Friday, December 23, 2011

City of Yesterday, Today

Extremists who mistakenly believe they are defending liberty have the Detroit suburb where I grew up in their vise, the New York Times reports:
In what could be a new high water mark of anti-Washington sentiment, the city of Troy, Mich., is rejecting a long-planned transportation center whose construction would have been fully financed with federal stimulus money.

The terminal, which would help Troy become a transportation node on an upgraded Detroit-to-Chicago Amtrak line, was hailed by supporters as a way to create jobs and to spur economic development. But federal money is federal money, so with the urging of the new mayor, who helped found the local Tea Party chapter, the City Council cast a 4-to-3 vote this week against granting a crucial contract, sending the project into limbo.

“There’s nothing free about government money,” Mayor Janice Daniels said in an interview. “It’s never free, and it’s crippling our way of life.” 
The street signs at the city's entrances say "City of Tomorrow, Today!" but it sounds like Mayor Daniels is leading Troy backwards, with great conviction.

Wednesday, December 21, 2011

A Professorial Dilemma (RIP, Saab)

Sad news from Trollhättan, the NY Times reports:
The owner of Saab Automobile finally threw in the towel Monday, filing for bankruptcy after hopes of a life-saving investment from Chinese investors collapsed in the face of opposition from General Motors.
This creates a dilemma for those of us who feel a professional obligation to uphold the stereotype of the Swedish-car driving college professor, but believe we are too cool for Volvos.

The Economist's "Schumpeter" column gave a the brand a nice (though slightly premautre) obituary in September.  It is still possible someone will buy the company whole in bankruptcy and restart it, but most reports suggest liquidation is more likely.

Wednesday, December 14, 2011

No "Buts" About It

From the NPR website:

The story itself is fine, though the "but" in the headline suggests that the editor who wrote it expected austerity to lead to (short-term) growth.  Most of us economists don't find the coincidence of fiscal tightening and slumping growth so surprising (see e.g., Krugman).

Last week's summit agreement to tighten enforcement of the budget rules in the "stability and growth pact" doesn't help matters.  One is reminded of the old joke that the Holy Roman Empire was "neither Holy, nor Roman, nor an Empire."  I suppose actually enforcing the rules would make it more of a "pact," but forcing procyclical fiscal policies won't be good for stability or growth (see this post by Antonio Fatas). 

So its not surprising that the Washington Post reports "In Europe, summit optimism fades." The half-life of "summit optimism" seems to be declining, which means that Europe must either (a) really fix things or (b) hold summits more frequently.  I think they're converging towards continuous summit. 

Friday, December 2, 2011

November Employment: The Good, the Meh, and the Bleh

From the BLS November employment report:
  • Good news: Significant drop in the unemployment rate, to 8.6% (from 9%)

  • Less good: Mediocre employment growth of 120,000 jobs (a "treading water" pace)

  • Not good: Labor force participation falls by 0.2 percentage points to 64%
The employment growth number comes from a survey of businesses (the "establishment survey") while the unemployment rate is calculated from a household survey (which has a smaller sample).  Continuing a recent pattern, employment growth looks better in the household survey: 278,000 more people said they were employed.  Also continuing the pattern of recent reports, the previous establishment survey numbers were revised upwards; September's job gain is now 58,000 higher and October's is up by 20,000.  Over the past several months, the revisions have been bringing the establishment report figures up closer to the better household survey numbers (which aren't subject to revisions).

By itself, 278,000 more people employed doesn't get the unemployment rate down by 0.4 percentage points.  The labor force fell by 315,000 (thus bringing the participation rate down).  The unemployment rate is measured as a percentage of the labor force, and to be counted in the labor force, someone must either be working or looking for work.  Another way of looking at it is that the number of people who were unemployed fell by 594,000 - roughly half of them got jobs, while the other half quit looking.

On a non-seasonally adjusted basis, the unemployment rate in November was 8.2% (down from 8.5% in October, mainly due to a big drop in participation) and payrolls rose by 339,000. That is, November is a month when the seasonal adjustment makes things look worse... it will be the opposite in January when all the extra holiday employees lose their jobs.

Wednesday, November 30, 2011

A Goolsbee is Haunting Europe

In a WSJ op-ed, further elaborated in an interview with Ezra Klein, Austan Goolsbee lays out some of the fundamental problems of the Euro, which go deeper than the immediate financial crisis.  In particular, the common currency closes off the avenue of exchange rate adjustment. That is, without the Euro, the DM would be rising and the Lira and Peseta falling, improving Italian and Spanish current account balances.  He concludes:
[E]ven if Europe addresses the banking-capitalization crisis of the moment, and even if it struggles its way through the near-term fiscal crises of Greece and Italy, then what? With little prospect for growth in its South, Europe remains on the romantic road to nowhere—a road that merely runs in a circle. Without growth there will always be another fiscal crisis ahead for yet another country unable to balance its budget but prevented from devaluing and exporting its way forward.

On this path, Europeans will forever need to fight off financial and fiscal panics while trying to build their castle on a hill.
What really matters is the real exchange rate - i.e., the price of one country's goods in terms of another's.  The real exchange rate between two countries is the nominal exchange rate times the ratio of the countries' price levels.  Even if both countries have the same currency, the real exchange rate changes if they have different inflation rates.  This means that Greece, Italy and Spain can have a real depreciation vis a vis Germany by having lower inflation, which would, over time, make their goods relatively cheaper.  Of course, to get very far with this, if German inflation is low, then the peripheral countries' price levels actually need to fall.  This is sometimes called "internal devaluation", and because it entails deflation, is quite painful.  This what Goolsbee is talking about when he says: "In the short run, that would mean directly and significantly grinding down wages to make them competitive—a grisly option, prone to causing mass unrest."

I think this would be significantly less painful if it didn't involve price levels actually falling and, in principle, it doesn't have to.  For simplicity, say the Eurozone consists of a "core" and "periphery" of equal size.  If Eurozone inflation is 4%, it could be 7% in the core and 1% in the periphery, which means the periphery experiences real depreciation at a 6% rate.  However, the ECB is quite firm about sticking to its mandate - which reflects German preferences - for inflation at or below 2%.

In a way, this is analogous to the Akerlof-Dickens-Perry case that slightly positive inflation facilitates real wage adjustment because it allows some real wages to fall without forcing very difficult nominal wage cuts.

Monday, November 21, 2011

Death, Taxes and Trade Disputes

Douglas Irwin, Free Trade Under Fire (3rd ed., 2009):
The tuna dispute was resolved in 1992 when the United States, Mexico, and eight other tuna-fishing nations signed an international agreement to regulate the conditions of tuna fishing.
Bridges Trade News Digest, Nov. 16, 2011:
At its last meeting on 11 November, the WTO Dispute Settlement Body (DSB) decided to extend the deadline for submitting an appeal on the latest Tuna-Dolphin (DS381) ruling issued in September (see Bridges Weekly, 21 September 2011).

In light of the Appellate Body’s substantial workload, the US and Mexico had jointly requested an extension of the normally sixty-day period, which otherwise would have expired on 15 November. In accordance with the agreed extension, an appeal will have to be submitted no later than 20 January.
Lesson: never use the word "resolved" when writing about trade disputes....

To be fair to Irwin, whose book I recommend (and assign to students), one could consider "Tuna-Dolphin" to be a series of disputes, one of which was resolved in 1992.

Tuesday, November 15, 2011

Is the ECB Determined to Go Down with the Ship?

With the risk premium on Italian government debt growing, the best hope for a resolution to the Euro crisis would seem to be for the European Central Bank to announce an unlimited intervention to cap the yield on sovereign bonds.  However, it steadfastly refuses to do so - presumably because it feels that such an action might risk a violation its prime directive of "inflation rates of below, but close to, 2% over the medium term."

In a recent Project Syndicate column, Brad DeLong argued that the ECB is failing to step up to the plate as the lender of last resort:
The ECB continues to believe that financial stability is not part of its core business. As its outgoing president, Jean-Claude Trichet, put it, the ECB has “only one needle on [its] compass, and that is inflation.” The ECB’s refusal to be a lender of last resort forced the creation of a surrogate institution, the European Financial Stability Facility. But everyone in the financial markets knows that the EFSF has insufficient firepower to undertake that task – and that it has an unworkable governance structure to boot.

Perhaps the most astonishing thing about the ECB’s monochromatic price-stability mission and utter disregard for financial stability – much less for the welfare of the workers and businesses that make up the economy – is its radical departure from the central-banking tradition. Modern central banking got its start in the collapse of the British canal boom of the early 1820’s. During the financial crisis and recession of 1825-1826, a central bank – the Bank of England – intervened in the interest of financial stability as the irrational exuberance of the boom turned into the remorseful pessimism of the bust.
Similarly, Barry Eichengreen writes:
Here’s where the political cover comes into play. Merkel and Sarkozy need to make the case that if the euro is to become a normal currency, Europe needs a normal central bank – one that does not merely target inflation like an automaton, but that also understands its responsibilities as a lender of last resort.
More on this from The Economist, Antonio Fatas, Gavyn Davies and Martin Wolf as well as a nice "news analysis" from the NY Times

If Italy is fundamentally solvent and merely facing a self-fulfilling "liquidity" panic (as investors sell bonds, yields rise, making it more costly to service its debts, which lowers the chances it will avoid default leading to investors selling bonds...), then it may not require much more than an announcement of a willingness to intervene to quell the crisis.  By restoring confidence, the ECB could bring yields down without having to do much actual bond-buying (i.e., Super Mario* can be Chuck Norris).

The crisis potentially spells the end of the Euro - so the ECB is putting its mandate ahead of its own self-preservation.  That is, it appears willing to risk its very existence for the sake of what it sees as its duty.  As a matter of economic policy, it looks disastrously foolish, and yet, there's something oddly noble-seeming about it.

*Admittedly, referring to Italian policymakers named Mario as "Super Mario" is getting stale quickly (and I can't imagine how much they must despise it); and the press needs to decide whether it is ECB President Mario Draghi or new Prime Minister Mario Monti who is called "Super Mario" (or perhaps not... a quick search of "Super Mario" on the FT reveals a potentially confusing solution: "Super Mario Brothers").  The Guardian compares two of the "Super Marios" and this FT profile argues Draghi earned his "super."

Friday, November 4, 2011

October Employment: Not Bad

Not really good, either...  The BLS reports that the unemployment rate ticked down to 9.0% (from 9.1%) in October.  Payroll employment increased (weakly) by 80,000; the private sector added 104,000 jobs but the public sector subtracted 24,000.   The numbers from the survey of households (which is used to calculate the unemployment rate) were a bit stronger - the number of people employed rose by 277,000.
Also, the payroll employment growth (from the survey of establishments) figures were revised upwards for August and September, by 57,000 and 55,000, respectively.

On a non-seasonally adjusted basis, the unemployment rate fell to 8.5% and payroll employment rose by 883,000.  That is, October is a month where a regular "seasonal" gain is removed to make the seasonally adjusted number.

Wednesday, November 2, 2011

Sigh. headline:

The Fed's forecasts are here.  Their projection for 2012 real GDP growth is 2.5-2.9%, down from the June estimate of 3.3-3.7%.

Romer: Bernanke's Volcker Moment?

In the Times last weekend, Christina Romer suggested a precedent for a switch in our monetary policy regime.  The Volcker Fed tightened money growth (thereby letting interest rates rise severely - the Fed funds rate was briefly above 19% at a couple of points in 1981) - the point was to bring the hammer down on inflation. As Romer notes, this very unpleasant policy was justified by a shift to a "monetarist" regime of targeting money growth.  As I've discussed before, I have mixed feelings about the lionization of Paul Volcker, but I think Romer has a good point that it may be time for another regime shift, this time to nominal GDP level targeting:
Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.
Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path. 
Just as Volcker's regime shift provided cover for a controversial action the Fed felt it needed to undertake (extreme tightening) and facilitated a shift in inflation expectations, a shift to a nominal GDP target would make possible (indeed, require) more aggressive expansion and thereby raise inflation expectations (which means lower real interest rates, ceteris paribus).

See also Paul Krugman, who agrees and Binyamin Appelbaum, who reports that the Fed is unmoved. Free Exchange's Greg Ip makes a contrary case and his colleague Ryan Avent responds.

Friday, October 28, 2011

GDP: The Video

Its not exactly "Thriller," but this video from Slate and NPR, starring Simon Johnson, is a relatively zippy exposition of what "Gross Domestic Product" means:

Its the first in a series.

Thursday, October 27, 2011

3Q GDP: Is the Recovery Recovering?

The BEA's advance estimate of real GDP growth for the third quarter was 2.5% (annual rate).  That's in the same ballpark as the long-run trend rate of growth - i.e., its a pretty normal growth rate, consistent with maintaining a stable unemployment rate as the labor force and productivity rise over time, but not fast enough to dig the economy out of the hole (14 million unemployed) that its in.  It is, however, a significant improvement over the first two quarters of 2011, which saw growth rates of 0.4% and 1.3%.
Also, this puts real GDP back above its pre-recession (4Q 2007) peak; a milestone we previously thought had been attained at the end of 2010 until the estimates were revised downwards last summer.

More reaction: The Economist's "Free Exchange" blogNYT's Catherine Rampell, Calculated Risk, James Hamilton, Mark Thoma, RTE's round up of Wall Street "economists."

Sunday, October 16, 2011

The Structure of Macroeconomic Revolutions?

Macroeconomics sometimes appears to be a somewhat confusing swirl of models and "schools of thought." This can be a somewhat off-putting feature to students (though for some of us it is also part of what makes macroeconomics more interesting than microeconomics).  When I introduce it to my students, I make a nod to Thomas Kuhn's "Structure of Scientific Revolutions" framework, which provides a way of putting some structure on the development of macroeconomics that is more sophisticated than framing it as a series of "debates" between "sides" (i.e., "classical" vs. "Keynesian", "saltwater" vs. "freshwater", etc.).

So I liked this post by Matthew Yglesias, where he invokes Kuhn and draws an analogy between macroeconomics and the Copernican revolution in astronomy.  He recounts how Copernican (Earth revolves around the sun) astronomy eventually supplanted Ptolemaic (Earth is center of universe), but initially the Ptolemaic system made much better predictions, and concludes:
My view, with both all due respect and all due derision, is that the Robert Lucas types are like the early Copernicans here. There’s something admirable in their insistence that it ought to all work out to an easily modeled system grounded in compelling theoretically considerations. The New Keynesian model is a mess, like late-Ptolemaic astronomy, thrown together to account for observed reality. But you don’t fly to a moon with an elegant model that delivers mistaken predictions about where the moon’s going to be. And what we actually need is a Kepler to give us an elegant model that actually predicts the phenomena, and then a Newton who can explain what that model means. 
Hmmm... I'm more inclined to place the users of old Keynesian models, including the IS-LM-based macroeconometric models used by policymakers, in the "late-Ptolemaic" role, but, in any case, the Kuhninan approach helps explain why I simultaneously agree with Brad DeLong, Paul Krugman and Greg Mankiw that the IS-LM model remains a very useful tool, while being a little more optimistic than Krugman about the state of macroeconomics.

Also, I'm not sure that Lucas and others (including new Nobel laureate Tom Sargent) who have pushed macroeconomics towards "structural" or "micro-founded" models are leading us to an "easily modeled system." What counts for "elegance" in modern macro is consistency between the macroeconomic model and micro-economically optimal behavior on the part of consumers and firms (I suppose the obvious retort to that is to invoke Emerson: "A foolish consistency is the hobgoblin of little minds").

Friday, October 7, 2011


A nice column from Floyd Norris on the parallels between Argentina's exit from its dollar peg, and Greece's potential exit from the euro.  It would be messy, in part because there is no legal mechanism in place to do that; or as Norris puts it:
The euro was designed to be the Roach Motel of currencies. Once you enter, you can never leave. There is no provision for departure. 
Hmm... Norris' column might be a good reading for Econ 270, but will Greece still be in the euro by spring semester??

Norris is referencing this vintage TV ad.

September Employment: Partly Cloudy

The BLS reported today that employers added 103,000 people to their payrolls in September, of which 45,000 were workers returning from the Verizon strike.  That's not a great number - due to natural growth in the labor force and productivity improvements, the economy needs to add roughly 130,000 jobs per month just to keep the unemployment rate from rising.  But in light of fears that the economy could be sliding into recession due to the hits on confidence from the debt ceiling fiasco and Europe's woes, a continuation of the pattern of sluggish employment growth may be somewhat of a relief.  Also, July employment growth was revised up from 85,000 to 127,000 and August was revised from 0 to 57,000.
The numbers from the household survey (which has a smaller sample, so is considered less reliable) were more encouraging.  The unemployment rate held steady at 9.1%.  The number of people employed rose by 398,000, but the reason that didn't bring the unemployment rate down is that the labor force grew by 423,000 and the labor force participation rate ticked up to from 64.0% to 64.2%.  The unemployment rate is measured as a percentage of the labor force, and to be counted as in the labor force, someone must report that they are working or looking for work, so this is a sign that people are re-entering the labor force, which may mean that they are more encouraged about prospects of finding a job.

Overall, the economy remains in a deep hole, with nearly 14 million people unemployed, 6.2 million of whom have been out of work for 27 weeks or longer.  Government continues to be a drag on employment (i.e., the exact opposite of what it should be doing); government payrolls fell by 34,000 in September.  The BLS noted that local government employment has fallen by 535,000 since September 2008 (more on this from Floyd Norris).

On a non-seasonally adjusted basis, the unemployment rate fell to 8.8% in September and payroll employment rose by 519,000.  That is, September is a month that normally sees an improvement in the employment picture, which is removed by the seasonal adjustment factor.

More reaction: Calculated Risk, Mark Thoma, RTE's round up of Wall St. "economists".

Thursday, October 6, 2011

Keynes and His Rivals

The New Republic has a very nice review essay by Robert Solow (the founding father of modern growth theory) on Sylvia Nasar's new book "Grand Pursuit: The Story of Economic Genius." I particularly liked these three sentences:
SCHUMPETER thought of Keynes as his natural rival for the title of “greatest economist.” They were born in the same year, 1883. Keynes probably did not believe that he had a natural rival.

Thursday, September 15, 2011

Changing the Rules?

In a recent speech, Chicago Fed President Charles Evans argued that the Fed has been neglecting the "maximum employment" part of its mandate "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Evans explains:
Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.
At his blog, Stephen Williamson offers a critique of the speech.  Among his arguments:
Evans is forgetting the lessons of the 1970s. What Evans is proposing is a change in the policy rule - a change in how the state of the economy maps into actions by the Fed. What economists understand today that they did not in 1975, is that commitment by the Fed to a policy rule is critical for its success in fulfilling its mandate. Once the public understands that the Fed intends to exploit a short-run Phillips curve relationship (and the problem is worse if the short-run inflation/unemployment tradeoff in fact does not exist), then all bets are off. High inflation can become well-entrenched and we have to go through an episode like the policy-induced "Volcker recession," followed by a long period where the Fed re-establishes its credibility. 
Although the wording of the Federal Reserve Act requires the Fed to care about both inflation and unemployment, as Williamson notes, its practice has evolved towards a de facto inflation targeting rule with an objective similar to the European Central Bank's "below, but close to 2%".  This is evinced by all the mentions of the Fed's "comfort zone" as well as the "longer run" projections of 1.5-2% inflation from Fed board members and regional bank presidents.  In terms of economic theory, it can be justified by the result, in some models, of "divine coincidence" - that policies which stabilize inflation also stabilize output.

If the Fed heeded Evans' argument, it would be more willing to risk breaking its inflation target rule to reduce unemployment.  In economic theory, one of the main points benefits of having a rule is that it lends "credibility" to monetary policy and "anchors" expectations (this speech by Charles Plosser is a nice intuitive exposition of the "time consistency" logic underlying this argument).  But that only works if the central bank actually follows its rule.  Hence Williamson's concern.

Inflation targeting is relatively new - New Zealand was the first to adopt the practice in 1989, and it has since been implemented by the UK, Canada, and the European Central Bank, among others.  Most of the countries that have adopted inflation targets have set them in the vicinity of 2%.

While there are good reasons in economic theory for having monetary policy rules, the past few years have raised questions over whether a 2% inflation target is the right rule.  There are several alternative rules that might have performed better in the wake of the financial crisis:
  1. Inflation targeting with a higher target would reduce the risk of hitting the "zero lower bound" on short-term interest rates.
  2. Price level targeting would require higher inflation to make up for periods of too-low inflation.  
  3. Nominal GDP targeting is a re-incarnation of Milton Friedman's stable money growth rule, focusing on the right hand side of the identity MV = PY, which avoids the problem of unstable velocity (V), which doomed the early 1980's experiments with money growth rules.
All three alternatives have been discussed over the past several years in commentary about policy and are good subjects for academic research, which may ultimately show that many of the world's central banks have adopted the wrong rule.  

However, that raises a conundrum: if the Fed breaks its (implicit) rule, even for the sake of adopting a better rule, it risks denting its credibility....

Of course, the real problem with Evans' speech is that Ben Bernanke has no hair, so there is no reason for him to act like his hair is on fire.  That may be why bald guys are so cool.

Sunday, September 11, 2011

Europe (Still) on the Brink

Europe has done a remarkable job of kicking the can down the road so far on the Euro-debt crisis.  But it sure looks like they won't be able to do that much longer.  Things are looking bad... really bad....

Ambrose Evans-Pritchard writes:
[T]he chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy - 16pc of GDP of net tightening in three years - without offsetting monetary stimulus, debt relief, or devaluation.

This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek parliament said, the debt dynamic is "out of control". 
Gavyn Davies:
Last week, several events conspired to make the crisis more alarming. In Greece, the government faced lower GDP growth and higher budget deficits, making the task of hitting deficit targets appear more improbable than ever. Even though the Papandreou government has refused to throw in the towel and intends to close the latest budget gap by raising E2bn from a new property tax, there seems to be no conceivable escape from the familiar downward spiral – more budgetary tightening, low growth, higher budget deficits, higher bond yields.

That leaves Germany with a clear choice, which is either to rescue Greece with a huge fiscal transfer or prepare to deal with the consequences of a Greek default, with a possible departure from the euro. To judge from today’s German newspapers, it is increasingly likely that they will choose to jettison Greece.
Barry Eichengreen:
Europe doesn’t have months, much less years, to resolve its crisis. At this point, it has only days to avert the worst.
Liz Alderman and Nelson Schwartz of the New York Times:
On Sunday, French government officials braced for possible ratings downgrades by Moody’s Investors Service of France’s three largest banks, BNP Paribas, Société Générale and Crédit Agricole, whose shares were among the biggest losers last week. The biggest banks in Europe, especially in France, hold billions of euros’ worth of Greek bonds, and investors fear even a partial default by Greece would sharply diminish the value of those assets, eroding already weak capital positions.

American financial institutions, typically heavy lenders to their French counterparts, have begun to pull back on these loans, but United States banks’ exposure to France remains substantial. 
It looks like we'll have something to talk about in Econ 270 this spring....

Update (9/12): A nice column today from Paul Krugman on the subject.

Saturday, September 10, 2011

The American Jobs Act

The big ticket items in the $447 billion stimulus recovery jobs act that President Obama announced in his address at the Capitol on Thursday include:
  1. $65 billion in cuts to employer payroll taxes
  2. $35 billion for employment of teachers, police and firefighters
  3. $30 billion for school modernization
  4. $50 billion infrastructure investment
  5. $175 billion in cuts to employee payroll taxes
  6. $49 billion for extended unemployment insurance/UI reforms
The most straightforwardly effective components of the package for increasing aggregate demand are #2, #3, #4 and #6. Direct spending on school buildings (#3) and infrastructure (#4) increase the government purchases component of demand (and "Ricardian" or "crowding out" effects that would reduce the impact in some models are irrelevant now). Cutbacks by state and local governments have become a big drag on the economy - state and local governent employment has fallen by over 650,000 over the past three years. The funding for employing teachers and "public safety and first responder personnel" (#2) will put a brake on that trend. That is, it will be an increase in demand (again through the government purchases component) and employment relative to what would occur otherwise.

Extending unemployment insurance (#6) is effective because much of the money goes to people who will spend it (i.e., people who are "credit constrained" from smoothing out their consumption over time).  This increases the consumption component by raising disposable income.  The release from the White House discusses some possible reforms to the unemployment insurance program as well - these are not detailed enough to evaluate, but possibly they might help mitigate one of the downsides of unemployment insurance, which is that it can reduce incentives to work (though I don't think that is a really significant contributor to unemployment now).

There is more uncertainty about the effectiveness of the social security payroll tax components.  Payroll taxes are the "contributions" paid equally by employers and employees (although employees only observe half of the tax through the "FICA" line on their pay stubs, in the long run, the burden of the entire tax - the "incidence" - largely falls on employees because their wages would be higher if employers did not have to make their contribution).

The largest part of the act (#5) is a one-year reduction in the employee contribution to 3.1% - the standard contribution is 6.2%, but was temporarily cut to 4.2% for this year in the deal that was struck in late 2010.  So, basically, this extends the existing cut, and adds another 1.1% to it.  As with unemployment insurance, the effect of a tax cut in increasing consumption depends on whether it is spent.  Households that are credit-constrained (living "paycheck to paycheck") are more likely to change their behavior.  In this regard, it is less well targeted than the unemployment insurance extension, but it is superior to an overall income tax cut. Because the payroll tax is somewhat regressive, only applying to the first $106,800 of wages (and not at all to capital income), the benefits go largely to the "middle class."  Although the primary desired effect is to increase consumption demand, even the parts of the tax cut that are not spent do have the benefit of helping improve the financial position of households.  Large debt burdens are part of the reason recoveries from "balance sheet recessions" are typically slow, so if part of the tax cuts goes to pay down debt, that could serve to hasten the return to normal household spending behavior.

The employer part of the payroll tax cut (#6) can be thought of as a positive "supply shock" lowering unit labor costs (in the short run, with lots of labor market slack, it won't lead them to raise wages).  In a traditional Keynesian framework, this would shift out the aggregate supply curve (or, equivalently, shift down the Phillips curve).  In a "New Keynesian" model, this is a reduction in the real marginal cost term in the New Keynesian Phillips Curve.  Since the binding constraint on the economy is on the demand side, the usefulness of this part of the policy appears questionable.  Indeed, reducing costs is deflationary, and deflation is a very bad thing.  But it is a bad thing that the Fed is determined to prevent, and that is why this part of the package may have a positive effect.  The Fed seems very averse to letting inflation become negative, but also very careful to try to keep it from going above 2% (in doing so, its placing too much weight on the "price stability" part of its mandate relative to the "maximum employment" part, as this justly-praised speech by Chicago Fed President Charles Evans argued). By putting downward pressure on costs, and therefore prices and inflation, the employer-side tax cuts may create more space for the Fed to act more aggressively.

An important part of the proposal is still to come - President Obama said that he would deliver plans to "pay for" the jobs act (i.e., offsetting tax and spending changes, presumably within the standard 10-year window customarily used to assess budget proposals).  This may be politically necessary, but, as I argued recently, there is no economic urgency for doing this, and I worry that political gridlock over paying for the bill could derail taking action now, which is urgent.

Its also worth noting that, while the exact timing of some of the provisions is unclear, it looks like most of the effect occurs in 2012.  That's a good thing, but even under the optimistic assumptions that something like this bill is enacted, and the Fed finds a will and a way to take more effective action, the economy is in a very deep hole and unemployment will still be elevated at the end of 2012. The expiration of the tax cuts puts in place an automatic fiscal contraction for 2013 (this is where the idea of "state contingent" policies would help, but would raise the headline cost, which is politically unpalatable right now).

Private-sector estimates suggest the bill would have a significant impact: Macroeconomic Advisors says it will raise GDP by 1.3% and increase employment by 1.3 million next year; Moody's (via Brad Plumer) puts it at 2% of GDP and 1.9 million jobs.  See also: Gavyn Davies, Paul Krugman, Ezra Klein, Mark Thoma.

Friday, September 2, 2011

August Employment: Flat Line

The BLS employment report for August is not a good one.  Total employment was unchanged - i.e., no net jobs were added - which is really losing ground because about 130,000-ish jobs need to be added each month just to keep up with population growth and technological progress.

Government continues to be a drag - government employment dropped by 17,000, and this would have been worse without 22,000 workers returning to work after the Minnesota shutdown.  The Verizon strike also had an effect, reducing payrolls by about 45,000.  That is, without the Verizon strike, there would have been a gain in private-sector payrolls of 62,000, which isn't particularly good.  Also, the employment growth for June and July were revised downward.
The payroll employment number is calculated from a survey of employers. The unemployment rate comes from a survey of households.  Overall, the household survey looks a little better (though it is considered less reliable because it has a smaller sample).  The unemployment rate held steady at 9.1% and the number of people employed rose by 331,000.  The labor force participation rate and employment-population ratio also ticked up slightly.

Overall, this report should help convince the Federal Open Market Committee to take more steps in the direction of "easing" policy, and add urgency to further fiscal policy action to try to stimulate job growth.

On a non-seasonally adjusted basis, payrolls increased by 118,000 (i.e., August is a month that normally has a slight gain, which is removed by the seasonal adjustment).  Non-seasonally adjusted unemployment was also 9.1% (but down from 9.3% in July).

Wednesday, August 31, 2011

The Fed's Mandate (an Explanation for Sen. DeMint)

Sen. Jim DeMint is describing the Fed's emergency lending during the financial crisis as a "shadow TARP."  In an opinion column for Politico, he writes:
The U.S. government was never meant to be a giant lender for the world’s most powerful banks.
Actually, that is exactly what the Fed was originally meant to do.  The preamble to the Federal Reserve Act is:
An Act To provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.
"Furnish an elastic currency" is another way of saying that the Fed should be a "lender of last resort" - lend money to banks whose funding sources can suddenly disappear in financial crises in order to prevent the system from collapsing.  The Fed was founded because the frequent financial "panics" of the late 19th and early 20th century made clear that the US needed a central bank to perform this function.

During the financial crisis, the Fed performed this function with ingenuity and determination, and we would be in a very different - and much, much worse (think "Mad Max") - world if it hadn't.

What is questionable is whether the Fed is fulfilling section 2A of the Federal Reserve Act (added in 1978), "Monetary Policy Objectives": 
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.
Some of us believe that the Fed could be doing a better job (or at least try harder) of getting us closer to "maximum employment".   Somehow DeMint manages to be concerned that the Fed is failing to achieve "stable prices".  He says:
Americans are feeling inflationary pangs at home, too. The congressional Joint Economic Committee found that since the Fed launched its program of quantitative easing in late November 2008, the value (trade weighted) of the U.S. dollar has declined 14 percent, which translates into higher food and fuel costs.
The graph below shows inflation, measured by the CPI (though I think a 'core' measure, which would show lower inflation recently, is a more appropriate guide for monetary policy) and the unemployment rate.
By historical standards, unemployment is very high now, while inflation is low (and the little tick upward at the end will likely vanish as the effect of the oil price increase earlier this year dissipates).

DeMint also approvingly cites the criticism of Chinese and German government officials:
Leaders from around the world have openly complained about the way the U.S. is intentionally weakening the dollar, since doing so cheapens the value of U.S. debt they hold. After the second round of quantitative easing was announced, Chinese Vice Finance Minister Zhu Guangyao said America “does not recognize, as a country that issues one of the world’s major reserve currencies, its obligation to stabilize capital markets.

German Finance Minister Wolfgang Schaeuble was more blunt, calling the Fed “clueless.”
DeMint appears to believe that US monetary policy should heed the criticism of foreign government officials. Perhaps the mandate of the Fed be changed to focus on the interests of other countries.  I think some people may believe that it should, since the US dollar is the global "reserve currency", but if we're going to do that, we might as well abolish the Fed and turn US monetary policy over to the United Nations.  It doesn't appear that the wording of the Federal Reserve Act is explicit on this point, but I think its pretty well understood that the language quoted above about "the economy", etc., refers to the US economy.  If they don't like our monetary policy, China and Germany (and everyone else) are free to choose other assets to buy.

This San Francisco Fed Economic Letter from 1999 describes nicely how and why the Fed's mandate has evolved.  It might be good reading for Senator DeMint.

Tuesday, August 23, 2011

A Better Analogy for the Deficit?

The recurrent "government should balance its budget like a household" trope has been one of the more infuriating aspects of recent debates over economic policy.  Its easy to see the appeal for politicians who want to appear to be talking "common sense," but the policy implications are destructive.  In the LA Times, I suggest a different analogy:
Politicians of both parties have furthered the misunderstanding by frequently drawing an analogy between the federal budget and household budgets. "Families across this country understand what it takes to manage a budget," President Obama declared in a February radio broadcast. "Well, it's time Washington acted as responsibly as our families do." While this comparison appeals to a general belief that we should "live within our means," it's also misleading.

Decisions about the federal budget are fundamentally different from those of individual households, because policymakers need to account for how their choices affect the economy as a whole. It is more appropriate to liken government budget deficits to prescription medicine. Just as medication can be helpful to a sick patient, deficits can aid a failing economy.
The debt ceiling debate showed how hard it is for the political system to deal with something that can be good in some circumstances, bad in others.  I hope this is a way of thinking of it that is simple and intuitive, but also right.

Of course, the ideal is to simultaneously have an expansionary policy now, but also a plan for a (roughly) balanced budget in the long run (i.e., after the economy has returned to health).  But the debt ceiling fight illustrated how raising the issue of long term projected imbalances starts a big fight over the ultimate size of government (which isn't what countercyclical policy is about).  With 14 million people unemployed - and interest rates very low - that is a dangerous distraction.

Sunday, August 7, 2011

Time to Cash in the Fed's "Credibility"?

Ezra Klein talks to Ken Rogoff:
Since 2008, Rogoff has recommended that the Federal Reserve commit to an extended period in which it will seek to set inflation at 4 percent. That would effectively make debt worth less. That’s anathema to central banks, which have spent the past few decades building their credibility as inflation fighters. But Rogoff is unimpressed. “All the central banks of the world have been fighting the last war,” he says. “This is a once-every-75-years great contraction where you spend your credibility. This is what that credibility is for.”
Update (8/12): Rogoff explains his thinking more in this FT column.

A Silver Lining to the Debt Ceiling Fiasco?

In a recent Project Syndicate column, Stephen Roach shared some observations from recent conversations with Chinese policymakers, who were not pleased with the debt ceiling mess:
Senior Chinese officials are appalled at how the United States allows politics to trump financial stability. One high-ranking policymaker noted in mid-July, “This is truly shocking… We understand politics, but your government’s continued recklessness is astonishing.”
Roach suggests that China may be losing its appetite for US Treasuries, and this, he believes, spells trouble for the US:
So China, the largest foreign buyer of US government paper, will soon say, “enough.” Yet another vacuous budget deal, in conjunction with weaker-than-expected growth for the US economy for years to come, spells a protracted period of outsize government deficits. That raises the biggest question of all: lacking in Chinese demand for Treasuries, how will a savings-strapped US economy fund itself without suffering a sharp decline in the dollar and/or a major increase in real long-term interest rates?
The US should hope he's right.  An abrupt reversal would be very disruptive, though it would probably do more harm to China than the US (provided the Fed steps in to limit the increase in US interest rates).  But China's massive purchases of US assets aren't a benefit to the US overall - they are part of a policy that has distorted the US economy away from tradable goods production and towards excess homebuilding (and asset bubbles).

The reason China has accumulated gigantic holdings of US Treasuries is that it has been intervening in foreign exchange markets - selling renminbi for dollars - to keep the value of its own currency down and the dollar up.  It then invests the dollars in Treasuries (i.e., the Treasury bond holdings are a consequence of the foreign exchange policy).  The result is US-produced goods are more expensive relative to Chinese goods. This contributes to the trade imbalance and reduces the size of US exporting and import-competing sectors.  Furthermore, many other countries feel the need to undertake similar interventions to maintain competitiveness vis a vis China, so it is not just the bilateral trade balance that is affected.

According to Roach, China has recognized the need to "rebalance" its own economy to rely less on exports and more on domestic consumption:
China has adopted a very transparent response. Its new 12th Five-Year Plan says it all – a pro-consumption shift in China’s economic structure that addresses head-on China’s unsustainable imbalances. By focusing on job creation in services, massive urbanization, and the broadening of its social safety net, there will be a big boost to labor income and consumer purchasing power. As a result, the consumption share of the Chinese economy could increase by at least five percentage points of GDP by 2015.
If the debt ceiling mess has given China's leadership a greater sense of urgency to get on with that, that's a good thing for them, and for us.

Roach's column came out before the S&P downgrade, but that may have reinforced China's views.

Friday, August 5, 2011

S&P Downgrade: Its the Institutions, Not the Debt

S&P just downgraded US government bonds from "AAA" to "AA+".  Their explanation:
We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.
That is, the downgrade has as much to do with the US political system as it does with debt levels.  The ugly spectacle of a faction of one political party taking the economy hostage in the debt ceiling debate has trashed the rating agency's (and everyone else's) confidence in Washington's ability to make difficult compromises.

July Employment: Merely Bad

Arriving the day after a stock market plunge set off renewed talk of a "double dip" recession, the July employment report almost looks good because it is merely bad.  According to the BLS, in July the economy added 117,000 jobs and the unemployment rate ticked down to 9.1% (from 9.2%).

Employment growth of 117,000 is just about the "treading water" level needed to keep up with population growth and productivity improvements, so it doesn't represent any progress in digging out of a deep hole.   Government continued to be a drag - private employment rose by 154,000, but government jobs fell by 37,000 (of which state government accounted for 23,000, which the BLS says was "almost entirely" due to the Minnesota shutdown).

Also, the employment growth figures for May and June, which had contributed to the economic fears, were revised up to 53,000 and 46,000, respectively (still quite bad, but better than 25,000 and 18,000 previously announced).

Employment (Nonfarm Payrolls, Seasonally Adj.)

The decline in the unemployment rate was due to people leaving the labor force, not job gains - in the survey of households (different from the survey of firms from which the headline jobs number is calculated), the number of people employed fell by 38,000, but the number of people in the labor force fell by 193,000.  The labor force participation rate therefore decreased, as did the employment-population ratio.

Employment-Population Ratio (Seasonally Adj.)
Not a good report, but one that suggests the economy is stagnating, not falling into a recession.  That might take the some of the edge off of yesterday's panic, but, then again, a little panic might be what we need to rouse policymakers into action....

Friday, July 29, 2011

2Q GDP: Bad Present, Worse Past

Even with expectations low, today's advance estimate of second-quarter GDP from the BEA was disappointing.  Real GDP grew at a 1.3% annual rate in the second quarter of 2011, and the first quarter's growth rate was revised downward to 0.4% (from 1.9% previously estimated).

Government purchases - the G component in the national income accounting identity - was a drag on real GDP for the third consecutive quarter.  In the second quarter, G decreased at a 1.1% annual rate (larger declines in federal nondefense and state and local government spending were partly offset by an increase in defense spending).  Consumption was basically flat (increasing at 0.1% annual rate), while investment rose at a 7.1% pace.  Net exports also made a positive contribution: exports increased at a 6% rate, compared to 1.3% for imports.

Today's release incorporated a large "annual revision" of past data, and it indicates that the recession was worse than previously believed: real GDP shrank 0.3% in 2008 and 3.5% in 2009 (compared to previous estimates of 0% and -2.9%).  This graph from Calculated Risk shows the changes:
According to the revised numbers, real GDP has not returned to its pre-recession level, as we had previously believed.

This makes the badness of the labor market somewhat less of a puzzle - the rise in unemployment had been more than the fall in output seemed to warrant based on historical relationships, but now we know that output was lower than we thought.

In this deep hole (and with long-run interest rates remaining very low), the policy focus on budget cuts makes no sense, of course.  Ryan Avent has a good analogy:
IN 2007, the great ship of the American economy began encountering darkening skies. In 2008, it was suddenly faced with a violent storm which blew it miles off course, well south of where it ought to have been. The country's leaders didn't know how far from their charted path they'd been swept, but they recognised a need to make a course correction. Now, three years later, a look at the maps tells us that the storm was more powerful than previously believed, and it left the vessel much farther south than anyone had expected. The course corrections made earlier? Far too small to bring the ship back to its previous path. Yet none of America's leaders are trying to steer the ship back northward. Indeed, many seem anxious to yank on the tiller and drag the economy farther south still.
Brad Plumer has a nice post on what the data suggest about the recovery act (a.k.a., the "stimulus"), and Brad DeLong has some quick policy suggestions (though there's little reason to hope we'll see anything like them).   Real Time Economics rounds up Wall Street "economist" reaction.

Friday, July 22, 2011

The Most Interesting Man in the World?

The January issue of Economica included a symposium in honor of A.W. (Bill) Phillips, marking the 50th anniversary of his original "Phillips Curve" article.  The first article is a biographical essay by Alan Bollard, which is fascinating reading:
The young Bill was clearly very talented, but his parents reluctantly decided that they could not afford to keep him at school, and any dreams of a university education were abandoned. Aged 15, Bill signed up as an apprentice electrician with the government's Public Works Department, which at that time was building infrastructure around rural New Zealand. He spent the next few years roughing it at working men's camps in remote rural sites, helping to build hydroelectric dams to generate electricity for the national grid. Bill had played with photography and seen early movies, and he was fascinated by the idea of ‘talkies’. He hired a hall in the Tuai camp and set up the first talkies cinema. Recreation involved playing his violin, riding an acquired motorbike and reading his treasured encyclopaedia of world religions.
But rural New Zealand was not enough. Phillips wanted to sample the world. In 1935, still aged only 21, he packed his swag and his fiddle, and shipped to Australia. Here he spent a couple of years travelling the outback, hitching rides on freight trains and working in mining camps. Money came from a range of jobs: picking bananas, working on building sites, mining gold, running a cinema, and even crocodile hunting. These were tough jobs in a rough country, but at the same time Phillips had set his intellectual sights higher. He enrolled in a correspondence course in electrical engineering and remembers learning his first differential equations under a harsh Australian sun at an outback mining camp.
Phillips had a lifelong fascination with Eastern cultures. In 1937, despite the worsening international situation, he boarded a Japanese ship to travel to Shanghai. While he was at sea, the Japanese invaded Manchuria, and the ship was diverted to Yokohama. Phillips took advantage of this by travelling around the newly militarized Japan; at one point he was detained by the authorities, who suspected that he might be a spy. Eventually he made his way out through Korea, Manchuria and Harbin, and crossed Russia on the Trans-Siberian railway. With Antipodean optimism, he looked for casual jobs across Soviet Russia, only to find them all taken by political prisoners. From Stalin's Moscow he travelled on through threatened Poland and Nazi Germany during the fragile last years of peace. He settled in London, where he found work as an electrical engineer. Having continued his correspondence course, Phillips now graduated from the Institute of Electrical Engineers, gaining his first formal qualifications. He also took classes in several languages.
Fortunately, Economica has given free online access, so you can read the rest, including his World War II adventures.  There is also the story of his famous machine - I posted a video of it in operation here.

Thursday, July 21, 2011

Rules-based Keynesian Policy?

John Taylor, who is one of the most prominent academic critics of administration and Fed policy over the past several years, grapples with the label "anti-Keynesian" that was pinned on him by The EconomistHe writes:
In a follow-up to the Economist article, David Altig, with basic agreement from Paul Krugman, argued that it was a misnomer because I developed and used macro models (now commonly called New Keynesian) with price and wage rigidities in which the government purchases multiplier is positive (though usually less than one), or because the Taylor rule includes real variables in addition to the inflation rate. In my view, rigidities exist in the real world and to describe accurately how the world works you need to incorporate such rigidities in your models, which of course Keynes emphasized. But you also need to include forward-looking expectations, incentives, and growth effects—which Keynes usually ignored.

In my view the essence of the Keynesian approach to macro policy is the use by government officials of discretionary countercyclical actions and interventions to prevent or mitigate recessions or to speed up recoveries. Since I have long been critical of the use of discretionary policy in this way, I think the Economist is correct so say that I am anti-Keynesian in this sense of the word. Indeed, the models that I have built support the use of policy rules, such as the Taylor rule for monetary policy or the automatic stabilizers for fiscal policy, which are the polar opposite of Keynesian discretion. As a practical prescription for improving the economy, the empirical evidence is clear in my view that discretionary Keynesian policy does not work and the experience of the past three years confirms this view. 
"Keynesian" means different things to different people - at its broadest, it means accepting that there are frictions in the economy which mean that aggregate demand matters and policy can have real effects.  This is in contrast to the pure classical view, in which Say's law holds, demand is irrelevant, and output depends on technology and preferences.  In the version of Keynesian economics in our undergraduate textbooks - the IS-LM/AS-AD framework - the frictions are nominal rigidities and the Keynesian model deals with "short run" fluctuations around a "long run" equilibrium determined by the classical model.  In this setting, both monetary and fiscal policy matter (by shifting the LM and IS curves, respectively), though early Keynesians emphasized fiscal policy and "monetarists" (most prominently Milton Friedman), gave primacy to monetary policy.  The version of Keynesian economics in our graduate textbooks and academic journals - "New Keynesian" - combines dynamic optimization with sticky prices, and explicitly addresses the lack of "forward looking expectations" in the traditional textbook version.  Furthermore, some argue that both the IS-LM and New Keynesian incarnations really miss the point and gloss over more fundamental irrationality and instability Keynes saw in the capitalist system.

As Taylor describes his views of the economy (and from what I know of his academic work), it seems consistent with mainstream New Keynesian economics (though his version has been less favorable to fiscal policy than some others).   His criticism of recent fiscal and monetary policy grows out of another longstanding conundrum in macroeconomics, "rules versus discretion."  He is not claiming that countercyclical fiscal and monetary policy are fundamentally impossible, which is what I would say is the true "anti-Keynesian" view.  Rather, he is arguing that discretionary policy may do more harm than good, and policy should be based on stable, predictable rules. 

A primary argument for rules is that discretionary "fine tuning" is impractical based on "long and variable" lags associated with (i) recognizing the state of the state of the economy, (ii) designing and implementing a policy and the (iii) the policy's impact reaching the economy.  Often lurking behind this argument is a political philosophy that is skeptical of government (no coincidence that Milton Friedman was the most famous proponent of rules - Brad DeLong recently argued this is how he resolved the contradiction between an economics that said monetary policy can be effective with a libertarian political philosophy).

Taylor is careful to say that he opposes "discretionary Keynesian policy" - I think "anti-discretion" might be a better characterization of his critique than "anti-Keynesian."  Of course, that only matters if it is possible to be "anti-discretion" without being "anti-Keynesian."  I think it is.

I don't share the political philosophy, but the experience of the last several years has underscored the practical difficulties of discretionary policy.  The early-2009 Obama administration with large congressional majority is about as close to government by center-left mainstream Keynesian technocrats as the American political system is likely to ever give us.  In retrospect, it is clear they misjudged the scope and duration of the downturn and were not able make adjustments as that became apparent.

Monday morning quarterbacking in April, I suggested that the stimulus should have been designed in a "state-contingent" fashion to remain in place until the recovery reached certain benchmarks.  It is a small step from there to a "rules based" countercyclical fiscal policy - policies like aid to state governments, extended unemployment benefits, payroll tax cuts and even increased infrastructure spending could be designed to kick in and ramp down automatically based on the state of the economy (e.g., with triggers based on the unemployment rate).   To me, that's very "Keynesian", but also "rules-based", and its easy to imagine that might have worked better than the actual policies that were put in place. 

Tuesday, July 19, 2011

Practical Lessons in Keynesian Economic Policy

Ezra Klein writes:
Keynes — and others who later elaborated on his work, like Hyman Minsky — taught us that although markets are usually self-correcting, they occasionally enter destructive feedback loops in which a shock to, say, the financial system scares business and consumers so badly that they hoard money, which worsens the damage to the system, which further persuades other economic players to hoard, and so on and so forth.

In that situation, the role of the government is to break the cycle. Because businesses and consumers have stopped spending, the government breaks the cycle by spending. As clean as that theory is, it turned out to be a hard sell.

The first problem was conceptual. What Keynes told us to do simply feels wrong to people. “The central irony of financial crises is that they’re caused by too much borrowing, too much confidence and too much spending, and they’re solved by more confidence, more borrowing and more spending,” Summers says.

The second problem was practical. “What I didn’t appreciate was the extent to which we only got one shot on stimulus,” Romer says. “In my mind, we got $800 billion, and surely, if the recession turned out to be worse than we were predicting, we could go back and ask for more. What I failed to anticipate was that in the scenario that we found we needed more, people would be saying that what was happening showed that stimulus, in general, didn’t work.”
Many of us economists believe Keynesian policies have been successful, and that more would have been better, but politics doesn't judge outcomes relative to a counter-factual scenario.  That is, the argument that things would have been far worse in the absence of a policy isn't a winner, even if it is correct.  Unfortunately, that means future policy makers are likely to draw exactly the wrong lessons, and do even worse next time (at least on the fiscal side; central bank independence gives monetary policy some space to follow academic rather than political views).

Furthermore, as Paul Krugman explains, the economics profession (or at least some parts of it) isn't playing an entirely helpful role.

Friday, July 15, 2011

Cavallo on Greece

Some have likened Greece's situation today to Argentina's in 2001, when, after repeated austerity "cures" failed, it ultimately was forced off its peg to the dollar and suffered a severe crisis, but a floating currency ultimately facilitated a recovery.   In a Vox column, former Argentine finance minister Domingo Cavallo offers some reflections on Argentina's experience and what it suggests for Greece.  Unfortunately for them, he says "Greece’s crisis is much more difficult to manage than the 2001 Argentinean crisis." (Yikes!!).   He offers some suggestions on how the debt restructuring should be done (and I think everyone who isn't a European government official sees that it needs to be done), but doesn't think Greece should leave the Euro.

Saturday, July 9, 2011

June Employment: Bad Economy!

A really bad employment report - according to the BLS, the economy only gained 18,000 jobs in June and the unemployment rate ticked up to 9.2% (from 9.1%).
The government continues to be a drag - private sector payrolls increased by 57,000, but government employment shrank by 39,000.  The employment numbers are calculated from a survey of businesses; the numbers from the BLS' survey of households (from which the unemployment rate is calculated) are even worse - the number of employed persons dropped by 445,000 and labor force participation decreased to 64.1%.

On a non-seasonally adjusted basis, the unemployment rate rose from 8.7% to 9.3% because of a large increase in the labor force (1.089 million, presumably due to the end of the school year) outstripped a small increase in employment (101,000).  Non-seasonally adjusted payrolls rose by 376,000.  The comparison between seasonally-adjusted and unadjusted numbers shows that June is a month that normally sees a big increase in labor force participation and employment, and this June's increase in employment is disappointing compared to what we would expect for this part of the year (and what is needed to keep pace with changes in the labor force).

The discussion in Washington seems increasingly detached from reality...

See also: Tim Duy, Menzie Chinn, Calculated Risk, Greg Ip.

Friday, July 1, 2011

Orzag for State-Contingent Stimulus

In a column for Bloomberg, former CBO chief and White House budget director Peter Orszag writes:
...[P]olicy makers should provide additional macroeconomic support in 2012 by extending the existing payroll tax holiday. But more than that, Congress should link the payroll tax to the unemployment rate. This would allow the tax holiday to automatically calibrate itself to existing conditions, providing support only when the economy is weak. If necessary, the underlying payroll tax rate could be raised to make this mechanism budget-neutral. 
As I said back in April, one of the main lessons I've drawn from recent experience is that the recovery act would have been much better if the support for the economy had been made state-contingent like this.  This is a way of overcoming two problems: (i) uncertainty about the speed of recovery (or lack thereof) and (ii) the political system's utter inability to deal with timing issues (nicely explained in Orszag's piece), as evidenced by the absurdity that it appears that we are heading for significant fiscal tightening even as nearly 14 million people remain unemployed.

Wednesday, June 22, 2011

Krugman on Keynes

Vox has published Paul Krugman's speech at a conference commemorating the 75th anniversary of The General Theory.  The speech brings together a number of themes Krugman has addressed at his blog.  Among other things, Krugman says:
The brand of economics I use in my daily work – the brand that I still consider by far the most reasonable approach out there – was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasises the way the economy can develop what Keynes called “magneto trouble”, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

It’s a deeply reasonable approach – but it’s also intellectually unstable. For it requires some strategic inconsistency in how you think about the economy. When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioural assumptions are essential.

So what? Inconsistency in the pursuit of useful guidance is no vice. The map is not the territory, and it’s OK to use different kinds of maps depending on what you’re trying to accomplish. If you’re driving, a road map suffices. If you’re going hiking, you really need a topographic survey.

But economists were bound to push at the dividing line between micro and macro – which in practice has meant trying to make macro more like micro, basing more and more of it on optimisation and market-clearing. And if the attempts to provide “microfoundations” fell short? Well, given human propensities, plus the law of diminishing disciples, it was probably inevitable that a substantial part of the economics profession would simply assume away the realities of the business cycle, because they didn’t fit the models.

The result was what I’ve called the Dark Age of macroeconomics, in which large numbers of economists literally knew nothing of the hard-won insights of the 30s and 40s – and, of course, went into spasms of rage when their ignorance was pointed out.
I share Krugman's view that the "textbook" Keynesian apparatus remains a useful apparatus for thinking about the economy.  However, I think his portrayal of the turn macroeconomics has taken over the past forty or so years is a bit unfair.  As Krugman notes, contemporary macroeconomic models are grounded in microeconomic optimization.  Although a foolish desire for consistency can be the hobgoblin of our little economist minds, there is more to the story - the shift in methodology was also motivated by real deficiencies in the Keynesian framework identified by Friedman and Lucas, as well as the "stagflation" of the 1970's, which appeared to contradict Keynesian theory.

Saturday, June 4, 2011

Toles on Austerity

I've been thinking I should say something about the contradiction between Washington's new obsession with budget cutting and the still-struggling economy, but this cartoon from Tom Toles nails it better than anything I could have said:

Friday, June 3, 2011

May Employment: Where are the Flowers

looks like no "green shoots" this spring....

The May employment situation report from the BLS confirms the impression from other bits of data (see Gavyn Davies and David Leonhardt from last week) that the already sluggish recovery is wobbling.  Payroll employment (from the BLS survey of firms) rose by 54,000, which is quite a bit less than the 130,000 or so needed to keep unemployment steady as the labor force grows and productivity increases.  The unemployment rate (from the survey of households), ticked up to 9.1% (from 9% in April). 
 The underlying numbers in the household survey (which gets second billing because it has a smaller sample) are slightly less unpleasant.  The number of people employed increased by 105,000, while the number of unemployed increased by 167,000.  This partly reflects re-entry into the labor force, 105,000 fewer people reported not being in the labor force, and the labor force participation rate ticked up from 64.15 to 64.22.

Mark Thoma has collected links to commentary on the report from around the econo-blogosphere.

Monday, May 23, 2011

Antidumping in Action

Today's Washington Post provides another example of our dysfunctional "Antidumping" rules in action.  This case is about antidumping tariffs imposed on furniture imports from China:
But do tariffs work? In the case of bedroom furniture, they’ve clearly helped slow China’s export machine. In 2004, before tariffs went into force, China exported $1.2 billion worth of beds and such to the United States. The figure last year was just $691 million.

Over the same period, however, imports of the same goods from Vietnam — where wages and other costs are even lower than in China — have surged, rising from $151 million to $931 million. The loss of jobs in America, meanwhile, only accelerated. 
This may be a case where the differential tariff treatment between Chinese and Vietnamese furniture which resulted from the antidumping case induced "trade diversion" - i.e., an efficiency loss because the trade preferences result in imports coming from someplace other than the low cost producer.  However, in this example, it could also be the case that comparative advantage shifted to Vietnam as China's labor costs have risen. 

The only Americans getting more work as a result of the tariffs are Washington lawyers, who have been hired by both U.S. and Chinese companies. Their work includes haggling each year over private “settlement” payments that Chinese manufacturers denounce as a “protection racket.”

Fearful of having their tariff rates jacked up, many Chinese furniture makers pay cash to their American competitors, who have the right to ask the Commerce Department to review the duties of individual companies. Those who cough up get dropped from the review list.
It is clear from the article that workers in the US industry have suffered from a disruptive wave of furniture imports.  While it may indeed be the case that the US no longer has a comparative advantage in furniture production, standard comparative static trade theory fails to account for the adjustment costs associated with reallocating resources.  That is, trade theory assumes full employment and that workers will be shifted to another sector, ignoring the fact that this process involves losing their jobs in one industry and, usually, a period of unemployment before finding a job in another.

Although it is also less than perfect, a more appropriate remedy in this case would be the application of "safeguard tariffs" which the President can impose (following the recommendation of the International Trade Commission) in cases where industries are disrupted by import surges.  Relative to antidumping tariffs, safeguards have the advantages of being (i) time limited, (ii) at the discretion of the president (who presumably can consider the interest of the nation as a whole, rather than just an affected industry or region), and (iii) not requiring any allegation of "unfair" trade practices on the part of the exporters (which are usually somewhat bogus).