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June 30, 2005

June 28-30 2005

June 30, 2005

BusinessWeek Has No Point To Miss

I would like to thank Christopher Farrell and Michael Mandel of BusinessWeek Online for their thought provoking post and column, but the significance of the distinction between hairshirts and growth proponents in advancing our understanding of economic ideas that is clear to the two of you is still unclear to me...

[Update: PGL at Angry Bear offers his comments.]

[Update: Once again, thanks to Michael Mandel for provoking thought. There are some very good books on what constitutes a valid school of economic thought and when recogonition of such schools advances our understanding of important economic principles. Arbitrary slices don’t cut it.]

    Posted by Mark Thoma on Thursday, June 30, 2005 at 02:17 PM in Economics, Macroeconomics, Press

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    Fed Watch: Not Ready to Say “Uncle”

    Tim Duy's Fed Watch continues: Today’s policy statement should leave little doubt that Greenspan & Co. intend to continue raising rates. Indeed, I was somewhat surprised to see a statement that, in my view, hardened the Fed’s more optimistic outlook for economic activity. From the May statement:

    Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually. Pressures on inflation have picked up in recent months and pricing power is more evident. Longer-term inflation expectations remain well contained.

    But from today’s statement:

    Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually. Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.

    The failure to characterize spending growth as slowing is, I believe, the notable shift in the policy outlook. Of course, with the upward revision in Q1 GDP growth, there exists a solid argument for the shift.

    I did anticipate maintaining the terms “accommodative” and “measured” which signal that they are not prepared to stop raising rates. I thought, however, that the FOMC would acknowledge the downside risks (weak manufacturing surveys and underlying durable goods numbers, for example), and I was off base here (in contrast to William Polley’s comments to my last post). In short: The thinking in the FOMC remains more optimistic on growth compared to the view of many market participants. FOMC members do not believe they have entered the ninth inning. The FOMC intends to continue raising rates, and likely do not have an end target in mind.

    [Note: Additional discussions are at Angry Bear here and here, and at The Big Picture.]

      Posted by Mark Thoma on Thursday, June 30, 2005 at 12:41 PM in Economics, Fed Watch, Monetary Policy

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      New Environmental Economics Blog

      I want to let you know about a new blog called Environmental Economics. There are currently seventeen contributors, a number that is growing. I've contributed a few things on government policy, e.g. I just posted Senators Call for an Investigation of Altered Climate Report, but that's not why I'm sending you there. There are posts on a variety of topics on environmental issues even though the blog is fairly new, so take a look!

        Posted by Mark Thoma on Thursday, June 30, 2005 at 09:00 AM in Economics, Environment

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        GOP: Doing Nothing is Not an Option

        According to a new USA Today/CNN/Gallup poll, approval of the president’s handling of Social Security reached new lows, and approval of both congressional parties is also declining. However, in a significant development, despite the increasing disapproval house Republicans announced they will vote on a proposal for personal accounts by fall:

        Approval of president's Social Security efforts dips, By Richard Wolf, USA Today: Americans disapprove of the way President Bush is handling Social Security by a ratio of more than 2-to-1, a new low … Opposition to Bush is greatest among seniors, women, and people with lesser incomes and levels of education. Democrats disapprove by … more than 20-to-1, but Republicans back Bush's performance on the issue by a 2-to-1 ratio. … Seven in 10 Americans say Bush has not been clear or specific enough ... Nearly eight in 10 say the same thing about Republicans in Congress. More than eight in 10 say Democrats haven't been clear.

        House GOP Pledges Fall Vote on Soc. Sec, By David Espo, AP: … Republican leaders announced Wednesday the House would vote by fall on legislation to establish individual accounts under Social Security. … As drafted, the House GOP plan omits steps to extend the program's solvency, despite Bush's insistence that changes are needed. … One lawmaker said GOP leaders had ultimately decided that doing nothing was not a realistic option. …

        My uncle, who drinks a bit, once told me that when his time comes they’ll have to beat his liver to death with a stick. That’s how I feel about private accounts.

          Posted by Mark Thoma on Thursday, June 30, 2005 at 12:33 AM in Economics, Politics, Social Security

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          June 29, 2005

          WSJ Commentary: Monetary Policy Does Not Affect Core Inflation

          The Wall Street Journal can do better than this. This article by Alan Reynolds of Cato claims that monetary policy has no effect on prices and inflation, a claim that is just plain dumb:

          The Fed's Crude Policy, By Alan Reynolds, The Wall Street Journal (subscription): … It is commonly assumed that the Fed "leans against" inflation -- raising interest rates when inflation accelerates and lowering rates when inflation slows. Yet the graph nearby (free) proves it is difficult to discover any coherent relationship between the funds rate and the "core" deflator for personal consumption expenditures (PCE), or any other measure of inflation not distorted by energy prices. … The only way to link the fed-funds rate to inflation is to assume the Fed suffered from "energy illusion" -- focusing on fluctuating energy prices rather than the impressive stability of other consumer prices. Perhaps the best way to show this is to look at the consumer price index with and without energy, so there can be no doubt that food prices (which are also excluded from core inflation) were irrelevant…

          Here’s the problem with this "analysis." Suppose that monetary policy perfectly controlled inflation. What would a graph of inflation over time look like (note that the author only shows a few years in the graph)? It would be a flat line with no variation from its target value whatsoever, and it would be uncorrelated with any other variable. The fact that there is no correlation between inflation and the ff rate would be an indication of the success of the policy, not that inflation and monetary policy are unrelated. Looking at such raw correlations tells us nothing at all about causal relationships. This is a very well known fallacy in the literature surrounding monetary policy and anyone who purports to write as an expert on monetary policy ought to be aware of this.

          As for the other part of the argument, there are sound theoretical reasons for looking at core inflation rather than total inflation that I won’t detail here. But suppose that core inflation is the target of monetary policy. Then core inflation would flat line but total inflation would not, and a measure of inflation including energy prices could show a correlation with the ff rate as claimed in the article.

          But the conclusion is exactly the opposite of what the author claims. Finding a correlation between the ff rate and inflation including energy prices means, if policy is successful, that policy does not target energy prices, not that it does.

          Monetary policy does not affect prices and inflation? This does not belong in the Wall Street Journal.

            Posted by Mark Thoma on Wednesday, June 29, 2005 at 09:37 AM in Economics, Monetary Policy, Press

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            June 28, 2005

            What We Don’t Know Can’t Hurt My Lobbyists

            Yet another example of attempts to manipulate inconvenient scientific evidence:

            Salmon: Protect the evidence, Seattle Post-Intelligencer: Sen. Larry Craig ... The Idaho Republican … is trying to eliminate scientific evidence of what is happening to fish in the Columbia River system. A Senate appropriations bill includes report language intended to kill … collecting data on the survival of salmon in the Columbia and Snake rivers. ... Craig and others are angry about recent federal court rulings protecting endangered fish. … Craig also has raised the idea of using the appropriations process to undo the court decisions, an extremely bad idea both in principle and practice. Congress must preserve the … integrity of the courts. The Senate should not try to undo the … science needed to protect threatened creatures and the environment …

            This needs to stop.

              Posted by Mark Thoma on Tuesday, June 28, 2005 at 08:53 PM in Environment, Politics, Regulation, Science

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              We Can't be Trusted With Your Money

              In one lockbox proposal after another the Republicans are announcing to the world again and again 'we can't be trusted with your money.' Even Bush says Social Security will be bankrupt because “we take your money and we spend it.” Lock the cookies away before I eat them!

              There's a better solution to a congress that can't control itself.

                Posted by Mark Thoma on Tuesday, June 28, 2005 at 07:08 PM in Economics, Social Security

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                The School of “Hairshirt” Economics

                Christopher Farrell of BusinessWeek Online creates some new (and confusing) schools of economic thought - the hairshirts and the Growth proponents:

                Alan Greenspan, Wizard or Villian (sic)?, By Christopher Farrell, BusinessWeek Online: Remember when Federal Reserve Board Chairman Alan Greenspan held sway over the American economy -- and imagination? … No more. Greenspan-bashing is now a popular sport ... One reason is that the 10-year economic expansion came to an end with the dot-com bust and subsequent recession. Another is that Greenspan's standing as the Monetary Maestro was overhyped during ... the 1990s. And the third is that his fallibility as a central banker was overemphasized during the difficult economy of the early 2000s. Indeed, the chairman has never recovered his lost luster.

                No mention of his support for the 2001 tax cuts?

                Still, Greenspan's most vehement critics go a lot further than this. They're convinced he has made a fundamental error as a monetary economist. Call it the hairshirt economists vs. the cheerleaders for growth-is-good. The hairshirts believe that for the health of the economy to be restored, the inevitable bust that follows a boom must be at least as great as the boom. Growth proponents -- and there's none greater than Greenspan -- believe that it's better to limit the fallout of a bust and get the economy growing again as quickly as possible.

                Hairshirt economists? What school is that? Though he makes reference to Schumpeter's evolutionary view of cycles (recesssions are good because they weed out the inefficient firms and workers) later it becomes evident he means classical economists, so why not just say that? And the Growth proponents – most of us would call them Keynesians. More on this shortly, but there are two fundamental confusions here. The first is to call the monetarists interventionists. The second is to confuse short-run stabilization policy with policies to promote long-run growth.

                … To the hairshirts' way of thinking, the great mistake Greenspan made was … to drive rates to a 45-year low to limit the damage from the recession. The Fed then nurtured the recovery by keeping money policy loose … The result: today's "low saving rates, the housing bubble, high debt loads, and a runaway current account deficit," writes Stephen Roach, chief economist at Morgan Stanley … The critics say Greenspan has transformed the economy into a giant bubble ... The longer he delays the day of reckoning, the worse the fallout will be when the bubble pops. That's a severe indictment -- but not necessarily a valid one. A problem with the anti-Greenspan mindset is that hairshirt economics was largely discredited during the Great Depression. The most infamous proponent … was Andrew Mellon, President Herbert Hoover's Treasury Secretary. He called for letting the Depression run its course without government interference …

                In case you missed it, that’s an endorsement of Keynesian economics and a claim that the Great depression invalidated classical economic policy (the monetarist, hands-off, laissez faire position), as he now notes

                … Mainstream economists of all schools, from Keynesianism to monetarism, turned away from hairshirt economics after the Great Depression. They realized that the government could play a positive role in counteracting contractionary forces in the economy. …

                This is really confused. How did Keynesians turn away from hairshirtism after the Great Depression? Keynesian economics didn’t even exist prior to the depression. What he’s trying to say is that the forced interventionist experiment caused by World War II was credited with ending the Great Depression leading to an endorsement of Keynesian economics over the classical hands-off position. And it’s just wrong to say that monetarists advocated government intervention. There was this long discussion, called the Keynesian-Monetary debate, on this issue.

                … Case in point: The chairmanan (sic) came under heavy criticism during the 1990s for not "taking the punchbowl away" ... The fear among most economists was that inflation would take off as the economy heated up. But Greenspan gambled … The bet paid off handsomely. American productivity has been running at an average annual rate of 3% since 1995, about double the pace of the previous two decades. Productivity is what economists really care about, because its growth rate is the foundation of higher living standards. … Indeed, most economists systematically overestimate the limits to growth …

                This is another fundamental misunderstanding. There are two distinct sets of economic policies, one set is about stabilizing the economy around the natural rate, whatever it might be, the other is about making economic growth as strong as possible. Long-run economic growth depends upon real, not monetary factors in almost all mainstream economic models. Monetary policy is designed to stabilize the economy around the natural rate, but it does not change the natural rate itself. Technology, growth in human and physical capital, growth in the labor force, etc. are the sources of growth. Monetary policy is not a large factor. It affects growth in the short-run, but not the long-run.

                … Perhaps there is a bubble in the housing market. … But a record 70% of American households now own their own homes. And growth is also persuading business leaders to invest … Greenspan is no economic wizard … He has made his share of mistakes ... But what should be defended is the economics of growth. Remember, not all price increases are bubbles, booms are better than busts, and growth is not only good -- it's vital.

                So, Greenspan is a monetarist interventionist Growth proponent following Keynesian short-run policies to promote long-run growth.

                Hare-brained hairshirt economics.

                [PGL at Angry Bear comments here.]

                  Posted by Mark Thoma on Tuesday, June 28, 2005 at 03:42 PM in Economics, Monetary Policy, Press

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                  No Change in The CBOT's Fed Funds Rate Target Probabilities

                  No surprises in the Chicago Board of Trade’s calculation of the probabilities of changes in the FOMC's federal funds target rate, as indicated by the CBOT 30-Day Federal Funds futures contract, just posting for the record:

                  CBOT Fed Watch - June 29 Market Close - Based upon the June 29 market close, the CBOT 30-Day Federal Funds futures contract for the July 2005 expiration is currently pricing in a 100 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3 percent to 3 1/4 percent at the FOMC meeting on June 30.

                  In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 4 percent probability of a further 25-basis point increase in the target rate to 3-1/2 percent (versus a 96 percent probability of just a 25-basis point rate increase).

                  June 23: 96% for +25 bps versus 4% for +50 bps. June 24: 96% for +25 bps versus 4% for +50 bps June 27: 96% for +25 bps versus 4% for +50 bps June 28: 96% for +25 bps versus 4% for +50 bps. June 29: 96% for +25 bps versus 4% for +50 bps

                  June 30: FOMC decision on federal funds target rate.

                  Thus, according to the CBOT 30-Day Federal Funds futures contract, there is a 100% chance the target rate will increase .25% to 3.25%, and a 4% chance it will increase an additional .25% to 3.50%.

                  [Update: June 29 - No change.]

                  June 27, 2005

                  Fed Watch: Ready to Pull the Trigger, Again

                  Tim Duy brings us his latest Fed Watch:

                  It appears that a 25bp rate hike is in the cards this week – a widely accepted view on the outcome of the two-day Fed meeting, as revealed in the market for fed funds futures via macroblog. So the interesting question is “What comes next?” I believe that the Fed remains not quite ready to signal the end to rate increases, as they tend to view US growth as fundamentally solid. Consequently, I also expect them to retain language describing policy as “accommodative.” That said, the Fed will likely tone down its assessment of the economy to acknowledge the lackluster flow of data from since their last meeting. The tone of the data also calls for retention of the measured pace language.

                  It is notable that Fedspeak, with the exception of Dallas Fed President Richard Fisher’s errant comments, has tended to be supportive of further rate hikes. For example, Mark Thoma referenced John Berry’s piece last week regarding interviews with Minneapolis Fed President Gary Stern and Richmond Fed President Jeffrey Lacker, neither of whom sounded ready to shift from the Fed’s path of measured rate increases. Two week’s ago, Kansas City Fed President Thomas Hoenig indicated that the neutral range for the Fed Funds rates is 3.5-4.5%. Of course, this is not terribly surprising; I have trouble imagining a central banker describing the current situation of near zero real short term rates as anything other than accommodative.

                  Last but most importantly, Fed Chairman Alan Greenspan’s testimony on June 9 gives no indication that he is ready to dramatically alter his take on economic activity. Note that Greenspan’s comments came after the disappointing ISM and employment reports. A few choice quotes:

                  “The most recent data support the view that the soft readings on the economy observed in the early spring were not presaging a more-serious slowdown in the pace of activity. Consumer spending firmed again, and indicators of business investment became somewhat more upbeat.”

                  “The alternating bouts of rising and falling oil prices have doubtless been a significant contributor to the periods of deceleration and acceleration of U.S. economic activity over the past year.”

                  “Despite the uneven character of the expansion over the past year, the U.S. economy has done well, on net, by most measures.”

                  “Accordingly, the Federal Open Market Committee in its May meeting reaffirmed that it '... believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.'”

                  Has much changed since Greenpan’s comments? Manufacturing activity has been mixed, with industrial production up and headline durable goods orders both up, the latter on the back of fresh Boeing orders, but nondefence, noaircraft capital goods down. The housing market continues to hold, with new sales up. Inflation figures were tame, as measured by the PPI and the CPI. Leading indicators were down, as were retail sales. And anecdotal evidence, as measure by the Beige Book, is consistent with these data snippets.

                  Reports from all twelve Federal Reserve Districts indicate that business activity continued to expand from mid-April through May. Most Districts--including New York, Richmond, Atlanta, Chicago, Minnesota, Kansas City, and San Francisco--characterized the pace of expansion as moderate, solid, or well-sustained. However, Philadelphia noted that the pace of growth had eased in May while Boston and Cleveland observed some unevenness across sectors.

                  Reports on retail sales in April and May were mixed.

                  Reports on residential real estate markets remained quite positive overall, although some slowing in activity was noted in a few markets.

                  Labor market conditions continued to improve in most Districts, and several reports cited difficulty finding specific types of workers.

                  Most Districts reported that manufacturing activity continued to expand, although several Districts noted that production had slowed or leveled off.

                  Overall, I would describe the incoming data as lackluster, and I believe the FOMC will as well. Nothing spectacular, nothing disastrous. Most notable is the rise in oil prices to record highs since the last FOMC meeting, an event that will likely cut both ways for the FOMC. Higher oil will likely cause a slowdown in the pace of activity (as noted by Greenspan above and macroblog here), but also implies incipient inflationary pressures.

                  So what’s the bottom line? Stay the course, remain confident about overall economic activity, but acknowledge the risks to the outlook. Or, in other words, hike rates and reduce accommodation at a moderate pace. Overall, I think the Fed will try to impart the feeling that while they are aware of the downside risks to the outlook, markets should expect additional rate hikes later this year.

                  [Note: Sorry for my absence from Mark’s blog – I tend to ease back for a few weeks after the school year comes to the close. Plus, it is a good opportunity to spend some time with our littlest economist at home.]

                  More Social Security Nonsense from the NRO

                  Here's the latest nonsense from the NRO on Social Security reform:

                  Bad Democratic Trinity - There are three Democratic plans for Social Security — and all are bankrupt, NRO: … Democrats have offered three positions on this issue, each as appetizing as a bowl of chilled spinach: The first and most popular Democratic plan could be dubbed: "Don't do something. Just stand there." Almost every Democrat seems content to delay indefinitely any Social Security reform …

                  Doing nothing is preferable to doing something stupid (see the DeMint proposal). His discussion of the Wexler proposal shows what happens if a Democrat tries to seriously engage and participate. Any Democratic proposal has no hope of passage or support, only ridicule, so the choice is solely to oppose or support the GOP proposals. Given what’s on the table, opposition to reform is more than appropriate.

                  The second Democratic approach resembles a Freudian slip from Senator Jon Corzine (D., N. J.) … Corzine disagreed, telling journalists: "U.S. Treasury securities have the ability to be paid under any circumstances based on the ability of the government to print money." Corzine's press secretary denied that this was an actual proposal…

                  This guy confuses an explanation of why the government will not default on its bonds (it’s a promise to pay dollars and dollars can always be printed) with a proposal for Social Security reform. This isn’t a proposal for Social Security reform and it’s as stupid as the DeMint plan to call it one.

                  The third Democratic position, call it "Pay Till It Hurts," comes from Rep. Robert Wexler (D., Fla.). … Too bad his plan is a tax hike. …

                  This, along with the fact that there really isn’t a solvency crisis despite what you’ve been told by the administration, is why the Democrats are not participating. It’s telling that in a column about the lack of Democratic proposals the one proposal out there is excoriated. He finishes with:

                  So, what Democrats recommend on Social Security is zippo, a debauched dollar, or a huge tax hike. …

                  And what the GOP offers is misleading rhetoric leading to stupid plans for reform, then blaming Democrats for their own failures. Gridlock is much preferable to anything I’ve seen from the GOP so far.

                  June 26, 2005

                  The Plot Against Social Security

                  This is a link to an adapted excerpt from Michael A. Hiltzik's new book, The Plot Against Social Security: How the Bush Plan Is Endangering Our Financial Future appearing in the Los Angeles Times. This article makes it very clear that the campaign to reform Social Security is driven by ideology, not economics. The article itself is fairly lengthy and, of course, the book is even longer. Here are a few passages worth highlighting, but read the whole thing and pay attention to the line at the end about a $100 million war chest:

                  Undoing the New Deal, by Michael A. Hiltzik, Los Angeles Times: … If there were any doubts that Bush's campaign against Social Security was not fiscal or economic but strictly ideological, Wehner's memo dispelled them in a stroke. But his words weren't meant for the public eye (although they were promptly leaked to the press). In its public language, the Bush campaign for Social Security reform has steered clear of the elemental ideological conflict, sticking instead to the language of economics. The magic of privatization, as President Bush would repeat often over the next few months, would save Social Security from impending bankruptcy; never was heard a single word about the goal of ensuring victory for the conservative movement in "the battle of ideas." … On Social Security privatization, Cato is the center of the universe. For 25 years the rightist think tank has been a relentless promoter of private accounts and the fount of hundreds of white papers, book-length studies and op-eds driving the battle plan. … Michael Tanner, the chairman of its Social Security task force … left no room for doubt that Cato … saw the issue in terms of ideology, not economics—as a classic battle to promote libertarian ideals hostile to the very principle of social insurance. "In the end, this isn't a debate about the system's solvency in 2018 or 2042," he told me, mentioning the years in which, according to Social Security doomsayers, the system's fiscal health would start to ebb, then collapse. "It's about whether you think the government should be in control of your retirement or people should take ownership and responsibility. That's why the debate is so intense—why would anyone get so excited about transition costs? This is about whether we redefine a relationship between individuals and government that we've had since 1935. …

                  When members of Congress returned to Washington in March 2005 from a mid-term break in their home districts, the Republicans seemed shaken. … In the weeks and months that followed, more polls suggested that on the issue of Social Security, public doubts were rising, if not about President Bush's courage and honesty, then at least about his wisdom. … And yet he stuck to his guns. "I'm going to continue traveling our country talking about Social Security reform," he told a news conference on June 2. What he didn't mention was that the war chest, $100 million strong, was still available for deployment. He sounded as though the fight had not yet begun. And it was entirely possible that he was right.

                  This battle isn't over.

                  The Use of Real-Time versus Revised Data in Monetary Policy Research

                  This is wonkish, and it's long. It's lonkish. It explains the use of real-time versus revised data in monetary policy research.

                  In the analysis of monetary policy there has been reference to the use of real-time data (e.g. see here and here). Because this is an important issue in the theoretical and empirical analysis of monetary policy, I thought I would explain what this issue is and why it matters.

                  The difference in the two types of data is easily explained. At the time policymakers decide policy, for example at the upcoming FOMC meeting this week, the data they will have available is real-time data. However, after the meeting, there will be substantial revisions in some of the key series used to guide policy. For example, as in this recent release from the BEA (5/26/05 ), 1st quarter GDP growth was revised upward from 3.1% to 3.5% a fairly large increase. Revised data are considered more accurate reflections of the economy, so in the past these data were almost always used in empirical investigations.

                  But that does not mean that revised data best reflect what policymakers use when choosing a course for monetary policy. Real-time data may be much better suited to analyzing policy decisions. To me, there are two arguments here. First, real-time data is what’s actually available in terms of hard numbers and that speaks towards its use. But there are many more signals about the economy than are reflected in a few summary statistics and perhaps the revised data better reflect what policymakers actually know as the contemplate future policy. It would be nice if it didn’t matter, but it does. There are test of important theoretical results that change depending upon which type of data are used.

                  A good place to start on these issues is Boivin (NBER May, 2005, this link is to a free April version), and there is more to this paper than just an analysis of what type of data to use, but that’s the focus of this post. I’ll present a summary of Boivin's paper later, but let’s go back to one of the seminal papers on the use of real-time data by Orphanides (AER 2001, JMCB 2003, these are free versions, not links to the actual published journal papers) who has led the charge on this issue.

                  Here’s the important issue. In the Taylor rule, there is a coefficient on the deviation of inflation from its target value. If this coefficient is greater than one, then the economy is stable and well-behaved according to popular theoretical models of the U.S. economy. However, if the coefficient is less than one, then the economy can potentially be less stable (I hope my colleagues will forgive me for using imprecise language here and not attempting an in depth discussion of indeterminacy, sunspots, and so on, and for not elucidating the two separate theoretical reasons for the change after 1980 noted by Clarida, et. al.).

                  An important paper by Clarida, Gali, and Gertler (QJE 2000) produces empirical evidence showing that prior to 1980 the coefficient on inflation in the Taylor rule was less than one, i.e. in the range of indeterminacy, but after 1980 it was greater than one, in the stable range. As Clarida, Gali, and Gertler note “…the economy exhibits greater stability under the post-1979 rule than under a rule that closely approximates monetary policy pre-1979.” Thus, according to these estimates, a substantial change in monetary policy occurred around 1980 that caused the economy to become much more stable.

                  This is where real-time data come in. Orphanides (2001, 2003) weighed in with a ‘wait just minute’ paper. He showed that if you use real-time rather than revised data, the differences pre and post-1980 are not so stark. In fact, he finds that the coefficient on inflation is greater than one in both time periods implying that monetary policy had followed a rule that produced a stable outcome for the economy in both time periods.

                  That brings us to a more recent word on this issue, and a good place to begin tracking back, Boivin (NBER 2005). Here’s his summary of the results:

                  Despite the large amount of empirical research on monetary policy rules, there is surprisingly little consensus on the nature or even the existence of changes in the conduct of U.S. monetary policy. Three issues appear central to this disagreement: 1) the specific type of changes in the policy coefficients, 2) the treatment of heteroskedasticity, and 3) the real-time nature of the data used. This paper addresses these issues in the context of forward-looking Taylor rules with drifting coefficients. The estimation is based on real-time data and accounts for the presence of heteroskedasticity in the policy shock. The findings suggest important but gradual changes in the rule coefficients, not adequately captured by the usual split-sample estimation. In contrast to Orphanides (2002, 2003), I find that the Fed's response to the real-time forecast of inflation was weak in the second half of the 1970's, perhaps not satisfying Taylor's principle as suggested by Clarida, Galìì and Gertler (2000). However, the response to inflation was strong before 1973 and gradually regained strength from the early 1980's onward. Moreover, as in Orphanides (2003), the Fed's response to real activity fell substantially and lastingly during the 1970's.

                  So, using real-time data it is not so clear that the Fed followed a stable rule prior to 1980 after all. What is the answer? Was the coefficient on inflation in the Taylor rule greater of less than one prior to 1980? What other results change when real-time data are used? This is an active area of research. I'll have to let you know...

                  Sunday Reading

                  Some opinions. It seems evident that the tone is changing and finally, though I hope this isn’t simply a case of seeing through wishful eyes, it appears that harder questions are being asked of this administration:

                  For the birds. I wonder if stories two and three are related?

                  Why we teach those boring classes on statistics and probability:

                  Attack of the robo lobsters

                  Machines really do mimic life:

                  Home prices, Oil Prices, Saving, China, and the Fed:

                  You guessed it. Social Security:

                  Serious story:

                  And, on the environmental front:

                  They probably should have let this guy finish his bong hit:

                  And finally, since it's time for summer reruns to begin, I thought I'd start the season off with an animation from Lee A. Arnold on Social Security. If you missed it the first time around, take a look:

                  June 25, 2005

                  The Wind Blows Both Ways in Washington

                  Here's a nice piece by Jared Bernstein of the Economic Policy Institute appearing in The American Prospect. Your left-side will feel better.

                  Does the Increase in the Price of Gold Signal Inflationary Expectations are Rising?

                  You might find this interesting. Speculators are dumping dollars and moving into real assets such as gold and a few analysts are predicting the price to nearly double over the next few years. Possible reasons? Higher inflationary expectations, flight out of real estate funds due to fears the peak is near, and flight out of hedge funds. Another factor, according to this article, appears to be Middle Eastern nations increasingly holding real assets such as gold in their portfolios rather than dollar denominated paper assets to avoid currency risk:
                  Gold rush may mean inflation bust - The metal's recent jump worldwide and high oil prices signal serious inflation pressures ahead, by Katie Benner, CNN/Money: GGold rising along with the dollar -- and with oil jumping to record highs near $60 a barrel -- may signal serious inflation woes ahead. … A handful of precious metals insiders … predicted that the price of spot gold will hit $850 an ounce in the next few years from its current level near $440. The last time it got anywhere near that high was in the late 1970s when out-of-control inflation, unrest in the Middle East and an oil crisis pushed the precious metal from $150 to $810 a troy ounce. Gold is currently trading 30 percent above its 10-year moving average … and gained five percent this month … While economists debate whether high oil prices will spark inflation or will slow economic growth by acting as a tax on consumers and businesses, the gold and bond markets have come down on the side of inflation. "The recent run in gold has moved in conjunction with rising crude prices," David Meger, senior metals analyst at Alaron Trading, said in a recent note. ... "Middle East nations are getting more petrol dollars as (oil) prices rise, and they're not putting it back into paper assets," said Charles de Vaulx, manager of the First Eagle Gold Fund. "They're trying to protect the value of their profits -- just like in the 1970s -- so they're buying gold," he … despite the fact that some market analysts … say the metal has become overbought in the short term. … When inflation grips a market, the value of dollar-denominated assets is eroded. So a shift to gold represents … a broader shunning of financial assets in favor of hard assets as a hedge against perceived currency risks. … At the moment, however, gold and the dollar are both rising. But metals traders argue that the price of gold is still an accurate indicator of inflation risks, because the dollar's rise doesn't reflect true strength, only relative value compared to an equally troubled currency. "Confidence in the euro as an alternative to the dollar has fallen apart," said Frank Holmes, chairman and chief investment officer as U.S. Global Funds. … Few analysts believe the metal will trade between $600 and $800 over the next few years, mostly because they assume rising oil prices will slow demand for fuel and eventually bring crude prices down. But consulting firms like Alaron Trading are still bullish on gold, particularly because they see weakness in a variety of paper assets. …"We're seeing both real estate and hedge fund become more uncertain now, and if it's going to happen, we'll see the investment demand for gold," de Vaulx said.
                  I don’t believe we will see significant inflation – the Fed will not let that happen – so I would not place as much emphasis as this article does on inflation fears as an explanation for the flight into gold. But feel free to disagree ...

                  'Holey' Flag Burning Amendment!

                  I am marking this day on my calendar. I agree with Cato:

                  Flag Desecration Amendment Undermines American Principles The House of Representatives approved a constitutional amendment Wednesday to prohibit desecration of the American flag. Roger Pilon, director of Cato's Center for Constitutional Studies, testified before the House on a similar amendment in 1999. "This amendment, as it tries to shield us from offensive behavior, gives rise to even greater offense. By offending our very principles, it undermines its essential purpose, making us all less free."
                  As nTrain notes here, "The greatest culprit of actual flag burning, it seems, are the Boy Scouts."

                  Real and Nominal Oil Prices Since 1970

                  The Wall Street Journal has a nice graph of real and nominal oil prices since 1970 highlighted with important historical events. Click here to take a look.

                  June 24, 2005

                  Bush's Pie in the Sky

                  More news of how this administration manipulates anything and everything for short-run political advantage:
                  Bush's Star Wars fantasy, The New York Times: A Pentagon panel of outside rocketry experts was too polite to use the phrase "pie in the sky," but they might as well have in excoriating the rush to deploy an unworkable antimissile system in time for President George W. Bush's 2004 re-election campaign. Although clearly bedeviled by test failures and unproven components, the first antimissile stations in this fantastic $130 billion-plus windfall for the defense industry were officially deployed on the West Coast last autumn - just in time to cover Bush's vow in 2000 to have the system up in four years. Predictably, the re-election was soon followed by more embarrassing test failures … According to a Washington Post report on the classified study, the experts concluded that the rush to deployment only compounded long-running technical problems. The badly flawed system remains unable to detect or destroy an incoming missile despite the continuing billions spent on complex problems with booster rocket, radar and satellite systems. … the Pentagon … has pronounced the program in a state of "evolutionary acquisition." This means the parts were designed and contracted out first in hopes of actually making them work later … the Pentagon, in rushing to deliver on the president's promise, suspended normal accountability standards for this offspring of the military industry's old Star Wars grail. Dozens of retired admirals and generals have urged the president to shift money to the more imminent threat of low-tech terrorism at America's vulnerable ports, borders and nuclear weapon depots. This advice has been ignored…

                  The CBOT's Fed Funds Rate Target Probabilities

                  Following up on David Altig’s post at macroblog, here is the Chicago Board of Trade’s calculation of the probabilities of changes in the FOMC's federal funds target rate, as indicated by the CBOT 30-Day Federal Funds futures contract:
                  CBOT Fed Watch - June 24 Market Close - Based upon the June 24 market close, the CBOT 30-Day Federal Funds futures contract for the July 2005 expiration is currently pricing in a 100 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3 percent to 3 1/4 percent at the FOMC meeting on June 30. In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 4 percent probability of a further 25-basis point increase in the target rate to 3-1/2 percent (versus a 96 percent probability of just a 25-basis point rate increase). June 23: 96% for +25 bps versus 4% for +50 bps. June 24: 96% for +25 bps versus 4% for +50 bps. June 30: FOMC decision on federal funds target rate.
                  Thus, according to the CBOT 30-Day Federal Funds futures contract, there is a 100% chance the target rate will increase .25% to 3.25%, and a 4% chance it will increase an additional .25% to 3.50%.

                  [Update 6/27/04: The probabilities are unchanged June 27: 96% for +25 bps versus 4% for +50bps.]

                  Lifting the Veil on Social Security Reform

                  I’ve done my share of critical pieces on the press. So when the press reports useful information, I should highlight that as well. It appears that the press sees through the GOP' latest proposal on Social Security reform and is willing to lift the veil on the underlying strategy. They report that the reform plan is nothing but a political trick that will increase the deficit indefinitely:
                  GOP Sounded the Alarm But Didn't Respond to It - Thomas Bill Does Not Address Social Security Solvency, By Mike Allen and Jonathan Weisman, Washington Post: For six months, Republicans have traveled the country as fiscal Paul Reveres, sounding the alarm about the coming collapse of Social Security. … But when House leaders finally rolled out their Social Security plan this week, it did nothing to address the problem that lawmakers and the president have convinced the public is looming as baby boomers retire. … House Ways and Means Committee Chairman Bill Thomas (R-Calif.) said … he decided to release the personal accounts plan now because he was "tired of reading all these stories about how nothing was happening and that it was dead in the water." "This was to show you we're not dead," he said in a brief interview. "We're not moribund. We're not disheartened or whatever. …." When House Republicans announced their plan Wednesday, they offered only a single sheet consisting of a dozen sentences and no dollar figures. An analysis of a similar plan conducted by the nonpartisan actuary of the Social Security Administration concluded that it would worsen the nation's fiscal picture. That plan, which was introduced in the Senate, would require the transfer of nearly $1 trillion in general tax funds to the Social Security system to avoid accelerating the date when the Social Security system will become insolvent. "The total debt held by the public is increased indefinitely," Chief Actuary Stephen C. Goss wrote. … Democrats said they view the new House plan as a political trick to try to portray them as obstructionist when they raised objections, and interviews with Republican lawmakers suggested there may be some truth to that. "If the Republicans take this to a vote and the Democrats try to stop us, I think we end up the winners," said Jim DeMint (R-S.C.), who introduced the plan in the Senate yesterday. "It'll help convince Americans in 2006 that we need a few more Republicans." … Robert Greenstein, executive director of the liberal Center on Budget and Policy Priorities, said the GOP plan's purpose "is not to restore solvency, but to serve as a foot in the door for more extensive private accounts in the future." Republicans indicated they hope the plan will pressure Democrats to negotiate, ... But Democrats immediately denounced the plan, and not one signed on to it. …
                  I believe the public is a whole lot smarter than those behind this reform proposal and the spin surrounding it give them credit for. [Update: A Boston Globe editorial "Social Security scam" is more direct in its appraisal of the proposal.]

                  Why Do So Many Households Hold So Few Interest-Bearing Assets?

                  I'm not sure this post will inspire as many comments as the post that follows it, but increasing national saving is an important issue both generally and in the Social Security reform debate, so I thought I'd present some empirical evidence on how the accumulation of financial assets by households changes as households become more informed about financial markets. A paper by Casey Mulligan (University of Chicago) and Xavier Sala-i-Martin (Columbia University) appearing in the Journal of Political Economy, Vol. 108, No. 5. (Oct., 2000), pp. 961-991 (JSTOR stable URL – subsc.) reports that according to the Survey of Consumer Finances, 59% of U.S. households hold no interest-bearing financial assets over and above employer held pension funds and IRAs. Why do so many households hold so few assets? The authors argue that the transactions and learning costs of entering financial markets are sufficiently high so as to more than offset the expected earnings for most households. They also suggest that people with retirement fund assets such as employer held pensions and IRAs have lower transactions and learning costs because their exposure to retirement assets may bring additional understanding of how such markets function. They find that “(a) the elasticity of money demand is very small when interest rate is small, (b) the probability that any individual holds any amount of interest-bearing assets is positively related to the level of financial assets, and (c) the cost of adopting financial technologies is negatively related to participation in a pension program.” I want to focus a bit more on (c) which tells us that participation in a pension program increases the likelihood of holding financial assets at all income levels. The Social Security debate is often centered around the idea of an ownership society for lower and middle income class workers so the focus will be on households with low amounts of financial wealth. A new econometrics textbook that will be out this fall uses data from the study to investigate this issue. The example in the book asks “How likely is an individual with $1,000 in total assets to hold any of it as interest-bearing assets if he or she has no retirement accounts?." At an asset level of $1,000 the probability (from probit estimates) that an individual will hold any of the $1,000 in interest bearing assets is 12%. However, when an individual already has a pension plan of some type, the probability of holding additional financial assets rises to 18%. Also, note that these percentages pertain to a particular asset level, $1,000, and according to result (b) the percentages increase as the asset level increases. This is evidence that one of the barriers to entering financial asset markets is the cost of learning how they operate. This may also explain why discussions of add-on accounts have noted much higher participation rates with opt-out as opposed to opt-in programs. There is a much larger incentive to learn what you need to know to protect the principal or liquidate the assets than there is to put the assets into a retirement account. That is, if the investments are automatic or if particular funds, etc. must be chosen there is an incentive to make sure the principal is protected and to learn the rules under which the principal can be drawn down if needed. In the process needed knowledge is obtained. When the system is opt-in, the expected return is not sufficient to trigger the learning needed as a prerequisite to participation in financial markets. Let me be clear. I believe the solvency issue has been oversold and we do not need to radically alter the Social Security program. This is in no way a call for private accounts to solve some imagined hyped-up problem. But decreasing the barriers to participation by lower and middle income households in financial markets is an important goal and this tells us something important about how to do that. As I watch colleagues fret over the very few retirement options available to them (me too), and these are Ph.D. economists, and as intelligent friends ask questions about annuities (like what the heck are they?), etc., it seems to me that these barriers are substantial. I do not know if it is lack of knowledge of the types of financial assets, their risk-return characteristics, knowing where to go to purchase assets at the lowest fee, and so on that constitutes the biggest barrier to participation. But the change in participation rates from 12% to 18% in the numbers above at relatively low asset levels from simply having a pension account no matter how passive the participation suggests there are potential gains to be made through better education. Less than full information among participants is a known market failure, especially when information is asymmetric (why do annuities come to mind again?). My casual observation, and more to the point empirical results, suggest lack of information is a substantial problem. If we can identify and overcome areas where lack of knowledge is a barrier to participation, perhaps we can increase participation in financial markets at all income levels, particularly among low to middle class households. What is the most important informational barrier? Is it as simple as knowing where to go to buy an asset like a T-Bill, corporate bond, or index fund? Or is it a lot more than that?

                  June 23, 2005

                  We'll Need DeMint to Pay for This Proposal

                  I’ve done quite a bit of writing about Social Security at this site so it might surprise you to learn that I almost never go to The reason is simple. On the few occasions I have ventured there, what I see posted irks me greatly, and then I feel compelled to rebut the misleading post du jour. Today, at the behest of PGL at Angry Bear, I ventured over there. And just like the times I’ve visited in the past, I can’t help but rebut the top post by Andrew Roth. It concerns the DeMint Social Security reform proposal:
                  The DeMint Proposal - Stop the Raid on Social Security Act, by Andrew Roth: How It Works: 1. Saves the surplus in voluntary personal accounts – the only true lockbox 2. Invests funds in government bonds initially 3. Stops the raid on the surplus – no more secret spending 4. Provides 100% current benefits 5. No payroll tax increases What It Accomplishes: * First step toward permanent solution * Ends Congress’ free lunch – forces government to recognize future obligations * Makes immediate down payment on long-term reform Just The Facts: * Prevents Congress from raiding over $792 billion between 2006 and 2016 * Rebates 2.2% of taxable earnings in 2006, allowing medium-earners ($35,000/year) to save over $770 * Invests in government bonds initially; offers other options later * Combines account and traditional benefits to meet current promises * Reduces Social Security’s long-term liabilities by $2.4 trillion
                  My post yesterday on Samuelson began with “Where do I start?” Those words echo again as I read this. So I’ll follow the advice of the always intelligent Mary Poppins and start at the beginning. How it works 1. The claim that personal accounts are a lockbox is misleading. I explain the reason in this post: Luskin is Wrong: Personal Accounts Do Not Protect Benefits. The post says "This is the standard lockbox argument for private accounts. Having had the solvency foundation crumble, this is their last resort, that the lockbox will prevent the government from spending your money. But it doesn’t, and closer inspection undermines this argument as well. Let’s take a numerical example..." 2. The personal accounts are to be invested in government bonds. Are these bonds the worthless promise Bush has been talking about? Why aren’t they proposing investing in private bonds? With government bonds, personal accounts are still financing the rest of government. In addition to the points in 1, what kind of lockbox is that? 3. What secret spending? Isn’t it public? Is congress spending money and not telling us? The real issue here is accountability and trust and what Roth's post tells us is that the GOP has neither – hence the call for a “lockbox” that isn’t. 4. 100% current benefits? There is no free lunch. Period. Quoting from this report on the proposal: “Another GOP staffer familiar with Tuesday's scheduled event said the participants will acknowledge that redirecting surplus Social Security funds will create budget problems elsewhere.” Something somewhere will have to be cut or taxes will need to be raised. 5. No payroll tax increase? That’s fine, I’m in agreement with that. But how will this be paid for? Will benefits be cut or will taxes be raised? Those are the choices. Which will it be? As the WP article notes: “The strategy is controversial because it would create new budget problems. Either the diverted money would have to be replaced with new taxes, or Congress would have to slash programs now funded by Social Security's excess payroll taxes.” Then the post goes on to claims about how they end the free lunch and so on. I see no reason to continue. Unless one of you has a question about something at SocialSecurityChoice.Org in the future, I don’t see much point in going back. Friends don't let friends read propoganda.

                  Did Monetary Policy Change Permanently in 1979?

                  [Note: This is a nice non-technical discussion of monetary policy, but the post is somewhat long. If you are more interested in Social Security and other issues, scroll right on by ...] There has been quite a bit of discussion concerning the merits, implementation, and effectiveness of inflation targeting lately at this site. I’ve been watching for something readable but still technically sound on this topic to pass along and I recalled this piece by Benjamin Friedman, first presented at the Federal Reserve Bank of St. Louis conference on “Reflections on Monetary Policy 25 Years After October 1979,” St. Louis, October 7-8, 2004. Before discussing the paper, let me point those of you who are advocates of inflation targeting and those of you who have reservations about inflation targeting to two readable papers on this issue:
                  • Friedman, Benjamin M. 2004. "Why the Federal Reserve Should Not Adopt Inflation Targeting." International Finance, 7 (March), 129-136. [copy here]
                  • Mishkin, Frederic S. 2004. "Why the Fed Should Adopt Inflation Targeting." International Finance, 7 (March), 117-127. [copy here]
                  The question Friedman is addressing in this paper is how policy to today is related, if at all, to changes in monetary policy implemented during the Volcker years in response to the October 1979 experience. There are three areas of focus, a change in policy objectives such as placing more weight on inflation and less on output, a change in the policy instrument such as a change from an interest rate target to targeting a monetary aggregate, and a change in focus from monetary aggregates such as M1 and M2 to measures of reserves or the monetary base. The paper also talks about why the Fed might be too hesitant to adjust interest rates in response to economic conditions as reflected in measures such as inflation and unemployment, another recent topic of discussion, and how this results in a lagged interest rate term in the Taylor rule (this is called smoothing). Finally, commitment to rules versus discretion in monetary policy is also discussed. For those who are interested in this topic, I think this is worth reading:
                  What Remains from the Volcker Experiment?, Benjamin M. Friedman, NBER Working Paper No. 11346, May 2005 (sub.): [also available free here]:… [T]here remains a widespread sense that the world of monetary policymaking in the United States has been somehow different since 1979. What exactly is different, and in what respects those differences stem from the innovations introduced in 1979, are questions well worth addressing. … [T]he broad public discussion of the Federal Reserve’s new approach in 1979 primarily emphasized the elevation of quantitative money growth targets … from the irregular and mostly peripheral role … to center stage. ... The Open Market Committee had chosen to place primary emphasis on the narrow M1 aggregate, but … Evidence since then shows that by the mid 1980s M1 had disappeared altogether as an observable influence on policymaking, and the same happened to the broader M2 measure by the early 1990s … [T]he main point here is simply that the reliance on money growth targets that was key to at least the public presentation of the new monetary policy regime in 1979 has now entirely disappeared. The same is true for … an open market operating procedure based on the quantity of either nonborrowed or borrowed reserves. … The only way in which some version of a reserves-based operating procedure could have survived … would have been if policymakers thought the relationship between reserves growth and economic activity was more reliable than the relationship between interest rate growth and economic activity. Few economists have been prepared to make that case. As a result, the Federal Reserve has gone back to carrying out monetary policy by fixing a short-term interest rate – in the modern context the overnight federal funds rate – just as it did for decades prior to 1979. That leaves … the Volcker experiment represent[ing] a new, presumably greater weighting attached to achieving “price stability” … has that greater weighting survived? The post-1979 record of price inflation in the United States surely creates some prima facie presumption to this effect. … Does this … represent a genuine change in the weighting placed on inflation … Or is there some other explanation, independent of the Volcker experiment? One point worth making explicitly is that … there is no evidence that the increased tolerance for interest rate fluctuations that the Federal Reserve exhibited during the Volcker period has survived. One of the most frequently offered criticisms of monetary policy operating procedures based on fixing short-term nominal interest rates is that central banks have traditionally proved too hesitant to adjust the interest rates they set, and when they do move interest rates they have tended to do so too slowly. The usual explanation is that, in addition to their objectives for such macroeconomic variables as price inflation and the growth of output and employment, central banks also take seriously their responsibility to maintain stable and well functioning financial markets … For this reason, now-conventional expressions of operating rules for monetary policy, like the “Taylor rule,” normally include a lagged interest rate along with measures of inflation and output (or employment) relative to the desired benchmark. Part of what distinguished the Volcker experiment was the unusually wide … fluctuations of short-term interest rates that occurred under the Federal Reserve’s quantity-based operating procedures. … in recent … no such fluctuations have been allowed to occur. Might the Federal Reserve again permit them if doing so seemed necessary to rein in incipient inflation? Perhaps so, but on the evidence there is no ground for claiming that this aspect of the 1979 experiment has survived either. … The United States experienced little inflation in the 1950s, and not much in the 1960s either. Hence the historical evidence is also consistent with the view that the 1970s were exceptional, rather than that the experience since 1979 has differed from what went before as a whole. Even the idea that the Volcker experiment represented a return to the greater policy weight on price stability vis-a-vis real outcomes that had motivated the Federal Reserve before the 1970s, and that this renewed commitment to price stability has lasted ever since, would make the events of 1979 a major and lasting contribution to U.S. monetary policymaking. But … other explanations are also possible. … Resolving the merits of … other potential interpretations of the historical record … is surely a worthwhile object of empirical research. … Finally, one further aspect of what 1979 may or may not have been about bears attention. Perhaps what was important about the changes … was not the specifics of money growth targets and reserves-based operating procedures but rather … in the traditional language of this subject, to impose “rules” where there had been “discretion.” … But to the extent that it was a form of rule … it too clearly failed to survive. Federal Reserve policymaking in recent years has epitomized what “discretion” in monetary policy has always been about. Precisely for this reason, advocates of rules over discretion today continue to seek some way of moving Federal Reserve policymaking in that direction. The proposal of this kind that has attracted the most interest currently is “inflation targeting.” Whether adopting inflation targeting would be a good or bad step for U.S. monetary policy is a separate issue. But one reason the issue is even on the agenda today is that the movement in this direction that the experiment of October 1979 represented did not last either.

                  It Ain't Over 'til It's Over

                  If you can’t get enough to read on Social Security reform, and that’s hard to imagine if you drop by here with any regularity, here are six stories on the GOP plan for Social Security (WP, NY Times, CNN, MSNBC, AP, Reuters). They are fairly similar in terms of notable points, so here’s the story from the Washington Post. This proposal is nothing new, it diverts money into private accounts and reduces traditional benefits. A proposal that has private accounts for only ten years, changes solvency estimates by only two years, has a maximum payout per person of $588, has clawback and administrative expenses large enough to cause negative returns by some estimates, reduces benefits by the earnings on the private accounts, and does not address the large budgetary consequences it brings about cannot possibly be a serious proposal. This is an attempt to open the door and build momentum towards something, anything, with the hope of reshaping and redirecting it once it begins to move forward. Republican strategies and justifications shift with the wind, but for now generating movement, or the appearance of pushing towards movement, and pressure on Democrats to compromise is the game. As the shells begin to move around quicker and quicker in coming weeks, do your best to keep you eye on the ball:
                  House GOP Offers Plan For Social Security - Bush's Private Accounts Would Be Scaled Back, By Mike Allen and Jonathan Weisman, Washington Post: … House Republican leaders yesterday embraced a new approach to Social Security restructuring that would add individual investment accounts to the program, but on a much smaller scale than the Bush administration favors. The new accounts would be financed by the Social Security surplus … Republicans hope the new proposal will shift the debate away from future benefit cuts … to ending what they call the "raid" on the current Social Security surplus. But the plan, unlike Bush's, would do nothing to remedy the New Deal-era program's long-term fiscal problems. An aide to House Speaker J. Dennis Hastert (R-Ill.) called the bill "a great start," and House Majority Whip Roy Blunt (R-Mo.) called it "an excellent first step." … Rep. Eric I. Cantor (R-Va.) … called it "a breakthrough day," and Sen. John E. Sununu (R-N.H.) said the announcement was a victory ... But Democrats were vociferous in their condemnation, and some Republicans in the Senate remained doubtful. … Although the new plan is considerably less broad than Bush's approach, it would still fundamentally change the way the Social Security system operates. This year, Social Security will bring in $69 billion more in taxes than the system pays in benefits. Congress will borrow that money to fund other programs and then send $69 billion worth of Treasury bonds to the Social Security Administration. Those bonds would be cashed to finance benefits once the system slipped into deficit. Under the new proposal, those bonds would go to private investment accounts that would be opened for workers unless they chose not to participate. …. The balance of the accounts, plus interest, would eventually be subtracted from a retiree's traditional Social Security benefit. The system, as proposed, would operate only as long as Social Security ran a cash surplus -- or just more than a decade. ... A nearly identical bill will be introduced in the Senate today. Republican strategists said the new plan is a way to pressure Democrats to negotiate, and to portray movement. … But critics say there is not enough money to make the plan viable. About 130 million Americans who pay into Social Security and are under 55 would be entitled to personal accounts. Excluding interest owed on borrowed Social Security funds, the cash surplus from Social Security taxes this year will leave enough for an average of $434 available for each account. The Social Security Administration projects that, at its height in 2008, the cash surplus will reach $97 billion, … leaving an average of $588 each. But that cash surplus would decline rapidly to zero after a decade. By 2016, all that would remain is $40 per account. "You'd launch a proposal without any means of perpetuating the funding," said Robert L. Bixby, executive director of the Concord Coalition, a budget watchdog group. House Republicans said the plan would extend solvency from 2041 to 2043 … If the size of the accounts would be small, the cost to the government would not, said Jason Furman, an economist at the liberal Center on Budget and Policy Priorities. The proposal would add $600 billion to the federal debt over the next decade, assuming that two-thirds of eligible workers take accounts. The plan would not cut benefits, and the cost to taxpayers of administering minuscule accounts could be huge. Furman said the plan would push the program to insolvency two years faster than doing nothing, because of administrative costs and the amount that was inherited. "This is the worst of all worlds," he said. "It has all the problems of any private accounts proposal with none of the benefits for solvency."

                  June 22, 2005

                  Time to Toss Samuelson

                  Where do I start? I will agree with Samuelson on one point. One of us does not understand macroeconomics:
                  Time to Toss the Textbooks, by Robert J. Samuelson, Washington Post: … Our ideas for explaining trends in output, employment and living standards -- what we call "macroeconomics" -- are in a state of disarray. … Let me give you three examples. We once thought we understood consumer spending, the economy's mainstay. For decades, disposable income and consumption spending advanced in lock step. Americans spent a bit more than 90 percent of their after-tax income and saved about 8 to 10 percent. … But since 1990, consumer spending has changed. It has consistently outpaced income growth. … The main cause is the "wealth effect." In the 1990s higher stock prices caused Americans to spend more; now higher home values … are doing the same. So consumer spending increasingly depends on "asset markets" -- stocks and homes -- and not just income…
                  So he says we don’t understand consumer spending and then he explains it. All he did was make consumption a function of wealth, something we’ve been doing since the 1950’s. We might wonder why wealth changes, e.g. what explains changes in housing markets, equity markets, and so on, but nobody is surprised that increases in wealth increase consumption. Let’s move on to Samuelson’s second point of misunderstanding:
                  … Economics textbooks once described the U.S. economy as mainly self-contained. ... Globalization has shattered this model. More industries face foreign competition or depend on foreign markets. ... Savings and investment have also gone global. … All this alters the U.S. economy. One theory of low American interest rates is that foreign money flows have pushed rates down. …
                  I hate to be the one to break it to him, but we’ve been adding terms like net exports to our models for a long time. Even principles books now routinely cover this, something that wasn’t true twenty or more years ago. I'd guess that's somewhere around the age of the textbook he references when he writes his comumns. If I thought it would help, I'd send him a new one. Next:
                  We can't determine "full employment.'' Economists call full employment the "natural rate of unemployment" -- the lowest rate consistent with stable inflation. Go lower and tight labor markets trigger a wage-price spiral. Unfortunately, we don't know what full employment is. The Congressional Budget Office now puts it at 5.2 percent. But past estimates have been too high and too low, because the "natural rate" … constantly changes. It's influenced by population changes (younger workers have higher unemployment rates) and government policies, among other things. …
                  So what’s the point? Because it’s hard to estimate exactly (even though he presumes to list the important factors that ought to go into a model of the natural rate) we shouldn’t even try? That instead we should operate with no information at all about the target level of output? And worse, he hasn’t identified a theoretical failing; this is a problem of measurement. We can’t measure the ex-ante real interest rate exactly either (because it depends upon expectations), but that doesn’t imply theory is wrong. Not at all. Another quote as we continue:
                  Although I could extend this list, the message would remain: Change has outpaced comprehension.
                  Yes, change in macroeconomics certainly has outpaced his comprehension. He asks:
                  Should we be worried?
                  If he reflects the best and brightest in our press corps, we should be very worried.

                  Is the Administration Dropping Private Accounts or Not? Yes and No.

                  There are several different articles on Social Security reform describing Republican Senator Bob Bennett’s proposal that excludes personal accounts and Bush’s head nod in his direction. CNN has both the AP and Reuter’s versions, and both Yahoo and BusinessWeek Online have another AP report. The position of the administration is a bit puzzling at first glance as it both embraces a proposal without personal accounts and simultaneously declares that personal accounts are a necessary part of any viable solution. Here’s the AP report from CNN. It amazes me that this report does not even mention that Bennett’s plan would cut benefits (Why oh why can't we have ...):
                  GOP senator to propose plan sans private accounts, AP: President Bush encouraged a Republican senator … to offer Social Security legislation that would not include private investment accounts … "He indicated that I should go forward and do that," Bennett said. … "This in no way should be interpreted to mean that the president is backing off of personal accounts," White House spokesman Trent Duffy said. "He is not." … Bennett said some Democrats have told him privately that they would support such a bill ... He said he is looking for Democrats to co-sponsor the bill, but he didn't have any to announce Tuesday. "We've had a lot of interest," he said. "We have a lot of hope that we can use this bill to break the logjam ..."
                  Rueters also carried the story and covers most of the same ground as the AP report. Importantly, the Reuters report adds that Bennett’s plan would cut benefits:
                  Bush may be flexible on accounts, Reuters: … Duffy said the White House understood that Bennett's plan would incorporate Bush's proposal to slow the growth of benefits for middle- and upper-income workers by linking them to prices rather than wages. On Tuesday afternoon, Bennett told CNN's Ed Henry that his proposal would maintain the scheduled growth in benefits for the bottom 30 percent of earners. …
                  Finally, another AP report (at Yahoo and BusinessWeek Online) notes a plan to divert the Social Security surplus into personal accounts (this plan is discussed here). It also discusses Bennett’s plan but does not add anything beyond the two reports discussed already. So what’s going on here? Why is Bush supporting legislation that doesn’t include personal accounts while simultaneously saying he is not backing off of personal accounts? He realizes that any proposal including personal accounts is a non-starter. So, in order to get the ball rolling he has to allow the initial proposal to drop personal accounts. For now, the goal is to build momentum towards change. Once that is underway and a proposal appears that has a chance (if that is even possible at this point), he can try and tack personal accounts onto it later as it passes through the legislative process. If a proposal without personal accounts goes through, then he can claim he saved the system from catastrophe and declare victory. If a proposal without personal accounts gets stalled, he can say he gave the Democrats what they wanted and they still stood in the way sticking them with the obstructionist label. Given the polls concerning the number of people who believe reform is needed, this is a viable strategy. And if somehow a proposal emerges and momentum for change builds to the point where compromise that incorporates personal accounts is embraced by Democrats, then he will most certainly declare victory. So long as he can get something rolling that appears to embrace compromise, the politics turn in his direction. The Democrats need to tread carefully. It’s still possible to snatch defeat out of the jaws of victory.

                  AFL-CIO on Verge of Splintering as Unionization Falls to Pre-New Deal Levels

                  This is too bad. There’s been quite a bit of focus on issues such as the federal funds rate lately, but this is much more important for labor than the federal funds rate going up or down by some fraction of a percentage point:
                  Disunity at big labor, By Robert Kuttner, Boston Globe: The AFL-CIO seems on the verge of splintering. Five of the most dynamic unions are threatening to leave the labor federation over differences of organizing strategies and financing. The timing is ominous. Earnings of ordinary workers are lagging inflation. Jobs, whether skilled or unskilled, are insecure, as are health and pension benefits. The future, except for a fortunate elite, seems to be outsourcing, downsizing, and Wal-Mart. Polls show that nearly half of America's workers want a union-- a right protected by the 1935 Wagner Act. But workers face ferocious, often illegal resistance by America's corporations aided by a friendly Bush administration. Rather than permit free collective-bargaining elections, most corporations harass and fire pro-union workers and treat small penalties as costs of doing business. Against this background, the unionized share of private-sector employment has dwindled to 8 percent of the workforce, or pre-New Deal levels. … [L]abor must organize or die. Wal-Mart, with its meager wages and dismal benefits, stands in mockery of everything that organized labor represents. But it will take the power of a united labor movement to make any headway against Wal-Mart and other low-wage employers…