (i.e., some kind of fiscal union is needed - on this, see Gavyn Davies).

Neither way out seems palatable to Germany.  The Economist's article argued that the disruption of leaving the euro would be considerably lower for Germany than for the peripheral countries, since the likely appreciation of the Mark would ease some of the tangles associated with re-denominating debt.  Perhaps the rest of the eurozone should consider taking Chancellor Merkel up on her offer...

Now, That's an Economic Message

When I read the "Economic View" column in today's NY Times:

Uncertainty is likely holding back the recovery. But its sources are far more fundamental than the tax and environmental issues that typically top the list of complaints. And the solution is certainly not for the government to do less. Rather, it needs to do much more...

Wall Street analysts often cite possible government regulations on the environment as another source of damaging uncertainty. But as with the deficit, inaction could be far more damaging than action. Climate change and dependence on foreign oil are problems that won’t go away on their own. Tabling plans to deal with them doesn’t make it easier for companies to plan and invest; it makes it harder.

Until businesses and communities know the costs and incentives for developing renewable energy, nuclear power and natural gas — and whether we will address climate change through prices or direct regulation — it will be very hard to invest in new power sources and related industrial technologies.

The deepest and most destructive uncertainty we face centers on the overall health of the economy and its prospects for growth. Unlike other postwar recessions that were caused by tight monetary policy and high interest rates, the recent downturn resulted from the bursting of a housing bubble and a financial crisis. Because we are in largely uncharted territory, figuring out how and when the economy will recover is much harder than usual...

How do we resolve uncertainty about future growth? The Federal Reserve, Congress and the president need to reaffirm that they will do whatever it takes to restore the economy to full health. They could take a lesson from President Franklin D. Roosevelt, who declared in his 1933 inaugural address that he would treat the task of putting people back to work “as we would treat the emergency of a war.” 

I think: now that is exactly the kind of message we need to hear from the White House.  And then I see that the column was written by Christina Romer, who was, until very recently, chair of the Council of Economic Advisors....

What We Believe and the Tools We Use

At Worthwhile Canadian Initiative, Nick Rowe writes:

What we research, and what we believe, aren't necessarily the same thing. What gets published in the journals is a survey of what we are currently researching. It isn't an accurate survey of what we currently believe. The whole point of a journal is not to publish what everybody already believes. The journals are a map of where we are currently exploring for gold. They are not a map of existing gold deposits. They are not a map of where we think gold might be found in places we can't currently explore.

To which I might add, economic models can be thought of as tools.  Using a particular tool (model) to do a job (normal science) shouldn't be taken to imply a belief that the model is the right one for all economic phenomena.  In many cases, its much easier to make progress (and get papers accepted) if one uses existing tools.  For instance, I've used a real business cycle model in my own research - it turned out to be an effective device to implement an idea I had about real exchange rate volatility.  But it does not mean that I believe that real business cycle theory is a correct explanation of economic fluctuations.

Its Hard to Hold a Candle

in the cold November rain....

The BLS November employment report is a bummer, especially in the wake of mostly improving economic reports (e.g., consumer confidence, unemployment insurance claims, regional manufacturing surveys, etc).

According to the BLS, employment increased by a mere 39,000 and the unemployment rate rose from 9.6 to 9.8%.

The rise in the unemployment rate was not, alas, due to people re-entering the labor force - the participation rate was unchanged at a (depressed) 64.5%.  According to the household survey, 173,000 fewer people were employed in November (recall that the headline employment number comes from the separate survey of businesses, while the unemployment rate is calculated using the household survey).

If the other, positive, economic reports are ultimately reflected in strong fourth quarter GDP, the employment numbers would be an indication of rising productivity (for the third quarter, the BLS reported 2.3% labor productivity growth).

Out of the 15.1 million unemployed (!!!!), 6.3 million have been unemployed for more than 27 weeks.  There was a good article yesterday in the Times on how long-term employment can have persistent effects, as people who have been unemployed for a long time become less employable (a form of what is sometimes called "hysteresis" in the economics literature).

Hopefully the report will concentrate some minds in Washington (but don't hold your breath).  It should strengthen the President's attempt to salvage an extension of unemployment benefits from the negotiations with the Republicans on extending the Bush tax cuts.

November is one of the months when the seasonal adjustment makes things look worse - on an unadjusted basis, the unemployment rate was 9.3% (up from 9% in October), and payroll employment increased by 217,000.

For more on the employment report, see Calculated Risk, David Leonhardt, Free Exchange, and Real Time Economics' roundup.

Update: Mark Thoma is critical of the White House response.  Floyd Norris has a reason to hope for an upward revision.

The Counterfactual

"It could have been worse" isn't a winning political argument (and probably wouldn't have been even if the White House managed to consistently make it), but its probably true.  Compared to a counter-factual of no stimulus, real GDP is between 1.4% and 4.1% higher because of the recovery act (ARRA), according to the Congressional Budget Office.  This has been nicely illustrated by the Center for Budget and Policy Priorities:

Also, the stimulus has lowered the unemployment rate by 0.8 to 2 percentage points - i.e., without it we'd be looking at 10.4% - 11.6%, instead of 9.6%.

$700 Billion Bailout Update

From the Congressional Budget Office, another downward revision to the estimated cost of that "$700 Billion Bailout":

CBO estimates that the cost to the federal government of the TARP’s transactions (also referred to as the subsidy cost), including grants that have not been made yet for mortgage programs, will amount to $25 billion. That cost stems largely from assistance to American International Group (AIG), aid to the automotive industry, and grant programs aimed at avoiding mortgage foreclosures: CBO estimates a cost of $45 billion for providing those three types of assistance. Other transactions will, taken together, yield a net gain of $20 billion to the federal government, CBO estimates.

It was not apparent when the TARP was created two years ago that the costs would be this low. 

Indeed.  And I don't think its apparent to most people now that the costs were this low (which is a real problem, as I discussed in this previous post).

Better (But Still Not Good Enough)

The BEA announces:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.5 percent in the third quarter of 2010, (that is, from the second quarter to the third quarter), according to the "second" estimate released bythe Bureau of Economic Analysis. 

That's an acceleration from the 1.7% annual growth rate in the second quarter, and an improvement over the "advance" estimate of 2%.   Growth is still below average, and far below the pace necessary to close the output gap (i.e., get the economy back to some semblance of "full employment").  But at least the second derivative is positive....

Of the 2.5% growth, consumption accounted for 2%, investment for 1.5% (of which 1.3% was due to inventories), government purchases 0.8%, and net exports -1.8% (i.e., imports grew faster than exports).

Richard's Blog

My Wesleyan colleague Richard Grossman has started a blog, Unsettled Account, which shares its title with his new book on the history of banking.  Check it out!

And Keynes, too

Ahem.  A notable Bloomsbury figure is curiously omitted from the Times' report on 36 Hours in Cambridge:

Punting down the River Cam in a flat-bottom boat is the classic way to see Cambridge, but mastering the long wooden pole takes practice. Book a 90-minute lesson with Scudamore’s Punting Company (Granta Place, Mill Lane; 44-1223-359750, scudamores.com), which will assign a well-muscled tutor to punt you down the gorgeous stretch of river that runs behind the colleges. Halfway through, the pole is handed to you, for a lesson in propelling the unwieldy craft. If you didn’t come to Cambridge for tutoring, rent a kayak from Scudamore’s and paddle to the Orchard Tea Garden (45-47 Mill Way, Grantchester; 44-1223-551125; orchard-grantchester.com), where E. M. Forster, Virginia Woolf, and Bertrand Russell hung out a century ago. 

Its a bit of a hike, but you can walk there (though it was beastly hot the day I did it - punting might have been better).