August 31, 2005
The Short-Run and Long-Run Consequences of AS and AD Shocks
Negative AD Shock, No AS Shock
In the second graph there is both an AD shock and a temporary AS shock. The AS shock temporarily lowers the natural rate of GDP as shown by the dashed line, but over time the shock dies out. As drawn, during the recovery the temporary decline in trend GDP constrains the recovery of actual GDP but both eventually return to the long-run trend.
Negative AD Shock, Temporary Negative AS Shock
In the final graph the supply shock is permanent (it could even dip lower initially with a temporary component tacked on). Once again, the economy returns to trend in the long-run, but the trend itself is lower.
Negative AD Shock, Permanent Negative AS Shock
There are many remaining issues about the speed of adjustment to both types of shocks, the relative size of the two types of shocks, how policy might impact these scenarios, and so on, but I hope this at least helps to clarify some of the basic issues. For example, I suspect some would, if applying this to the hurricane, not see the demand side shock being as large as I've drawn it (or even exist at all), and the position of the economy right now is below the trend not above it as shown in the figures. In such a case the AS shock itself could depress output independent of and demand side considerations. To imagine such a case, take AD shocks out of the diagram entirely by assuming the economy is initially at trend (no wavy line). Then, with GDP always at the natural rate, the path of trend GDP after the shock traces out the path of actual GDP. The goal is to illustrate basic dynamics (constrained by my limited skill at drawing these figures - that's why I started above trend) not to capture every feature of the present situation. However, comments today by Bernanke and others indicate that they see a scenario along the lines of the middle case as most likely (with small AD shocks and moderately sized temporary AS shocks). Supply will be disrupted, but only temporarily, and although there will be negative consequences in the short-run, the economy will recover over time. A path something like:
No AD Shock, Temporary Negative AS Shock
But in any case, you can see the possibilities depending on the size of the shock(s) , whether the shock(s) are permanent or temporary, and the intitial position of the economy when the shock(s) hit.
Guest Post - Oregon Wild Fish Face Extinction
Posted by Mark Thoma on Wednesday, August 31, 2005 at 02:52 PM in Environment
Bernanke on Katrina: Short-Run Contraction, Reconstruction Will Add Jobs
Hurricane Katrina to have 'modest' economic impact - White House adviser, AFX: The wider US economy should see only a "modest" impact from Hurricane Katrina although the hardest-hit regions will suffer, a White House official said "Clearly it's going to affect the Gulf Coast economy quite a bit. You've had a lot of property damage. Basic services are down," Ben Bernanke, chairman of the Council of Economic Advisers, told the CNBC network "And so economic activity in that area is going to be, really reduced and that will be enough to have a noticeable or at least some impact on the aggregate data," he said … Bernanke acknowledged a "tough situation" on gasoline but said the effects should wear off. "My guess is though that as long as we find that the energy impact is only temporary, and there is no permanent damage to the infrastructure ... the effects in the overall economy will be fairly modest," he said "As long as there is not some kind of fundamental long-lasting impact on the infrastructure, which so far I don't see much indication of, I expect it will be absorbed relatively easily the way we absorbed previous natural disasters like Hurricane Ivan (last year)."
Even the worst-affected states like Louisiana and Mississippi should see some benefits in time, Bernanke added. "Reconstruction will add jobs and growth to the economy," he said
Posted by Mark Thoma on Wednesday, August 31, 2005 at 11:34 AM in Economics
Guest Post - The Fed versus the ECB: Learning Models and Monetary Policy
The Economic Consequences of Hurricane Katrina
The economists in this report predict a decline in economic growth in the short-run, but a rebound in the longer run when rebuilding and restocking begins. I will focus on the damage to the lower Mississippi transportation network and the general short and long-run effects in the remarks below. The full article also details other effects such as those on oil prices, fisheries, tourism, and so on:
Hurricane Is Felt on Many Fronts. by James S. Granelli, LA Times: Hurricane Katrina's most noticeable effect on American pocketbooks may be $3-a-gallon gasoline, but the devastation it caused to New Orleans and the Gulf Coast is likely to affect the U.S. economy in less obvious ways. … The Gulf of Mexico produces about a quarter of the nation's oil and natural gas, and several major gasoline refineries are nearby. The city's port is a key entryway for bulk commodities, such as coffee and steel, and an outlet for grain exports from the nation's heartland. Moreover, New Orleans is a major hub in the Gulf Coast's rail and highway network, ... Now much of that is in disarray. "They need to make sure that trade and commerce continues to flow," said John Silvia, an economist at Wachovia Bank in Charlotte, N.C.
Although it is too early to measure the full effect of the storm on the U.S. economy … The biggest effect on the nation's economy is expected on the energy front. ... But the effect reaches much deeper than energy prices. Katrina hit area seaports hard. New Orleans had been looking to the newly opened $100-million Napoleon Avenue Container Terminal to compete with Houston and other ports. … The Port of New Orleans connects with many different forms of transport, including all six major U.S. railroads and barges operating on the Mississippi River. It is the largest source for seaborne imports of coffee, natural rubber and steel, according to port statistics. ... In Gulfport, Miss., warehouses and much of the pier structure appear to be gone ... Gulfport is a major point of export for fruit and frozen chicken ... In addition, Alabama lumber products firms could be hurt especially hard. Chiquita Brands International Inc., one of the world's largest banana producers, said it suspended shipments because of damage to its facilities at Gulfport. The company … said it would divert those shipments to facilities in South Florida and Texas until its Mississippi facilities were repaired. Steel imported at New Orleans … will probably head to Houston now, where inland transport could cost four times as much ... Railroads will suffer in the short term ... Economist Silvia said eastbound trains were being stopped at Houston, and westbound ones were being stopped at Memphis, Tenn., and Atlanta. … Century City-based Northrop Grumman Corp. said its shipbuilding facilities along the Gulf Coast were hit with the "full force" of the hurricane, although most ships under construction appeared to have escaped major damage, the company said. …
On a longer-term basis, however, retailers of staple goods — food, clothing and household items — are likely to see a surge in sales as consumers work to replace necessities that were lost, said Jerry Hirshberg, a retail analyst at Standard & Poor's in New York. "There is going to be a lot of catch-up buying and restocking," he said. The construction industry is a probable beneficiary, but not right away, said Gary Schlossberg, senior economist at Wells Fargo Capital Markets in San Francisco. Home builders and reconstruction supply firms are among the companies that will see a surge in business once rebuilding gets underway, but that can often take months, Schlossberg said. The trucking industry also will gain from rebuilding, and trucking companies will probably show a net benefit, as long as fuel prices come down, A.G. Edwards transportation analyst Donald Broughton said…
[Update: This report from CNN Money indicates oil will be released from the Strategic Petroleum Reserve.]
[Update: White House adviser Bernanke discusses the economic consequences of Katrina.]
Note: Daily coverage of the economic consequences of Katrina can be found on the main blog page.
Posted by Mark Thoma on Wednesday, August 31, 2005 at 03:24 AM in Economics
Children in Poverty
August 30, 2005
[Update: Please see the comment by Movie Guy for an extensive set of links on Katrina's aftermath.]
Posted by Mark Thoma on Tuesday, August 30, 2005 at 08:55 PM in Miscellaneous
Fed Watch: Minutes + Katrina = More Tightening
A quick missive from the beach while my son is taking a nap in anticipation of a hard afternoon playing in the sand…
Reading the news on Katrina and the Fed minutes side by side, I can’t help but think the damage in the Gulf States only gives the Fed more license to hike rates further. This, I believe, is at odds with the opinions of almost every commentator I have seen on CNBC who seem to believe that the solution for every economic disruption is a rate cut. While I think that has been true for the entirety of the Greenspan Fed to date, I sense the story will not be the same this time.
In the forecast prepared for this meeting, the staff raised its projection for economic growth over the remainder of 2005 in light of incoming data suggesting greater near-term momentum in aggregate demand. At the same time, however, it trimmed the growth rate forecast for 2006, reflecting the effects of higher energy prices, higher long-term interest rates, and the somewhat slower growth of productive capacity implied by the annual revisions to the national accounts. The output gap was predicted to be essentially closed by the end of this year…. Notwithstanding recent benign readings on inflation, the forecast for core PCE inflation was raised somewhat, owing in part to the recent further rise in energy prices and, in light of the revisions to historical data, a higher assumed trajectory for the nonmarket component of core PCE prices.
Note the story for 2006, particularly higher energy costs and slower capacity growth, both of which will tend to exert upward pressure on prices. Moreover, interest rates have dropped since this forecast was revealed to the FOMC, suggesting stronger demand than expected three weeks ago. The conclusion of the staff is to look for higher core inflation next year – not exactly what a central bank already on a tightening campaign is interested in seeing.
Next from the minutes:
Participants viewed the increases in market interest rates over the intermeeting period as an appropriate response to the stronger economic outlook. A few participants voiced concerns that still-low interest rates and insufficient recognition by investors of the dependency of the Committee's policy expectations on economic data were continuing to foster an inappropriate degree of risk-taking in financial markets.
Sounds like Greenspan’s warning from Jackson Hole. Note also that interest rates have confounded the Fed once again and turned downward, only exacerbating the worries of those who fret about the consequences of this extended period of low rates. Of course, some of those at the FOMC meeting are concerned that demand will slow quicker than anticipated…
Another participant mentioned, however, that recent sluggish growth of the monetary aggregates suggested that the stance of policy was not overly accommodative. Moreover, with a higher proportion of mortgages now tied to short-term rates, it was noted that increases in short-term rates could have a somewhat larger-than-usual effect on spending.
I love the minutes – a little something for everybody! The whole message of the data is then to stay the course:
On balance, current financial conditions, which embedded expectations of future policy tightening, were generally seen as likely to be consistent with sustained moderate economic growth and containment of pressures on inflation in coming quarters.
Notice the term “embed expectations of policy,” which means the high odds traders place in seeing a 4% funds rate (thank you David Altig) at the end of the year. Would the Fed want to disappoint? At this point, I think not.
The FOMC ultimately concludes that interest rates will likely have to trend higher, although, as always, they remain data dependent. As I suggested in my last post, I see the data as supportive of further rate hikes. Moreover, I tend to view Katrina as having a net inflationary impact, which adds another round of ammunition for the inflation hawks on the FOMC.
As noted by James Hamilton, Katrina disrupted the already strained US refinery industry. Unleaded gas prices have surged 35 cents a gallon as of 1:30 EST. Moreover, natural gas prices are sharply higher as well. The impact, in my mind, is a classic supply side shock; we can’t really argue that this latest surge in energy prices is driven by strong demand, placing the Fed in the famous conundrum – fight weak output, or fight inflation? But wait, maybe output, nationally, will not be a problem after all. The Gulf States will need extensive rebuilding as Katrina was likely the costliest storm in US history. Consider the billions and billions of dollars of construction materials that will be streaming into the region over the next few years. Possiby enough to offset the impact of slowing housing markets elsewhere…? Something worth thinking about… Moreover, we still have the problem of a construction worker in Orange County out of work while a job site in New Orleans sits idle for lack of workers. You guessed it, more structural adjustment for the economy, on top of that which I believe will be driven by higher energy prices.
In my mind, then, the stage is set for an economic situation that is not easily fixed by cutting rates – but instead one that calls for an even stronger commitment to price stability.
[Update: The conditions in New Orleans have, sadly, deteriorated. Additional comments can be found here.]
[Update: White House adviser Bernanke discusses the economic consequences of Katrina.]
Guest Post - Activist Monetary Policy in the Fed and the ECB
Progressive Tax Reform Democrats Can Support?
For this reason, when my dissertation adviser from long ago, whose opinion I value, sent me a link to an article from Economist’s Voice (no relation, they voice, I view) saying I should consider posting it, it caught my attention. I’m hoping it will catch yours as well as a means of opening this conversation. The article deals with two important problems, the low saving rate and progressive tax reform. Interestingly, the article sees rising income inequality and the pressure to “keep up with the Joneses” as a source of low U.S. saving, something I'm not entirely sold on, but fortunately that mechanism is not required for the proposal to address saving and tax reform issues. The tax reform proposal involves progressive taxation on income after saving. The proposal progressively raises the price of current consumption relative to future consumption to encourage more saving, e.g. if I save a dollar this year and spend it next year, taxes are avoided. And, importantly, the tax would be relatively easy to implement since it is structured much like the current tax system. The major difference is that the tax is calculated based upon income after saving rather than just income:
Robert H. Frank (2005) "Progressive Consumption Taxation as a Remedy for the U.S. Savings Shortfall", The Economists' Voice: Vol. 2: No. 3, Article 2: The American savings rate, always low by international standards, has fallen sharply in recent decades. One in five American adults now has net worth of zero or less, and more than half of all retirees experience significantly reduced living standards when they stop working. … I argue here that low U.S., savings rates are in large part a result of pressures to keep pace with community spending standards, pressures that have been exacerbated by rising income and wealth inequality. Replacing the income tax with a progressive consumption tax would stimulate additional savings by reducing the price of future consumption relative to current consumption as compared to its price under the current income tax. Perhaps more important, a progressive consumption tax would stimulate savings by altering the social context that shapes spending decisions.
Why Do Americans Save So Little? Although numerous factors contribute to our savings deficit, I will mention only two and focus on one. First, we often find it difficult to summon the willpower to save. And second, we often confront pressures to keep pace with community spending standards. The self-control problem can be remedied by individual action. But the problem of keeping pace requires collective action.
The Self-Control Problem Although the pain from reducing current consumption is experienced directly, the pain from diminished future consumption can only be imagined. So the act of saving requires self-control. If the temptation of current consumption were the only important source of our savings shortfall, individuals could solve the problem unilaterally—for example, by signing a contract to divert some portion of future income growth into savings until a target savings rate was reached. Thus, if a family’s income grew by three percent each year, it could commit itself to divert, say, one third of that amount—starting next year—into savings.
The Collective-Action Problem Our savings shortfall also stems from a second source, one that is much harder to address by unilateral individual action. The following thought experiment illustrates the basic problem: If you were society’s median earner, which of these two worlds would you prefer?
A. You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or
B. You save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests.
Because the concept of a “good” school is inescapably relative, this thought experiment captures an essential element of the savings decision confronting most middle-income families. If others bid for houses in better school districts, failure to do likewise will often consign one’s children to inferior schools. ... The choice posed by the thought experiment is one that most parents would prefer to avoid. But when forced to choose, most say they would pick the second option. Context influences our evaluations of not just schools but virtually every other good or service we consume. To look good in a job interview, for example, means simply to dress better than the other candidates. It is the same with gifts:
In a poor country, a man proves to his wife that he loves her by giving her a rose but in a rich country, he must give a dozen roses.
The savings decision thus resembles the collective action problem inherent in a military arms race. Each nation knows that it would be better if all spent less on arms. Yet if others keep spending, it is simply too dangerous not to follow suit. Curtailing an arms race thus requires an enforceable agreement. Similarly, unless all families can bind themselves to save more, those who do so unilaterally will pay a price. They risk having to send their children to inferior schools. Or they may be unable to dress advantageously for job interviews. Or they may be unable to buy gifts that meet social expectations. Temptation and collective action problems may explain why Americans save too little, but why do we save less than other nations, which themselves confront these problems?
How Income Inequality Exacerbates the Savings Shortfall Inequality in income and wealth has always been more pronounced in the U.S. than in other industrial nations. That fact helps explain why our savings rate was lower to begin with. And the fact that inequality has increased in recent decades helps explain why the savings gap has grown. Inequality is linked to savings because of its effect on community consumption standards. This is a controversial claim because, according to the reigning economic theories of consumption, the distribution of income has no effect on individual spending decisions. These theories predict that consumption in the various income categories will rise in proportion to the corresponding changes in income. … In contrast, models that incorporate positional concerns predict that sharply increased spending by top earners will exert indirect upward pressure on spending by the median earner. When top earners build larger houses, for example, they shift the frame of reference that defines the aspirations of others slightly below them. And when they build bigger houses, they in turn shift the frame of reference for others just below them, and so on. This explains why the median size of a newly constructed house … had risen more than 30 percent to over 2100 square feet by 2001—roughly twice the increase predicted by traditional theories ... Additional evidence supports the view that expenditure cascades in housing and other areas, and the implied reductions in savings rates, are at least in part a consequence of increased income inequality...
Stimulating Additional Savings A law requiring that each family save a portion of its income growth each year would attack the self control and collective action problems simultaneously. A less intrusive approach would be to make consumption less attractive by taxing it. Shifting to a progressive consumption tax would change our incentives in just this way. Because the amount a family consumes each year is just the difference between the amount it earns and the amount it saves, a system of progressive consumption taxation could be achieved by making savings exempt from tax. A family would report its income to the IRS just as it does now, but would then deduct the amount it had saved during the year. ... The marginal tax rate on low levels of taxable consumption would start low—say, at 20 percent. Maintaining the current tax burden across income levels would ... require that marginal tax rates rise steadily with taxable consumption ... The objection that higher marginal tax rates on income discourage investment does not apply to higher marginal tax rates on consumption. Indeed, because a progressive consumption tax exempts income from taxation until it is spent, the tax would shift incentives in favor of savings and investment.
It might seem that steep marginal tax rates at the highest consumption levels would severely compromise the ability of many wealthy Americans to support the standard of living to which they have grown accustomed. But what sorts of sacrifices, exactly, would this tax entail? … an American CEO “needs” a 30,000 square-foot mansion only because others of similar means have houses that large. ... if all CEOs were to build smaller houses, no one would be embarrassed ... many CEOs might even prefer to have smaller houses. It is a nuisance, after all, to recruit and supervise the staff needed to maintain a large mansion. ... A progressive consumption tax would increase savings not only by reducing the price of future consumption ..., but also by changing the frame of reference that shapes spending. ... If people at the top built smaller mansions, those just below the top would be influenced to spend less as well, quite apart from any change in relative prices. Their cutbacks, in turn, would influence others just below them, and so on, ... Given the importance of context, the indirect effects of a progressive consumption tax promise to be considerably larger than the direct effects...
Concluding Remarks … there is little question that Americans save too little. Evidence suggests that we do so in part because we face pressure to keep pace with escalating community consumption standards. To solve this collective action problem, we must change incentives. A progressive consumption tax would directly increase the incentive to save for individual families at all income levels. And the resulting changes in spending would alter social frames of reference in ways that would further increase savings. Is there any prospect that a progressive consumption tax might actually be adopted? Many conservatives have long advocated that we move from income taxation to consumption taxation. Their preferred form of consumption tax, the flat tax, has drawn fire on distributional grounds. ... If the flat tax fails to attract political support, pro-growth conservatives might be willing to consider a progressive consumption tax in its place. Indeed, just such a tax—the so-called Unlimited Savings Allowance Tax—was introduced in the Senate in 1995 with bipartisan sponsorship. This proposal is ripe for another look.
One final comment to reinforce something said in the introduction. While I like the proposal, and the idea is simple, tax income minus saving at a progressive rate to make current consumption relatively expensive and encourage saving, I'm not sure I buy into the "keep up with the Joneses" explanation for the low saving rate given in the article. However, it is not necessary to believe this hypothesis in order to support the other merits of the tax reform proposal such as its progressive nature and its ability to provide incentives to increase saving by changing the intertemporal price of consumption.
Jack Kemp Tells White House to Drop Insistence on Social Security Solvency Reform
To GROW the Majority, by Jack Kemp, Copley News Service: A couple of weeks ago, I pointed out that President Bush has a golden opportunity right after Labor Day to advance the ownership society by repealing the death tax and giving working men and women the opportunity to own personal retirement accounts, which would both get a better rate of return and be inheritable by their families. The administration's general position on both issues is well known - it supports both - but where it stands on the legislative strategy remains a mystery. That's a real challenge but a great opportunity. It is particularly challenging where Social Security is concerned because the president's advisers have insisted that any personal-accounts bill also must guarantee permanent solvency, a simple political impossibility this year. If the president hopes for a legislative success on Social Security, it is essential for him to clear up the mystery. Now is the time to go on record enthusiastically in favor of making a down payment on solvency by stopping the raid on Social Security and devoting payroll tax surpluses to starting personal retirement accounts, an idea being promoted by the Leadership and Ways and Means Committee members in the House and introduced by Jim DeMint, R-S.C., in the Senate…
And there’s also this:
A revamp for Social Security plan, by Tami Luhby, Newsday.com: In what would be a stinging defeat for President George W. Bush, the House of Representatives will likely cast aside the administration's Social Security proposal, according to experts from two think tanks close to the debate. Instead, the House Ways and Means Committee appears set in the coming weeks to offer a plan putting only surplus Social Security revenues in private accounts, they said. Such a bill would not make the system solvent longterm nor allow workers to contribute to private accounts - two pillars of Bush's plan. It also lacks Democratic support. A Ways and Means spokeswoman said only that chairman Bill Thomas (R-Calif.) is still formulating his plan. Taking the lead in forming Social Security legislation in Congress, the committee is looking at the watered-down proposal because of stiff Democratic opposition and a lack of unity among Republicans about Bush's plan, said Michael Tanner, the Social Security expert at the right-leaning Cato Institute. … Bush wants to allow workers to put part of their payroll taxes into private accounts and, to make the system solvent, cut benefits to future retirees. But he has failed to rally many Americans to his cause.
Asked about the surplus-funded accounts, Bush spokesman Trent Duffy said they "do some very good things." He also, however, noted Bush's goals, which include solvency…
For further discussion on the merits of the proposal Kemp, Tanner, and others are promoting, see Another Social Security proposal I don't like, But I Can't Follow the Money, Breaking Down S.1302: Private Accounts with No Solvency On Top, We'll Need DeMint to Pay for This Proposal, and Concerns about the latest Social Security proposal.
[Update: Here's a better link to the Kemp editorial - no registration required.]
August 29, 2005
In Search of Accurate Economic Data
Measuring the Economy May Not Be as Simple as 1, 2, 3, by Jonathan Weisman, Washington Post: The Census Bureau tomorrow will release the latest statistics on poverty in the United States, the income level of an average household and the number of Americans still lacking health insurance. Don't believe the numbers. A growing chorus of experts and politicians is raising questions about the data that frame Americans' understanding of their nation's well-being. … "We're getting at best an impressionistic sense of what's going on in the economy," said Rep. Rahm Emanuel (D-Ill.), who recently introduced legislation to establish an independent commission aimed at overhauling government economic statistics. "Major policy decisions are being made based on data that is inadequate to the task."
This seemingly technical problem has real-world consequences, allocating federal assistance to some who don't need it while cutting off others who do, raising the costs of programs like Social Security, or pushing policies for problems that may not exist. For example, since poverty levels are not adjusted for regional costs of living, the working poor in expensive urban centers like Washington are routinely excluded from federal programs because their income lifts them above the official poverty line. The rural poor in low-cost states like Arkansas often can afford considerably higher standards of living than their urban compatriots...
Perhaps no statistic has more critics than the poverty rate ... University of Chicago economist Robert T. Michael, who chaired a National Academy of Sciences panel tasked to update poverty statistics a decade ago, called the current poverty data "truly awful." ... Officially, the poverty rate has drifted upward since 2000, ... But a more sophisticated measurement … shows the official rate has consistently understated poverty. ... At the same time, household incomes may be understated because they do not include non-cash income like food stamps. … Since poverty rates are based on pre-tax income, refunds like the earned income credit do not count. … For more than 20 years, the Census Bureau has been developing alternative poverty measures, many of which answer these criticisms, ... But it is up to the White House budget office to change the official measurement, and successive administrations have declined to do so…
The Census Bureau on Tuesday will also update its count of the uninsured, and any change from the 2003 figure of 45 million likely will be slight. But recent studies by the Urban Institute and the Annandale-based Actuarial Research Corp. concluded the number is overstated by 4 million to 9 million people, largely because it includes Americans already enrolled in Medicaid and other federal health care programs. …
From the conservative Heritage Foundation to the more liberal Brookings Institution, economists agree the government's basic measurement of consumer price changes is overstating inflation. ... The Labor Department's standard consumer price index measures the cost of a basket of goods in urban areas as they rise over time. But since 2000, the department's Bureau of Labor Statistics has also tracked more realistic spending patterns, allowing for the substitution of products when prices spike. This "chained" CPI, … would cut $70 billion from Social Security payments while raising income tax collection by $83 billion, according to Brookings Institution economists. Yet Congress has made no effort to change the official inflation measurement, in part because lawmakers have no desire to slow the growth of either tax bracket increases or Social Security benefits. "This is a political decision, and no one wants to make it," said Fritz Scheuren, president of the American Statistical Association.
More recently, a debate has begun over the nation's savings rate, which officially hovers just above zero. When Congress returns in September, the House Ways and Means Committee will try to put together legislation to raise personal savings through tax credits and other incentives. But according to David Malpass, chief global economist at Bear Stearns & Co., the … official savings rate measure does not consider economic gains from patents, innovation, capital gains or land appreciation. "We may be throwing billions of dollars at a problem that isn't there," said Emanuel, who has advocated savings proposals.
The statistics for any given time period will not, in general, be perfectly accurate. But the question is how large the errors are and whether the statistics are correct on average. The implication in the article is that there are problems with easy solutions, but it isn’t that simple. This is an area of ongoing concern and the BLS and others do a considerable amount of research on these issues. For thos who are interested, research from the BLS on improving price indices, poverty measures, and other problems can be found here. Work from Census on poverty measures is here. If we are going to try and implement some of this work, let’s be sure to set politics aside. I think Big Picture would agree.
The Relationship between Government Spending and Consumption
As explained, there is a difference in the predictions of RBC models relative to IS/LM and modified New Keynesian models. The post at New Economist briefly reviews the theoretical models and their predictions, and then looks at the empirical evidence on government spending and consumption relationships.
Krugman Pops Greenspan’s Bubble
Greenspan and the Bubble, by Paul Krugman, NY Times: Most of what Alan Greenspan said at last week's conference in his honor made very good sense. But his words of wisdom come too late. He's like a man who suggests leaving the barn door ajar, and then - after the horse is gone - delivers a lecture on the importance of keeping your animals properly locked up. ... I have never forgiven the Federal Reserve chairman for his role in creating today's budget deficit. In 2001 Mr. Greenspan ... gave decisive support to the Bush administration's irresponsible tax cuts, urging Congress to reduce the federal government's revenue so that it wouldn't pay off its debt too quickly. Since then, federal debt has soared. But as far as I can tell, Mr. Greenspan has never admitted that he gave Congress bad advice. He has, however, gone back to lecturing us about the evils of deficits.
Now, it seems, he's playing a similar game with regard to the housing bubble. At the conference, Mr. Greenspan didn't say in plain English that house prices are way out of line. ... What he did say ... was that "this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent." And he warned that "history has not dealt kindly with the aftermath of protracted periods of low-risk premiums." I believe that translates as "Beware the bursting bubble." But as recently as last October Mr. Greenspan dismissed talk of a housing bubble: "While local economies may experience significant speculative price imbalances, a national severe price distortion seems most unlikely." Wait, it gets worse. These days Mr. Greenspan expresses concern about the financial risks created by "the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages." But last year he encouraged families to take on those very risks, touting the advantages of adjustable-rate mortgages and declaring that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage." If Mr. Greenspan had said two years ago what he's saying now, people might have borrowed less and bought more wisely. But he didn't, and now it's too late.
There are signs that the housing market either has peaked already or soon will. And it will be up to Mr. Greenspan's successor to manage the bubble's aftermath. How bad will that aftermath be? The U.S. economy is currently suffering from twin imbalances. On one side, domestic spending is swollen by the housing bubble .... On the other side, we have a huge trade deficit, which we cover by selling bonds to foreigners. As I like to say, these days Americans make a living by selling each other houses, paid for with money borrowed from China. One way or another, the economy will eventually eliminate both imbalances. But if the process doesn't go smoothly - if, in particular, the housing bubble bursts before the trade deficit shrinks - we're going to have an economic slowdown, and possibly a recession. In fact, a growing number of economists are using the "R" word for 2006. And here's where Mr. Greenspan is still saying foolish things. In his closing remarks he suggested that "an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports and a corresponding improvement in the current account deficit." Translation, I think: the end of the housing bubble will automatically cure the trade deficit, too. Sorry, but no. A housing slowdown will lead to the loss of many jobs in construction and service industries but won't have much direct effect on the trade deficit. So those jobs won't be replaced by new jobs elsewhere until and unless something else, like a plunge in the value of the dollar, makes U.S. goods more competitive on world markets, leading to higher exports and lower imports. So there's a rough ride ahead for the U.S. economy. And it's partly Mr. Greenspan's fault.
August 28, 2005
Beware of Gaps in Our Knowledge
When we use the term transparency, at least as I understand it, we mean more than simply explaining what the central bank is doing, more than a portal to watch what is happening. Transparency also means giving markets the ability to duplicate the central bank's decision-making process and accurately predict how the central bank will respond in a particular circumstance. If the central bank is tempted into following false short-run signals, then such predictability is undermined to the detriment of output stability. Even policy that seems appropriate based upon the data at hand could look foolish in hindsight as better data become available. And such data revisions are not trivial nor confined to a short time period after the data are released. As the remarks by ECB president Trichet note, substantial revisions of 1999 data are still occurring in 2004. A very informative example of the problems with relying upon short-run measures of activity, in the example here the output gap is the focus, is provided from the experience of the ECB. This section is part of a larger discussion:
Monetary Policy and 'Credible Alertness,' by Jean-Claude Trichet, President of the ECB at the Panel Discussion “Monetary Policy Strategies: A Central Bank Panel”, at the Symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 27 August 2005: A corollary: beware of false signals In my view, the statement that a reputation for consistent behaviour is an asset carries an important corollary with it. We should guard against over-reacting to indicators that might give a distorted picture of economic reality and thus promote policies that might be regretted – and hastily reversed – in retrospect. To be more specific, … we would ideally need accurate, quantitative, contemporaneous readings of the current pertinent economic, monetary and financial data. For instance, knowledge of the level of production that would be consistent with stable prices, the so-called “natural” rate of output, would be an important tool for assessing whether the stance of policy is broadly appropriate. However, estimates of the time-varying natural rate of output, and by implication measures of economic slack, are notoriously very imprecise. Even in hindsight, different estimation methods yield quite dispersed figures. Allowing for data revisions … only makes the uncertainty surrounding those measures more pervasive.
Now, acting too strongly on such indicators, only to be forced to reverse gear soon thereafter as new estimates become available, risks the danger of an erratic policy process. Importantly, it confounds the markets, which … try to make sense of our past behaviour using the wisdom that is only available in hindsight. If this gives indications that differ markedly from those which could be reasonably inferred in real time, ... Even prudent policy conduct could appear ex post – and be deplored – as evidence of incorrect decisions. This could drain the central bank’s stock of credibility.
All this is not new and revives memories of the 1970s. Were the spectacular policy mistakes of that unfortunate decade due to poor economic theory, poor policy or a biased representation of the economy? It was probably a blend of all of these factors, with the last one carrying substantial weight. Advances in theory since the 1970s and more sophisticated econometrics have not immunised the policy process from these potential pitfalls. And here is a concrete example of what I mean. The first estimates of the output gap are typically available during the reference year, and are then revised over subsequent years. It is important to note that the final estimate is not available for a very long period of time: 1999 estimates, for example, were still revised by non-negligible amounts in 2004. Revisions are also large: they can often affect the sign, as well as the magnitude of the estimates. In the case at hand, for example, the revised output-gap measure available to us today is positive in almost all estimates for 1999, 2000 and 2001, but it was estimated to be negative in real time [as shown in Chart 1].
Uncertainty is even higher for output gap projections, which are the only measures of output gap existing at the beginning of each year. For example, the real-time estimates of the output gap for 2005, published in spring by the European Commission, the IMF and the OECD, differ on average more than 25% from the output-gap projections that these institutions made at the end of 2004. And, if we add to the real-time measures of the output gap for 2005 the average size of revisions observed in the past, we can conclude that it may ex post turn out to be anything between -3.6% and +0.8%.
Clearly, output-gap measurement issues are not a fact of the past. Central banks also need to cope with this problem at present. I take this as a warning that the central bank should not rely on any simple indicator of economic slack in taking its policy decisions. To conclude this point I would say that there are, undoubtedly, great differences in terms of monetary policy strategy between us at the ECB and, to use Alan Blinder terms, the Greenspan’s Fed. ... It is true that, in that sense, we belong to two different schools of thoughts on each side of the Atlantic.
But there is an important point on which on the contrary we share exactly the same views. We both want to be as comprehensive as possible ... We both do not want to neglect any information ... We both do not want to rely exclusively on a single particular model of the economy, as sophisticated as it may be. I have myself said several times that the Governing Council of the ECB has no intention of being the “prisoner” of a single system of equations. We both highly praise “robustness”. There is no substitute for a comprehensive analysis of the risks to price stability that pays due attention to all relevant information. It stands better chances of anchoring policy and – through that channel – expectations in a durable fashion.
Transparency of a Different Sort
Grand Canyon to Get Glass-Bottomed Walk, AP: ...An American Indian tribe with land along the Grand Canyon is planning to build a glass-bottomed walkway that will jut out 70 feet from the canyon's edge. The horseshoe-shaped skywalk, expected to open in January, ... with a glass bottom and sides, will be supported by steel beams and will accommodate 120 people, though it is designed to hold 72 million pounds, said Sheri Yellowhawk ..."You're basically looking 4,000 feet down. It's a whole new way to experience the Grand Canyon," Yellowhawk said. Admission will be $25...
Posted by Mark Thoma on Sunday, August 28, 2005 at 11:07 AM in Science
Diplomacy, Bolton Style
The US vs The UN, by David Usborne, The Independent: America's controversial new ambassador to the United Nations is seeking to shred an agreement on strengthening the world body and fighting poverty intended to be the highlight of a 60th anniversary summit next month. In the extraordinary intervention, ... Mr Bolton has demanded no fewer than 750 amendments to the blueprint restating the ideals of the international body ... The document is littered with deletions and exclusions. Most strikingly, the changes eliminate all specific reference to the ... Millennium Development Goals, accepted by all countries at the last major UN summit in 2000, including the United States. The Americans are also seeking virtually to remove all references to the Kyoto treaty and the battle against global warming. They are striking out mention of the disputed International Criminal Court and drawing a red line through any suggestion that the nuclear powers should dismantle their arsenals. Instead, the US is seeking to add emphasis to passages on fighting terrorism and spreading democracy. ... To the dismay of many other delegations, the US has even scored out pledges that would have asked nations to "achieve the target of 0.7 per cent of gross national product for official development assistance by no later than 2015". All references to the date or the percentage level are gone... Passages that look forward to a larger role for the General Assembly are gone. Rejected also is a promise to create a standing military capacity for UN peacekeeping. ... The move by Mr Bolton has thrown preparations for the summit into turmoil. ... Failure to reach an agreement could embarrass Tony Blair, who is believed to have given broad backing to Mr Annan's original draft. ... Some UN insiders concede that at 29 pages the proposed text was probably far too long ... in its present form it would ask the US to promise to uphold treaties and conventions it has already rejected, including the Kyoto pact. The president of the General Assembly, Jean Ping of Gambia, must now try to save the summit from disaster. ... There is no doubt in the corridors of New York that something must be stitched together before the summit, even if it ends up being very short. ... The problem is that the summit is less than three weeks away...
Wow. I'm surprised that I'm surprised. One general comment. I believe it's a mistake not to honor the commitments of your predecessors, even those you may not fully agree with. Once the U.S. gives its word, once we make a promise to the rest of the world, it's important that we not renege on that promise at the whimsy of each new administration. If our commitments cannot be trusted beyond 4-8 years, we will never deal effectively with longer-run problems, and we will never be credible brokers in the world.
August 27, 2005
Greenspan’s Closing Remarks
- He warns about impending fiscal imbalances due to the deficit, Social Security obligations, and so on, but he assumes this will be fixed, one way or the other, before disaster looms. Given this post, that is welcome (not the assumption, the warning).
- He warns against the temptation to monetize the debt – a topic that, in my opinion, has not received nearly enough attention (see here for one mention of it). It will be tempting to print money in the future to pay the debt obligations held by the foreign and domestic sectors. After all, a little anticipated inflation isn't that harmful. Is it?
- He warns about the dangers of repeating the 1970s which to me signals that inflation vigilance will be foremost in the Fed’s mind in coming months.
- He notes the housing boom will invariably cool.
- He cites the surprising correlation between CA deficit and equity extraction (see here for more on this), and he says the end of the housing boom could lead to personal saving increasing and the current account improving. Whether the adjustment will be in the form of a hard or soft-landing depends upon the degree of flexibility, his pitch for free and open markets (see his opening remarks).
- He promotes the risk management approach to monetary policy, and strongly rejects explicit inflation targeting. But he realizes this will be a topic of debate once he is gone.
- He says debates on asset price targeting will continue and that this is already part of Fed’s information set for assessing economic conditions. But he says he does not envision successful asset price targeting anytime soon, though it is a possibility for the future.
And here are his remarks in their entirety:
Closing remarks by Chairman Alan Greenspan, Jackson Hole, Wyoming: The Federal Reserve will almost surely face as many uncertainties over the next eighteen years as it has over the past eighteen. Technology continues to bring rapid change and, hence, considerable uncertainty, to the global marketplace. Monetary policy, supervision and regulation activities, and payments system operation will need to be calibrated to respond to the influences of that technological change.
Other forces will be at work on the economic environment as well. The inexorable aging of our population will markedly influence the policy milieu in the years ahead. Monetary policy, for example, cannot ignore the potential inflationary pressures inherent in our current fiscal outlook, especially those that could arise in meeting commitments to future retirees. However, I assume that these imbalances will be resolved before stark choices again confront us and that, if they are not, the Fed would resist any temptation to monetize future fiscal deficits. We had too much experience with the dangers of inflation in the 1970s to tolerate going through another bout of dispiriting stagflation. The consequences for both future workers and retirees could be daunting.
Nearer term, the housing boom will inevitably simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease. As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures. The estimates of how much differ widely.
The surprisingly high correlation between increases in home equity extraction and the current account deficit suggests that an end to the housing boom could induce a significant rise in the personal saving rate, a decline in imports, and a corresponding improvement in the current account deficit. Whether those adjustments are wrenching will depend, as I suggested yesterday, on the degree of economic flexibility that we and our trading partners maintain, and I hope enhance, in the years ahead.
On monetary policy, I envision a continuous refinement of our risk-management paradigm. I presume maximum sustainable economic growth will continue to be our goal, with price stability pursued as a necessary condition to promote that goal. To date, we have chosen not to formulate explicit inflation targets, in part, out of concern that they could inhibit the effective pursuit of our goal.
I remain unpersuaded that explicit numerical inflation targets are a key characteristic that distinguishes behavior among the world's central banks. Despite the various public characterizations of the form of monetary policy regime, the Federal Reserve and most other central banks generally pursue price stability and, consistent with that goal, ease when economic conditions soften and tighten when they firm. That said, I am certain this will remain a topic of lively discussion here and at other monetary forums in years to come. Participants on all sides of that debate will be well served by keeping open minds and remaining attentive to the evidence as events unfold and practices evolve.
Debates on the relative merits of asset price targeting also will continue and possibly intensify in the years ahead. The configuration of asset prices is already an integral part of our evaluation of the large array of forces that influence financial stability and economic growth. But given our current state of knowledge, I find it difficult to envision central banks successfully targeting asset prices any time soon. However, I certainly do not rule out that future work could improve our understanding of asset price behavior, and with it, the conduct of monetary policy.
* * *
I will miss debates on such topics with members of the Federal Open Market Committee and with the staffs of the Board and the banks. The Federal Reserve is a remarkable institution. Aside from its technical expertise in supervision and regulation and in overseeing an increasingly complex payments system, it combines for monetary policy an academic sophistication and a market-sensitive understanding that is brought to bear in formulating the tie between instruments and the goals of monetary policy.
Surely difficult challenges lie ahead for the Fed, some undoubtedly of our own making, and others that will be thrust on us by market or other forces. Having been exposed to the inner workings of this extraordinary institution for nearly two decades, I have little doubt that my successors, and theirs, will continue to sustain the leadership of the American financial system in an ever-widening global economy.
Robert Rubin Praises Greenspan’s Opposition to Deficits
Rubin Praises Stance Of Greenspan on Deficits, by Nell Henderson, Washington Post: Former Treasury secretary Robert E. Rubin, wading into a debate about the proper role of the Federal Reserve in national budget policy, Friday praised Alan Greenspan for actively opposing large federal budget deficits during his 18 years as Federal Reserve chairman. Rubin, who served under President Clinton… blamed President Bush's 2001 tax cuts for helping swing the budget from surplus that year to deficits since. … Bush administration officials dispute Rubin's explanation for the current budget deficits. "The greatest single cause of the fiscal surplus of the 1990s was the stock market bubble, which led to an unsustainably high level of economic activity and tax revenues," said Ben S. Bernanke, the chairman of Bush's Council of Economic Advisers. Together with the 2001 terrorist attacks and the war on terror, the collapse of the bubble was the major cause of the shift toward deficits after 2000, said Bernanke, …
Some economists … have criticized Greenspan for venturing beyond monetary policy to offer his personal opinions on fiscal policy … how to manage deficits or surpluses, and whether and how to alter Social Security. "We question the wisdom of a central bank head taking public positions on political issues unrelated to monetary policy," former Fed vice chairman Alan S. Blinder and Ricardo Reis, both Princeton University economists, wrote in the first paper presented here Friday. But Rubin … took aim at such thinking. "I believe the Fed should not only pursue sound and disciplined monetary policy, but should also stand for the principle of sound and disciplined fiscal policy." … Rubin also countered charges by many Democrats … that Greenspan bears responsibility for current budget deficits because of his public call for tax cuts in January 2001, just days after Bush was inaugurated. When the federal government was facing huge projected budget surpluses in 2001, Greenspan urged Congress to reduce them by cutting taxes. But he also warned that the forecasts could be wrong and suggested the cuts be structured with "triggers" that would alter them automatically if deficits reappeared. … Rubin described Greenspan's 2001 testimony as offering "a truly complex framework for making the decision" and added, "The framework, on balance, was right."
On why the Fed should discuss the deficit, but not politics, see here. Also, see here for evidence supporting Rubin’s claim about triggers. Let me be clear. The tax cuts contributed mightily to the deficit despite Bernanke's protestations otherwise, and Greenspan supported those tax cuts. Most of us agree so far I think. The point of departure is on how strongly Greenspan warned about deficits in his 2001 testimony and in subsequent statements. He did warn about deficits in his testimony, he did talk about triggers (but not in his testimony as noted in the link above), but unlike Blinder and Reis I fault him for saying too little about the deficit, not for saying too much, after his 2001 testimony (to be fair, they are saying he should speak out on matters affecting monetary policy and that is what I am saying too). Monetary and fiscal policy are directly connected through the government budget constraint and with interest rate targets, questions of debt monetization are important for the Fed to consider as it conducts policy. I believe we should have heard much more than we did from Greenspan about the implications of budget deficits for monetary policy and hence for the economy more generally. I'm not talking about his philosophical views on the size of government, privatization, and so on, but rather the implications of deficits for monetary policy and the economy. I think it is a big mistake for the Fed chair to engage in political dialogue. However, saying nothing when there is a deficit problem that affects monetary policy is just as political as speaking out. We should have heard more.
[Update: Brad DeLong, and others, are also mystified by Bernanke's claims regarding the surplus.]
Ending Extreme Poverty
Can Extreme Poverty Be Eliminated?, Jeffrey Sachs, SciAm: Almost everyone who ever lived was wretchedly poor. Famine, death from childbirth, infectious disease and countless other hazards were the norm for most of history. Humanity’s sad plight started to change with the Industrial Revolution, beginning around 1750. …. Two and a half centuries later more than five billion of the world’s 6.5 billion people can reliably meet their basic living ... One out of six inhabitants of this planet, however, still struggles daily to meet some or all of such critical requirements as adequate nutrition, uncontaminated drinking water, safe shelter and sanitation as well as access to basic health care. ... Every day more than 20,000 die of dire poverty, for want of … essential needs.
For the first time in history, global economic prosperity, brought on by continuing scientific and technological progress and the self-reinforcing accumulation of wealth, has placed the world within reach of eliminating extreme poverty altogether. This prospect will seem fanciful to some, but the dramatic economic progress made by China, India and other low-income parts of Asia over the past 25 years demonstrates that it is realistic.
Moreover, the predicted stabilization of the world’s population toward the middle of this century will help by easing pressures on Earth’s climate, ecosystems and natural resources … that might otherwise undo economic gains. Although economic growth has shown a remarkable capacity to lift vast numbers of people out of extreme poverty ... Market forces and free trade are not enough. Many of the poorest regions are ensnared in a poverty trap: they lack the financial means to make the necessary investments in infrastructure, education, health care systems and other vital needs. Yet the end of such poverty is feasible if a concerted global effort is undertaken ... In my recent book, The End of Poverty, I argue that a large-scale and targeted public investment effort could in fact eliminate this problem by 2025, much as smallpox was eradicated globally. This hypothesis is controversial, so I am pleased to have the opportunity to clarify…
Economists have learned a great deal during the past few years about how countries develop and what roadblocks can stand in their way. ... Public opinion in affluent countries often attributes extreme poverty to faults with the poor themselves—or at least with their governments. Race was once thought the deciding factor. Then it was culture: religious divisions and taboos, caste systems, a lack of entrepreneurship, gender inequities. Such theories have waned as societies of an ever widening range of religions and cultures have achieved relative prosperity. ... Most recently, commentators have zeroed in on “poor governance,” often code words for corruption. ... Development assistance efforts have become largely a series of good governance lectures. The … data … indicates that governance makes a difference but is not the sole determinant of economic growth. ... Geography—including natural resources, climate, topography, and proximity to trade routes and major markets—is at least as important as good governance. ... Other geographic features, such as the heavy disease burden of the tropics, also interfere. ... The good news is that geographic factors shape, but do not decide, a country’s economic fate. Technology can offset them: drought can be fought with irrigation systems, isolation with roads and mobile telephones, diseases with preventive and therapeutic measures. The other major insight is that … a rising tide does not necessarily lift all boats. Average income can rise, but if the income is distributed unevenly the poor may benefit little, and pockets of extreme poverty may persist ... Moreover, growth is not simply a free-market phenomenon. It requires basic government services: infrastructure, health, education, and scientific and technological innovation. Thus, many of the recommendations of the past two decades emanating from Washington—that governments in low-income countries should cut back on their spending to make room for the private sector—miss the point. Government spending, directed at investment in critical areas, is itself a vital spur to growth, especially if its effects are to reach the poorest of the poor.
So what do these insights tell us about the region most afflicted by poverty today, Africa? Fifty years ago tropical Africa was roughly as rich as subtropical and tropical Asia. As Asia boomed, Africa stagnated. Special geographic factors have played a crucial role. Foremost among these is the existence of the Himalaya Mountains, which produce southern Asia’s monsoon climate and vast river systems. Well-watered farmlands served as the starting points for Asia’s rapid escape from extreme poverty during the past five decades. ... Africa did not experience a green revolution. Tropical Africa lacks the massive floodplains that facilitate the large-scale and low-cost irrigation found in Asia. Also, its rainfall is highly variable, and impoverished farmers have been unable to purchase fertilizer. The initial Green Revolution research featured crops, especially paddy rice and wheat, not widely grown in Africa ... The continent’s food production per person has actually been falling, and Africans’ caloric intake is the lowest in the world … Its labor force has remained tethered to subsistence agriculture. Compounding its agricultural woes, Africa bears an overwhelming burden of tropical diseases. … malaria is more intensively transmitted in Africa than anywhere else. And high transport costs isolate Africa economically. In East Africa, for example, the rainfall is greatest in the interior of the continent, so most people live there, far from ports and international trade routes. Much the same situation applies to other impoverished parts of the world, notably the Andean and Central American highlands and the landlocked countries of Central Asia. ... Rural areas therefore remain stuck in a vicious cycle of poverty, hunger, illness and illiteracy. Impoverished areas lack adequate internal savings to make the needed investments because most households live hand to mouth. The few high-income families, who do accumulate savings, park them overseas rather than at home. This capital flight includes not only financial capital but also the human variety, in the form of skilled workers—doctors, nurses, scientists and engineers, who frequently leave in search of improved economic opportunities abroad. The poorest countries are often, perversely, net exporters of capital.
The technology to overcome these handicaps and jump-start economic development exists. Malaria can be controlled ... Drought-prone countries in Africa with nutrient depleted soils can benefit enormously from drip irrigation and greater use of fertilizers. Landlocked countries can be connected by paved highway networks, airports and fiber-optic cables. All these projects cost money, of course. Many larger countries, such as China, have prosperous regions that can help support their own lagging areas. ... Most of today’s successfully developing countries, especially smaller ones, received at least some backing from external donors at crucial times. ... We in the U.N. Millennium Project have … estimated … the “financing gap” that international donors need to make up. ... Adding it all up, the total requirement for assistance across the globe is around $160 billion a year, double the current rich-country aid budget of $80 billion. ... Other organizations, including the International Monetary Fund, the World Bank and the British government, have reached much the same conclusion. We believe these investments would enable the poorest countries to cut poverty by half by 2015 and, if continued, to eliminate it altogether by 2025.
They would not be “welfare payments” from rich to poor ... We would be giving a billion people a hand up instead of a handout. If rich nations fail to make these investments, they will be called on to provide emergency assistance more or less indefinitely. They will face famine, epidemics, regional conflicts and the spread of terrorist havens. ... The debate is now shifting from the basic diagnosis of extreme poverty and the calculations of financing needs to the practical matter of how assistance can best be delivered. ... When pollsters ask Americans how much foreign aid they think the U.S. gives, they greatly overestimate the amount—by as much as 30 times. Believing that so much money has been donated and so little has been done with it, the public concludes that these programs have “failed.” The reality is rather different. ... A second common misunderstanding concerns the extent to which corruption is likely to eat up the donated money. Some foreign aid in the past has indeed ended up in the equivalent of Swiss bank accounts. That happened when the funds were provided for geopolitical reasons rather than development ... When assistance has been targeted at development rather than political goals, the outcomes have been favorable, ranging from the Green Revolution to the eradication of smallpox and the recent near-eradication of polio. The aid package we advocate would be directed toward those countries with a reasonable degree of good governance and operational transparency. In Africa, these countries include Ethiopia, Ghana, Mali, Mozambique, Senegal and Tanzania. The money would not be merely thrown at them. ... All these programs should be closely audited. Western society tends to think of foreign aid as money lost. But if supplied properly, it is an investment that will one day yield huge returns, much as U.S. assistance to western Europe and East Asia after World War II ... As U.N. Secretary-General Kofi Annan wrote earlier this year: “There will be no development without security, and no security without development.”
August 26, 2005
Catch Up Larry!
Are any of the Fed bigwigs in Jackson Hole watching the market price-rule indicators? Do they understand the teachings of Milton Friedman and Frederich Hayek — that markets, which contain more information than economic models, are the best judges of economic “risk management”?
He seems to be unaware of that Milton Friedman now supports inflation targeting (see here too). He might also want to read up on the modern versions of Hayek which also support the Fed’s movement towards inflation targeting and transparency (he could start here, here, and here, or read this). Setting aside the over-tightening debate he refers to, which is separate, he can believe whatever out of the mainstream position he wants, but he should be a little more careful about whom he cites as supporting it. And in answer to his question, I think the Fed bigwigs understand the teachings of Milton Friedman and Friedrich Hayek very, very, well, more so than a certain columnist at the NRO.
Fed Watch: Forecast Calls For More Rate Hikes
Warning: Lengthy post as my brains empties in preparation for a week on the Oregon Coast.
The data this month have been somewhat disappointing, as noted here by David Altig, and as later seen in a weak durable goods report. On the other hand, anecdotal evidence aside, data suggest that the housing market remains healthy or too healthy as the case may be. Given the overall steady stream of positive economic news this summer, this monthly blip will not dissuade the Fed from its current policy path toward still higher rates.
Let’s begin with a word on energy. Energy prices are a double edged sword at this point. One edge is inflationary, while the other depresses demand. Given, however, that we have had little indication that the Fed has shifted its thinking on the underlying economy (in a word, solid), policymakers will keep their eyes trained on the inflation side of the sword. Indeed, the most recent run in both oil and natural gas suggest upward price pressures will continue and intensify as the leaves start to fall. And I doubt very much that the waning days of the Greenspan Era will be characterized by an easing of inflation vigilance. Chicago Fed President Michael Moskow (channeled via Mark Thoma) pretty much laid down the gauntlet on that issue:
''Core inflation is now at the upper end of the range that I feel is consistent with price stability,'' Moskow said ... ''Appropriate policy means that we continue to reduce accommodation and return to a neutral federal funds rate,'' ... Moskow didn't give an estimate of the neutral rate that would keep the economy growing without spurring inflation. … ''If we do not remove that accommodation, or raise rates, then you risk significantly higher inflation in the economy,'' he said … ''inflation this year and next is likely to come in at the high end'' of the Fed's forecast of 1.75 percent to 2 percent...
In light of the data, energy prices, and Moskow’s comments, consider the calendar for the rest of the year. The FOMC meets again on September 20. I, along with everyone under the sun, expect another 25bp with similar language. The next meeting is on November 1, after the Q3 GDP report. Note that economists are looking for something in the 4+% range. Let’s assume that the inventory story from the Q2 report was overblown and, given that car makers still can’t move a vehicle without bargain pricing won’t be rebuilding stocks any time soon. So cut that number to 3.5%, or even 3%. Given the underlying price pressures stemming from energy and, depending who you talk to, low unemployment rates, the Fed would take even such a weakened GDP report as license to move again in November. And unless we see some radical change in the economic outlook, the 3Q GDP report will also carry forward to a December rate hike. Happy holidays to all.
So I see the calendar as supportive of another 75bp this year – which will come close to cutting the yield curve to zero unless long term rates start to move – and I see no indications from Fed officials to tell me that this story is wildly wrong.
The Fed appears to be sending out other indications that the plan is still to drain excess liquidity from the financial system, or in Fedspeak, remove the accommodative environment. First, from Greenspan’s speech today at Jackson Hole:
“Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”
I read this as another warning that the days of easy money are drawing to a close, at least from the Fed’s perspective. This isn’t simply a prediction either; the Fed actually has something to say about liquidity. Greenspan sees the potential for a happy ending:
“If we can maintain an adequate degree of flexibility, some of America's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more-wrenching changes in output, incomes, and employment.”
Of course, not all interest rates are cooperating with this plan, as one of my favorite graphs from the Wall Street Journal illustrates just so clearly:
The narrowing yield spread has been the topic of endless posts, and probably reflects no single cause. A number of factors are likely at play, including foreign capital flows (here and here), weak global investment demand (here), and a “perception of abundant liquidity.” Regarding the last, one has to wonder if financial market participants are not entirely convinced that the Fed will continue to raise rates and narrow the spread, or, if the Fed did so to the detriment of the economy, it would quickly reverse course to support financial markets – the “Greenspan put.” To me, the latter is not a given this time, especially in an environment of rising energy prices.
Regarding those higher energy costs, one does not have to be a peak oil follower to believe that lack of investment in recent decades has left open the possibility of sustained higher prices for the near future. If indeed energy prices are sending such a signal, then market forces will kick into action, shifting resources into energy investment and conservation. This is not, however, a straightforward transition – today’s carpenter in Orange County will not suddenly be shifted to building natural gas pipelines in northern Canada. Today’s SUV owner will not be jumping into a hybrid tomorrow. As the economy adapts to a new energy environment, these fundamental structural frictions imply lower productivity. Again, more reason for the Fed to keep its foot on the break.
And, suppose I am wrong and higher energy prices are simply a bubble waiting to collapse. The sudden shift would take away some inflationary pressures, but send consumers back into the malls at a time when the Fed already believes underlying growth is solid….you can’t win for losing on this one. Moreover, regardless of energy costs, as I opined in an earlier post, the low interest rate environment and the willingness of investors to send capital into the housing markets implies a risk that the Fed will have to strangle the non-consumption sectors of the economy – which don’t amount to much anymore – in order to keep inflationary pressures at bay.
Couple the Greenspan comments with this little gem from yesterday’s Wall Street Journal (subscription):
The Federal Reserve Bank of New York will meet with Wall Street banks next month to discuss the still relatively opaque market for credit derivatives.
The market is a young but rapidly growing one where traders and investors use the derivatives to buy and sell protection against defaults. Trading volumes have soared, but back-office functions needed to make sure trades get completed haven't kept up with that growth.
It is these so-called settlement issues that the New York Fed wants to discuss with the bankers on Sept. 15. New York Fed President Timothy Geithner sent a letter to dealers on Aug. 12 inviting them to meet on "how best to address a range of important issues in the credit-derivatives market."
While those issues appear technical, they are essential to keep losses from snowballing into more systemic problems when the markets are volatile.
To be sure, I wouldn’t want to blow such news of such a meeting out of proportion. The long lead time between the invite and meeting implies that no crisis is imminent. Instead, the Fed is showing a healthy concern that the not all markets are prepared for the eventual end to “abundant liquidity.”
But again, my point here is that the Fed has some control over “abundant liquidity” in the economy. I doubt that it is coincidence that these warnings continue to emanate from Constitution Ave. during a period of (continued) monetary tightening that does not appear to be entirely reflected in credit markets. In short, regardless of the possibility of a recession in 2006, I still see the Fed as laying the groundwork for continued monetary tightening, even as they see the possibility that financial markets are not entirely prepared for that outcome.
Greenspan Sums It Up
Reflections on central banking, by Alan Greenspan: …our analysis of economic developments almost surely will need to deal in greater detail with balance sheet considerations than was the case in the earlier decades of the postwar period. ... Our forecasts and hence policy are becoming increasingly driven by asset price changes. ... Whether the currently elevated level of the wealth-to-income ratio will be sustained in the longer run remains to be seen. But arguably, the growing stability of the world economy over the past decade may have encouraged investors to accept increasingly lower levels of compensation for risk. … The lowered risk premiums--the apparent consequence of a long period of economic stability--coupled with greater productivity growth have propelled asset prices higher. ... Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. ... But what they perceive as newly abundant liquidity can readily disappear. … history has not dealt kindly with the aftermath of protracted periods of low risk premiums.
Greenspan also talked about risk management in the face of model uncertainty, the subject of this recent post:
Despite extensive efforts to capture and quantify what we perceive as the key macroeconomic relationships, our knowledge about many critical linkages is far from complete and, in all likelihood, will remain so. Every model, no matter how detailed or how well conceived, designed, and implemented, is a vastly simplified representation of the world ... Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and the sometimes asymmetric costs or benefits of particular outcomes, the paradigm on which we have settled has come to involve … risk management. ... The risk-management approach has gained greater traction as a consequence of the step-up in globalization and the technological changes of the 1990s, which found us adjusting to events without the comfort of relevant history to guide us. ... In effect, we strive to construct a spectrum of forecasts from which, at least conceptually, specific policy action is determined through the tradeoffs implied by a loss-function. In the summer of 2003, for example, the Federal Open Market Committee viewed as very small the probability that the then-gradual decline in inflation would accelerate into a more consequential deflation. But because the implications for the economy were so dire should that scenario play out, we chose to counter it with unusually low interest rates. The product of a low-probability event and a potentially severe outcome was judged a more serious threat to economic performance than the higher inflation that might ensue in the more probable scenario. .... Given the potentially severe consequences of deflation, the expected benefits of the unusual policy action were judged to outweigh its expected costs.
The last part is consistent with the Cogley and Sargent paper on Fed policy in the face of model uncertainty linked above. On the policy front, Greenspan also discussed, indirectly, the debate over flexible policy versus commitment to an inflation targeting rule such as a Taylor rule. As has been widely noted in the past, Greenspan prefers to retain flexibility:
At various points in time, some analysts have held out hope that a single indicator variable--such as commodity prices, the yield curve, nominal income, and of course, the monetary aggregates--could be used to reliably guide the conduct of monetary policy. If it were the case that an indicator variable or a relatively simple equation could extract the essence of key economic relationships from an exceedingly complex and dynamic real world, then broader issues of economic causality could be set aside, and the tools of policy could be directed at fostering a path for this variable consistent with the attainment of the ultimate policy objective.
He then goes on to explain why the Fed dropped monetary aggregates as policy targets:
M1 was the focus of policy for a brief period in the late 1970s and early 1980s. That episode proved key to breaking the inflation spiral that had developed over the 1970s, but policymakers soon came to question the viability over the longer haul of targeting the monetary aggregates. The relationships of the monetary aggregates to income and prices were eroded significantly over the course of the 1980s and into the early 1990s by financial deregulation, innovation, and globalization. For example, the previously stable relationship of M2 to nominal gross domestic product and the opportunity cost of holding M2 deposits underwent a major structural shift in the early 1990s because of the increasing prevalence of competing forms of intermediation and financial instruments.
He notes the importance of anchored expectations for monetary policy and gives Paul Volcker credit for making substantial progress on this front:
Our appreciation of the importance of expectations has also shaped our increasing transparency about policy actions and their rationale. We have moved toward greater transparency at a "measured pace"… monetary policy itself has been an important contributor to the decline in inflation and inflation expectations over the past quarter-century. Indeed, the Federal Reserve under Paul Volcker's leadership starting in 1979 did the very heavy lifting against inflation. The major contribution of the Federal Reserve to fashioning the events of the past decade or so, I believe, was to recognize that the U.S. and global economies were evolving in profound ways and to calibrate inflation-containing policies to gain most effectively from those changes.
Finally, Greenspan issued two warnings, one about protectionism as a hindrance to the flexibility needed to deal with economic shocks and the other about rising budget deficits:
The developing protectionism regarding trade and our reluctance to place fiscal policy on a more sustainable path are threatening what may well be our most valued policy asset: the increased flexibility of our economy, which has fostered our extraordinary resilience to shocks. If we can maintain an adequate degree of flexibility, some of America's economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more-wrenching changes in output, incomes, and employment.
[Update: The Washington Post has a summary of the paper "Understanding the Greenspan Standard," by Alan S. Blinder and Ricardo Reis of Princeton University. Also, the WSJ reports on Blinder's remarks.]
Grassley: No Consensus within GOP on Social Security Reform
...Several senior citizens asked Grassley about Social Security. Grassley said he wants to see reform. The question is what to do. "I can't even get a consensus among [fellow] Republicans," Grassley said …
House Ways and Means Chairman Bill Thomas says they'll vote on a bill "one way or the other."
Should Central Banks Respond to Asset Price Inflation?
Greenspan Fans at Jackson Hole May Differ on View of Bubbles, Bloomberg: Federal Reserve Chairman Alan Greenspan's hands-off policy toward soaring stock and housing prices may be one part of his legacy that doesn't last long beyond the end of his term... Greenspan … holds that central banks should work to ease the aftermath of burst asset bubbles instead of trying to prevent them by raising interest rates. While the Federal Open Market Committee so far has supported Greenspan's view, that may change.
Fed Bank of San Francisco Senior Vice President Glenn Rudebusch ... said there's no ''open and shut case'' against the idea of using rates to deflate threatening bubbles. Fed Governor Donald Kohn has directly cited housing as one of the ... imbalances in the economy. ''I consider it an open issue for the Federal Reserve,'' former Fed Governor Laurence Meyer … said in an interview. ''It will be more of an issue when Greenspan is gone because he was so definitive on the indirect approach to asset bubbles.'' … Central bankers in Europe and New Zealand also disagree with the hands-off approach to asset prices; the Bank of England, raising rates in 2003, even explicitly cited housing markets that threatened to blow its inflation goal off course… ''The biggest challenge for central bankers for the next decade is going to be dealing with asset valuations,'' said Stephen Cecchetti, former research director at the New York Fed ... ''It would be irresponsible to walk away and say, 'We only care about inflation.'''
The European Central Bank, Bank of England and central banks in Australia and New Zealand all have narrower mandates than the Fed … All three have defined that mandate to include leaning against asset prices when they begin to cause broad imbalances in lending and spending ... Otmar Issing, ... chief economist of ... the ECB, also challenges the idea it's better to clean up after bubbles burst than to try to prevent them. ''Do the reservations towards using monetary policy rates for fighting asset price bubbles mean that the central bank is forced to play the role of an inactive bystander in such circumstances?'' ... ''This may be too extreme a conclusion.'' Reserve Bank of New Zealand Governor Alan Bollard has said he considers it both sensible and part of his duty to ''prevent the emergence of large speculative asset-price bubbles.'' His comments in a January 2004 speech remain ''the current thinking'' of the bank...
Greenspan's contrary conclusions stem in part from a view that governments shouldn't be in the business of picking correct valuations for free markets, and that trying to stop bubbles may do greater overall damage. That position has support beyond the Federal Reserve. ... Even banks that act against bubbles acknowledge risks. Charles Bean, the Bank of England chief economist … said in January 2004 that a rate hike large enough to dent an asset-price boom may have a ''significant adverse impact'' on growth. He turned out to be right. … The Bank of England's experience may lend weight to Greenspan's view that interest rates are too blunt to use against specific asset markets. The best strategy is ''to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion,'' ... That conclusion is now being reassessed, even within the Fed. While tax cuts combined with the Fed's interest-rate cuts did limit the 2001 recession to just eight months, the recovery was stymied by lingering business caution. Hiring was slower after the 2001 recession than in any other expansion in post-war history. … ''The dot-com bubble spurred over-investment in fiber optic cable and decimated the provision of venture capital for new technology start-ups for years,'' Rudebusch, the senior vice president at the San Francisco Fed … ''It is possible to conceive of a situation in which reducing the bubble in advance is a preferred policy strategy.''...
Posted by Mark Thoma on Friday, August 26, 2005 at 12:42 AM in Science
Explaining the Statistical Discrepancy Between GDP and GDI with Non-Defense Related Government Consumption
Some may be here for the first time, so let me briefly recall the puzzle. In trying to determine why the GGP/GDI ratio varies, I decomposed GDP into C, I , G, and NX and discovered G appeared more correlated with the discrepancy than the other components of GDP.
Here are the pictures. The statistical discrepancy has a fairly persistent pattern over time. Dividing the discrepancy by GDI (which doesn't alter the pattern much, it just makes the series more homoskedastic so the pattern is easy to identify) gives:
The other series in the graph, government spending divided by GDI, G/GDI, duplicates the pattern in the discrepancy fairly well and that is what surprised me and others I’ve shown this to. Why are the two series so correlated? Is it spurious (Klein found a similar result so I’m less inclined to believe this), or is there information that can be used to both understand the source of the discrepancy and perhaps even reduce it as a consequence?
The patterns seem fairly close, though the association may not be quite as strong for a longer sample:
Still, it does appear that the two series move together for the most part.
After digging up a few papers the last few days on this topic, most notably these (here and here), I decided to graph the components in G divided by GDI. By looking at each component individually perhaps the source of the correlation can be better identified. There are two fundamental components in G, federal expenditures and state and local expenditures. Within each of these, spending is broken down according to consumption and investment. Finally, federal expenditures are divided into defense and non-defense spending.
The first graph shows state and local government expenditures and the discrepancy since 1980, and the second shows federal government expenditures since 1980. Both series, as in all graphs in this post, are divided by GDI:
Neither graph seems very revealing, though states and local does fit well up until around 1998. Here are the same two graphs for the full sample:
Let’s try another cut. Instead of dividing government expenditures into state and local versus federal, let’s divide them into defense and non-defense spending. Here are the graphs from 1980:
That appears to be a more fruitful cut. Non-defense spending is much more correlated with the discrepancy than defense related spending. Here’s the full sample:
Not a perfect correlation, but enough to wonder what is driving it. Let’s try yet another cut, this time separating into government consumption and government investment expenditures (all categories, e.g. state and local, federal, defense, and non-defense are included):
and, as usual, for the full sample:
Consumption to GDI moves closer to the discrepancy to GDI series than does the investment to GDI series. Overall the suggestion is that non-defense consumption exhibits the discrepancy pattern more clearly than the other series. Let’s graph that series to see if this conjecture holds:
And, for the full sample:
This does appear to provide a closer association.
So, what I’ve learned is that a good place to look for the source of the discrepancy is in non-defense government consumption expenditures. Now I need to determine why this particular series is correlated with the discrepancy.
China Privatizes State-Owned Firms to Help Lagging Stock Market
China to Allow More Stock Sales, by Peter S. Goodman, Washington Post: China on Wednesday freed more than 1,300 largely state-owned companies to gradually sell shares of stock now controlled by the Communist Party government, putting nearly $270 billion worth of state assets on the trading block. This unprecedented wave of privatization is aimed at lifting domestic stock markets and furthering the country's transition toward capitalism...
The move is "a huge deal," said Stephen Green, senior economist at Standard Chartered Bank in Shanghai … which examines China's privatization. "The state-owned shares have been an albatross around the neck of the market. This is a pretty good sign that they're serious about reform."
Ever since China established its first stock exchange in 1990, Communist Party leaders have struggled to convince investors that they are running a real market as opposed to a capital-raising machine in which the government manipulates share prices to serve the interests of favored state firms. … Roughly two-thirds of the shares of listed firms remain non-tradable, locked in the hands of state-owned parent companies that are impervious to the interests of minority shareholders. The plan announced on Wednesday … is aimed at convincing investors that state interference is a relic of the past, with stock prices reflective of real values in a more transparent marketplace. … Analysts emphasized that the plan should not be construed as an indication that the government has embraced wholesale privatization. The majority of the companies that trade on the Shanghai and Shenzhen exchanges are small arms of giant firms that remain wholly controlled by the state, or inconsequential and poorly managed firms … The government's decision to put more of these shares into private hands does not signal an intent to relinquish control over the largest and most strategically important state-owned firms, which still dominate key sectors of the Chinese economy such as steel, auto-making, telecommunications and commercial aviation. "This is basically a mechanism to get the stock market to function, which it has not done in four years," said Arthur Kroeber, managing editor of the China Economic Quarterly. "This is the state privatizing junk that it's not interested in but retaining control over the core companies."… Analysts said the initiatives are aimed at making China's stock markets more attractive to investors, particularly foreign banks ... The control of listed firms by the state has fostered the sense that China's markets are beset by inside deals and shoddy corporate governance. And foreign investors have been reluctant to plunge in …
August 25, 2005
Why is the Fed Slow to Respond to Changes in Beliefs About Economic Structure?
Cogley, Timothy and Sargent, Thomas J., "The Conquest of U.S. Inflation: Learning and Robustness to Model Uncertainty" (April 2005). ECB Working Paper No. 478 SSRN, and free on author website, February 2004 version Abstract: Previous studies have interpreted the rise and fall of U.S. inflation after World War II in terms of the Fed's changing views about the natural rate hypothesis but have left an important question unanswered. Why was the Fed so slow to implement the low-inflation policy recommended by a natural rate model even after economists had developed statistical evidence strongly in its favor? Our answer features model uncertainty. Each period a central bank sets the systematic part of the inflation rate in light of updated probabilities that it assigns to three competing models of the Phillips curve. Cautious behavior induced by model uncertainty can explain why the central bank presided over the inflation of the 1970s even after the data had convinced it to place much the highest probability on the natural rate model.
This is further explained later in the paper:
...A number of alternative explanations for the high U.S. inflation of the 1970s refrain from assigning an important role to policy makers' changing beliefs about the natural rate hypothesis. For example, DeLong (1997) questions the motives of Arthur Burns. Parkin (1993) and Ireland (1999) say that discretionary policy making combined with a higher natural rate of unemployment resulted in a higher inflationary bias. Chari, Christiano, and Eichenbaum (1998) and Albanesi, Chari, and Christiano (2003) ascribe the high inflation to an expectations trap. Orphanides (2003), Lansing (1999), and Romer and Romer (2002) emphasize that the Federal Reserve was slow to detect the productivity slowdown and the rise in the natural rate of unemployment. Primiceri (2003) emphasizes evolution in the Fed's estimates not only of the natural rate but also of the slope of the short-term trade-off between inflation and unemployment. We believe that there is some truth in all of these ideas but explore a different explanation. We show that concerns about the robustness of a proposed inflation-stabilization policy across alternative models would have induced policy makers to choose high inflation even though the data favored a model that recommended low inflation... In two competing models that had smaller but still non-zero probability weights, a policy of quickly reducing inflation would have been calamitous. If very bad results are associated with a particular policy according to any of the models that retain a positive but small … probability, our ... policy maker refrains from that policy. In this way, our ... model rationalizes the idea that the high inflation of the 1970s reflected the Fed's desire to guard against the bad outcomes that would have come from a low-inflation policy under models that by the 1970s should have had low ... probabilities.
What does this tell us? As an example, suppose the Fed currently has two models in mind, a soft-landing model and a hard-landing model as they look at housing, the trade balance, and the budget deficit. Even if they are fairly certain the soft landing model is correct, if there is a small chance that the hard-landing model is correct, this will cause them to avoid any policy that might take the economy in a direction that is disastrous within the hard-landing model.
I believe there is model uncertainty right now and furthermore, depending upon the model used and who is doing the talking, raising interest rates substantially can have disastrous consequences, but so can the high inflation policy mistakes of the 1970s that are the subject of the CS paper. The Fed will not risk a repeat of that episode if it can help it. Others may have different interpretations of the models and disaster risks on each side of the current interest policy (which is part of the CS point), but to me, assuming the paper does capture Fed behavior, this implies a continued “measured” strategy to avoid tipping the scales too far in either direction with a bias against inflationary outcomes replicating the 1970s. Consider this statement from Michael Moskow, president of the Chicago Fed:
Those of us who lived through the period of the late 60s, the 70s and even the early 80s remember how painful that was and how deleterious high rates of inflation are ... So it's very important, very important, that we keep inflation contained.
In any case, in the face of model uncertainty, interpreting Fed behavior as avoiding the chance of large mistakes is good advice.
Update: From the NY Times:
"We really do not know how this system works," [Greenspan] told members of the Fed's policy-making committee in Washington, according to transcripts released earlier this year. "It's clearly new. The old models just are not working."
*All papers cited can be found the references to the CS paper.
Chicago Fed’s Michael Moskow Defends Further Rate Increases
Fed's Moskow Sees More Inflation Risk, Higher Rates, Bloomberg: The Federal Reserve must keep raising interest rates because the economy is growing near its full potential and inflation is at the high end of the acceptable range, Michael Moskow, president of the Chicago Fed, said in a speech. ''Core inflation is now at the upper end of the range that I feel is consistent with price stability,'' Moskow said ... ''Appropriate policy means that we continue to reduce accommodation and return to a neutral federal funds rate,'' ... Moskow didn't give an estimate of the neutral rate that would keep the economy growing without spurring inflation. … ''If we do not remove that accommodation, or raise rates, then you risk significantly higher inflation in the economy,'' he said … ''inflation this year and next is likely to come in at the high end'' of the Fed's forecast of 1.75 percent to 2 percent...
Moskow, 67, has been president of the Chicago Fed bank since 1994 and is a voting member of the Federal Open Market Committee this year. He has never dissented on a rate decision, joining Chairman Alan Greenspan in the majority on every vote. … ''The risk is higher than it was a year ago,'' he said. ''Because the economy is running nearer to potential, unfavorable cost developments are more likely to pass through to core inflation.'' … Moskow told reporters … that there is little evidence that the increase in oil prices is changing consumers' habits. ''So far the increases have not had a noticeable impact on demand,'' he said. ''Will it have a more significant impact in the future? I don't think anybody knows for sure. ...'' … He said he expects ''solid growth'' in consumer spending because ''employment gains have increased incomes, rising equity and home prices have boosted wealth, and currently households are not experiencing difficulty servicing their debt.'' … Along with inflation, Moskow said the risks to growth include rising oil prices, the large U.S. current account deficit and a possible decline in home prices.
Moskow also said the economy has reached full employment ... ''While unemployment was lower in the late 1990s, at the Chicago Fed we think that given current economic circumstances, 5 percent is about as low as the unemployment rate can go on a sustained basis,'' he said. … ''Financial market data and surveys suggest that the private sector's long-run inflation expectations remain stable,'' he said. If higher oil prices or ''a string of higher inflation numbers'' threaten to increase inflation expectations, ''the Fed would need to respond accordingly in order to restore price stability,'' he said. ''Those of us who lived through the period of the late 60s, the 70s and even the early 80s remember how painful that was and how deleterious high rates of inflation are,'' Moskow said in response to a question from the audience. ''So it's very important, very important, that we keep inflation contained.''
Crisis in the delta, Editorial, LA Times: Fish life in the Sacramento-San Joaquin delta is declining at crisis levels, and state officials are at a loss to explain why, or what to do about it. The situation has potentially grave implications for an estimated 24 million Californians who get some or all of their water from the Rhode Island-size estuary south of Sacramento and east of San Francisco Bay...
The delta crisis provides a critical test of CalFed, the multibillion-dollar, multi-agency program created by the state and federal governments to end the continual water wars focusing on the delta. The health of the delta depends on leaving sufficient water to wash naturally into San Francisco Bay. The viability of CalFed is in question because Congress has not come up with the promised federal share of its costs, future state funds are threatened by budget shortfalls and water interests — farmers, urban water districts and environmentalists — can't agree on how future projects should be financed.
Meanwhile, state and federal experts are baffled by the decline in fish life. The populations of striped bass, the endangered delta smelt, the threadfin shad and a variety of plankton are at record lows, and the problem seems to be getting worse. This is all the more puzzling because, unlike previous species declines, this one doesn't appear to be drought-related. ... Environmentalists and the sportfishing industry blame too much pumping. The fishermen want to cut off water exports, which is impossible. … Steve Hall, head of the Assn. of California Water Agencies — a coalition of urban and farming districts … says that exports have not been a factor even though pumping reached record levels over the last three years. Hall said the decline in fish life is caused by toxic blooms triggered by "alien" algae, possibly introduced by the purging of ship ballast. Water agencies are arguing for even more pumping. … State officials need to be sure that CalFed has the money and scientific help it needs in attacking the delta crisis. Gov. Arnold Schwarzenegger has asked the Little Hoover Commission to look into CalFed's structural problems. … The delta is vital to California's economy and lifestyle. Its ecological collapse is unthinkable.
Unthinkable is right. As a kid growing up, I could not have imagined it.
Posted by Mark Thoma on Thursday, August 25, 2005 at 12:15 AM in Environment
August 24, 2005
Another Look at Housing…
I have tended to shy away on the housing story, leaving it to other bloggers such as Calculated Risk. I am sympathetic to those who view it as a bubble, but have limited my comments to likely Fed reaction to such a bubble.
Today, however, I was unsettled by the combination of weak durable goods numbers, strong housing numbers, and this morning’s Wall Street Journal piece regarding global capital flows into the US housing market. Like many, I see the need for an eventual rebalancing – a shifting away from consumption and housing and toward investment – of growth in the years ahead. Consequently, I would be displeased to see that the Fed’s contractionary campaign failed to yield such a result. But if the housing sector stays strong while other sectors stagnate, the day of reckoning is pushed further into the future.
With that in mind, I wanted to get a better sense of the Fed’s impact on the housing market. To be sure, this is an exercise in “optical econometrics,” but I think the data tells an interesting story just the same. [Note: I used the Fed St. Louis Fed site as my data source.] First, a look at 30 year mortgage rates and housing starts:
Quite honestly, this picture doesn’t tell me much. Sure, the rate spike in the early 1980s corresponds to a housing downturn, and low rates today correspond to strong housing starts, but why exactly is housing in a downtrend during the late 1980’s even as rates are falling? I felt I was missing some appropriate measure of monetary policy. So I took another pass at the data, using the spread between mortgage rates and the fed funds rate:
I lagged the spread 12 months. The most visible feature in this chart is the strong correlation between the lagged spread and housing starts during the 1970s and early 80’s. That relationship, however, begins to break down in the late 1980’s. Of course, I am not surprised that the data would exhibit a structural break. After all, deregulation and financial innovations have radically altered the mortgage markets. Lower down payments, expanded uses of ARMs, declining lending standards, etc. have all played a part in altering the link between interest rates and housing starts. Has the international sector played a role? For that, I went back to a relationship I stumbled upon a year ago or so: that between the current account (as a percentage of GDP) and housing starts.
Interesting, no? The relationship between the current account and housing starts during the 1970’s and early 1980’s is likely spurious. Recessions are consistent with both weak housing and improving CA deficits. But the relationship tightens up dramatically in the second half of the 1980’s, and note that this past recession saw neither significant improvement in the CA deficit nor deterioration in housing starts. So, I don’t think this is entirely a spurious relationship, especially for the last 20 years. Something structural is likely happening.
All in all, it suggests to me that international factors – specifically, the willingness of foreign investors to place their capital into the US – have a significant place in explaining the consumption binge/CA deficit/low interest rate issue. This places me in the camp of David Altig, who had a similar take on today’s WSJ article.
Of course, the international angle only increases the difficulty of the Fed’s job – the willingness of foreign capital to flow into the US could mean the Fed will end up strangling the non-housing sectors of the economy to keep overall inflation expectations in line.
Update: Explaining the Systematic Statistical Discrepancy
The paper by Klein and Makino finds significant correlations between the sum of corporate profits and proprietors’ income, exports, and government consumption expenditures, and the statistical discrepancy. This earlier post on this site indicates that such correlations do exist as claimed by Klein and Makino, but the paper by Fixler and Grimm using a longer data set could not confirm these results. Here are the papers. The paper links are followed by one quote bearing on this issue from Fixler and Grimm. The Klein and Makino abstract follows and then a section from Fixler and Grimm is presented. I’ve also included a paper on this issue in Australia if anyone is interested, the third on the list. This paper finds that in the Australian national income accounts private investment appears to be the source of the discrepancy:
- Reliability of the NIPA Estimates of U.S. Economic Activity, by Dennis J. Fixler and Bruce T. Grimm, Survery of Current Business, February 2005.
- Economic interpretations of the statistical discrepancy, L.R. Klein and J. Makino, Journal of Economic and Social Measurement, Volume 26, Number 1, 2000, (abstract only).
- An Examination of the Statistical Discrepancy and Private Investment Expenditure, by Christopher Bajada, Journal of Applied Economics, May 2001.
Here is footnote 17 from the Fixler and Grimm article in Survey of Current Business:
footnote 17. According to a study of the statistical discrepancy in 1947–97 by Klein and Makino (2000), the discrepancy was statistically significant in explaining its values four quarters later, and after the discrepancy was adjusted to remove trends, the sum of corporate profits and proprietors’ income, exports, and government consumption expenditures were statistically significant in explaining the statistical discrepancy. Replication of their work by BEA for 1983–2002 and using data from the 2003 comprehensive NIPA revision found that none of the explanatory measures were statistically significant and that the four-quarter-lag effects of the discrepancy were also not significant.
As noted above, it seems clear that such correlations do exist. The question is why they are correlated which has yet to be answered.
Here’s the abstract from Klein and Makino:
Abstract: Through many comprehensive revisions of the National Income and Product Accounts (NIPA) of the US, a significant discrepancy has persisted, namely that between the estimate of the headline total now called Gross Domestic Product (GDP) from the side of expenditures or from the side of imcome payments. This discrepancy is not trivial (now in the neighborhood of -\$100^+ bn.); it is not random; it is wrongly attributed exclusively to the income side estimates. There have been interesting proposals for systematically allocating it among NIPA entries according to some statistical rule. Students of the discrepancy, over the years, have noted systematic variation with respect to international trade, inventory investment, total output and other variables. In recent years, the income side total has given a different estimate of the historical rate of change of output per worker, obviously an extremely important statistic. In a fresh examination of the discrepancy through 1996 (quarterly), we find, in this paper, suggestive correlation with business earnings, itself a very important but difficult magnitude to measure. If the NIPA data are to be used in an important way for policy guidance, a more careful treatment based on economic and statistical analysis is called for.
And finally, section 5 from Fixler and Grimm. Note the warning at the end on the use of quarterly data (I don’t think the annual/quarterly issue at the end is a problem for what I’ve presented so far):
5. The Statistical Discrepancy In principle, GDP and GDI should be equal. However, they usually differ because they rely on different source data that are not necessarily compatible. The statistical discrepancy is defined as the difference between GDP and GDI. The statistical discrepancy may be regarded as the net sum of offsetting, unknown, measurement errors. For example, if the output of drycleaning and laundry services is measured in a Census Bureau survey, and the income for this activity is measured in IRS income tax documents, a discrepancy might arise. This is true of many income-side and product-side measures.
In theory, an econometric analysis should be able to determine which income-side and product-side measures have the greatest ability to explain the statistical discrepancy. In practice, most major GDP components are highly correlated with one another, and most major GDI components are only slightly less highly correlated with one another. All of the measures are considerably less correlated with the statistical discrepancy.
As a result of the correlations among GDP and GDI components, the principal contributors to the statistical discrepancy are difficult to identify. Revisions to each component of GDP and of GDI will pass through one-for-one to the statistical discrepancy, but the effects of the revisions partly offset one another, and multicollinearity is again a substantial problem. BEA’s statistical findings about the relationships between the movements in the statistical discrepancy and those in GDP and GDI components have been inconclusive. Research on the statistical discrepancy and related topics is continuing at BEA.
For the latest annual estimates, the statistical discrepancy has large positive values in 1989–97; it dips sharply to negative values in 1998, and then it recovers to a near-zero value in 2002 (chart 3).
Annual data should be used to study the statistical discrepancy and revisions to it; if quarterly data are used, two factors act to obscure the relationships between the statistical discrepancy and the income-side and product-side components:
Seasonal adjustments. Although these adjustments remove regular fluctuations from seasonally unadjusted source data, the adjustments are not made in lockstep, and the adjustment process includes some judgments that might not be the same for related income-side and product-side measures.
Interpolation and extrapolation. The use of methodologies to interpolate or to extrapolate quarterly estimates by less-than-perfect indicator series may lead to incompatible quarterly estimates for income-side and product-side components. In addition, revisions to the indicator series or the use of different indicator series in later estimates may lead to revisions to the estimates of the statistical discrepancy.
Mixed Messages in Housing and Durable Goods Reports
New Home Sales Rise for July, Fueled by West, By Vikas Bajaj, NY Times: …A day after a report showed slowing sales of existing homes in July, the government reported today that sales of new homes rose at a brisk pace in that month, driven by big increases in the West. But the new homes report also showed a big drop in prices, which contrasted with largely unchanged prices in the earlier report. … Sales of new homes rose 6.5 percent in July, as median prices fell 7.1 percent … The two sets of data were less divergent when they were measured against July 2004. New home sales rose 17 percent and median prices … fell 4 percent in July from the same period last year. By comparison, the existing home sales were up 4.7 percent from a year ago and prices were up 14.1 percent. … [H]ours before the new home sales data was released, the Commerce Department reported that orders for durable goods fell sharply, and unexpectedly, in July as demand for planes, defense equipment, computers and a range of other expensive items fell. … It was the biggest monthly drop in durable goods order since January 2004. The decline was broad based and showed up in virtually every industry classification … Economists said the true test of whether the economy is slowing or not will be provided by reports on jobs and wages expected out early next month…
For those looking for signs of what the Fed will do, I don’t think these reports will deter the Fed from the transparent measured path they are now on. There’s not enough weakness to prevent them from raising rates again, and there is not so much strength that they will feel compelled to raise rates by more than the 25 bps increments we have seen to this point. As always, more data on prices, employment, wages, and activity will be helpful in clearing up the picture.
What Inferiority Complex? The Swedish Welfare State
In defense of the welfare state, by Jonathan Power, International Herald Tribune: (Stockholm) The statistics had arrived on the Swedish prime minister's desk … It was good news. Goran Persson, now in his ninth year of office, told me that the growth rate for this year will be near 3 percent and next year more than 3 percent - enough, he said, to maintain Sweden's trajectory of the last decade, which was "above the average for the European Union" and, in particular, "as good as the Anglo-Saxons, Britain and the U.S." ... This raised the first question - how does this self-confessed socialist state do it? What is the secret for success when Swedish taxes are the highest in the world and the welfare state is the country's single largest employer? After all, when Persson came in as finance minister in 1994 the country was reeling economically, as state expenditures on the health and social sectors raced ahead of the country's ability to generate wealth.
"If you have a free economy," explained the prime minister, "a highly educated work force, a very healthy people, very high productivity and a sound environment then you can create the critical size of resources to create good growth. "That has to be joined with adequate public financing of universities, research and development. As long as we are efficient and constantly challenging ourselves we continue to be productive. "Then if we produce successful growth, the government gets the public's support for high taxes. If the quality of the public sector is good, then a prosperous people will continue to vote for funding it."
The Social Democrats have been in power for most of the last 73 years. But recently public opinion has turned away from the government, partly because of the prime minister's apparent dictatorial style and partly because of a series of scandals including his slow response to the tsunami, when hundreds of Swedes on vacation in Thailand died. ... Many have observed that Sweden cannot sustain its generous womb-to-tomb system if so many Swedes abuse the system by calling in sick and claming unnecessary disability leave. On an average day, one-fifth of the potential workforce is claiming these rights, in a country that along with France and Japan is the healthiest in the world. "I had a new report on my desk today to show that we are getting these figures down," [Persson] said. "It is now under control. We have given employers an incentive to convince their personnel to return from sick leave by offering them a tax benefit if they succeed. … At the same time, we have been scrutinizing those doctors who have been too generous in signing sick notes."
Persson … ends the conversation with two quick jabs. "Europe has a lack of confidence vis-à- vis the U.S.," he said. "The U.S. is competitive, but not as competitive as we think. We are too self-critical in Europe, even though we have a much better social system and in Sweden are just as productive. On unemployment, it is overlooked that the U.S. has approaching two million people in jail and out of the labor market."…
A Nice Environment for a Visit
August 23, 2005
Have No Fear, The Non-Activist Fed Will Still Be Here
Greenspan will leave a less activist Fed, by Kenneth Rogoff, FT: As Alan Greenspan’s fifth and final term as Federal Reserve chairman comes to a close in January next year, more and more people are asking the question: “What were the secrets of his extraordinary success and can he pass them on to his successor?” This is not a small question given the Fed chairman’s legendary reputation for obfuscation. (According to Andrea Mitchell, his wife, Mr Greenspan had to propose three times before she understood him.)
There are, indeed, huge stakes for the global economy as the world’s most important financial position changes hands. ... However, if one looks at how the science of monetary policy has evolved over the past two decades, there is cause for optimism. In particular, although many people believe that monetary stabilisation policy has been more central than ever under Mr Greenspan, his greatest success may have come from making it less so. Let us get one thing straight. Alan Greenspan is the Michael Jordan/Lance Armstrong/Garry Kasparov of modern-day central bankers. … Mr Greenspan’s deft handling of the October 1987 stock market crash – only months after he took office – was bold and brilliant. He poured liquidity with abandon into a financial system that might otherwise have seized and collapsed. ... The Greenspan team executed a similar strategy in the wake of the September 11 2001 terrorist attacks…
He has been no less successful in the day to day routine of monetary policy. When Mr Greenspan came to the Fed, he took charge of a great team of economists and made them better. ... The enormous prestige and respect he has brought to the job has, in turn, been a huge tool in recruitment and retention of top talent. And yet, there is a curious disconnection between what most academics see as the limits of monetary policy and the popular conception of Mr Greenspan’s wide-sweeping power. … Doesn’t everyone now agree that activism has been the hallmark of the hyper-successful Greenspan Fed? Is the main complaint about the ECB and the Bank of Japan not that they are too passive?
In fact, theory and practice have converged more than meets the eye. Newer theories … have resuscitated an important role for monetary policy, albeit a narrower one than Keynes’ postwar followers once imagined. In addition, the Greenspan Fed is not nearly as activist as it seems. … By and large, Fed policy is aimed at maintaining a stable inflation rate, except in the face of clearly discernable big shocks. ... Some of Mr Greenspan’s most influential calls have come precisely from explaining how changing trends in productivity and globalisation were affecting the interest rates required to maintain price stability...
The salient effects of the Fed’s stabilising strategy, and similar ones followed by most other leading central banks around the world, have been stunning. The risk premium on long-term interest rates is down sharply, helping fuel sustained growth and expansion. (Let us set aside the thorny problem of the concomitant global housing bubble for another day.) … the volatility of global output growth has been falling steadily since the mid-1980s. Financial market deepening has also been a factor in lowering volatility by helping spread risk ... But financial market deepening, in turn, owes much to today’s more stable monetary policies. One only has to look at countries such as Mexico and Brazil ... to realise what lasting damage a history of exotic monetary policies can inflict. Also thanks to the Fed’s extraordinary success in stabilising inflation expectations, the US economy has been able to shrug off (so far) the recent round of oil price hikes. In the old days, the Fed would have been forced to jack up interest rates sharply to prevent a wage-price spiral.
Paradoxically, then, the Greenspan Fed has succeeded by reducing the role of monetary policy, rather than by enhancing it. Factoring in the superb staff and generally strong team in place on the federal open market committee, there is no reason to fear the post-Greenspan world…
Optimistic Assessment of Housing from Market Participants
US home sales dip but prices still rising, by Sheila Jones and Richard Beales, FT: US home sales fell in July from a record in June, but home prices continue to rise at double-digit rates, according to the National Association of Realtors. Total existing-home sales slipped 2.6 per cent in July to a seasonally adjusted annual rate of 7.16m from an upwardly revised record of 7.35m in June. Sales were 4.7 per cent higher than the 6.84m-unit pace in July 2004. David Lereah, NAR’s chief economist, said home sales remained in historic territory. “The level of existing-home sales in July was the third highest on record,” he said. “This is a big number any way you slice it, and housing is continuing to stimulate the overall economy.” … Mr Lereah noted that the strongest rates of price growth tended to move geographically. “In examining the hottest markets for home price appreciation, we see a rolling boom moving from one metro area to another over time, as well as a spillover effect into nearby areas with lower home prices,” he said. … Al Mansell, NAR president, said the rate of price growth reflected supply and demand. “Housing inventory levels improved in July, but they’re still quite lean by historic standards,” he said. “If the supply of homes rises, it should … take some of the pressure off of prices. Even so, we expect home price appreciation to remain above normal over the next year.”
Meanwhile, the Mortgage Bankers Association said on Tuesday it believed that suggestions of a widespread housing bubble and worries about aggressive mortgage financing products could be overdone. In a detailed analysis of the US housing market, the MBA - which represents the mortgage finance industry - concluded that there were risks, including high rates of price appreciation and a “significant share“ of speculative investment in some regional markets. It also said that relatively new financing products including interest-only mortgages were accounting for an “unusually large” proportion of the market. But the association emphasised mitigating factors, including a “healthy” economy and growing household net worth. While cautioning borrowers to approach mortgage financing with “preparedness and scrutiny“, the MBA said borrowers, lenders and investors shared a common interest in avoiding mortgage defaults and other problems. “The mortgage market is fundamentally working: lenders are innovatively creating mortgage products that meet the needs of borrowers, while taking appropriate measures to manage risk,” the MBA said.
My own view is a bit more cautious.
Aggregate Activity Watch: Are We Late or Early?
Does anybody really know what time it is? Does anybody really care? Most of you will want to skip this. Somehow, I became interested in explaining the statistical discrepancy. As this paper notes, it’s an important issue because the growth rates of GDP and GDI, quantities that differ by the discrepancy, can give different indications about the strength of economic growth.
Integrating Expenditure and Income Data: What To Do With the Statistical Discrepancy?, J. Joseph Beaulieu and Eric J. Bartelsman (SSRN paper): Abstract: The purpose of this paper is to build consistent, integrated datasets to investigate whether various disaggregated data can shed light on the possible sources of the statistical discrepancy. ... We find a few “problem” industries that appear to explain most of the statistical discrepancy. Second, we explore what combination of the expenditure data and the income data seem to produce the most sensible data according to a few economic criteria. A mixture of data that do not aggregate either to GDP or to GDI appears optimal.
Bad Monkey Memes?
Gambling Monkeys Compelled by Winner's High, LiveScience.com: When given a choice between steady rewards and the chance for more, monkeys will gamble, a new study found. And they'll keep taking risks as the stakes rise and dry spells get longer. ... The male rhesus macaque monkeys were shown either of two lights on a screen. Looking at a "safe" light yielded the same fruit juice reward each time. Looking at the "risky" light meant a larger or smaller juice reward. ... The monkeys overwhelmingly preferred to gamble, even when the game was changed so that gambling yielded less juice over time. ... In test two, the researchers made the average payoff for the risky target less than for the safe target. "We found that they still preferred the risky target," Platt said. "Basically these monkeys really liked to gamble." Platt ... fiddled with the odds even more, forcing a string of losses. But something kept the monkeys going ... "It seemed very, very similar to the experience of people who are compulsive gamblers"...
Goodfriend and King: Fed Credibility and Long-Term Interest Rates
The Incredible Volcker Disinflation, Marvin Goodfriend and Robert King, NBER WP 11562, August 2005, (NBER, earlier free version here or here): Abstract: Using a simple modern macroeconomic model, we argue that the real effects of the Volcker disinflation in the early 1980s were mainly due to imperfect credibility, evident in volatility and stubbornness of long-term interest rates. Studying recently released transcripts of the Federal Open Market Committee, we find -- to our surprise -- that Volcker and other FOMC members also regarded long-term interest rates as key indicators of inflation expectations and of their disinflationary policy's credibility. We also consider the interplay of monetary targets, operating procedures, and credibility during the Volcker disinflation.
Missing Rungs on the Social Ladder
Soaring costs leave poor students struggling to make grade, by Scott Heiser, FT: … While US inflation has been contained for the past decade, the higher education sector has proved a glaring exception. The College Board … says tuition and fees rose 10.5 per cent in the 2004 academic term at four-year public (government-funded) universities, and 6 per cent at four-year private universities. Adjusted for inflation, students at four-year public institutions paid 51 per cent more in 2004 than in 1994, while those at four-year private universities paid 36 per cent more. … The rising cost of higher education in the US is raising new questions about whether universities will still be able to serve as ladders of social mobility. … US higher education is already the most expensive among advanced industrialised countries. ... Yet enrolment at US universities continues to surge, rising from 14m in 1995 to 16m last year. Indeed, the benefits have proved well worth the costs, in spite of the growing debt burdens for students. US Census Bureau data show that average lifetime earnings of college graduates are $2.1m, compared with $1.2m for high school graduates. Students from poorer families, for whom higher education has long been the best road out of poverty, are becoming especially concerned. Thomas Mortenson, a scholar with the Pell Institute, has found that … the number of bachelor degrees awarded to students from the poorest quarter of US families has stayed nearly level over the past decade, and has improved only slightly since 1970. In contrast, degrees given to students from the richest quarter of US families have risen steadily from about 40 per cent in 1970 to nearly 75 per cent today. In 2003, 74.9 per cent of the top income class attained degrees, compared with just 8.6 per cent of the bottom income class. Inequity at top schools is a particular problem …
401(k) Opt-Out Regulation Proposed by Labor Department
Rule would encourage automatic 401(k) enrollment, by Kathy Chu, USA Today: The Department of Labor expects to propose a regulation by year's end that will encourage companies to automatically enroll their workers in 401(k) plans. … Once the regulation is proposed, the public will be able to comment on it before it becomes final. The regulation could affect millions of workers in 450,000 retirement plans. … The Labor Department says the proposed regulation should give employers who automatically enroll workers in a 401(k) plan some protection from lawsuits if the investment options chosen are "reasonable." Some companies are reluctant to use automatic enrollment for fear that employees whose investments lost money would sue. … Many companies that automatically enroll employees use conservative money-market or stable-value funds as a default. ... If employers view the Labor Department's guidance favorably, it could be seen as removing the last barrier to automatic enrollment … Automatic enrollment can be extremely effective in boosting 401(k) participation, especially among young and lower-income workers … Taking advantage of 401(k) plans is becoming increasingly important as companies drop pension plans…
The Systematic Statistical Discrepancy Between GDP and GDI
Here’s what I did. I used three data series, GDI (gross domestic income), the statistical discrepancy ( the difference between GDP and GDI, call it DISC), and G (government spending). Here’s a graph of DISC/GDI and G/GDI:
Why are these two series so closely related? I would have thought, before seeing this picture, that the discrepancy was mostly random and unpredictable, but it isn’t. It appears largely predictable from movements in G, though this may be spurious, e.g. a third variable may be causing both.
With the question is better formulated, the next step is understanding the correlation. William Polley suggests in an email it may be that business cycle conditions are driving both variables, i.e. G acts as an automatic stabilizer and varies negatively with output over the business cycle, and the discrepancy also varies systematically over the cycle so that the correlation in the graph is spurious. This is worth checking because, as he notes, it would mean we are systematically mismeasuring output over the business cycle.
In the first post, there was also a suggestion that I/GDI moves with the discrepancy. It does, but not as closely as G/GDI, particularly between approximately 1991 and 1996:
Some progress, but, once again, more to follow...
Update: Here is a graph of the Disc/G ratio:
Because G trends upward, this is essentially a graph of the Disc with a heteroskedasticity correction. The scale is shifted a bit relative to the graph above it because it's not a two-scale graph, but the pattern is the same. You can see the correction here (note this starts at 1959):
Dividing by G normalizes the larger movements at the end. Dividing G by GDI and Disc by GDI in the graphs above does the same thing, dividing by GDI normalizes G and Disc.
The surprise to me was that dividing G by GDI produced the pattern evident in the raw Disc series, and even more evident in the normalized series.
August 22, 2005
Updated Evidence on the Productivity Puzzle
I still need to figure out why these move together. I’m finding out all I don’t know about how the NIPA accounts are actually calculated by the BEA. I hope I’m not missing something simple! In any case, there’s still more to follow. One way or the other, I want to understand why GNP/NI varies through time. Repeating from the earlier post, here's how these series are related:
Recall that S = I + (G-T) + NX. Then S/NI = I/NI + (G-T)/NI + NX/NI. Replace S to obtain (GNP-C-T)/NI = I/NI + (G-T)/NI + NX/NI so that GNP/NI = C/NI + T/NI + I/NI + (G-T)/NI + NX/NI (this is just GNP=C+I+G+NX divided by NI). But this just relates the terms, it doesn't explain why GNP/NI varies, nor why GNP/NI and G/NI move together.
Update #1: I should have put these in from the start. Following up on PGL's comment, NNP (net national product) is GNP-depreciation. NI (national income) is NNP-indirect business taxes (e.g. sales taxes). Then NI = GNP - depreciation - indirect business taxes. So the difference between GNP and NI is depreciation + indirect business taxes, and there is also the statistical discrepancy to account for. But, again, why does this vary with G? I keep getting the feeling there's something simple I'm missing. I hope at some point to relate this back to productivity (which measure, income or product, is used matters), but for the moment I've become interested in explaining the pattern Brad DeLong first identified here.
A Common Misconception Regarding Keynes and Neoclassical Economics
America benefits from the wisdom of Adam Smith, by Thomas Bray, The Detroit News: In 1971, seeking to justify the scrapping of the gold standard … Richard Nixon declared "we are all Keynesians now." He was referring to British economist John Maynard Keynes, who in the 1930s called the gold standard a "barbarous relic" ... Alas for Nixon, those policies were no more successful in the 1970s than they had been in combating the long Depression. … President Bush responded to the bursting of the economic bubble of the late 1990s in quite a different fashion ... He cut tax rates and has generally supported Federal Reserve Board Chairman Alan Greenspan's efforts to keep prices on an even keel. ... As a result, the economy has responded with two years of uninterrupted, low-inflation growth, despite the phenomenal spike in oil prices. Bush might say we are all Adam Smithians now, referring to the British economist who argued for the market system and against unbridled government intervention. Indeed, last February, no less than Alan Greenspan paid a remarkable homage to Adam Smith in a lecture in Kirkaldy, Scotland, Smith's birthplace. … Nonetheless, intellectuals and politicians forgot about Smith. They rushed to embrace Keynesian theory, whose near-mystical complexities allowed them to believe government could stimulate the economy to even higher performance. Alas, most of their imagined improvements turned out to have counterproductive long-term effects. As a result, Smith is getting a fresh hearing, as the Greenspan lecture suggests…
First, note that Bray congratulates Greenspan and Bush for their use of tax and monetary policy to manage the economy, then states how faithful this is to the ideas of Adam Smith. Sorry, but that’s not quite the laissez faire approach Smith had in mind. But my main purpose is not this particular point so let’s move along. The editorial proceeds on an incorrect premise, one that is common so it’s worth dispelling.
When the General Theory appeared in manuscript form, some neoclassical economists expressed concern on this very issue. Keynes, upon hearing this, wanted to counter this notion strongly and included the following statement in his book to express his solidarity with neoclassical economics. While there was disagreement over the extent to which his model truly represented a generalization of the neoclassical model and not a special case, that Keynes believed it was a generalization of the neoclassical model rather than a replacement for it is not in doubt. Also note his discussion of tax and interest rate policy in the first paragaph, precisely the type of Keynesian policy the editorial congratulates Bush and Greenspan for using:
The General Theory of Employment, Interest and Money, ch. 24: … the foregoing theory is moderately conservative in its implications. For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected. The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. ... But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary...
Our criticism of the accepted classical theory of economics has consisted not so much in finding logical flaws in its analysis as in pointing out that its tacit assumptions are seldom or never satisfied, with the result that it cannot solve the economic problems of the actual world. But if our central controls succeed in establishing an aggregate volume of output corresponding to full employment as nearly as is practicable, the classical theory comes into its own again from this point onwards. If we suppose the volume of output to be … determined by forces outside the classical scheme of thought, then there is no objection to be raised against the classical analysis of the manner in which private self-interest will determine what in particular is produced, in what proportions the factors of production will be combined to produce it, and how the value of the final product will be distributed between them. …. Thus, apart from the necessity of central controls to bring about an adjustment between the propensity to consume and the inducement to invest, there is no more reason to socialise economic life than there was before. …
Thus I agree with Gesell that the result of filling in the gaps in the classical theory is …to indicate the nature of the environment which the free play of economic forces requires if it is to realise the full potentialities of production. … the modern classical theory has itself called attention to various conditions in which the free play of economic forces may need to be curbed or guided. But there will still remain a wide field for the exercise of private initiative and responsibility. Within this field the traditional advantages of individualism will still hold good.
Let us stop for a moment to remind ourselves what these advantages are. They are partly advantages of efficiency — the advantages of decentralisation and of the play of self-interest. ... But, above all, individualism, if it can be purged of its defects and its abuses, is the best safeguard of personal liberty in the sense that, compared with any other system, it greatly widens the field for the exercise of personal choice. It is also the best safeguard of the variety of life, which emerges precisely from this extended field of personal choice, … it is the most powerful instrument to better the future.
Whilst, therefore, the enlargement of the functions of government, involved in the task of adjusting to one another the propensity to consume and the inducement to invest, would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it, on the contrary, both as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative.
Remember the conditions during the Great Depression. Keynes believed he was stopping the capitalist system from destruction by the only “practicable means,” not replacing it with a new paradigm. He wanted to restore the system to full employment where the wonders of the free market system can express themselves, not a State run economy.
By embracing Keynes, neoclassical economics is not rejected, it is enhanced. It allows a theory of the short-run to emerge within the classical structure. Without such a theory our understanding of economic fluctuations is limited. There is currently a movement within the economics profession to do just this type of synthesis. Real business cycle models, i.e. supply-side models, are adequate models of the long-run but do not explain demand side short-run economic fluctuations very well. Because of this, they are limited in their applicability. Models with wage and price rigidities, New Keynesian models, do have the ability to explain such short-run fluctuations but pay scant attention to long-run issues. Combining these two models, a real business cycle model for the long-run and a New Keynesian model of wage and price rigidity for the short-run, is a promising avenue for explaining macroeconomic fluctuations. Incorporating New Keynesian theory into these models does not undermine free market principles nor the belief in individual liberty. Quite the contrary. By having more realistic models of economic fluctuations, policy and institutions can be designed to enhance the performance of markets and thereby enhance economic well-being.
Thomas Promises Vote on Social Security Reform Despite GOP Rift
'Grow accounts' beckon, by Donald Lambro, Washington Times: It's now almost certain the House will vote this fall on a Social Security reform bill to let workers invest part of their payroll taxes in U.S. Treasury bonds they would own. Contrary to the belief President Bush's investment accounts plan is dead, half of his reform proposal is alive and kicking in the House. … The so-called "grow accounts" bond investment bill has the full support of House Republican leaders, including Speaker Dennis Hastert of Illinois and Majority Leader Tom DeLay of Texas, who is pushing for an early vote. The only thing missing right now is Mr. Bush's support. The White House has been cool to the idea, but conservative strategists say the bill would "pass the House in a heartbeat" with the president's backing. … Whether the trimmed-down retirement accounts proposal will be part of a more comprehensive reform bill being assembled by Ways and Means Chairman Bill Thomas, California Republican, or passed separately isn't clear, a senior House Republican leadership official told me. But the … bill will come up for a vote in the House this year, "one way or another," he said…While the … idea is less than the sweeping privatization reform conservative reformers wanted, they now see the stripped-down proposal as "the camel's nose under the Social Security tent" that would eventually lead to a more expanded program including stocks. … How about it, Mr. President?
The camel’s nose under the Social Security tent. Hmmm. What does the camel really want?
The Never Ending Greenspan Story
The activist unafraid to depart from the rules, by Andrew Balls, Financial Times: … Mr Greenspan took over at the Fed on August 11 1987 – less than two weeks before “Black Monday”, when the Dow Jones industrial average dropped 22.6 per cent; the largest daily fall in the history of the US stock market. Mr Greenspan’s immediate response, saying the Fed would pump money into the financial system to maintain liquidity, helped to put an end to worries about how the central bank would fare after the departure of Paul Volcker, his predecessor. … Mr Greenspan has cemented the Fed’s anti-inflation credibility but his reputation has been built on the flexibility he has shown. The challenge for his successor will be to match Mr Greenspan’s record of getting the big calls right. …
Mr Greenspan made clear from the outset that he wanted to see lower inflation than the 4 per cent rate he inherited. … Yet it is simplistic to call him a mere inflation hawk. ... Mr Greenspan has been prepared to tolerate higher “headline” inflation at times when it was clear this was not feeding into higher “core” inflation. … There have been times when Mr Greenspan persuaded his colleagues to raise rates faster than they wanted to – but also times when he has persuaded the FOMC to hold off. In sum, he is better described as an activist than a hawk…
Over the period since 1987 as a whole, the Fed has followed a highly predictable approach. The “Taylor rule” … offers a good overall guide to monetary policy in the Greenspan era. It provides an equation that describes Fed monetary policy as reacting to growth that diverges from the economy’s potential rate, and to inflation relative to a presumed inflation target. ... Larry Meyer, … who was a Fed governor in 1996-2002, says: “The chairman played by the rules in normal times. There is often this notion that he has a seat-of-his-pants, ‘you can’t write it down’ approach, but the Taylor rule fits extremely well most of the time. What distinguished the chairman was when he had to depart from the rules.”
Many economists believe Mr Greenspan’s crowning achievement was his response to signs of the productivity boom of the 1990s. He understood the change early and acted upon it, allowing unemployment to fall lower than many economists thought was possible without stoking inflation. … He has distinguished himself in crisis management. After the crash of 1987 he ignored advice that he should wait and gauge the impact on the economy. He also increased liquidity in 1998 after the Asian financial crisis and Russia’s default, and in 2001 after the September 11 terrorist attacks. While this can be can be explained in terms of risk management, it can also seen as the exercise of typical Greenspan discretion…
Mr Greenspan has contrasted his risk-management approach with the standard academic economist’s confidence in economic models and policy rules. The presumed favourites to replace him – Martin Feldstein of Harvard, Glenn Hubbard of Columbia and Ben Bernanke of Princeton – are academic economists, though the White House has said it is considering other candidates including business and Wall Street figures. Henry Kaufman, the Wall Street economist and financial consultant, says: “It is very helpful to have a broad-based individual who knows financial markets.”…
Mr Greenspan has been criticised for dabbling in politics. He is not a particularly partisan Republican – he supported the Clinton administration’s tax increases of the early 1990s as well as the Bush tax cuts of this decade – but has an overriding belief in the power of market forces and the benefits of unfettered capitalism. …
Monetary policy in this … illustrates another feature of the Greenspan era: the Fed’s move towards greater transparency, which has gathered pace. ... During the past two years the FOMC has given guidance on the likely course for the federal funds rate, since June of last year raising the rate by a quarter-point at each meeting and saying each time it expected to continue raising rates at a “measured” pace. This year, the Fed began publishing FOMC minutes sooner, making them a more timely guide to the committee’s thinking … A more formal and clearly explained strategy may help a successor to establish credibility. …
Mr Greenspan’s view that the Fed should not try to burst a bubble by raising interest rates when the outlook does not demand it is based partly on the difficulty … of spotting the difference between an unsustainable surge in prices based on speculation and a sustainable one based on fundamentals. But Mr Greenspan believes in any case that … the Fed’s job to pursue policies aimed at low inflation and full employment, not to target asset prices… Alan Blinder, the Princeton professor who is giving a paper on the Greenspan era at this week’s Jackson Hole symposium, calls this the Fed’s “mopping up” strategy. …
Mr Greenspan has suggested that the Fed’s success in securing low inflation and less volatile economic growth may itself lead to more speculation in asset markets, as investors conclude that these good times are likely to continue. Part of the next Fed chairman’s inheritance will be a housing market that … is showing signs of “froth” in a number of cities, amid buy-to-let speculation that has resulted in “speculative fervour” in some areas. At their June meeting, the … Federal Open Market Committee discussed house prices and came to the same conclusion as it had with the stock market: the Fed should deal with the consequences in the event of a market disturbance. Henry Kaufman, the Wall Street economist, believes the FOMC is too sanguine: that the housing market poses grave risks for the economy and that the Fed’s assurances that it will raise rates at a “measured” pace have contributed to a household debt-financed consumption binge and to speculative activity by investors. “The new exuberance is in the housing area, and that problem will have to be resolved by the next chairman,” Mr Kaufman says…
The Visible Foot
Not the Biggest Man on Campus, but Surely the Biggest Foot, by Michael Brick, NY Times: …. When Brooklyn College started renovating its lecture halls in May, scientists began packing what they had assumed was a case containing a plaster cast of dinosaur tracks, a teaching tool held in such regard that it was often obscured by a projector screen. Removing the case, they found that the block on the wall ..., so phony-looking it could be mistaken for something carbon-frozen in "The Empire Strikes Back," was a real rock embedded with tracks more than 100 million years old, worth hundreds of thousands of dollars and holding immense archaeological value. ... There are two tracks in the rock, a shallow one a couple of feet across and a deeper, narrower one the shape of a crescent. Based on the kinds of tracks common to the Paluxy River bed, the scientists at Brooklyn College said the big one was probably made by a Pleurocoelus, a 20-ton herbivore that has been named the Texas state dinosaur. The smaller one may have come from an Acrocanthosaurus, a sharp-toothed monster Pleurocoeluses sought to avoid meeting in dark cretaceous alleys...
Posted by Mark Thoma on Monday, August 22, 2005 at 01:26 AM in Science
August 21, 2005
Evidence on the Productivity Puzzle
As Brad noted, an important issue to resolve is the difference in measures of gross national product and national income, measures that ought to be the same. This issue is also covered in the NY Times as he notes in a follow-up. Brad explains why this is important and since this post will run long anyway, I will not repeat the reasoning here other than to note that it affects our view of the strength of productivity, an important issue for monetary policy. The goal here is to present evidence that narrows the scope of possible explanations (there is an update to this post here).
A similar effect is also present in GDP/NI, but it is not nearly as pronounced. In fact, this looks like a series with relatively flat periods and periods of increase, e.g. there are steady increases from around 1974-1987 (or maybe from 1965-1987 depending on how you look at it) and from 1999-2004 and perhaps beyond as the downturn at the end could be transitory:
Next, here are the components the output measure, C, I, G, and NX relative to NI. In addition, the deficit is also graphed relative to NI.
Here are the graphs, first C and G relative to NI. These are somewhat similar towards the end of the sample, and both series are fairly stable. They do not appear to match the GNP/NI series very well:
Next, here is NX/NI which isn’t as stable, but does not follow the same pattern as GNP/NI either, the pattern we are trying to explain:
Just to check, here’s a graph of net taxes to NI, T/NI, which also follows a different pattern:
Finally, the graphs for I and the deficit relative to NI do show a pattern similar to the pattern for GNP/NI, so it appears the key to explaining the puzzling pattern in GNP/NI may lie with the comparison of movements in GNP/NI with movements in these series:
Furthermore, these two series mirror each other to a large extent, particularly towards the end of the sample, implying that they are negatively related. That is, an increase in the budget deficit is associated with a decline in investment, both relative to NI. To make it easy to compare the graphs, here’s the GNP/NI graph again along with the Deficit/NI ratio:
This pattern in the GNP/NI series seems particularly close to the pattern in the deficit/NI series, though the reverse pattern in I/NI is close too. Thus, the explanation for variation in GNP/NI appears to be driven by the the deficit/NI and I/NI ratios or by a common set of factors driving all three series. Now the question is why these series are so similar. More to follow.
Update: Here's how the terms are related. Recall that
S = I + (G-T) + NX.
S/NI = I/NI + (G-T)/NI + NX/NI.
This is then (GNP-C-T)/NI = I/NI + (G-T)/NI + NX/NI,
GNP/NI = C/NI + T/NI + I/NI + (G-T)/NI + NX/NI.
But this just relates the terms, it doesn't explain why GNP/NI varies, nor why GNP/NI, (G-T)/NI, and I/NI covary.
Bubbling with Anti-Exuberance
Be Warned: Mr. Bubble's Worried Again, By David Leonhardt, NY Times: Abby Joseph Cohen, the Goldman Sachs strategist ... sat directly to Alan Greenspan's right. One chair away was Robert J. Shiller, a largely unknown Yale economist. As they ate lunch in a stately dining room at the Federal Reserve that day in December 1996, Mr. Shiller argued that the stock market had risen to irrational levels. ... he asked Mr. Greenspan, the Fed chairman, when the last time was that somebody in his job had warned the public that the stock market had become a bubble. Mr. Greenspan listened without giving his opinion, and Mr. Shiller went home ... Three days later ... Mr. Shiller heard on the radio that stocks were plunging because Mr. Greenspan had asked in a speech whether "irrational exuberance" was infecting the markets. "I may have just started a worldwide stock-market crash," the professor told his wife, Virginia, who accused him of delusions of grandeur. Today, nine years after his lunch with Mr. Greenspan and five years after the markets finally did crash, Mr. Shiller is sounding the same warning for real estate that he did for stocks. ... He predicts that prices could fall 40 percent in inflation-adjusted terms over the next generation and that the end of the bubble will probably cause a recession at some point...
[H]e has become the bugaboo of the multibillion-dollar real-estate industry. Its executives … say that low interest rates and a growing population will keep house prices rising, even if future increases are smaller than recent ones. … "Shiller is predicting the mountain goes into the sea," Robert I. Toll, the chief executive of Toll Brothers, a home builder, said in a recent interview, without having been asked about the economist. "He's selling himself." To Mr. Shiller, though, it is a question of history, not salesmanship. Most people have never looked at decades and decades of home prices, because such data have been almost impossible to find. … But Mr. Shiller has unearthed some rare historical housing data for other countries. Using old classified advertisements, he was then able to fashion a chart for the United States that goes back to the 19th century.
It all points to an unavoidable truth, he says. Every housing boom of the last few centuries has been followed by decades in which home values fell relative to inflation. Over the long term, the portion of income that families spend on their shelter stays about the same. Builders become more efficient ... Places that were once sleepy hinterlands, like the counties south of San Francisco … turn into bustling centers that take pressure off prices elsewhere. Even now, the United States remains a mostly empty nation.
"This is the biggest boom we've ever had," said Mr. Shiller, who bought into the boom himself in 2002, with a vacation home near one of Connecticut's Thimble Islands. "So a very plausible scenario is that home-price increases continue for a couple more years, and then we might have a recession and they continue down into negative territory and languish for a decade. "It doesn't even attract that much attention," he continued. "There will be many people thinking it was a soft landing even though prices may have gone down in real terms by 40 percent."
Mr. Shiller begins his story 400 years ago, in the country that helped invent the idea of a bubble. In 1585, workers in Amsterdam began to dig a canal through the city. It became known as the Herengracht, or gentlemen's canal, for the fashionable row houses that soon sprang up on its banks. Merchants moved into many of them, and the canal remains one of the city's finest addresses today.
In recent years, a Dutch economist named Piet M. A. Eichholtz heard about a book from the 1970's that traced the Herengracht's history, including records of every sale. But his efforts to track down a copy failed - until he was browsing through a secondhand bookstore in Amsterdam … not long after Mr. Shiller's lunch with Mr. Greenspan, and stumbled across one. It had all the details Mr. Eichholtz wanted. To translate the sales into an index of prices over the years, Mr. Eichholtz turned to a method invented by Mr. Shiller and a colleague. … On the Herengracht, those returns have often been fantastic for 25 or even 50 years at a time. Home prices soared in the first half of the 17th century, … But they came crashing down in the 1670's, when the prime minister was killed, and partially eaten, by a mob of angry Dutch, and the country nearly disintegrated. … Again and again, the cycle repeats itself. But there is essentially no long-term trend, beyond a general rise in house prices that roughly matches gains in peoples' incomes. As Amsterdam became a global city and its population exploded, demand for homes increased - but so, too, did supply.
Prices have hardly become more stable over the last 400 years; in fact, they've jumped up and down more in the 20th century than they did during the 18th and 19th. Only the 17th century, that time of cannibalized prime ministers, was more volatile. "A whole lot of the price increases you see in houses is imaginary, because it's just inflation," said Mr. Eichholtz, a professor at Maastricht University. "People say, 'I have a house. It protects me against the economic imbalances or misfortunes of the country.' The big lesson is that real estate does not give you the protection that people think it does."
A history of Norwegian house prices that Mr. Shiller has found shows the same pattern. … But this is actually a happy story in many ways. Over the long course of history, families have not been forced to devote an ever-larger chunk of their money to the roof over their heads. …
Mr. Shiller takes no credit for the phrase "irrational exuberance." He does not remember using it during the conversation. … His good friend, Jeremy J. Siegel, an economist at the University of Pennsylvania, stumbled upon a 1959 quotation from Fortune magazine in which Mr. Greenspan discussed "over-exuberance" in the financial community. The phrase is probably his. … Mr. Shiller has little company for his radical notion that house prices could fall by 40 percent. ... Mr. Shiller himself confesses to some doubt. … "We do have a shortage of land in the prestige areas, and so there is a potential for them to go up," he added. "But I just know that the trend over the last century has been for new prestige areas to appear." If he is right, the Herengracht also looks due for one of its occasional corrections. Prices there have doubled, even accounting for inflation, over the last decade or so. It almost seems like they might never fall again.
Irwin Stelzer Says Fed Will Proceed Carefully Along the Measured Path
It’s steady as she goes for Fed chief in booming US, Irwin Stelzer, Times Online: Alan Greenspan … might … describe the situation in which he now finds himself as a quandary, a state of extreme perplexity. Start with the contradictory nature of the information about the state of the economy. Last week the government reported that the producer price index had jumped 1% in July, … an indication that inflation is taking off, that high oil prices are finally seeping into the prices of other goods, and that interest rates should be raised. Well, not so surely.
It turns out that the core index was driven upwards by seasonal factors and a rise in car prices. … The Fed chairman’s crystal ball is made even cloudier by uncertainty as to just how fast the economy is growing. Initial reports suggested that the economy grew at an annual rate of 3.4% in the second quarter, … But it turns out that … unexpectedly large spurt in imports mean that … output might have been lower than the original data suggest. Greenspan also has to wrestle with major uncertainties concerning the state of the housing market … and the rate at which productivity is increasing. With the labour market tightening, and wages inching up, offsetting increases in productivity are needed to keep labour costs under control. So inflation fighters view with alarm the recent decline in the increase in productivity. … That worry might be misplaced. Productivity in the non-financial corporate sector, the measure that Greenspan watches most closely, rose … significantly faster ...
The evidence suggests that, despite worries … he is satisfied that the economy is on a sustainable growth path, and that his policy of “measured” interest-rate increases is just the thing the economy needs to prevent inflation. Which brings us to oil prices. The rise of crude oil prices … has fueled inflation fears. In the past, monetary policymakers have responded by raising interest rates. That was a mistake. … it would be folly to tighten monetary policy in response to a rise in oil prices, rather than a jump in the general price level. Indeed, other things being equal, the Fed would be tempted to loosen monetary policy to offset the drag created by the higher oil prices … My guess is that Greenspan won’t panic and accelerate the interest-rate increases he is planning in his hunt for a level that will neither speed up nor slow down economic growth. Nor will he abandon his current “measured” increases, at least not just yet. He is unlikely to loosen policy to accommodate higher oil prices until he has a strong indication that the drag they create is overwhelming the growth-creating forces driving the economy. Steady as she goes is likely to be the message, at least for now.
What they say, The Observer: Stephen Roach, chief economist at Morgan Stanley: 'There's an awful lot of issues he's had to cope with. He's done a masterful job in dealing with many of them. But the starting-point in terms of his legacy for me is the way in which he has failed to stop the process of asset bubbles, starting with equities and now into property. 'In the late 1990s he should have been predisposed very differently in addressing the equity bubble. Not only did he fail to use margin requirements as a signaling measure, but he continued to extol the virtues of a productivity-led boom. It is argued that he can deal with bubbles after the fact, but it may be a solution that only works once. Now we have another bubble, and it's an even bigger one.
'It depends on how deeply you look at the economy: on the surface, growth is solid, inflation is low, unemployment is low; but when you look just below the surface, you see some very serious problems. After his "irrational exuberance" speech, he took a lot of political flak, and he did alter his stance. In retrospect that was a serious mistake.'
Ravi Batra, professor of economics at the Southern Methodist University, Dallas, and author of Greenspan's Fraud: 'He helped to bring about a rise in taxes for the poor: he's the author of regressive taxes for America, which led to very poor economic growth rates. That policy had consequences for the whole world. In the UK and Germany, tax policy became regressive, and led to a slowdown in demand growth. 'In terms of monetary policy, he caused the stock market bubble in the US, and he used his monetary policy to suppress wage gains. He would raise interest rates on the pretext that it would cause inflation whenever wages threatened to rise. Greenspan's monetary policy helped to create the stock market bubble.' 'He favoured the financial economy because he wanted to get reappointed as chairman of the Fed again and again: and Wall Street is the key to the reappointment.'
Charles Goodhart, former member of the Bank of England's Monetary Policy Committee: 'He is a great figure. He took over in rather difficult circumstances, immediately before the crash in 1987, and he managed to keep everything going through that. He handled the financial crises in the 1990s very effectively. There are those who say he recognised irrational exuberance early, and then changed his mind. At the same time, it's got to be said that he saw the acceleration in American labour productivity far earlier than anyone else did. 'You could say he missed the stock market bubble, but even if he had read it right, what could he have done about it? Given that inflation was relatively stable, and the economy was getting on very well, it would have been very difficult.'
Sir Digby Jones, director general of the CBI: 'Alan Greenspan is the doyenne of central bankers. The first two thirds of his tenure were hugely successful. He never played to the crowd; he raised or cut interest rates when he judged best, not the market. But he probably overstayed his welcome. Although he was not the only one responsible, America's trade deficit has ballooned and the country is in hock to China. It happened on his watch.'
John Calverley, chief economist at American Express and author of Bubbles and How to Survive Them: 'He was very good at dealing with a weak economy, and with the aftermath of a bubble. He dealt with the 1987 stock market crash very well: he immediately cut interest rates and made sure it didn't have a lasting impact. He did the same thing again in 2001-02, when he cut interest rates to one per cent. The criticism would be that he's not quite so hot at dealing with the boom period. 'He talked about irrational exuberance, but when prices started to go up again, he backed away. He became a bit of a cheerleader for the technology and general stock bubble. I think generally the economy is strong, but the one cloud on the horizon is house prices.'
Einstein’s Need for Office Supplies Revealed by New Discovery
Handwritten Einstein Manuscript Discovered, AP: The original manuscript of a paper Albert Einstein published in 1925 has been found in the archives of Leiden University's Lorentz Institute for Theoretical Physics...
The handwritten manuscript titled "Quantum theory of the monatomic ideal gas" was … Considered one of Einstein's last great breakthroughs, it was published in ... January 1925. ... said professor Carlo Beenakker. "You can even see Einstein's fingerprints in some places, and it's full of notes and markups from his editor." ... The paper predicted that at temperatures near absolute zero — around 460 degrees below zero — particles in a gas can reach a state of such low energy that they clump together in one larger "mono-atom." The idea was developed in collaboration with Indian physicist Satyendra Nath Bose and the then-theoretical state of matter was dubbed a Bose-Einstein condensation...
Posted by Mark Thoma on Sunday, August 21, 2005 at 02:07 AM in Science
Reuters: Rare Randy Romeos Ravaged
Scientists try to save rare and randy warbler, Reuters: Europe's rarest songbird is facing extinction, despite being the most promiscuous and energetic lover in the avian world … The male aquatic warbler is described as "continuously ready to mate" and able to indulge in record-breaking mating sessions ... However, numbers have slumped to less than 20,000 in the past century -- a decline of 95 percent … as humans have ravaged its habitat. … as marshlands are drained and farmland is expanded. The male bird plays no part in nest-building or raising chicks and spends most of its time hunting for willing females and mating at length. … most birds … get the business over in a mere one to two seconds' sexual contact … aquatic warblers spend up to 35 minutes copulating…
Posted by Mark Thoma on Sunday, August 21, 2005 at 01:53 AM in Science
August 20, 2005
The Economist: The Future of Iraq's Economy Looks Grim
Struggling to pick up the pieces, The Economist: A new report from the International Monetary Fund says that Iraq’s economic growth is stalling because of the deteriorating security situation. Political progress, too, seems to have slowed, with the government struggling to produce a new constitution. Without substantial improvement in one of these areas, the future of Iraq looks grim:
In Iraq these days, ... If the government can get the struggling economy back on its feet, rising incomes will sap the supply of desperate insurgents. But as a new report from the International Monetary Fund (IMF) makes clear, it will be devilishly hard to get the economy back on track without first stemming the tide of the insurgency, which is devastating efforts at reconstruction. Iraq’s all-important oil industry is the most obvious victim of this. … This slump … is caused by the unexpectedly low volume of oil production, ... The report attributes this to the insurgency, which has made Iraq’s oil infrastructure one of its primary targets.
The insurgency is hobbling development efforts in other ways. The threat of violence has deterred investment in the country; ... Security and insurance reportedly make up 30-50% of total reconstruction costs. The result is economic insecurity that undoubtedly makes recruiting easier for the insurgents. … Public services, which help form people’s opinion of the government, remain patchy and unreliable. Last week Muqtada al-Sadr, the Shia cleric who at one time headed his own insurgent force, began calling for protests against the poor level of water and power services. While virtually all of Iraq’s households are hooked up to the electric grid, and most of them have access to piped water, many report that the reliability of supply is very poor.
These problems are less likely to be fixed while Iraq’s politics remain testy and fractured. ... Meanwhile, the country’s economic team struggles on as best it can. The IMF highlights several areas of concern, chief among them the parlous state of Iraq’s budget. Problems in the oil sector have deprived the state of much-needed revenue for reconstruction. … The IMF is urging Iraq’s economic team to begin phasing out domestic subsidies for petroleum products, which are a drain on the budget; Iraqis can buy petrol at a mere 1.3 American cents per litre. These subsidies are estimated to cost the government nearly $8 billion each year. Ministers seem to agree that ending them is a good idea, but they know that this will not be popular.
Monetary policy is also fraught with difficulties. Consumer price inflation was over 30% in the year to December 2004. ... The Fund attributes the difference to increased violence in the months leading up to the January 2005 parliamentary elections, which raised the prices of key commodities like gas and food. The Central Bank of Iraq recently broadened the range of tactics it uses to mop up excess liquidity in the system and maintain the dinar’s de facto peg to the dollar, which, given the primitive state of Iraq’s financial system, is the best mechanism the bank has to keep prices stable. ... the IMF gives a warning that much more needs to be done, and thinks that inflation may surge again in the coming months to produce an average of as much as 20% for 2005.
Overall, Iraq’s economic team seems to be saying the right things. It has plans to modernise the undercapitalised banking system, which currently has no facilities for electronic payments and only a rudimentary process for cheque-clearing. It is working to reduce Iraq’s external debt, which even after a round of debt forgiveness will stand at an excruciating three times GDP. And it is trying to put in place the fiscal and monetary mechanisms that will let the government piece the country back together. Until the insurgency wanes, however, things may fall apart faster than even a crack economic team can pick up the pieces.
If the Cause Be Not Good
"If the cause be not good," Shakespeare cautioned in "Henry V," "the king himself hath a heavy reckoning to make, when all those legs and arms and heads, chopped off in battle, shall join together at the latter day and cry all 'We died at such a place,' . . If these men do not die well, it will be a black matter for the king that led them to it."
Posted by Mark Thoma on Saturday, August 20, 2005 at 01:08 AM in Iraq
Media Bears, Editorial, WSJ: The paradox of the year is why so many Americans tell pollsters they feel bad about an economy that's been so good, with solid job growth and corporate profits, rising wages and home prices, and a huge decline in the budget deficit. Perhaps one reason is because the media keep saying the economy stinks.
That's the conclusion of a study to be released today by the Media Research Center, which finds that so far this year 62% of the news stories on the Big Three TV networks have portrayed the U.S. economy in negative fashion. The "negative full length TV news stories on the economy outnumbered positive stories by an overwhelming ratio of 4 to 1," the MRC reports. … Contrast that funeral dirge with what Federal Reserve Chairman Alan Greenspan told Congress that same day: "The outlook is one of sustained economic growth." … Media coverage of President Bush's tax cuts has been particularly slanted. ... The favorite criticisms were liberal echoes that it would bust the budget and favor the rich. Earlier this year, a news story on National Public Radio announced that "as everyone knows, the primary cause of the budget deficit was the Bush tax cuts." No word yet on whom NPR is crediting with this year's revenue surge of $262 billion. Robert Rubin? Given all of this doom-and-gloom reporting, maybe the surprise is that Americans are nonetheless behaving with their typical optimism, buying goods and services, bidding up the stock market, and creating new businesses. They may repeat to pollsters what they hear on TV, but they are acting on what they see with their own eyes.
One reason for the pessimism in the news reports is very simple. That opinion was shared by most professional economists, I am sure it was more than 62%, and still is. And the WSJ and NRO can keep claiming that tax cuts improved the deficits all they want, it doesn’t make it true. The tax cuts favored the rich and made the deficit worse. Here are analytics on tax cuts and deficits, not hopeful opinion expressed as though it were fact. And since we are playing the quote game, here’s one from Greenspan that was left out of the editorial:
Unless Congress makes major changes in how it makes the budget, he said, the country will run deficits large enough to cause the economy "to stagnate or worse." … Mr. Greenspan, in testimony before the Senate Budget Committee, described the economy as healthy but said it faced far too many uncertainties …
The WSJ editorial page ought to clean up its own act before lashing out at other news agencies. Cheerleading is not analysis. But the red pom-poms are cute.
Update: From Mediamatters
... Accusing CBS Evening News of an overly bleak portrayal of the economy, an August 19 Wall Street Journal editorial falsely suggested that a July 20 CBS report ignored Federal Reserve Board Chairman Alan Greenspan's assessment that the "outlook is one of sustained economic growth" in order to cast the economy as "very tenuous." In fact, the CBS News report noted Greenspan's economic forecast, and featured the exact Greenspan quote the Journal provided. Also, it was not CBS' position that the economy is "very tenuous," but that of an unidentified man who was interviewed for the report....
Thanks, But I’ll Have the Brussels Sprouts and Lima Beans Instead
In Meatro, SciAm: Talk about a meat dish. A team has proposed a way to grow meat in the lab. Muscle precursors … could be extracted from a desired animal and grown on … small collagen beads that swell when heated. Stretching the film or expanding the beads just 10 percent at a time should induce the cells to fuse and become muscle fibers. Investigators have already produced skeletal muscle for clinical applications, and [a] team member … is currently growing chicken cells on beads. In theory, a handful of animals could produce the world’s meat supply without being sacrificed …
Posted by Mark Thoma on Saturday, August 20, 2005 at 12:06 AM in Science
August 19, 2005
BusinessWeek Interview with Chinese Economist Fan Gang
China Is a Private-Sector Economy, BusinessWeek: Fan Gang is one of China's best-known economists. He directs the National Economic Research Institute, a Beijing think tank affiliated with the China Reform Foundation. He's an adviser to the Chinese government and has been a consultant to the World Bank, U.N. Development Program, and other international agencies. Fan has published eight books and more than 100 academic papers. He has been an advocate of tight monetary policy coupled with expansionist macroeconomic policy to compensate for still-inadequate private investment in areas like infrastructure…
Q: What is China's basic challenge? A: China has two big issues. First, it is an emerging economy, and second it is an economy in transition. The first challenge requires development. The second requires reform at the same time. Plus, it has the world's biggest population. And China is the only really large country with only one coastline. That translates into big regional disparity. This is why China is full of problems.
Q: What's the role of the state sector vs. the private sector? A: The major reform achievement has been in privatizing state enterprises. The private sector accounts for 70% of gross domestic product. There are 200 large state companies -- basically, they are in utilities, some in heavy industries, some in resource industries. Traditionally, this is where governments have invested.
China Mobil and China Telecom are huge, but these are natural monopolies. Even France and Britain had those large state companies for a long time. If you take these away, China is a private-sector economy. In the financial sector, reform has been much delayed. Banking is still a state monopoly, and a concentrated monopoly.
In heavy industries, there are many private steel companies and chemical companies. Private companies have been behind the recent boom in capacity. They hired managers from state companies, then started up in a very efficient, competitive way. In terms of competitiveness, they are better than Taiwanese companies. The have the newest equipment, along with some local equipment. However the private sector is hard to document. There is a lot that is not on the table.
Q: How would you characterize China's financial markets? A: The capital markets and securites (sic) markets still are underdeveloped, because 70% of shares of almost all listed companies are not tradable. So there can't be takeovers -- only when the management wants to sell, which is usually when the business is nothing to them. Just a few months ago, an experimental program was announced to make the nontradable shares tradable. This should be good news in the long run.
Q: What about bank reform? A: There has been some progress in the banking sector. There still is political interference, but control of the banks has been centralized [away from local governments]. As a result, the whole system is more independent of the local politicians. The managements of local branches aren't appointed by local governments any more.
The reform has started -- but maybe too late. The government has injected money into the banks to float shares. To improve the capital market, 20% to 30% of their shares have to be sold to the public. But [more state injections are likely].
Q: Will foreign banks be able to compete in China? A: The government still controls the pace of liberalization. By the end of 2006, the market will open. But banks still need licenses.
The real issue is that when foreign banks come into the Chinese market, they will find it is very difficult to compete with the retail networks of the state banks. Chinese banks have thousands and thousands of branches to collect local deposits. It will take years for foreign banks to make an impact. To do business in yuan, [foreign banks] will have to borrow from the Chinese banks.
Also, Chinese deposit rates have not been liberalized. So the banks' margins are big. They can invest a lot in ATMS, bank cards, the Internet, on so on. And they don't charge depositors for these services.
Q: Will China's current-account surplus abate? A: Trade has essentially been in balance, except recently. The current account is high basically because of capital inflows. But how much is Chinese money? Many companies are just moving funds in commercial bank foreign currency accounts, [and those funds] don't count in reserves.
Before, the market speculated that the yuan would devalue. Now, [companies] are moving their money back into China through trade channels. They can wait, and they know the loopholes.
Q: What should China do with the yuan? A: I believe that it is a good idea to let the yuan trade in a bigger range. Small steps will invite speculation. My main argument is that this is a global issue. What worries me most is the fiscal deficit of the U.S. That is the whole reason for these imbalances. The U.S. dollar is international money, and the real problems will be borne by everybody. A dollar devaluation will become our revaluation problem.
Pollution in China
According to the World Bank, six of the world’s ten most polluted cities are in China. It is also a very inefficient user of energy requiring 4.7 times as much energy to produce a unit of GDP than in the U.S., a consequence of subsidized fuel in China leaving little incentive to implement energy saving technology and lax environmental regulation. The energy subsidies and the lack of environmental regulation contribute to the cost advantage enjoyed by Chinese producers. And, according to BusinessWeek, China is becoming even less efficient in its energy usage:
China's Dirty Face, BusinessWeek Slide Show: As the Middle Kingdom's economy has grown, so have the environmental costs of largely unregulated growth. Despite a clean-up of Beijing and a handful of other big cities, most of China is still reeling from the devastation wrought by three decades of communist industrial development and the subsequent 25 years of quasi-capitalism. ... Of the world's 10 most-polluted cities, 6 are in China, according to the World Bank, which estimates that pollution costs China more than $54 billion a year in environmental damage and health problems.
The problems are compounded by China's inefficient use of electricity, oil, and coal. China consumes 4.7 times as much energy as the U.S. to produce each dollar of GDP-- and 11.5 times as much as Japan. Alarmingly, the nation is getting less efficient, not more. After making steady progress in energy efficiency for two decades, China has been consuming energy at a rate faster than its GDP since 2002.
Coal may be the biggest culprit. China has tens of thousands of small mines that pay scant attention to environmental concerns or safety ... Such neglect helps keep costs down, so most of China's electricity comes from power plants that burn high-sulfur coal. Worse, few have effective emission controls, a big contributor to the acid rain that falls on one-third of the country.
In its quest for development, China is building highways -- and cars -- at an accelerating pace. There are 26 million cars on the road today, and that number is expected to double by 2010. By then, automobiles are expected to account for nearly two-thirds of China's air pollution. Some officials, though, are trying to hold the line on auto emissions ... And Beijing has equipped more than 2,500 buses with engines powered by natural gas, at a total cost of $26 million.
Some 70% of China's lakes and rivers are heavily polluted, largely because more than 80% of its sewage flows untreated into waterways. What's more, even where waste-treatment gear is installed, some companies opt to pay fines rather than operate expensive equipment. Regulators say that while most major industrial plants have water-treatment facilities, one-third don't operate them at all and another third use them only occasionally. There's a bit of good news: China expects to invest $61 billion in city waste-water treatment facilities between now and 2010…
The Evolution of Our Preferences: Evidence from Capuchin-Monkey Trading Behavior
Chen, Keith, Lakshminarayanan, Venkat and Santos, Laurie, The Evolution of Our Preferences: Evidence from Capuchin-Monkey Trading Behavior. Cowles Foundation Discussion Paper No. 1524 (SSRN link, free link from author page): Behavioral economics has demonstrated systematic decision-making biases in both lab and field data. But are these biases learned or innate? We investigate this question using experiments on a novel set of subjects — capuchin monkeys. By introducing a fiat currency and trade to a capuchin colony, we are able to recover their preferences over a wide range of goods and risky choices. We show that standard price theory does a remarkably good job of describing capuchin purchasing behavior; capuchin monkeys react rationally to both price and wealth shocks. However, when capuchins are faced with more complex choices including risky gambles, they display many of the hallmark biases of human behavior, including reference-dependent choices and loss-aversion. Given that capuchins demonstrate little to no social learning and lack experience with abstract gambles, these results suggest that certain biases such as loss-aversion are an innate function of how our brains code experiences, rather than learned behavior or the result of misapplied heuristics.
Posted by Mark Thoma on Friday, August 19, 2005 at 01:44 AM in Economics
Suboptimal Saving in 401(k) Plans
It is typically difficult to determine whether households save optimally. But in some cases, savings incentives are strong enough to imply sharp normative restrictions. We consider employees who receive employer matching contributions in their 401(k) plan and are allowed to make discretionary, penalty-free, in-service withdrawals. For these employees, contributing below the match threshold is a dominated action. Nevertheless, half of employees with these clear-cut incentives do contribute below the match threshold, foregoing matching contributions that average 1.3% of their annual pay. Providing these "undersavers" with specific information about the free lunch they are giving up fails to raise their contribution rates.
Despite widespread popular concern that American households are not saving properly for retirement, it is typically difficult to demonstrate that a household’s savings decisions are suboptimal. The lifecycle savings problem is sufficiently complex and economic theory sufficiently rich that few restrictions can be imposed on the range of savings behaviors we should observe in the absence of mistakes; nearly any choice can be theoretically justified by some combination of preferences and information unobserved by the econometrician.
In this paper, we identify a sizeable group of employees whose observable choice set in an important retirement savings vehicle, the 401(k), includes actions that are clearly precluded by normative economic theory. These individuals, who are over 59½ years old, have their 401(k) contributions matched by their employer; that is, for every dollar they contribute up to a certain threshold, their employer will make an additional proportional contribution. Furthermore, they have virtually unconstrained access to their 401(k) balances because their companies allow employees over 59½ to make discretionary, penalty-free, in-service 401(k) withdrawals. For these individuals, a contribution rate below the match threshold is a dominated strategy.
Nevertheless, we find that many of these employees are not contributing up to the match threshold. We calculate a lower bound on the welfare losses for these below-threshold employees by computing the difference between the payoffs to their current savings strategy and one which clearly dominates.
The dominating strategy we consider for these below-threshold employees is increasing their contribution rate up to the match threshold. This incremental contribution triggers an instantaneous windfall gain because of the employer match. The employee then immediately withdraws the incremental contribution. This strategy, which we will refer to as the –withdrawal strategy,- has no impact on the employee’s non-401(k) finances and hence need not affect current levels of consumption. However, it increases the employee’s 401(k) balance by the amount of the incremental contribution multiplied by the employer match rate. Because this withdrawal strategy is not necessarily the globally optimal strategy for the employee, the increased 401(k) balance represents a lower bound on the welfare gain available to the employee if she perfectly optimized.
The lower bound on welfare loss can be substantial. Consider a 60-year-old employee who does not currently contribute to her 401(k) plan but whose company would match her contributions dollar-for-dollar up to 5% of her salary. If her biweekly salary is $2,000, then the incremental value of contributing up to the match threshold is bounded below at $2,000 × 5% = $100 every two weeks. Executing the withdrawal strategy, she would end up with an extra $2,600 in her 401(k) account each year. Alternatively, if the firm allows it, she could withdraw the $2,600 in employer matching contributions as well and increase her consumption by $2,600 per year without decreasing her assets relative to her non-contributing strategy.
Despite the large gains from contributing up to the employer match threshold, we find that roughly half of our sample of older employees picks a dominated contribution rate below the match threshold. We refer to those employees contributing less than the match threshold who could profitably benefit from the withdrawal strategy described above as “undersavers.” (We use this term narrowly for those whose 401(k) contributions are too low; we do not mean to imply that these employees are necessarily saving too little in a normative sense, since it may be optimal for them to follow the withdrawal strategy and use the proceeds to increase their current consumption while leaving their savings path unchanged.) The average annual welfare loss found among these “undersavers” is 1.3% of their yearly salary. The fact that so many employees in our sample fail to take full advantage of the employer match is surprising because one would a priori expect this population to be particularly eager to contribute to their 401(k). Since they are at least 59½ years old, the need for retirement savings should be salient to them. Having decades of experience managing their money, they should be more financially savvy than their younger counterparts. And, with an average of 14.3 years of tenure at their respective companies, they have had ample time to familiarize themselves with their 401(k) plans.
To better understand why these employees do not take full advantage of their 401(k) match, we analyze a combined survey/field experiment conducted jointly with Hewitt Associates, the benefits administration and consulting firm that supplied our 401(k) data. Survey responses indicate that neither perceived direct transactions costs nor satiation explain the failure to contribute to the match threshold. Rather, undersavers appear to be much less financially sophisticated and knowledgeable about their firm’s 401(k) plan. Nevertheless, explaining the foregone opportunity-while highlighting the fact that there is no loss of liquidity from contributing up to the match threshold-produces only an infinitesimal response, raising 401(k) contribution rates by one tenth of one percentage point relative to a control group. Evidence that undersavers are more prone to delay taking other profitable actions suggests that time inconsistent preferences may also play a role in undermining optimal contribution choice.
Philadelphia Fed Says Manufacturing Activity is Robust
- The manufacturing diffusion for the region index is up from 9.6 last month to 17.5, its highest reading since April.
- Prices held steady. 78% of firms left prices unchanged, 12% raised prices, and 9% lowered prices.
- The employment index increased slightly to just above its average for the previous three months. 21% of firms increased employment, 15% reduced employment.
- 31% of firms reported paying higher input costs and they expect input costs to increase further in the future.
- Expectations for the next six months are optimistic and improved markedly from July.
- The new orders index, an indicator of future activity, was up sharply.
Before presenting the report, and remembering these are monthly indicators for a particular region that is generally indicative of overall manufacturing activity, let me note a few things. Input costs are rising and output prices are holding steady. In the future, that means pressure to raise prices and to reduce costs through productivity enhancing improvements. The latter variable is an unknown going forward, econbrowser for one is optimistic concerning productivity, though there are other views and uncertainties.
I believe the Fed will see two things as it contemplates future monetary policy. It will see the increase in manufacturing activity as yet one more indication of solid growth and the rise in input costs as a sign of building price pressure. Despite pleas to the contrary, and my own view that given the long lags in the effects of monetary policy the time has come to begin asking when enough is enough (for me, as of the moment, that is 4.25%), that points to rate increases.
One more thing. The impetus to hold down input costs through productivity enhancements that replace labor, and to hold down costs by holding down wages will continue so long as the profit squeeze continues. So, although there is some increase in the employment index, and expectations about future hiring are positive in the report, the rise in input costs from non-wage factors such as energy is not great news from labor’s perspective.
Here's the report:
Business Outlook Survey, August 2005 (Link)
Activity in the region’s manufacturing sector continued to expand in August, at a somewhat faster pace than in July. Indicators for general activity, new orders, shipments, and employment remained positive and increased from their readings last month. Firms continued to report a rise in prices for inputs, but prices for their own manufactured goods held relatively steady. Also this month, the region’s manufacturing executives were significantly more optimistic about future activity than they were in July.
Most Current Indicators Rise
The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, increased from 9.6 in July to 17.5 in August. The eight-point gain brings the index to its highest reading since April (see Chart). Thirty-six percent of the firms reported increases in activity this month, compared to 28 percent last month. Other broad indicators showed improvement. The new orders index increased nearly 15 points, to its highest reading since April. The current shipments index increased five points. Unfilled orders rose this month: the unfilled orders index increased 16 points, its first positive reading in eight months. The delivery time and inventory indexes also increased.
The improvement in manufacturing activity was accompanied by a slight increase in the employment index this month. The employment index increased three points, to just above its average over the previous three months. The percentage of firms reporting increased employment (21 percent) was higher than that of firms reporting lower employment (15 percent) for the 23rd consecutive month. On balance, the workweek was mostly steady this month.
Manufacturers’ Prices Nearly Steady Despite Higher Costs
Despite continued cost pressures, prices for firms’ own manufactured goods were essentially steady this month. Only slightly more firms reported higher prices for their own manufactured goods (12 percent) than reported lower prices (9 percent), and 78 percent of the firms indicated steady prices. The current prices received index fell from 12.0 to 3.0, its lowest reading since August 2003.
Despite the moderation in the prices received for their own manufactured goods, firms reported higher production costs. Thirty-three percent of firms reported higher input costs this month. The prices paid diffusion index, which decreased one point, remains near the 21-month low it reached in June.
In a special question this month, firms were asked about their expectations of price increases for selected inputs over the remainder of this year. Seventy-six percent of the manufacturers expect further increases in energy costs, 65 percent expect price increases for raw materials, and 52 percent expect increases for intermediate goods. Firms expect energy prices to increase an average of 5.4 percent over the remainder of the year, raw materials 2.8 percent, and intermediate goods 2 percent.
Six-Month Forecasts More Optimistic
Overall expectations for the next six months remain optimistic and improved markedly from July. The index for future activity increased from 15.3 in July to 33.4, its highest reading since December (see Chart). Other future indicators also increased this month: the future shipments index rose 10 points, and the future new orders index rose eight points. Manufacturing executives were slightly more optimistic about adding to their payrolls over the next six months: the future employment index increased seven points. Nearly 29 percent of the firms indicated plans to increase employment over the next six months; 16 percent plan to decrease employment. Firms, on balance, expect increases in the average workweek; the future workweek index rose 15 points.
Indicators continue to point to an expansion of the region’s manufacturing sector, as most indicators of current performance increased from their July readings. Firms continued to report higher prices for inputs, but prices for their own manufactured goods were nearly steady this month. Firms expect continued price increases for energy, raw materials, and intermediate goods over the next six months. Future indicators for general activity and employment, up notably this month, point to expectations among the region’s manufacturers of continued growth in their business over the next six months.
August 18, 2005
Googling Google for Answers
Google to Sell Up to $4 Billion in New Stock, by Vikas Bajaj and Jennifer Bayot, NY Times: Surprising investors and analysts, Google said today that it would sell up to $4 billion in stock, but the Internet search company offered few details on what it would do with the cash other than to hint at possible acquisitions. ... the company ... noted that it did not have any "agreements or commitments" to buy any companies or assets rights now, and in the meantime would park the money in investments that could be easily sold off... Perhaps, one analyst said, Google views this as an opportune time to cash in on its high stock price to give itself more room to maneuver in the future when its stock price is not quite as lofty...
Is it simply taking advantage of the current high price of its stock and building up reserve assets, or does it have specific plans such as attempting to increase its competitive position in Asia? I did like this part of the filing:
We may apply the proceeds of this offering to uses that do not improve our operating results or increase the value of your investment.
Posted by Mark Thoma on Thursday, August 18, 2005 at 12:15 PM in Economics
What’s Different in the Oregon Labor Market?
I recently came across data for Oregon’s labor force participation rate. The data is compiled by the Oregon Department of Labor, but I don’t believe it is published anywhere. I tried to derive it once, but could not find monthly data on Oregon’s working age population. I was fortunate enough to learn of this data via Brent Hunsberger, a reporter with The Oregonian, who passed it on to me this week.
The data speaks to the debate regarding the usefulness of the labor force participation rates as an indicator of labor market health – see my thoughts here and James Hamilton’s here. To me this data raises more questions than it answers. A look at the data:
Oregon’s LFP rate follows the general US trend, a steady decade’s long increase, a plateau in the late 1990s, and a general decline beginning, for Oregon, at the end of 2000. What is surprising is the steepness of the decline in Oregon’s LFP rate! On average, between 1976 and 2000, Oregon’s FLP rate was, 1.7 percentage points higher than the US. Over the past five years, however, that gap has steadily narrowed and the rates have converged.
I suspect that we can tell a cyclical story for Oregon – indeed, the cyclical story I cautioned against applying to the US as a whole. For a period, Oregon suffered from the highest unemployment rate in the nation during the last downturn, peaking at 8.5% in June 2003. It is likely that the weak job market drove a substantial number of workers out of the labor force, and perhaps out of the state altogether. And, arguably, the labor market recovery since mid-2003 has not been strong enough to lure many back into the labor force. Moreover, the lower than normal LFP rate for Oregon could explain why I hear from so many employers complaining that they can’t find workers.
Still, I am not completely happy with this explanation. During the early 1980’s, Oregon experienced a deep recession that, again, exceeded the national average – the unemployment rate climbed to 12.1% in November 1982 (the national peak was 10.8%). But during the early 1980’s the Oregon LFP rate rose and exceed the national figure by as much as 2.8%. So it doesn’t seem that the same dynamics are at play in these two episodes. Demographics are likely exerting some force as well. Perhaps there has been an influx of retirees into Oregon in the past five years. Unfortunately, I don’t have the Oregon LFP rates by age or sex. It would be nice to have state level discouraged worker data as well.
The data does suggest a possible approach to disentangling the structural versus cyclical forces. If LFP rates exist for all 50 states, it might be possible to identify the cyclical influences via differences in state economies.
Price Controls on Fuel in China
The Great Engine of China Is Low on Fuel, by Keith Bradsher, NY Times: April 15 - Service stations across China are starting to run short on diesel this spring, while electricity blackouts here in southeastern China are growing worse as power stations cut back on purchases of fuel oil. ... The Guangzhou Boaosi Appliance Company, which makes refrigerators here, is without electricity from the municipal grid four days a week, and just bought a costly generator last month to continue operating on diesel.
The diesel and power shortages have one thing in common: they are largely the result of the clash between China's Communist past and its increasingly capitalist present. The government has set retail prices too low for diesel and electricity. So businesses, facing high world oil prices, are supplying less of both. … China has embarked on a binge of construction of new power plants, many of them coal-fired. These are already starting to make blackouts less common elsewhere in China and hold the promise of eventually letting the electricity supply catch up with demand … Diesel generators have become a necessity for factories across much of China in the last few years, as electricity demand has soared past supply, and they have helped turn China into the world's second-largest oil importer, after the United States. …
Fuel Shortages Put Pressure on Price Controls in China, by Keith Bradsher, NY Times: Sudden shortages of gasoline and diesel in Southeastern China are reigniting a debate here: Is pressure from state companies, coupled with freely available information on oil prices, driving China to accept market forces faster than it may have wanted? Dozens of service stations in Southeastern China, notably in cities near Hong Kong, abruptly ran out of fuel this week just as officials in Beijing were debating requests from domestic oil companies to charge more for diesel and gasoline. The shortages have produced long lines of angry motorists at service stations and have disrupted some freight shipments, as trucks do not have the diesel to make trips. Some in China and abroad say the state oil companies created the shortages to increase prices. … Sam Dale, an Asian oil analyst in Singapore with Energy Intelligence … said oil companies appeared to be putting pressure on the Chinese government to free retail prices, by running their refineries below capacity and holding back supplies from the market. "It's an artificial shortage," he said. … Mr. Jia said Sinopec service stations would be fully stocked by Thursday in cities near here that have been experiencing shortages. Sinopec's refineries are operating at 89 to 90 percent of capacity, compared with past rates as high as 97 to 98 percent, Mr. Jia said. There is a shortfall mainly because some refineries are closed for maintenance, but some refinery managers are also reluctant to produce at full tilt when retail prices are low, he added. Sinopec's closest domestic rival in refining, PetroChina, is more active in Northern China. PetroChina officials had no comment on Wednesday.
The low fuel prices, which have helped to fuel China’s economic growth, are not sustainable, and China cannot build power plants fast enough to satisfy the excess demand at current controlled prices. It will be interesting to see how China’s competitiveness is affected when firms are forced to absorb the full cost (or more of the cost) of energy inputs into production decisions.
Measuring Human Well-Being
A Measured Approach, By Partha Dasgupta, Scientific American: Most contemporary economists … observe that the Western world’s economic output has increased remarkably since the industrial revolution. They note that this increase has been fueled by the accumulation of produced capital assets … and improvements in knowledge, human skills and institutions … They argue that if knowledge and skills are allowed to accumulate through education and research and development, productivity can be further increased and the world economy will enjoy growth in output for a very long while. Some economists, however, note that the earth is finite and reject this brand of optimism, instead insisting that we are already using nature’s services at or beyond the maximum rate that the biosphere can support in the long term. They argue that policies should immediately be put in place to stop the growth in the use of nature’s services.
These economists … are right to question the optimistic view for its neglect of nature’s limits, but they themselves … are silent on how to reach policy conclusions, and they do not provide a meaningful way to judge the human costs and benefits of stopping any further growth in the use of resources. A few economists … seek to avoid both sets of weaknesses by refining the concept of sustainable development—a path along which well-being across the generations does not decline with the passage of time and may even improve. … To achieve this result, each generation should bequeath to its successor at least as much wealth per capita as it itself inherited. … Economic development should be viewed as growth in wealth per capita, not growth in gross domestic product per capita. There is a big difference between GDP and wealth. … GDP per capita can increase even while wealth per capita declines. GDP can be a hopelessly misleading index of human well-being.
How have nations been doing when judged by the criterion of sustainable development? Figures recently published by the World Bank for the depreciation of several natural resources (oil, natural gas, minerals, the atmosphere as a sink for carbon dioxide, and forests as sources of timber) indicate that in sub-Saharan Africa both GDP per capita and wealth per capita have declined in the past three decades (graphs above). In contrast, in the Indian subcontinent, even while GDP per capita has increased, wealth per capita has declined. The decline has occurred because relative to population growth, investment in produced capital and improvements in institutions have not compensated for the degradation of natural capital. Moreover, countries that have experienced higher population growth have also lost wealth per capita at a faster rate.
Better news comes from the economies of China and most of the OECD (Organization for Economic Cooperation and Development) countries: they have grown in terms of both GDP per capita and wealth per capita. … It would seem, therefore, that during the past three decades the rich world has enjoyed sustainable development, while development in the poor world (barring China) has been unsustainable. One can argue, however, that the above estimates of wealth movements are biased. Among the many types of natural capital whose depreciation do not appear in the World Bank figures are freshwater, soil, ocean fisheries, forests and wetlands as providers of ecosystem services, as well as the atmosphere, which serves as a sink for particulates and nitrogen and sulfur oxides. Moreover, the prices the World Bank has estimated to value the natural assets on its list are based on assumptions that ignore the limited capacity of natural systems to recover from disturbances. If both sets of biases were removed, we could well discover that the growth in wealth in China and the world’s wealthy nations has also been negative. … Humanity must design institutions and policies that will enable economies to attain sustainable development. To that end, economists now have in hand a framework (estimates of wealth such as the ones given above) for making policy suggestions that are a lot sharper than the cry that humanity must implement a steady-state economy now.
Note: there is also an index of sustainable economic welfare discussed in the article that I will try and cover soon.
Fed Governor Gramlich: Low Inflation Helps to Fight Unemployment
Gramlich Says Fed Keeps Oil From Stoking Inflation, Bloomberg: The Federal Reserve's commitment to fight inflation may be keeping soaring oil prices from triggering a broader increase in consumer prices, Fed Governor Edward M. Gramlich said in an interview. ''It is a wondrous event for those of us who were here in the `70s,'' when oil prices caused inflation to surge, Gramlich said yesterday from his office in Washington.
The Fed's efforts may have ''worked in keeping inflation at bay when oil or gas prices have gone up so much.'' Gramlich, 66, is leaving the Fed on Aug. 31 after almost eight years to return to teaching at the University of Michigan. … Gramlich said he overestimated the potential for soaring oil prices to stoke inflation. … Lower labor costs overseas should help the U.S. to continue growing without accelerating inflation, Gramlich said yesterday. … The former dean and college professor, known as ''Ned,'' will be the second Fed governor to leave this year, clearing the way for George W. Bush to become the first president since Ronald Reagan to have either appointed or reappointed all seven central bank board members. ... Gramlich is resigning with more than two years left in his Fed term. … ''On the fundamentals of monetary policy, there is quite a broad consensus on the Open Market Committee,'' Gramlich said. ''It's important to keep inflation low, to keep prices stable. If you do that, you probably have more freedom, not less freedom, to fight unemployment.'' … ''I am pretty proud of monetary policy,'' he said. ''It's possible that even if there are new people at the table, you wouldn't see much change in policy.''
As monetary policy and inflation targeting are the topic here, this gives me an opportunity to direct you to a post at New Economist on Taylor Rules with discussion and links to papers concerning some of the limitations of using Taylor rules to guide monetary policy.
Taking Fox News with a Grain of Salt
Fair? Balanced? A Study Finds It Does Not Matter, by Alan B. Krueger, NY Times: The share of Americans who believe that news organizations are "politically biased in their reporting" increased to 60 percent in 2005, up from 45 percent in 1985, according to polls by the Pew Research Center. Many people also believe that biased reporting influences who wins or loses elections. A new study by Stefano DellaVigna of the University of California, Berkeley, and Ethan Kaplan of the Institute for International Economic Studies at Stockholm University, however, casts doubt on this view. Specifically, the economists ask whether the advent of the Fox News Channel, Rupert Murdoch's cable television network, affected voter behavior. They found that Fox had no detectable effect on which party people voted for, or whether they voted at all. …
Fox surely injected a new partisan perspective into political coverage on television. Did it matter? The Fox News Channel started operating on Oct. 7, 1996, in a small number of cable markets. Professors DellaVigna and Kaplan painstakingly collected information on which towns offered Fox as part of their basic or extended cable service as of November 2000, and then linked this information to voting records for the towns. Their sample consists of 8,630 towns and cities from 24 states. … Local cable companies adopted Fox in a somewhat idiosyncratic way. In November 2000, a third of the towns served by AT&T Broadband offered Fox while only 6 percent of those served by Adelphia Communications offered it. Fox spread more quickly in areas that leaned more to Republican candidates, but the imbalance was only slight. Furthermore, looking within Congressional districts, the likelihood that a town's cable provider offered Fox in 2000 was unrelated to the share of people who voted for Bob Dole, the Republican candidate for president in 1996, or the residents' educational attainment, racial makeup or unemployment rate. … the … question is whether the introduction of Fox in a community raised the likelihood that residents voted for George W. Bush over Al Gore in the 2000 election, as compared with the share who voted for Bob Dole over Bill Clinton in the (pre-Fox) 1996 election. … When they made statistical adjustments to hold constant differences in demographic characteristics and unemployment, and looked at differences in voting behavior between towns that introduced and did not introduce Fox within the same Congressional district, the availability of Fox had a small and statistically insignificant effect on the increase in the share of votes for the Republican candidate. Thus, the introduction of Fox news did not appear to have increased the percentage of people voting for the Republican presidential candidate. A similar finding emerged for Congressional and senatorial elections.Voter turnout also did not noticeably change within towns that offered Fox by 2000 compared with those that did not. …
Why was Fox inconsequential to voter behavior? One possibility is that people search for television shows with a political orientation that matches their own. In this scenario, Fox would have been preaching to the converted. This, however, was not the case: Fox's viewers were about equally likely to identify themselves as Democrats as Republicans, according to a poll by the Pew in 2000.
Professors DellaVigna and Kaplan offer two more promising explanations. First, watching Fox could have confirmed both Democratic and Republican viewers' inclinations, an effect known as confirmatory bias in psychology. (Borrowing from Simon and Garfunkel, confirmatory bias is a tendency to hear what we want to hear and disregard the rest.) When Yankee and Red Sox fans watch replays of the same disputed umpire's ruling, for example, they both come away more convinced that their team was in the right. One might expect Fox viewers to have increased their likelihood of voting, however, if Fox energized both sides' bases.
The professors' preferred explanation is that the public manages to "filter" biased media reports. Fox's format, for example, might alert the audience to take the views expressed with more than the usual grain of salt. Audiences may also filter biases from other networks' shows. The tendency for people to regard television news and political commentary as entertainment probably makes filtering easier. …
Ancient Proto-Thracian Treasure
Somebody found the end of the rainbow. There are two more pictures in the continuation frame:
Archaeologists Find Ancient Treasure, by Nevyana Hadjiyska, AP: Bulgarian archaeologists have unearthed about 15,000 tiny golden pieces that date back to the end of the third millennium B.C. — a find they said Wednesday matches the famous treasure of Troy.
The golden ornaments, estimated to be between 4,100 and 4,200 years old, have been unearthed gradually during the past year from an ancient tomb near the central village of Dabene, about 75 miles east of the capital, Sofia, said Vasil Nikolov, an academic consultant on the excavations. "This treasure is a bit older than Schliemann's finds in Troy, and contains much more golden ornaments," Nikolov said.
Heinrich Schliemann, an amateur German archaeologist, discovered the site of ancient Troy in 1868 and directed ambitious excavations that proved he was right. The treasure consists of miniature golden rings, some so finely crafted that the point where the ring is welded is invisible with an ordinary microscope. "We don't know who these people were, but we call them proto-Thracians," Nikolov said. They likely were ancestors of the Thracians, who lived in what is now Bulgaria and parts of modern Greece, Romania, Macedonia and Turkey until the 8th century A.D., when they were assimilated by invading Slavs. … "This is the oldest golden treasure ever found in Bulgaria after the Varna necropolis," Dimitrov said. The golden artifacts from a vast burial complex discovered in the 1970s near the Black Sea port of Varna date back to the end of the fifth millennium B.C. and are internationally renowned as the world's oldest golden treasure.
Posted by Mark Thoma on Thursday, August 18, 2005 at 01:26 AM in Science
The Health Care Gap
Race Gap Persists In Health Care, Three Studies Say, By Rob Stein, Washington Post: Black Americans still get far fewer operations, tests, medications and other life-saving treatments than whites, despite years of efforts to erase racial disparities in health care and help African Americans live equally long and healthy lives, according to three major studies being published today. Blacks' health care has started to catch up to whites' in some ways, but blacks remain much less likely to undergo heart bypasses, appendectomies and other common procedures. They receive fewer mammograms and basic tests and drugs for heart disease and diabetes, and they have fallen even further behind whites in controlling those two major killers, according to the first attempts to measure the last decade's efforts to improve equality of care.
Together, the research paints a discouraging picture of the nation's progress in closing the gap for one of the fundamental factors that affect well-being -- health care -- during a period when blacks have made progress in areas such as income and education. … Despite the sobering findings, experts said they were encouraged that some care did improve for blacks when the government put pressure on health plans and doctors by requiring them to report whether they were meeting certain minimum standards. … "These persistent disparities are saying that systematically, based on an individual's skin color, Americans are still treated very differently by our health care system," said David Williams of the University of Michigan at Ann Arbor. "This is clearly unacceptable, given the values of our society. It's wrong both on a moral dimension and on a very practical dimension of ensuring life and the pursuit of happiness."
The cause of the persistent disparities has been the focus of intense research and debate. Blacks and other minorities tend to be poorer and less educated, which accounts for some of the differences. Some experts argue that blacks also tend to live in places where doctors and hospitals provide inferior care. Others suspect that cultural, or even biological, differences may also play a role. The most intense debate has centered on whether subtle racism pervades the health care system. "There are clearly large gaps in the quality and quantity of care of African Americans relative to whites. But these papers cannot be used to argue that this is a result of discrimination," said Amitabh Chandra of Harvard University. "It could be that whites are getting way too much care than they should be getting."
The only hint of a cause offered by the new studies was the finding that gains tended to occur for the simplest care -- such as prescribing drugs -- and gaps tended to widen for more complex treatment. … In the second study, Viola Vaccarino of Emory University and colleagues studied the records of 598,911 patients treated for heart attacks at 658 hospitals from 1994 to 2002. Blacks remained much less likely than whites to get basic diagnostic tests known as angiographies, as well as drugs or procedures to reopen clogged arteries, such as angioplasties. Women were also less likely to get appropriate care than men, with black women receiving the worst care of any group, the researchers found.
In the third study, Amal N. Trivedi of Harvard Medical School and colleagues analyzed data on 1.5 million Medicare patients in 183 managed care plans from 1997 to 2003, examining whether women had mammograms, and whether heart disease and diabetes patients got basic tests and treatments. The quality of care overall improved significantly for both blacks and whites, ... But ... "There's no measure where the performance for blacks is higher than for whites or even equal," Trivedi said. "Clearly, there's a lot more work that needs to be done."
Did Somebody Call for an Auctioneer?
...We've been raised never to trust a politician, but we also don't recall meeting any who can be purchased by 18 holes...
I'm wondering how much more than that they had to pay to clear the market.
August 17, 2005
PPI Rises Strongly on Higher Energy Costs
I do want to add one note to the stories I've seen on this so far. With input costs rising faster than output prices, the squeeze on profit will make it more difficult for wages to increase to compensate for increased productivity and to compensate for inflation. This may explain, in part, why wages have remained flat during the recovery. Thus, even if energy prices fall, inflation pressure and hence pressure to raise rates will remain due to underlying pressure for wages to rise.
The Use of Leading Economic Indicators in Economic Forecasting
Forecasters Rely on Today to Predict Tomorrow, Caroline Baum, Bloomberg: ...The sentiment shift, based on high-frequency data, is even harder to understand in light of the economy's steady performance. ... Weak numbers yield a weak outlook. Strong numbers mean good times ahead. Where's the forecasting?
The Index of Leading Economic Indicators, which isn't a bunch of randomly selected components, is signaling slower, not faster, growth ahead. The 10 components of the LEI were all chosen because of a demonstrated ability to predict future economic activity. ... The level of the LEI, which "has an average eight to nine months lead time at peaks and troughs -- shorter at troughs -- has flattened out after strong growth in 2003 and 2004,'' Ozyildirim said. As long as the weekly and monthly numbers come in strong, economists will be guided by mostly contemporaneous indicators released with a lag. How come no one follows the leaders?
The paper by Stock and Watson linked above and the work that followed in the next 15 years or so look at these issues in considerable detail and answer the questions raised in the column. For those interested, the question of the optimality of the LEI and other indicators for use in economic forecasting has been examined extensively with Stock and Watson leading voices in this area. A very, very quick search of "Stock Watson Forecasting GDP" in Google Scholar turns up the following papers on this topic (some of the abstracts are below for quick reference). One more note. The comments about forecasters being swayed by high frequency data is why repeated warnings have been issued on this very topic (example), the latest being this nice piece of work on David Altig's site to extract the trend component of the CPI from the high frequency noise. Here are some papers relating to the use of the LEI and forecasting more generally:
- New Indexes of Coincident and Leading Economic Indicators, Stock and Watson 1990
- A Procedure for Predicting Recessions With Leading Indicators: Econometric Issues and Recent Experience, Stock and Watson 1992
- This is what the leading indicators lead, Maximo Camacho and Gabriel Perez-Quiros, 2002
- How did leading indicator forecasts do during the 2001 recession, Stock and Watson 2003
- Forecasting Output and Inflation: The Role of Asset Prices, Stock and Watson 2003
- Forecasting with Many Predictors, Stock and Watson 2004
This is just a quick sample - there is lots, lots more on this topic. If you are interested in LEIs, it would be a good idea to read this on recent changes in how the yield spread is incorporated into the LEI.
New Indexes of Coincident and Leading Economic Indicators, Stock and Watson 1990:
During six weeks in late 1937, Wesley Mitchell, Arthur Burns, and their colleagues at the National Bureau of Economic Research developed a list of leading, coincident, and lagging indicators of economic activity in the United States as part of the NBER research program on business cycles. Since their development, these indicators, in particular the leading and coincident indexes constructed from these indicators, have played an important role in summarizing and forecasting the state of macroeconomic activity. The paper reports the results of a project to revise the indexes of leading and coincident economic indicators using the tools of modern time series econometrics. This project addresses three central questions. The first is conceptual: is it possible to develop a formal probability model that gives rise to the indexes of leading and coincident variables? Such a model would provide a concrete mathematical framework within which alternative variables and indexes could be evaluated. Second, given this conceptual framework, what are the best variables to use as components of the leading index? Third, given these variables, what is the best way to combine them to produce useful and reliable indexes? The results of this project are three experimental monthly indexes: an index of coincident economic indicators (CEI), an index of leading economic indicators (LEI), and a Recession Index. The experimental CEI closely tracks the coincident index currently produced by the Department of Commerce (DOC), although the methodology used to produce the two series differs substantially. The growth of the experimental CEI is also highly correlated with the growth of real GNP at business cycle frequencies. The proposed LEI is a forecast of the growth of the proposed CEI over the next six months constructed using a set of leading variables or indicators. The Recession Index, a new series, is the probability that the economy will be in a recession six months hence, given data available through the month of its construction. This article is organized as follows. Section 2 contains a discussion of the indexes and a framework for their interpretation. Section 3 presents the experimental indexes, discusses their construction, and examines their within-sample performance. In Section 4, the indexes are considered from the perspective of macroeconomic theory, focusing in particular on several salient series that are not included in the proposed leading index. Section 5 concludes.
This paper examines the forecasting performance of various leading economic indicators and composite indexes since 1988, in particular during the onset of the 1990 recession. The primary focus is on an experimental recession index (title "XRI"), a composite index which provides probabilistic forecasts of whether the U.S. economy will be in a recession six months hence. After detailing its construction, the paper examines the out-of-sample performance of the XRI and a related forecast of overall economic growth, the experimental leading index (XLI). These indexes performed well from 1988 through the summer of 1990 - for example, in June 1990 the XLI model forecasted a .4% (annual rate) decline in the experimental coincident index from June through September, when in fact the decline was only slightly greater, .8%. However, the XLI failed to forecast the sharp declines of October and November 1990. After exploring several possible explanations, we conclude that one important source of the forecast error was the use of financial variables during a recession that was not associated with a particularly tight monetary policy. Financial indicators - and the experimental index - were not alone, however, in failing to forecast the 1990 recession. An examination of 45 economic indicators shows that almost all failed to forecast the 1990 downturn and the few that did provided unclear signals before the recessions of the 1970s and 1980s.
How did leading indicator forecasts do during the 2001 recession, Stock and Watson 2003
The 2001 recession differed from other recent recessions in its cause, severity, and scope. This paper documents the performance of professional forecasters and forecasts based on leading indicators as the recession unfolded. Professional forecasters found this recession a difficult one to forecast. A few leading indicators (stock prices, term spreads, unemployment claims) predicted that growth would slow, but none predicted the sharp economic slowdown. Several previously reliable leading indicators (housing starts, orders for new capital equipment, consumer sentiment) provided no early warning signals. When combined, the leading indicator performed somewhat better than a benchmark autoregressive forecasting model.
Forecasting with Many Predictors, Stock and Watson 2004
Academic work on macroeconomic modeling and economic forecasting historically has focused on models with only a handful of variables. In contrast, economists in business and government, whose job is to track the swings of the economy and to make forecasts that inform decision-makers in real time, have long examined a large number of variables. In the U.S., for example, literally thousands of potentially relevant time series are available on a monthly or quarterly basis. The fact that practitioners use many series when making their forecasts – despite the lack of academic guidance about how to proceed – suggests that these series have information content beyond that contained in the major macroeconomic aggregates. But if so, what are the best ways to extract this information and to use it for real-time forecasting? This chapter surveys theoretical and empirical research on methods for forecasting economic time series variables using many predictors, where “many” can number from scores to hundreds or, perhaps, even more than one thousand. Improvements in computing and electronic data availability over the past ten years have finally made it practical to conduct research in this area, and the result has been the rapid development of a substantial body of theory and applications. This work already has had practical impact – economic indexes and forecasts based on many-predictor methods currently are being produced in real time both in the US and in Europe – and research on promising new methods and applications continues. Forecasting with many predictors provides the opportunity to exploit a much richer base of information than is conventionally used for time series forecasting. Another, less obvious (and less researched) opportunity is that using many predictors might provide some robustness against the structural instability that plagues lowdimensional forecasting. But these opportunities bring substantial challenges. Most notably, with many predictors come many parameters, which raises the specter of overwhelming the information in the data with estimation error. For example, suppose you have twenty years of monthly data on a series of interest, along with 100 predictors. A benchmark procedure might be using ordinary least squares (OLS) to estimate a regression with these 100 regressors. But this benchmark procedure is a poor choice. Formally, if the number of regressors is proportional to the sample size, the OLS forecasts are not first-order efficient, that is, they do not converge to the infeasible optimal forecast. Indeed, a forecaster who only used OLS would be driven to adopt a principle of parsimony so that his forecasts are not overwhelmed by estimation noise. Evidently, a key aspect of many-predictor forecasting is imposing enough structure so that estimation error is controlled (is asymptotically negligible) yet useful information is still extracted. Said differently, the challenge of many-predictor forecasting is to turn dimensionality from a curse into a blessing.
This is what the leading indicators lead, Maximo Camacho and Gabriel Perez-Quiros, 2002
We propose an optimal filter to transform the Conference Board Composite Leading Index (CLI) into recession probabilities in the US economy. We also analyse the CLI's accuracy at anticipating US output growth. We compare the predictive performance of linear, VAR extensions of smooth transition regression and switching regimes, probit, non-parametric models and conclude that a combination of the switching regimes and non-parametric forecasts is the best strategy at predicting both the NBER business cycle schedule and GDP growth. This confirms the usefulness of CLI, even in a real-time analysis.
Forecasting Output and Inflation: The Role of Asset Prices, Stock and Watson 2003
Because asset prices are forward-looking, they constitute a class of potentially useful predictors of inflation and output growth. The premise that interest rates and asset prices contain useful information about future economic developments embodies foundational concepts of macroeconomics: Irving Fisher’s theory that the nominal interest rate is the real rate plus expected inflation; the notion that a monetary contraction produces temporarily high interest rates— an inverted yield curve—and leads to an economic slowdown; and the hypothesis that stock prices reflect the expected present discounted value of future earnings. Indeed, Wesley Mitchell and Arthur Burns (1938) included the Dow Jones composite index of stock prices in their initial list of leading indicators of expansions and contractions in the U.S. economy. The past fifteen years have seen considerable research on forecasting economic activity and inflation using asset prices, where we interpret asset prices broadly as including interest rates, differences between interest rates (spreads), returns, and other measures related to the value of financial or tangible assets (bonds, stocks, housing, gold, etc.). This research on asset prices as leading indicators arose, at least in part, from the instability in the 1970s and early 1980s of forecasts of output and inflation based on monetary aggregates and of forecasts of inflation based on the (non-expectational) Phillips curve. One problem with using monetary aggregates for forecasting is that they require ongoing redefinition as new financial instruments are introduced. In contrast, asset prices and returns typically are observed in real time with negligible measurement error. The now-large literature on forecasting using asset prices has identified a number of asset prices as leading indicators of either economic activity or inflation; these include interest rates, term spreads, stock returns, dividend yields, and exchange rates. This literature is of interest from several perspectives. First and most obviously, those whose daily task it is to produce forecasts—notably, economists at central banks, and business economists—need to know which, if any, asset prices provide reliable and potent forecasts of output growth and inflation. Second, knowledge of which asset prices are useful for forecasting, and which are not, constitutes a set of stylized facts to guide those macroeconomists mainly interested in understanding the workings of modern economies. Third, the empirical failure of the 1960svintage Phillips curve was one of the crucial developments that led to rational expectations macroeconomics, and understanding if and how forecasts based on asset prices break down could lead to further changes or refinements in macroeconomic models. This article begins in section 2 with a summary of the econometric methods used in this literature to evaluate predictive content. We then review the large literature on asset prices as predictors of real economic activity and inflation. This review, contained in section 3, covers 93 articles and working papers and emphasizes developments during the past fifteen years. We focus exclusively on forecasts of output and inflation; forecasts of volatility, which are used mainly in finance, have been reviewed recently in Ser-Huang Poon and Clive Granger (2003). Next, we undertake our own empirical assessment of the practical value of asset prices for short- to medium-term economic forecasting; the methods, data, and results are presented in sections 4–7. This analysis uses quarterly data on as many as 43 variables from each of seven developed economies (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) over 1959–99 (some series are available only for a shorter period). Most of these predictors are asset prices, but for comparison purposes we also consider selected measures of real economic activity, wages, prices, and the money supply. Our analysis of the literature and the data leads to four main conclusions. First, some asset prices have substantial and statistically significant marginal predictive content for output growth at some times in some countries. Whether this predictive content can be exploited reliably is less clear, for this requires knowing a priori what asset price works when in which country. The evidence that asset prices are useful for forecasting output growth is stronger than for inflation. Second, forecasts based on individual indicators are unstable. Finding an indicator that predicts well in one period is no guarantee that it will predict well in later periods. It appears that instability of predictive relations based on asset prices (like many other candidate leading indicators) is the norm. Third, although the most common econometric method of identifying a potentially useful predictor is to rely on in-sample significance tests such as Granger causality tests, doing so provides little assurance that the identified predictive relation is stable. Indeed, the empirical results indicate that a significant Granger causality statistic contains little or no information about whether the indicator has been a reliable (potent and stable) predictor. Fourth, simple methods for combining the information in the various predictors, such as computing the median of a panel of forecasts based on individual asset prices, seem to circumvent the worst of these instability problems. Some of these conclusions could be interpreted negatively by those (ourselves included) who have worked in this area. But in this review we argue instead that they reflect limitations of conventional models and econometric procedures, not a fundamental absence of predictive relations in the economy: the challenge is to develop methods better geared to the intermittent and evolving nature of these predictive relations. We expand on these ideas in section 8.
How Fast Do Houses Slide Down the Hill?
How Will Home Boom End?, by James R. Hagerty, The Wall Street Journal: When America's housing boom finally ends, don't expect a loud pop. "It's not going to be a big dramatic event," says William Apgar, senior scholar at Harvard University's Joint Center for Housing Studies. Unlike stock prices, the housing market can't collapse in a few days. People can dump their stocks almost instantly, but it often takes months to sell a house. In past housing busts in California, New England and elsewhere, many owners who couldn't get what they considered a reasonable price yanked their houses off the market. The number of transactions plunged but prices fell only gradually, often over several years.
Still, that's little reassurance for Americans who are worried that they bought at the top of the market or for those waiting for prices to ease before jumping in. And the end of the boom is likely to be painful for many people. Among the most vulnerable: people who may have to sell in a weak market because of a job loss or transfer; those with little or no equity in their homes and big mortgages; and those counting on big gains in home equity to make up for a lack of retirement savings. The housing boom has been an enormous boost to the economy, spurring construction, increasing the net worth of millions of families and allowing Americans to borrow against the rising value of their homes. … Economists disagree about how much damage a housing downturn would inflict on the economy. … Predictions that the housing market would falter soon have proved premature repeatedly. Still, many economists believe the boom is now peaking or will do so within a year or so. Few expect a sharp fall in prices nationwide but lots of economists think prices will decline at least modestly in some of the cities along the East and West coasts, where buying has been most frenzied. … How bad could the next downturn be? Optimists say that the pace of price increases will merely slow to a more sustainable level. Many economists say past drops in house prices have been recorded only in places where lots of jobs have been lost. One example is Los Angeles, hit by a rapid shrinkage of the aerospace industry in the early 1990s. In cities with strong job markets, home prices have tended to keep rising, albeit at a slower rate, when the market cooled.
Even so, history shows that house-price declines are less rare than many Realtors suggest in their sales spiels. Richard J. DeKaser, chief economist at National City Corp., a Cleveland-based banking concern, recently studied home prices in 299 metropolitan areas over the past 20 years. He found that 63 of them at some point suffered declines of 10% or more over periods of at least two years. … The median decline in those 63 markets was 17%. … Unless interest rates rise much more sharply than expected, there is no reason to expect a national housing crash, says Allen Sinai, chief global economist at Decision Economics Inc. in Boston. "I don't think this is a situation of boom-bust," he says. But Edward Leamer, an economics professor at the University of California Los Angeles, thinks a housing downturn could "kick the economy into slow growth and possibly an outright recession." He counts 10 declines in residential investment since World War II. Eight of them, he says, provided the early warnings for recessions.
And of course, if you are interested in housing, Calculated Risk should be a regular stop.
Housing Dangers Along the Measured Path
The Energy in Real Estate, By John Makin, Wall Street Journal Editorial: America's economy is heavily dependent on a housing boom to offset the substantial drag on growth arising from the doubling of oil prices since spring 2004. Meanwhile, the Fed's steady rate increases, now expected to boost short-term rates above 4% by early next year, will at least slow, and perhaps reverse, the sharp rise in housing prices -- just as the Bank of England's modest 125-basis point tightening did in 2003-4. The U.K. experienced a sharp drop in consumption and growth shortly after housing began to falter. The Fed will need to engineer a carefully modulated tightening to avoid the same fate for the U.S.
The record of central banks in quelling housing bubbles over the past 15 years is not encouraging. In fact, discussions today of real estate markets in New York, L.A., Las Vegas, Miami, and other cities remind me of the stories I was hearing when I lived in Tokyo in 1988-89. … Of course, there are differences between Japan's real estate boom 15 years ago and that in the U.S. today. Japan's banking system became heavily exposed to real estate investments, especially as land prices shot up. Today, American banks are less exposed to the real estate bubble, …. It is American households that are primarily exposed to a collapse of the real estate bubble in the U.S.
Today's U.S. real estate bubble is a crucial ingredient in sustaining global demand growth for two reasons. First, demand growth is weak outside the U.S., in Europe, the U.K., China and emerging Asia. Japan has seen a modest increase in growth of domestic demand as real wages have ceased falling after a decade of weakness, but this is not sufficient to sustain global demand growth. The second and most important reason for the crucial role of the U.S. real estate bubble is that it is offsetting the drag from higher oil prices on U.S. growth. … How vulnerable is U.S. growth to the real estate bubble? While the bubble is heavily concentrated in metropolitan areas, overall rising real estate values have contributed massively to household wealth and even to disposable income as the innovative mortgage sector arranges for easy withdrawal of rising equity in homes. The existence of a bubble in major metropolitan areas is not in doubt. The ratio of home prices to incomes is two to three standard deviations above the average since 1980 in over 20 major cities … The tension in the U.S. housing sector is rising, as it did in Japan after 1989 and in the U.K. last year, because the central bank is raising interest rates. ... So far, the impact of Fed tightening on the real estate sector has been limited to sporadic signs of slower price increases in some markets. This is partly because even though the Fed has raised short-term interest rates, long-term interest rates are actually lower than they were a year ago -- the famous Greenspan "conundrum."
That said, the sharp rise in short-term interest rates makes it more difficult to arrange effective low "teaser rates" that attract more spending on real estate by increasing affordability. With short-term rates rising and housing prices having risen by another 20%, affordability is becoming an increasing problem at the margin …
The contribution of the U.S. real estate boom to household consumption and U.S. demand growth, not to mention the U.S. construction industry, can be sharply curtailed even if price increases just drop from the current 20%-plus level to 5% or below, much as they have done in the U.K. Falling house prices are not required for housing to become a drag on growth. … Once the momentum for ever-rising prices is lost and house prices actually begin to level off, the desired stock of housing falls. Then, construction activity ceases and the rush of speculators to purchase more real estate evaporates and turns into a desire to sell. If the process is orderly, housing price inflation just falls toward zero. If it is disorderly, as was the case in Japan by 1991, house and real estate prices collapse as panicky speculators, unable to service their mortgages because of falling rents and less ability to obtain loans, start dumping properties. A mere leveling of housing prices (a probable event in the coming year) would be sufficient to remove the boost from housing that is worth about 1 percentage point of growth. With that impetus eliminated and the drag from higher oil prices continuing, the U.S. growth rate could easily drop to 2.5% or lower, depending upon the future path of energy prices, the persistence of the negative impact of past energy price increases, and the sharpness of the drop in house prices. … The notion that world growth is sustainable given oil at $65 a barrel because the U.S. can shrug off the implied energy drag depends almost entirely on a continued U.S. housing boom. Yet the Fed is raising interest rates, a policy move that has already quelled the housing boom in the U.K., Australia and New Zealand as it did in Japan 15 years ago. There are signs of cooling emerging already in some of the "hot" U.S. housing markets as inventories of unsold house build and rents slip on speculative properties. The Fed needs to keep moving cautiously on tightening over the year because the housing slowdown will probably arrive suddenly as speculative sentiment dies. Further, the drag from higher energy prices has risen sharply in recent weeks. It remains to be seen whether the final, delicate phase of such a tightening will be administered by Mr. Greenspan or his successor. President Bush will no doubt be very interested to hear from prospective Fed chairmen their plans for executing such a tricky monetary maneuver.
The Perfect Everyday Woman
For Everyday Products, Ads Using the Everyday Woman, by Stuart Elliott, NY Times: Madison Avenue is increasingly interested in using everyday women in advertising instead of just waifish supermodels. The change comes after the Dove ... introduced what it called a "campaign for real beauty," which presents women in advertisements as they are rather than as some believe they ought to be...
There have been many previous instances of ads that showed so-called real women in place of professional models, which receded as the allure of glamour again reared its beautiful head. This week, Nike is introducing a humorous ... campaign for exercise gear, ... One ad, which begins boldly, "My butt is big," features an oversize photograph of the derrière in question. Another Nike ad declares, "I have thunder thighs," while a third asserts: "My shoulders aren't dainty or proportional to my hips. Some say they are like a man's. I say, leave men out of it." ... Chicken of the Sea brand of tuna introduced a television commercial showing a gorgeous young woman being ogled by the men in her office. She can escape their wolfish ways only in the elevator, which she enters alone, then breathes a sigh of relief - revealing that she really has a more-than-ample stomach, which she had been holding in. ...
Why the new style of ads now? One reason, said Nathan Coyle, senior strategist at Brain Reserve in New York… is the advent of reality television. "Your neighbors, everyday people, are the new celebrities," Mr. Coyle said ... Kelly Simmons, president of a brand consulting company in Philadelphia named Bubble, offered another reason: the aging of the baby-boom generation ... will start turning 60 on Jan. 1. "There's no question baby boomers feel better about their bodies," Ms. Simmons said, "and are determined to age beautifully," ... Nancy Monsarrat, United States director for advertising at Nike in Beaverton, Ore., said that in addition to the different attitudes about body image among boomer women, "younger women have a different perspective" from that of their counterparts a decade or two ago...
It also could also just be a way to get attention for their product in the short-run rather than a long-run change in underlying consumer preferences.
Posted by Mark Thoma on Wednesday, August 17, 2005 at 01:44 AM in Economics
Dynamic Factor Models for VAR Analysis
This paper considers VAR models incorporating many time series that interact through a few dynamic factors. Several econometric issues are addressed including estimation of the number of dynamic factors and tests for the factor restrictions imposed on the VAR. Structural VAR identification based on timing restrictions, long run restrictions, and restrictions on factor loadings are discussed and practical computational methods suggested. Empirical analysis using U.S. data suggest several (7) dynamic factors, rejection of the exact dynamic factor model but support for an approximate factor model, and sensible results for a SVAR that identifies money policy shocks using timing restrictions.
…In this paper, we examine VAR methods that can be used to identify the space of structural shocks when there are hundreds of economic time series variables that potentially contain information about these underlying shocks. … The premise of the dynamic factor model (DFM) is that there are a small number of unobserved common dynamic factors that produce the observed comovements of economic time series. These common dynamic factors are driven by the common structural economic shocks, which are the relevant shocks that one must identify for the purposes of conducting policy analysis. Even if the number of common shocks is small, because the dynamic factors are unobserved this model implies that the innovations from conventional VAR analysis with a small or moderate number of variables will fail to span the space of the structural shocks to the dynamic factors. Instead, these shocks are only revealed when one looks at a very large number of variables and distills from them the small number of common sources of comovement.
There is a body of empirical evidence that the dynamic factor model, with a small number of factors, captures the main comovements of postwar U.S. macroeconomic time series data. Sims and Sargent (1977) examine a small system and conclude that two dynamic factors can explain 80% or more of the variance of major economic variables, including the unemployment rate, industrial production growth, employment growth, and wholesale price inflation; moreover, one of these dynamic factors is primarily associated with the real variables, while the other is primarily associated with prices. Empirical work using methods developed for many-variable systems has supported the view that only a few – perhaps two – dynamic factors explain much of the predictable variation in major macroeconomic aggregates (e.g. Stock and Watson (1999, 2002a), Giannone, Reichlin, and Sala (2004)). These new methods for estimating and analyzing dynamic factor models, combined with the empirical evidence that perhaps only a few dynamic factors are needed to explain the comovement of macroeconomic variables, has motivated recent research on how best to integrate factor methods into VAR and SVAR analysis (Bernanke and Boivin (2003), Bernanke, Boivin, and Eliasz (2005; BBE hereafter), Favero and Marcellino (2001), Favero, Marcellino, and Neglia (2004), Giannone, Reichlin, and Sala (2002, 2004), and Forni, Giannone, Lippi, and Reichlin (2004)); we return to this recent literature in Sections 2 and 5.
This paper has three objectives. The first is to provide a unifying framework that explicates the implications of DFMs for VAR analysis, both reduced-form (including forecasting applications) and structural. In particular we list a number of testable overidentifying restrictions that are central to the simplifications provided by introducing factors into VARs.
Our second objective is to examine empirically these implications of the DFM for VAR analysis. Is there support for the exact factor model restrictions or, if not, for an approximate factor model such as that of Chamberlain and Rothschild (1983)? If so, how many factors are needed: two, as suggested by Sargent and Sims (1977) and more recent literature, or more? Another implication of the DFM is that, once factors are included in the VAR, impulse responses with respect to structural shocks should not change upon the inclusion of additional observable variables; but is this borne out empirically?
Our third objective is to provide a unified framework and some new econometric methods for structural VAR analysis using dynamic factors. These methods build on the important initial work by Giannoni, Reichlin, and Sala (2002) and BBE (2005) on the formulation and estimation of structural VARs using factors obtained from large data sets, and we adopt BBE’s term and refer to these system as FAVARs (Factor-Augmented VARs). We consider a variety of identifying schemes, including schemes based on the timing of shocks (as considered by BBE), on long run restrictions (as considered by Giannoni, Reichlin, and Sala (2002)), and on restrictions on the factor loading matrices (as considered by Kose, Otrok and Whiteman (2003), among others). We present feasible estimation strategies for imposing the potentially numerous overidentifying restrictions.
We have three main empirical findings, which are based on an updated version of the Stock-Watson (2002a) data set (the version used here has 132 monthly U.S. variables, 1959 – 2003). First, it appears that the number of dynamic factors present in our data set exceeds two; we estimate the number to be seven. This estimate is robust to details of the model specification and estimation method, and it substantially exceeds the estimates appearing in the earlier literature; we suggest that this estimate is not spurious but rather reflects the narrow scope of the data sets, combined with methodological limitations, in the early studies that suggested only one or two factors.
Second, we find that many of the implications of the DFM for the full 132- variable VAR are rejected, however these rejections are almost entirely associated with coefficients that are statistically significantly different from zero but are very small in an economic or practical sense.
Third, we illustrate the structural FAVAR methods by an empirical reexamination of the BBE identification scheme, using different estimation procedures. We find generally similar results to BBE, which in many cases accord with standard macroeconomic theory; but we also find many rejections of the overidentifying restrictions. These rejections suggest specific ways in which the BBE identifying assumptions fail, something not possible in exactly identified SVAR analysis…
August 16, 2005
If I Only Had a Big Blue Brain
Big Blue to Build a Brain, by Susan Kruglinski, Discover: Some say the most complex object in the universe is the human brain and that the brain’s most complex creation is the computer. With this in mind, a team of Swiss neuroscientists and computer engineers plan to go full circle: They want to program a computer to create a brain.
The scientists, in collaboration with IBM, are launching the effort by building a computer model of the neocortical column of a rat, a single circuit of about 10,000 cells, each of which is capable of thousands of connections. Rat brain information is being downloaded into IBM’s Blue Gene computer, which can crunch through 22 trillion operations per second. Although this first model will depict only the electrical activity of the neurons, future versions will also simulate chemicals in the brain, of interest because the combination of electricity and chemistry may cause thought. Eventually, as the simulations become more sophisticated and computer technology advances, the team hopes to replicate the entire rat brain. From there they will work their way up to humans, eventually creating a computer version accurate enough to be used to research normal and abnormal brain activity. Critics say that there is still too much mystery surrounding the goings-on of neurons to create an accurate computer reproduction. But project leader Henry Markram of the Swiss Federal Institute of Technology in Lausanne believes he has accumulated enough data to get things started. “The first goal is to understand this [neocortical] column,” he says. “If we understand that, I believe we are going to crack the main difficulties of understanding how the brain processes, stores, and retrieves information. That alone is an immense achievement.”
Update: Some touchy-feely science for the Big Blue Brain:
Flexible 'E-skin' Could Endow Robots with Humanlike Sense of Touch, Scientific American: ... Scientists have developed a pliable artificial skin that can sense pressure and temperature...
Machines have feeling too.
Posted by Mark Thoma on Tuesday, August 16, 2005 at 02:43 PM in Science
Investors Shy Away from U.S. Equities
American investors move away from US assets, by Jennifer Hughes, FT: American investors diversified away from the US at the fastest rate in 10 years, even as foreign buyers stepped up their purchases of US assets, data released on Monday suggested. US investors bought $146bn of overseas bonds and equities in the past 12 months more than at any time since 1994. But despite anxieties about the still-growing US current account deficit, overseas investors poured a net $71.2bn into US assets, up from a revised $55.8bn in May, according to the Treasury.
The capital flows, which more than covered the $58.5bn trade deficit for June, suggest that confidence in the strength of the US economy will be sufficient to sustain the external deficits. The dollar rose to $1.236 from $1.239 against the euro on the news. The US needs to attract more than $2bn in net inflows each working day to cover the current account gap, of which the capital and trade accounts are the most visible and biggest components. “The bulk of the current account financing burden falls on securities rather than direct investment …,” said Sean Callow, senior currency strategist at Westpac Bank…
US financial markets have paid particularly close attention to foreign appetite for US assets amid concerns that Asian central banks could be curbing their purchases of US bonds. Lower demand from overseas could push US borrowing costs sharply higher.
The inflows into the US were led in June by the corporate bond market. … But overseas investors remained wary of US stock markets. … “That they're buying bonds and not stocks has to be a bit of a concern,” said Mr Callow. “It suggests investors are happy to take fixed coupon payments on bonds but not convinced enough to bet on equity market appreciation.”
American investors' interest in overseas assets is the latest example of a growing trend. According to the Treasury, US investors bought $9.64bn of foreign equities, up from $4.7bn in May and taking the 12-month total to $96.2bn. … State Street's indicators have shown weak demand for US equities over recent weeks from both domestic and foreign buyers, even when good news has lifted stocks. “This is one of the reasons we're still negative on the dollar,” added Mr Garvey.
Brad Sester has more on the puzzling global flow of funds.
CPI, Residential Construction, and Industrial Production Reports Released
Though hints of a slowdown can be found in some of the reports, e.g. industrial production and the leveling of housing starts, the .5 percent increase in the CPI including food and energy, the headline figure, and the robust growth of new building permits in housing will not dissuade the Fed from further rate increases. Unless new data changes the course, rates are going up, but I believe this report makes it less likely rates will go up by 50 bps instead of 25 bps as some have been advocating and predicting. There are more reports on prices and activity later this week, so we'll know a little more then. Some will see the energy component as justifying a larger increase (headline CPI translates into an annual rate of over 6%), but until the rise in energy prices begins to show up as an increase in the price of other goods generally, and so far that is not in evidence, the transparently measured path will continue.
[Update: I want to add one note. One figure that is not, in my view, receiving enough attention is the medical care inflation figures. In July, medical costs increased .4% and relative to a year ago medical care prices increased 4.2%. Month after month (and as General Glut properly notes in comments, year after year and decade after decade since 1980 as well) medical costs have been consistently higher than the CPI average contributing to the upward pressure on prices.]
Government Budget Gimmicks
"This law says to every dishonest corporate leader: You'll be exposed and punished. The era of low standards and false profits is over. No board room in America is above or beyond the law."
The government’s budget accounting is as bad or worse. John M. Berry of Bloomberg agrees:
Federal Budget Making Is 'Let's Pretend' Farce, John M. Berry, Bloomberg: Budget making in Washington has become a continuous political farce of let's pretend. Pretend that new legislation is going to cost a set amount and not a penny more. Pretend that the cost of yet one more tax cut or new spending program is OK because some other spending can be cut to offset it. Pretend that every dollar being spent is worth it because it will create jobs. Pretend that no tax can ever be raised because it would dangerously damage economic growth. The result is a steady diet of large budget deficits, as the nonpartisan Congressional Budget Office reminded everyone yesterday in one of its regular updates of the budget and economic outlook. Assuming current laws were unchanged, as the CBO is required to do, the cumulative budget deficit was projected to be about $2.1 trillion for the coming 10 years. Using some more realistic assumptions about extending expiring tax cuts, increases in discretionary spending and gradually reducing the military costs of fighting in Iraq and Afghanistan, the total would be more than double that amount. Except for the continuing annual surpluses in Social Security, the CBO's baseline deficit projection would have been nearly $4.6 trillion...
The article goes on to detail several specific instances of misleading (a kind word to use here) representations of budget figures. The disconnect between the reported deficit numbers and the actual deficit is far too large, and much of that can be solved with an honest representation of revenues and commitments.
One final note on deficits. You will hear a lot about the uptick in revenues and the fall in the deficit forecast in coming days. As you do, please remember that according to the Congressional Budget Office the uptick is temporary, something the Washington Times story does not even bother to mention. This graphic on the debt (from here) also puts the news in perspective.
[Update: For more on the budget picture and the interpretation of the latest data on the deficit, see Brad DeLong here and here, and MaxSpeak here. PGL at Angry Bear also comments on the deficit figures.]
Does Gossip Increase Efficiency?
Have You Heard? Gossip Turns Out to Serve a Purpose, By Benedict Carey, NY Times: Juicy gossip moves so quickly - He did what? She has pictures? - that few people have time to cover their ears, even if they wanted to. "I heard a lot in the hallway, on the way to class," said Mady Miraglia, 35, a high school history teacher in Los Gatos, Calif., … "To be honest, it made me feel better as a teacher to hear others being put down," she said. "I was out there on my own, I had no sense of how I was doing in class, and the gossip gave me some connection. And I felt like it gave me status, knowing information, being on the inside." Gossip has long been dismissed by researchers as little more than background noise, blather with no useful function. But some investigators now say that gossip should be central to any study of group interaction.
People find it irresistible for good reason: Gossip not only helps clarify and enforce the rules that keep people working well together, studies suggest, but it circulates crucial information about the behavior of others that cannot be published in an office manual. … This grapevine branches out through almost every social group and it functions, in part, to keep people from straying too far outside the group's rules, written and unwritten ... In one recent experiment, Dr. Wilson led a team of researchers who asked a group of 195 men and women to rate their approval or disapproval of several situations in which people talked behind the back of a neighbor. In one, a rancher complained to other ranchers that his neighbor had neglected to fix a fence, allowing cattle to wander and freeload. The report was accurate, and the students did not disapprove of the gossip. But men in particular, the researchers found, strongly objected if the rancher chose to keep mum about the fence incident. "Plain and simple he should have told about the problem to warn other ranchers," wrote one study participant, expressing a common sentiment that, in this case, a failure to gossip put the group at risk. … Knowing that your boss is cheating on his wife, or that a sister-in-law has a drinking problem or a rival has benefited from a secret trust fund may be enormously important, and in many cases change a person's behavior for the better. … Adept gossipers usually sense which kinds of discreet talk are most likely to win acceptance from a particular group. For example, a closely knit corporate team with clear values - working late hours, for instance - will tend to embrace a person who gripes in private about a colleague who leaves early and shun one who complains about the late nights. By contrast, a widely dispersed sales force may lap up gossip about colleagues, but take it lightly, allowing members to work however they please, said Eric K. Foster, a scholar … who recently published an analysis of gossip research. It is harder to judge how gossip will move through groups that are split into factions, like companies with divisions that are entirely independent, Dr. Foster said. "In these situations, it is the person who gravitates into an intermediate position, making connections between the factions, who controls the gossip flow and holds a lot of power," he said. Such people can mask devious intentions, spread false rumors and manipulate others for years ... But to the extent that healthy gossip has evolved to protect social groups, it will also ultimately expose many of those who cheat and betray. …
I hope the last line is true with regard to the political arena.
Posted by Mark Thoma on Tuesday, August 16, 2005 at 01:53 AM in Economics
The Crisis Question
...Estimates by Social Security Administration trustees indicate that if no adjustments are made ... benefit pay outs would not be reduced until 2042. A reporter asked Ms. Chao how the system could be in “crisis” if it is expected pay out full benefits for the next 37 years...
She didn’t have a good answer, except to say “I don’t think anyone would dispute that Social Security should be reformed.” Apparently, she didn’t realize the reporter had done just that.
So there we have it. A crisis is paying full benefits for 37 years, and this is under conservative assumptions. Under reasonable assumptions full benefits can be paid for much longer than that.
August 15, 2005
San Francisco Fed Researcher Glenn Rudebusch on Bubbles and Monetary Policy
Fed May Need to Raise Rates to Stop 'Bubbles,' Researcher Says, Bloomberg: U.S. central bankers may need to consider raising interest rates to keep surging property prices from creating a financial crisis or a long-term economic slowdown, a researcher with the Federal Reserve Bank of San Francisco said. ''While there are hurdles to clear, the door may be open for using higher interest rates to help reduce or contain price bubbles,'' Glenn Rudebusch, the bank's associate research director, said in an interview Aug. 12.
Rudebusch's comments go beyond the stance taken by Fed Chairman Alan Greenspan and the rest of the Federal Open Market Committee, which decided at its June meeting not to use higher rates to address "possible mispricing'' of assets … Greenspan "has stated his view and thinks it is delusional to think monetary policy is a good tool for popping asset price bubbles,'' Rudebusch said. ''There's still a lot of research to be done and it's not an open-and-shut case.'' … Greenspan told Congress in testimony earlier this year that while there was "froth'' in some local real estate markets, there probably isn't a nationwide bubble in home prices. … Policy makers, in theory, have two choices when asset prices rise in a way that may reflect ''price speculation or irrational investor euphoria,'' Rudebusch said in an Aug. 5 letter posted on the bank's Web site. One is a ''standard policy'' that uses higher rates to offset increased inflation pressures and rising consumer demand that might be triggered, for example, by a booming stock market, he said. The other is a ''bubble policy'' that goes further and tries to reduce the size of the bubble by setting interest rates ''even higher.'' Some surging asset prices may hurt the economy in a way that's difficult to undo, he said. The dot-com bubble, for instance, ''spurred overinvestment in fiber-optic cable and decimated the provision of venture capital for new technology startups for years.''
Central bankers need to answer three questions before taking a bubble policy approach, Rudebusch said. The first is whether a bubble can be identified. Another is whether the fallout from such a bubble will be significant and hard to correct later. The third is whether interest rates are the best tool for addressing rising asset prices. … Rudebusch said ''there is no bottom line on the appropriate policy response to asset price bubbles.'' Further research and experience are needed to settle the debate, he said.
Does Michael Barone Believe the Poor Lack the Genetic Intelligence and Drive Needed to Compete in the Emerging U.S. Meritocracy?
Unless I am misreading this, and please help me if I am, I find the theme of this editorial offensive. Does it really conclude with the idea that although the paths upward in society are closing, people should be happy they can "...find a valued place in society?" That the U.S. should be pleased with the idea that recent trends "...will lead the U.S. toward something resembling a caste society, with the underclass mired ever more firmly at the bottom and the cognitive elite ever more firmly anchored at the top." What is the strange logic that produces the conclusion that because there is less upward mobility, the social conditions are fairer than they used to be as his opening sentence and further remarks suggest? After reading his remarks, I know one person who isn't a member of the "cognitive elite," and I am reminded of our president's propensity to brag about his own academic failings. Cream may not be the only thing that floats to the top.
Read it yourself. Here it is in its entirety. As you read, think of the claim that the Democrats are the party of elitists. I would be happy to learn I completely misinterpreted this editorial because I thought and hoped these ideas died long ago:
Is Social Mobility on the Decline?, by Michael Barone, Creators Syndicate: Has a fairer America also become an America with less social mobility? That is the uncomfortable question raised by John Parker's long American survey in The Economist last month.
"A decline in social mobility would run counter to Americans' deepest beliefs about their country," Parker writes. "Unfortunately, that is what seems to be happening. Class is reappearing in a new form."
This was the conclusion, as well, of a recent series of articles in The New York Times -- although, as the Times and Parker both note, polls show that Americans think their chances of moving up are better than a generation ago. Statistics tell a different story: There is a higher correlation today between parents' and children's income than in the 1980s, and the income gap between college graduates and non-graduated doubled between 1979 and 1997.
"America," concludes Parker, "is becoming a stratified society based on education: a meritocracy."
Parker's view parallels that of another Brit, Ferdinand Mount, former editor of the Times Literary Supplement, in his 2004 book, "Mind the Gap: The New Class Divide in Britain." Mount notes that income inequality has been increasing in Britain, not just during the Thatcherite 1980s, but since Tony Blair's New Labor government took office in 1997 -- much to the dismay of many Labor ministers. He notes also that Britons are not converging on one lifestyle -- Uppers and Downers, as he calls them, still dress differently and speak with different accents -- and that Britain, more open to upward mobility in the past than popular legend would have it, is becoming less so.
This he partly blames on the abolition by equality-minded Laborites years ago of the academically demanding grammar schools that were the routes out of the working class for so many Labor politicians themselves.
"We cannot help noticing," Mount concludes, "that the old class system has been reconstituted into a more or less meritocratic upper tier and a lower tier which is defined principally by its failure to qualify for the upper tier."
Which is exactly what Richard Herrnstein and Charles Murray predicted for America in their controversial book "The Bell Curve," published 11 years ago. Herrnstein and Murray noted that intelligence is both measurable and in some large but unquantifiable part hereditary, an unexceptionable finding for experimental psychologists but maddening to social engineers. As college education becomes open to all with the requisite intelligence, graduates will tend to marry graduates and produce children with similar intelligence, while others will tend to produce children without it.
"Unchecked, these trends," Herrnstein and Murray wrote, "will lead the U.S. toward something resembling a caste society, with the underclass mired ever more firmly at the bottom and the cognitive elite ever more firmly anchored at the top."
Which leads to the question children ask on long car trips: Are we there yet? Mount says Britain is and Parker says America may well be. And maybe so.
Yet should we be so gloomy about this? The British have tended to see their society as a one-ladder system, with Oxford and Cambridge graduates at the top and lavatory cleaners at the bottom. Yet in America (and I think in Britain, too), there are many ladders upward, with many intermediate rungs. Not everyone has an emotional need to be on top: How many people, if they thought seriously about it, would really want the burdens of a CEO, however lavish the pay?
Meritocracy may leave people with no one to blame for failure. But, as Herrnstein and Murray argued, almost all Americans have the ability "to find valued places in society."
And that depends not so much on intelligence as on personal behavior. Here, perhaps, we are coping with meritocracy already. New York Times columnist David Brooks points out that since 1993, we have seen declines in violent crime, family violence, teenage births, abortions, child poverty, drunken driving, teenage sex, teenage suicide and divorce. We are seeing increases in test scores and, as Parker notes, in membership in voluntary associations.
As Murray has written, all you need to do to avoid poverty in this country is to graduate from high school, get and stay married, and take any job. The intelligence needed to get a place in the cognitive elite may become more concentrated in a fair meritocratic society, but the personal behaviors needed to find a valued place in society are available to everyone.
Meritocracy may mean less mobility, but that is bearable if, as Brooks says, "America is becoming more virtuous."
Just for the record, I know some really dumb and lazy rich people.
[Update: Brad DeLong has an excellent follow-up.]
A Flat Tax Recipe for Disaster
One Simple Rate, by Steve Forbes, WSJ Editorial: A major domestic battle looms this fall, when tax reform -- a centerpiece of the president's bold domestic agenda -- will finally be on the table. ... After the political shellacking the White House took on Social Security, the administration will be strongly tempted to take a conciliatory path that supports only superficial reforms … Such a course would have perilous consequences. … My flat tax plan has one simple rate, on the federal level: 17% on personal income; and 17% on corporate profits. There would be generous exemptions … The economic boom the flat tax would unleash would be stupendous, ushering in a long-term, non-inflationary expansion of historic proportions. The current expansion would pale in comparison. Once again, we would be the clear global leader … between 2005 and 2015, the Forbes Flat Tax Plan would generate $56 billion more in new government revenue than the current income tax. More important, an estimated $6 trillion in additional assets would be created, an immense boost to our nation's balance sheet. This study also predicts that that flat tax would lead to nearly 3.5 million new jobs by 2011 -- jobs that otherwise would not exist. …
Gosh Steve, why that’s just magical. It would create over 500,000 additional jobs a year? Magical. And you cut taxes on every single person and increase revenues by $56 billion? Recent tax cuts have made the deficit worse so that will be even more amazing. And we could sure use another $6 trillion in assets. By the way, who will own those assets?
For anyone wearing magic spell protection, it is obvious that this is a recipe for fiscal disaster. Haven’t the deficits of Reagan and Bush, and Bush taught us anything? Here’s the trick for shaking off the spell. As you look at the graph below, say to yourself again and again: Look at the red part of the line... Look at the red part of the line... Look at the red part of the line... Look at the red part of the line... Look at the red part of the line...
Source: National Debt History by President [The source states: "The data plotted here were taken directly from the White House web site and plotted without modification." I checked to be sure and the graph is a plot of the OMB Gross National Debt numbers in Historical Table 7-1.]
Big-Government Conservatives, Editorial, WP: Three times in the past quarter-century, conservative leaders have promised to restrain wasteful government spending. President Ronald Reagan tried it … And President Bush has tried it ... None of these efforts proved politically sustainable. ... Mr. Bush's attempt at spending discipline has been especially limp. … The nation is at war. It faces large expenses for homeland security. It is about to go through a demographic transition that will strain important entitlement programs. … Remember, Republicans control the Senate and the House as well as the White House. So somebody remind us: Which is the party of big government?
It’s Not Too Late to Send a Card…
In Praise of Social Security, 70 Years Old, By Michelle Singletary, WP: … Curiously, when I checked the official White House Web site three days before the 70th anniversary, there was no mention of it. What a shame this administration, which says it is determined to "reform" Social Security and keep it solvent, didn't see fit to appropriately celebrate the anniversary of the passing into law of one of the most successful government programs in this country's history.
Putting Greenspan in His Proper Place
Greenspan's legacy: plenty to praise, less to lambaste, By David R. Francis, Christian Science Monitor: Greenomics. Embodiment of Prosperity. Maestro. Sacred cow. Fraud. Political hack. All these terms have been used to refer to Federal Reserve Chairman Alan Greenspan. He's the world's most powerful economic official. … That makes him a target for both virulent attacks and worshipful praise - especially now since Mr. Greenspan's 18-year Fed tenure is ending. … Already, economists are evaluating the central bank chairman's role in financial history. His legacy will be examined later this month at a high-powered conference in Jackson Hole, Wyo., sponsored by the Kansas City Fed branch. … Economist Allan Meltzer … places Greenspan in "the front rank" of the 12 chairmen that have led the Fed in its modern era - since reforms of 1935-36. Like many others, …[he]… praises Greenspan for his success during much of his tenure in achieving the Fed's top two objectives: low inflation and low unemployment. Robert Barro, a Harvard University economist, praises Greenspan for an "extremely good job" at keeping inflation close to 2 percent a year by one measure. Another achievement is the Fed's increased transparency. It quickly advises the public of its monetary policy, even hinting at future moves. …
… Greenspan … doesn't escape criticism. Mr. Meyer, author of a new book, "A Term at the Fed: An Insider's View," holds that Greenspan was wrong to state his views on issues outside the purview of the Fed. "The chairman should not become a party in partisan debates about economic policies," he says. For example, in 2001, Democrats accused Greenspan of breathing life into President Bush's proposal for massive tax cuts that soon swelled a budget deficit. In 2003, Greenspan cast doubts on the Bush plan for a second round of tax cuts. The economy needed no new stimulus, and the lost revenue would expand the deficit, Greenspan testified. "The Fed chairman should not try to make fiscal policy," responded a Republican senator at the time. Greenspan has also supported generally Republican views that the minimum wage should not be raised and that Social Security badly needs trimming. Professor Barro calls Greenspan's verbal interventions in nonmonetary policies "a bit of a mistake." …
What Meltzer, Barro, and Meyer see as praiseworthy - Greenspan's steady, disciplined hand on the monetary steering wheel, and his aggressive preemptive moves to alleviate crises … economist Ravi Batra regards as having had "devastating" effects on ordinary Americans. The Southern Methodist University economist and author of a another new book on the Fed ("Greenpsan's Fraud") argues that by pumping up America's money supply in crises and tightening monetary policy afterward, the Fed hasn't let booms last long enough for workers' wages to catch up with growing productivity. "CEOs have gained ... and workers have suffered sharply," he says. Real wages have fallen. More Americans have slipped into poverty. And so goes the debate over Greenspan's performance. …
August 14, 2005
Krugman and Tanner Debate Social Security on its 70th Birthday
Social Security's future debated, By John Davis, Poughkeepsie Journal: HYDE PARK — About 1,000 people gathered at the Franklin D. Roosevelt estate Saturday to mark the 70th anniversary of the Social Security program, signed into law by President Roosevelt on Aug. 14, 1935. A debate on the future of the federal program, which provides a guaranteed income for the elderly and disabled, was the centerpiece of the outdoor event. … Most of those attending were seniors who are members of retired groups opposed to the proposals of President Bush and others who want to reform Social Security by allowing some private investments of payroll taxes. … It was hard to find anyone — young or old — Saturday who supported any of the plans to privatize Social Security. The exception was Michael Tanner of the Cato Institute, a Washington-based libertarian think tank, who was there to debate the future of Social Security with Paul Krugman, an editorial columnist for the New York Times.
"Every event needs a sacrificial lamb," Tanner said in taking his seat on the stage. "They'll be serving portions of me, I understand, for lunch." Tanner argued workers who now pay 12.4 percent on their first $90,000 annual income in payroll taxes, should have more control over how their contributions are invested. "You have no legal right to those benefits at all," Tanner said. "There is nothing in the world that is less guaranteed than a politician's promise."
Krugman — the clear favorite of the crowd, based on applause — said despite the rhetoric coming from the White House and other quarters, Social Security is not in need of reform. "The fact that we're here celebrating Social Security shows some politicians' promises are worth more than others," Krugman said. "Social Security as it is currently constituted is very efficient. We're talking about a system that really works quite well."
Tanner called for allowing workers to invest their share of the annual Social Security payroll tax surplus, which, he said, would put an end to the federal government borrowing and spending that money. "That surplus is being spent on everything the government does from rutabaga research to the war in Iraq," Tanner said. "If Congress is going to spend like a drunken sailor, take the bottle away from them."
Krugman, however, said the surplus is needed to offset a decline in federal revenues augmented by the Bush tax cuts. "Those tax cuts, rather than the spending binge, are the primary cause of the (federal) deficit," Krugman said. The debaters fielded a number of questions and comments from the gathering. …
This line from Krugman is my favorite from the debate, "The fact that we're here celebrating Social Security shows some politicians' promises are worth more than others." The whole idea that personal accounts are needed because of the inability of congress to act in their constituents best interest, because congress is morally bankrupt, always rings hollow to me. Don’t change the system, change congress. If congress is going to "spend like a drunken sailor" then throw them out of the House. If they thought you'd actually vote them out for this stuff, they’d behave differently, but they don't think you will. Why is that?
Update: Here is Krugman's NY Times column on Social Security turning 70:
Social Security Lessons, by Paul Krugman, NY Times: Social Security turned 70 yesterday. And to almost everyone's surprise, the nation's most successful government program is still intact. Just a few months ago the conventional wisdom was that President Bush would get his way on Social Security. Instead, Mr. Bush's privatization drive flopped so badly that the topic has almost disappeared from national discussion. But I'd like to revisit Social Security for a moment, because it's important to remember what Mr. Bush tried to get away with.
Many pundits and editorial boards still give Mr. Bush credit for trying to "reform" Social Security. In fact, Mr. Bush came to bury Social Security, not to save it. Over time, the Bush plan would have transformed Social Security from a social insurance program into a mutual fund, with nothing except a name in common with the system F.D.R. created. In addition to misrepresenting his goals, Mr. Bush repeatedly lied about the current system. Oh, I'm sorry - was that a rude thing to say? Still, the fact is that Mr. Bush repeatedly said things that were demonstrably false and that his staff must have known were false. The falsehoods ranged from his claim that Social Security is unfair to African-Americans to his claim that "waiting just one year adds $600 billion to the cost of fixing Social Security." Meanwhile, the administration politicized the Social Security Administration and used taxpayer money to promote a partisan agenda. Social Security officials participated in what were in effect taxpayer- financed political rallies, from which skeptical members of the public were excluded. I'm writing about this in the past tense, but some of it is still going on. Last week Jo Anne Barnhart, the commissioner of Social Security, published an op-ed article claiming that Social Security as we know it was designed for a society in which people didn't live long enough to collect a lot of benefits. "The number of older Americans living now," wrote Ms. Barnhart, "is greater than anyone could have imagined in 1935." Now, it turns out that an article on the Social Security Administration's Web site, "Life Expectancy for Social Security," specifically rejects the idea the Social Security was originally "designed in such a way that few people would collect the benefits," and the related idea that the system faces problems from "a supposed dramatic increase in life expectancy in recent years." And the current number of older Americans as a share of the population is just about what the founders of Social Security expected. The 1934 report of F.D.R.'s Commission on Economic Security, which laid the groundwork for the Social Security Act, projected that 12.7 percent of Americans would be 65 or older by the year 2000. The actual number was 12.4 percent. Despite Ms. Barnhart's efforts, however, privatization seems to be dead for the time being. The Democratic leadership in Congress defied the punditocracy - which was very much in favor of privatization - by refusing to cave in, and the American people made it clear that they like Social Security the way it is. But the campaign for privatization provided an object lesson in how the administration sells its policies: by misrepresenting its goals, lying about the facts and abusing its control of government agencies. These were the same tactics used to sell both tax cuts and the Iraq war. And there are two reasons to study that lesson. One is to be prepared for whatever comes next on Mr. Bush's agenda. Despite the tough talk about Iran, I don't think he can propose another war - there aren't enough troops to fight the wars we already have. But there's still room for another big domestic initiative, probably tax reform. Forewarned is forearmed: the real goals of reform won't be as advertised, the administration will say things about the current system that aren't true, and the Treasury Department will function in a purely partisan capacity. The other is that the public's visceral rejection of privatization, together with growing dismay over the debacle in Iraq, offers Democrats an opportunity to make an issue of the administration's pattern of deception. The question is whether they will dare to seize that opportunity, when for some of them it means admitting that they, too, were fooled.
Just one comment. Krugman is more optimistic than I am that private accounts are dead. I see one last concerted effort coming this fall. I hope he's right.
Iraq Not Free to Choose Economic Structure
Bush's economic invasion of Iraq, by Antonia Juhasz, LA Times: On Monday, Iraq's National Assembly will release a draft constitution to be voted on … in two months. Since February, vital issues have been debated … the role of Islamic law, the rights of women, the autonomy of the Kurds and the participation of the minority Sunnis. But what hasn't been on the table is … the country's economic structure.
The Bush administration has succeeded in maintaining a stranglehold on issues such as public versus private ownership of resources, foreign access to Iraqi oil and U.S. control of the reconstruction effort — all of which are still governed by administration policies put into place immediately after the invasion. The Bush economic agenda favors foreign interests — American interests — over Iraqi self-determination. Over a year ago, orders were put in place by L. Paul Bremer III, then the U.S. administrator of Iraq, that were designed to "transition [Iraq] from a … centrally planned economy to a market economy" virtually overnight and by U.S. fiat. … Laws governing banking, investment, patents, copyrights, business ownership, taxes, the media and trade have all been changed according to U.S. goals, with little real participation from the Iraqi people. … The constitutional drafting committee has, in turn, left each of these laws in place.
A central component of the Bush economic agenda is foreign corporate access to, and privatization of, Iraq's once state-run economy. Thus, an early Bremer order allowed foreign investment in and the privatization of all 192 government-owned industries (excluding oil extraction). … Oil is, of course, at the heart of the agenda. In 2004, U.S.-appointed interim Prime Minister Iyad Allawi submitted guidelines to Iraq's Supreme Council for Oil Policy suggesting that … the [Iraq National Oil Company] be partly privatized in the future" and opened to international foreign investment, according to International Oil Daily. … The U.S.-appointed interim Finance Minister Adel Abdul Mehdi explained that the new law would be "very promising to the American investors and to American enterprise, certainly to oil companies." A few weeks later, Mehdi became one of Iraq's two vice presidents and Allawi was elected to the National Assembly. Iraq's new oil law is on track for implementation in 2006.
Finally, consider Iraq's reconstruction, which also remains firmly under U.S. control. One of Bremer's orders denied the Iraqi government the ability to give preference to Iraqis in the reconstruction effort. Instead, more than 150 U.S. companies were awarded contracts totaling more than $50 billion, more than twice the GDP of Iraq. Halliburton has the largest, worth more than $11 billion, while 13 other U.S. companies are earning more than $1.5 billion each. … By all accounts, the draft constitution has failed to provide Iraqis with the means to control their economic future. … Just as discussions are finally emerging for ending the U.S. military occupation of Iraq, so too must the economic invasion be brought to an end.
AARP Reaffirms Support for Social Security Solvency Reform
To: National Desk Contact: David Irwin of AARP New York
HYDE PARK, N.Y., August 13 /U.S. Newswire/ -- More than one hundred AARP members gathered at Hyde Park today to celebrate Social Security's birthday and to remind Congress and the public that reform of the program must focus on workable solutions that keep the program alive for all generations, not those that will weaken the program such as private "carve out" account proposals.
"We are here to celebrate the success of 70 years of Social Security but we are also working hard to ensure that the program is strengthened so 70 years from today our children and grandchildren can benefit from it," said Rosalyn Feder, an AARP member from Staten Island. "Making the right changes today will help ensure a guaranteed financial foundation for everyone tomorrow."
AARP also marked Social Security's birthday with the release of a new poll showing that not only has public confidence in Social Security increased in recent years, but the program has also surpassed pensions and savings as the top source of income Americans expect to rely on in retirement.
"It's time for Congress to put aside divisive ideas that don't solve the problem and get serious about strengthening Social Security so it's fair for all generations," said Lois Aronstein, AARP New York State Director.
And here’s yesterday’s press release:
To: Assignment Desk, Daybook Editor Contact: David Irwin of AARP
-- AARP Available for Comment on Social Security Birthday, Reform Proposals and the Need to Strengthen the Program for All Generations
What: AARP members from across New York State will converge on Hyde Park for Social Security's 70th birthday celebration with a very serious message for Congress about the nation's most successful program - "Strengthen It - Don't Destroy It!" Fueled by a new AARP survey showing Social Security as the top source of income Americans expect to rely on in retirement, over 100 members will be on hand to remind Congress and the public that Social Security reform must focus on workable solutions that keep the promise of the program alive for all generations. AARP members will be available to media for commentary on current reform proposals and the need to strengthen Social Security.
Who: AARP members from through New York State When: Saturday, August 13 10 AM to 3 PM
Where: Franklin D. Roosevelt Presidential Library, 4079 Albany Post Road, Hyde Park, New York 12538 Why: Current proposals to create private accounts by draining money out of Social Security will weaken the program for future generations. Every generation loses under these plans for Social Security. In New York State, Social Security provides benefits to over three million people, including retired workers, widows and widowers, disabled workers and children. AARP is committed to defeating these proposals and strengthening Social Security
Here’s the Democrats latest position:
U.S. Democrats demand conditions on Social Security, Reuters: On the eve of Social Security's 70th anniversary, Democrats said on Saturday they are ready to move toward revamping the financially troubled retirement program but warned against stripping away benefits to retirees and relying on private accounts for funding. "We have a moral obligation to stand up and protect Social Security for the next 70 years and beyond -- that means stopping privatization and dropping partisan demands for private accounts," said Rep. John Salazar, a Colorado Democrat, in his response to President George W. Bush's radio address. … "Social Security has never failed to pay promised benefits, and Democrats will fight to make sure that Republicans do not turn a guaranteed benefit into a guaranteed gamble," said House Democratic leader Nancy Pelosi of California. "Democrats stand ready to address the challenges facing Social Security's solvency, but this cannot begin until Republicans begin talking about ways to make Social Security stronger, not weaker," she said.
The solvency door is opening. Will the key players get stuck as they all rush to fit through the opening at once resulting in legislative gridlock, or does one side have the upper hand? Is there anyone left to block the doorway? We’ll see where this goes.
August 13, 2005
Unintelligent Complex Design
The explanation can be used to predict experimental outcomes or data gathered from the historical record and it’s ability to explain the facts can be challenged in the process. The ability to challenge the model's predictions is essential. Nothing in science will ever be inconsistent with the world from coming into being through some unimaginable force. An intelligent designer could have started this universe an instant ago with all of our memories and perceptions, all of the information present in the universe, pre-programmed to his/her/its whim. Though this sounds to me like a pretty good scientist, the story itself will never be science. It is a belief and nothing more. There is no way to ever test the proposition that the world suddenly arose as it is an instant ago and that’s what makes all the difference between science and intelligent design.
What follows is science. There is a long introduction, but it’s in question #1 that follows the introduction where the complexity issue is addressed directly. If you are interested in this issue, this is something you should know about:
[Update: I just learned that Kevin Drum references the same article a few days ago.]
Testing Darwin, Discover, February 2005 (Subscription link, Free link at author's web site): If you want to find alien life-forms, hold off on booking that trip to the moons of Saturn. You may only need to catch a plane to East Lansing, Michigan. The aliens of East Lansing are not made of carbon and water. They have no DNA. Billions of them are quietly colonizing a cluster of 200 computers in the basement of the Plant and Soil Sciences building at Michigan State University. To peer into their world, however, you have to walk a few blocks west on Wilson Road to the engineering department and visit the Digital Evolution Laboratory. Here you'll find a crew of computer scientists, biologists, and even a philosopher or two gazing at computer monitors, watching the evolution of bizarre new life-forms.
These are digital organisms-strings of commands-akin to computer viruses. Each organism can produce tens of thousands of copies of itself within a matter of minutes. Unlike computer viruses, however, they are made up of digital bits that can mutate in much the same way DNA mutates. A software program called Avida allows researchers to track the birth, life, and death of generation after generation of the digital organisms by scanning columns of numbers that pour down a computer screen like waterfalls.
After more than a decade of development, Avida's digital organisms are now getting close to fulfilling the definition of biological life. “More and more of the features that biologists have said were necessary for life we can check off,” says Robert Pennock, a philosopher at Michigan State and a member of the Avida team. “Does this, does that, does this. Metabolism? Maybe not quite yet, but getting pretty close.”
One thing the digital organisms do particularly well is evolve.“ Avida is not a simulation of evolution; it is an instance of it,” Pennock says. “All the core parts of the Darwinian process are there. These things replicate, they mutate, they are competing with one another. The very process of natural selection is happening there. If that's central to the definition of life, then these things count.”
It may seem strange to talk about a chunk of computer code in the same way you talk about a cherry tree or a dolphin. But the more biologists think about life, the more compelling the equation becomes. Computer programs and DNA are both sets of instructions. Computer programs tell a computer how to process information, while DNA instructs a cell how to assemble proteins.
The ultimate goal of the instructions in DNA is to make new organisms that contain the same genetic instructions. “You could consider a living organism as nothing more than an information channel, where it's transmitting its genome to its offspring,” says Charles Ofria, director of the Digital Evolution Laboratory. “And the information stored in the channel is how to build a new channel.” So a computer program that contains instructions for making new copies of itself has taken a significant step toward life.
A cherry tree absorbs raw materials and turns them into useful things. In goes carbon dioxide, water, and nutrients. Out comes wood, cherries, and toxins to ward off insects. A computer program works the same way. Consider a program that adds two numbers. The numbers go in like carbon dioxide and water, and the sum comes out like a cherry tree.
In the late 1990s Ofria's former adviser, physicist Chris Adami of Caltech, set out to create the conditions in which a computer program could evolve the ability to do addition. He created some primitive digital organisms and at regular intervals presented numbers to them. At first they could do nothing. But each time a digital organism replicated, there was a small chance that one of its command lines might mutate. On a rare occasion, these mutations allowed an organism to process one of the numbers in a simple way. An organism might acquire the ability simply to read a number, for example, and then produce an identical output.
Adami rewarded the digital organisms by speeding up the time it took them to reproduce. If an organism could read two numbers at once, he would speed up its reproduction even more. And if they could add the numbers, he would give them an even bigger reward. Within six months, Adami's organisms were addition whizzes. “We were able to get them to evolve without fail,” he says. But when he stopped to look at exactly how the organisms were adding numbers, he was more surprised. “Some of the ways were obvious, but with others I'd say, 'What the hell is happening?' It seemed completely insane.”
On a trip to Michigan State, Adami met microbiologist Richard Lenski, who studies the evolution of bacteria. Adami later sent Lenski a copy of the Avida software so he could try it out for himself. On a Friday, Lenski loaded the program into his computer and began to create digital worlds. By Monday he was tempted to shut down his lab and dedicate himself to Avida. “It just had the smell of life,” says Lenski.
It also mirrored Lenski's own research. Since 1988 he has been running the longest continuous experiment in evolution. He began with a single bacterium-Escherichia coli-and used its offspring to found 12 separate colonies of bacteria that he nurtured on a meager diet of glucose, which creates a strong incentive for the evolution of new ways to survive. Over the past 17 years, the colonies have passed through 35,000 generations. In the process, they've become one of the clearest demonstrations that natural selection is real. All 12 colonies have evolved to the point at which the bacteria can replicate almost twice as fast as their ancestors. At the same time, the bacterial cells have gotten twice as big. Surprisingly, these changes didn't unfold in a smooth, linear process. Instead, each colony evolved in sudden jerks, followed by hundreds of generations of little change, followed by more jerks.
Similar patterns occur in the evolution of digital organisms in Avida. So Lenski set up digital versions of his bacterial colonies and has been studying them ever since. He still marvels at the flexibility and speed of Avida, which not only allow him to alter experimental conditions with a few keystrokes but also to automatically record every mutation in every organism. “In an hour I can gather more information than we had been able to gather in years of working on bacteria,” Lenski say.“ Avida just spits data at you.”
With this newfound power, the Avida team is putting Darwin to the test in a way that was previously unimaginable. Modern evolutionary biologists have a wealth of fossils to study, and they can compare the biochemistry and genes of living species. But they can't look at every single generation and every single gene that separates a bird, for example, from its two-legged dinosaur ancestors. By contrast, Avida makes it possible to watch the random mutation and natural selection of digital organisms unfold over millions of generations. In the process, it is beginning to shed light on some of the biggest questions of evolution.
QUESTION #1: WHAT GOOD IS HALF AN EYE?
If life today is the result of evolution by natural selection, Darwin realized, then even the most complex systems in biology must have emerged gradually from simple precursors, like someone crossing a river using stepping-stones. But consider the human eye, which is made of many different parts-lens, iris, jelly, retina, optic nerve-and will not work if even one part is missing. If the eye evolved in a piecemeal fashion, how was it of any use to our ancestors? Darwin argued that even a simpler version of today's eyes could have helped animals survive. Early eyes might have been nothing more than a patch of photosensitive cells that could tell an animal if it was in light or shadow. If that patch then evolved into a pit, it might also have been able to detect the direction of the light. Gradually, the eye could have taken on new functions, until at last it could produce full-blown images. Even today, you can find these sorts of proto-eyes in flatworms and other animals. Darwin declared that the belief that natural selection cannot produce a complex organ “can hardly be considered real.”
Digital organisms don't have complex organs such as eyes, but they can process information in complex ways. In order to add two numbers together, for example, a digital organism needs to carry out a lot of simpler operations, such as reading the numbers and holding pieces of those numbers in its memory. Knock out the commands that let a digital organism do one of these simple operations and it may not be able to add. The Avida team realized that by watching a complex organism evolve, they might learn some lessons about how complexity evolves in general.
The researchers set up an experiment to document how one particularly complex operation evolved. The operation, known as equals, consists of comparing pairs of binary numbers, bit by bit, and recording whether each pair of digits is the same. It's a standard operation found in software, but it's not a simple one. The shortest equals program Ofria could write is 19 lines long. The chances that random mutations alone could produce it are about one in a thousand trillion trillion.
To test Darwin's idea that complex systems evolve from simpler precursors, the Avida team set up rewards for simpler operations and bigger rewards for more complex ones. The researchers set up an experiment in which organisms replicate for 16,000generations. They then repeated the experiment 50 times.
Avida beat the odds. In 23 of the 50 trials, evolution produced organisms that could carry out the equals operation. And when the researchers took away rewards for simpler operations, the organisms never evolved an equals program. “When we looked at the 23 tests, they were all done in completely different ways,” adds Ofria. He was reminded of how Darwin pointed out that many evolutionary paths can produce the same complex organ. A fly and an octopus can both produce an image with their eyes, but their eyes are dramatically different from ours. “Darwin was right on that-there are many different ways of evolving the same function,” says Ofria.
The Avida team then traced the genealogy leading from the first organism to each one that had evolved the equals routine. “The beauty of digital life is that you can watch it happen step by step,” says Adami. “In every step you would ordinarily never see there is a goal you're going toward.” Indeed, the ancestors of the successful organisms sometimes suffered harmful mutations that made them reproduce at a slower rate. But mutations a few generations later sped them up again.
When the Avida team published their first results on the evolution of complexity in 2003, they were inundated with e-mails from creationists. Their work hit a nerve in the antievolution movement and hit it hard. A popular claim of creationists is that life shows signs of intelligent design, especially in its complexity. They argue that complex things could never have evolved, because they don't work unless all their parts are in place. But as Adami points out, if creationists were right, then Avida wouldn't be able to produce complex digital organisms. A digital organism may use 19 or more simple routines in order to carry out the equals operation. If you delete any of the routines, it can't do the job. “What we show is that there are irreducibly complex things and they can evolve,” says Adami.
The Avida team makes their software freely available on the Internet, and creationists have downloaded it over and over again in hopes of finding a fatal flaw. While they've uncovered a few minor glitches, Ofria says they have yet to find anything serious. “We literally have an army of thousands of unpaid bug testers,” he says. “What more could you want?”
QUESTION #2: WHY DOES A FOREST HAVE MORE THAN ONE KIND OF PLANT?
When you walk into a forest, the first thing you see is diversity. Trees tower high overhead, ferns lurk down below, vines wander here and there like tangled snakes. Yet these trees, ferns, and vines are all plants, and as such, they all make a living in the same way, by catching sunlight. If one species was better than all the rest at catching sunlight, then you might expect it to outcompete the other plants and take over the forest. But it's clear that evolution has taken a different course.
Figuring out why is a full-time job for a small army of biologists. … [link to article]
QUESTION #3: WHY BE NICE?
Human society depends on countless acts of cooperation and personal sacrifice. But that doesn't make us unique. Consider Myxococcus xanthus, a species of bacteria that Lenski and his colleagues study. Myxococcus travels in giant swarms 100,000 strong, hunting down E. coli and other bacteria like wolves chasing moose. They kill their prey by spitting out antibiotics, then spit out digestive enzymes that make the E. coli burst open. The swarm then feasts together on the remains. If the Myxococcus swarm senses that they've run out of prey to hunt, they gather together to form a stalk. The bacteria at the very top of the stalk turn into spores, which can be carried away by wind or water to another spot where they can start a new pack. Meanwhile, the individuals that formed the stalk die.
This sort of cooperation poses a major puzzle because it could be undermined by the evolution of cheaters. … [link to article]
QUESTION #4: WHY SEX?
Birds do it, bees do it, and even fleas do it-but why they all do it is another matter. Reproduction is possible without sex. Bacteria and protozoa simply split in two. Some trees send shoots into the ground that sprout up as new trees. There are even lizard species that are all female. Their eggs don't need sperm to start developing into healthy baby female lizards.
“One of the biggest questions in evolution is, why aren't all organisms asexual?” says Adami. Given the obvious inefficiency of sex, evolutionary biologists suspect that it must confer some powerful advantage that makes it so common. But they have yet to come to a consensus about what that advantage is. … [link to article]
QUESTION #5: WHAT DOES LIFE ONOTHER PLANETS LOOK LIKE?
Life on Earth is based on DNA. But we can't exclude the possibility that life could evolve from a completely different system of molecules. And that raises some worrying questions about the work going on these days to find signs of extraterrestrial life. NASA is funding a wide range of life-detecting instruments, from rovers that prowl across Mars to telescopes that will gaze at distant solar systems. They are looking for the signs of life that are produced on Earth. Some are looking for high levels of oxygen in the atmospheres of other planets. Others are looking for bits of DNA or fragments of cell walls. But if there's non-DNA-based life out there, we might overlook it because it doesn't fit our preconceptions. “We can look at how known life-forms leave marks on their environment,” says Evan Dorn, a member of Chris Adami's lab at Caltech, “but we can never make universal statements about them because we have only one example.” Dorn says Avida is example number two. … [link to article]
QUESTION #6: WHAT WILL LIFE ON EARTH LOOK LIKE IN THE FUTURE?
One of the hallmarks of life is its ability to evolve around our best efforts to control it. Antibiotics, for example, were once considered a magic bullet that would eradicate infectious diseases. In just a few decades, bacteria have evolved an arsenal of defenses that make many antibiotics useless. Ofria has been finding that digital organisms have a way of outwitting him as well. Not long ago, he decided to see what would happen if he stopped digital organisms from adapting. Whenever an organism mutated, he would run it through a special test to see whether the mutation was beneficial. If it was, he killed the organism off. “You'd think that would turn off any further adaptation,” he says. Instead, the digital organisms kept evolving. They learned to process information in new ways and were able to replicate faster. It took a while for Ofria to realize that they had tricked him. … [link to article]
Posted by Mark Thoma on Saturday, August 13, 2005 at 06:21 PM in Science
Greenspan Pressures Regulators to Rein in Housing Speculation
Inside Report: Greenspan's Concerns, By Robert Novak: Federal Reserve Chairman Alan Greenspan, worried about excesses in real estate investment, has privately called on other federal regulators to take a closer look at imprudent speculation. According to Fed sources, Greenspan has told the regulators that there is a limit to what the central bank's monetary policy can do in tamping down inflationary pressures. He has been in contact with the Comptroller of the Currency and the Office of Thrift Supervision, among other agencies…
The Insurance Value of Increasing the Federal Funds Rate
Paying the fiddler is always painful. If we intentionally unbalance the economy to attenuate a recession, then much like the Keynesian policy of running a surplus in good times to pay for the deficits used to smooth the bad times, rising interest rates and slower economic growth are the costs that must be paid to attain a healthier more balanced economy during the recovery period. But it's always tempting to avoid such costs.
It is not clear to me which is worse from labor’s perspective, slowing the economy during the recovery to rebalance which has the benefit of reducing the chance of a bigger calamity later, or more employment but higher risks from allowing the imbalance to remain. Think of the housing sector as a balloon with too much air, a balloon ready to pop if subjected to additional stress. The chance of the balloon bursting is reduced if we let the air out very slowly and carefully. Thinking further of the escaping air as resources flowing out of the housing sector, we shouldn't allow the air escape, but instead use it to re-inflate balloons representing other sectors of the economy to the extent possible. There are lots of policies that can be implemented to facilitate this structural change outside of monetary policy, policies that allow as little air to escape as possible during the sectoral reallocation, and those ought to be pursued vigorously.
As I see it, commentators cannot simultaneously complain about Fed policy regarding both the potential for the housing bubble bursting, which requires higher interest rates as a remedy, and a sluggish labor market, which calls for a leveling or lowering of rates. We can debate whether past Fed policy got us into this predicament, and we should review the game film carefully to correct any errors in policy, but now that we are here we have to choose a problem to work on, the Fed cannot solve both at once. Currently I see the need for rebalancing as greater than the need for leveling or lowering rates, but it is not an easy call, and there are arguments on both sides.
The goal here is not to say that rates should be raised for sure in the next few FOMC meetings, for one thing new data could change the outlook. The focus is on the rebalancing aspect because I believe that getting the air out of the balloon at a slow, measured pace so as to re-inflate other sectors, with everybody warned that it is happening so that if the balloon pops loudly nobody jumps out of their seat, is best for now. The goal is to highlight that there is a potential benefit from higher rates that has nothing to do with slowing the economy out of fear of inflation. Inflation in and of itself is not, nor has it ever been, my worry. I want labor and other resource and output markets to be as robust as possible against shocks when the next one hits, and one will hit someday, and rebalancing the economy is an essential insurance policy against such risks. Slower output growth during the rebalancing period is the cost of the insurance premium for labor and I understand that some feel the insurance is far too expensive. For now, I do not.
[Update: The purpose of writing this was to generate discussion on "bubble" policy and this is my attempt to make a case for it. I was happy to see the discussion continue with comments from Glenn Rudebusch, a researcher with the SF Fed, on "bubble" policy who discusses this topic further and sets conditions that must be met prior to the implementation of policy directed at bubble management.]
August 12, 2005
Global Warming Doubts Eliminated by Correction of Data Error
Scientists find errors in global warming data, By Dan Vergano, USA Today: Satellite and weather-balloon research released Friday removes a last bastion of scientific doubt about global warming, researchers say. Surface temperatures have shown small but steady increases since the 1970s, but the tropics had shown little atmospheric heating - and even some cooling. Now, after sleuthing reported in three papers released by the journal Science, revisions have been made to that atmospheric data. Climate expert Ben Santer of Lawrence Livermore National Laboratory in California, lead author of one of the papers, says that those fairly steady measurements in the tropics have been a key argument "among people asking, 'Why should I believe this global warming hocus-pocus?' " … "Our hats are off to (them). They found a real source of error," says atmospheric scientist John Christy of the University of Alabama at Huntsville, whose team produced the lower temperature estimates. …
For the record, I am not promoting global warming so I can have a few more sunny days. Besides, the research also says the winters are getting cloudier which only makes the dreariest days even drearier.
The science is convincing, especially now, but I doubt this will end the debate over this issue. Even if the warming is acknowledged, the next step for opponents will be to say it's not very costly. For example, from the report above from USA Today:
Mark Herlong of the George C. Marshall Institute declined to comment. The group, financed by the petroleum industry, has used the data disparities to dispute the views of global-warming activists. In recent years, however, the institute has softened its public statements, acknowledging that the planet is indeed getting warmer but still maintaining that the change is happening so slowly that the impact is minimal.
These groups will not be easily convinced that the long-run benefits of reducing global warming exceed the long-run costs.
[Note: A slighly different version is posted at Environmental Economics.]
The Ayn Rand Institute Calls for Euthanasia for Social Security as it Nears its 70th Birthday
On Its 70th Birthday, Put Social Security Out of Our Misery, by Ayn Rand Institute: This month marks the 70th birthday of Social Security. In the program’s old age, many politicians are worried about its health and debating about how to cure it. One side, led by President Bush, says that Social Security is in mortal peril, and must be saved via “partial privatization.” The other side says that Social Security is just a little sick, and needs only a little tinkering to be restored to health. Both sides, however, agree on one absolute: Social Security should be saved. … they believe, some form of mandatory government-run retirement program is morally necessary. But is it?... If Social Security did not exist--if the individual were free to use that 12% of his income as he chose--his ability to better his future would be incomparably greater. … And yet Social Security's advocates continue to push it as moral. Why? The answer lies in the program's ideal of "universal coverage"--the idea that, as a recent New York Times editorial preached, "all old people must have the dignity of financial security" -- regardless of how irresponsibly they have acted. … Observe that Social Security's wholesale harm to those who would use their income responsibly is justified in the name of those who would not. The rational and responsible are shackled and throttled for the sake of the irrational and irresponsible. Those who wish to devote their wealth to saving the irresponsible from the consequences of their own actions should be free to do so through private charity, but to loot the savings of untold millions of innocent, responsible, hard-working young people in the name of such a goal is a monstrous injustice. Social Security in any form is morally irredeemable. We should be debating, not how to save Social Security, but how to end it...
I guess being poor is behaving irresponsibly. I have written many times on why Social Security is needed, about market failures in retirement savings markets, and so on, so I won’t rebut the idea that Social Security is unnecessary yet again. The goal here is to point out why many distrust any movement towards reform even when there may be reason, in a rational world, to put some reforms in place, e.g. to encourage add-on savings accounts. There is a large group that wants Social Security ended, there is no compromise in that position, and it is useless to engage in reform dialogue of any sort with this group. When the other side will not compromise, it's best to just say no and not negotiate at all even if it means being called obstructionists.
The NRO versus Bernanke
First, here’s the NRO hit piece from John Tamny intended to undermine Bernanke’s chances at becoming Fed chair. This all started with Bernanke’s announcement that the administration opposed Social Security reform that did not address both personal accounts and solvency, a position the NRO does not agree with:
The Scary Side of Ben Bernanke, by John Tamny, NRO: Last Friday’s Wall Street Journal reported that … of potential replacements for Alan Greenspan … Bernanke [is] the frontrunner on Tradesports.com. Bernanke recently weighed in with his opinions on the economy in the Journal, and while he lauded tax cuts, free trade, and legal reform, a supply-sider he is not. … About taxes, … Bernanke is clearly in the Keynesian camp … holding that they should be reduced during times of slack demand and increased when economic growth reaches its natural “limits.” While Keynesians see tax cuts through a demand-driven, short-term stimulus prism in which their impact gradually recedes, supply-siders encourage marginal rate cuts for their long-term (and continuous) incentive effects on economic activity. …
Moving to the economic impact of demand, Bernanke asked how much demand in the latest quarter “appears to have been satisfied out of inventories rather than from new production.” But supply-siders don’t even consider this … “Demand” will always exist, as human wants are unlimited. But what Bernanke deems “demand” is in fact producers offering up their surpluses for those of others. In the supply-side model, what Bernanke sees as a fall in aggregate demand is in fact a fall in production — something supply-siders agree results from governmental meddling along the lines of excessive taxation, regulation, and unstable money. Further … on … Bernanke wrote about employment, and his belief that there is a “highest level of employment that can be sustained without creating inflationary pressure.” … Leaving aside … the static assumptions that would lead one to believe in “full” employment and “limits” to economic growth in the first place, … our companies … are not hamstrung by the “output gap” beliefs held by Bernanke — beliefs that assume growth is limited to static estimates about our domestic production capacity. … Assumptions about full employment and limits to growth are always a bit silly … ideas pushed by Bernanke are downright fatuous. Although he didn’t discuss money in the Journal editorial, a June New York Times article noted Bernanke’s belief that the gold standard made the Great Depression worse. Plus, in a 2002 speech, he lauded the ability of the government to use the printing press to “generate higher spending and hence positive inflation.” If his adherence to a Phillips Curve orthodoxy made his belief in a price-rule already seem shaky, his direct comments about money should remove all doubt. … [J]ust as important will be Bush’s Federal Reserve appointments, foremost of which will be Alan Greenspan’s replacement … For his views on taxes and growth-limits alone, Bernanke would be a big step in the wrong direction. For his views on money, Bernanke has the potential to be very dangerous.
At least Bernanke understands money. For openers, the comments above non-withstanding, Bernanke has left no doubt about his commitment to inflation targeting (e.g., see here, here, here, here, and here, and if there’s still doubt, there are more). This is an editorial that is either ignorant of basic economic ideas or intentionally distorts to achieve a political end, sacrificing any regard for professional integrity in the process.
Let’s take a couple of examples. Take the notion that supply shocks are permanent but demand shocks only have temporary effects that causes Tamny so much consternation. That’s standard economic theory and you will find very little disagreement on that basic point among economists. Yet Tamny tries to use it against Bernanke by claiming demand is supply, i.e. by claiming the notion of aggregate demand is wrong. Quoting, “demand is in fact producers offering up their surpluses for those of others,” and “a fall in aggregate demand is in fact a fall in production.” A fall in demand is a fall in supply? That’s not even close. Supply-siders who understand the underlying theory recognize there are both nominal (demand) and real (supply) shocks in these models. A change in the money supply is not a supply-shock, is it? Of course not. If it’s not a demand shock either, then what is it? He doesn’t even understand the theory he’s trying to promote. Furthermore, it doesn’t even represent Bernanke’s position. For example, he said very recently “In the long run the most important issue … about … economic growth … is … taking the actions necessary to … keep taxes low …”
Next, let’s take his distinction between statics and dynamics where he criticizes the notion of full employment. There is a difference between resource constraints at a point in time (static) and over time (dynamic). At any point in time, there is a well-defined notion of maximal resource usage. There are only so many workers, a limited quantity or raw materials, and so on, and there’s a well-defined notion of full-employment (e.g. see Mankiw’s text on the determinants of the natural rate of output). No matter what Tamny says in his attempt to hurt Bernanke’s chances at becoming Fed chair, at a point in time our ability to provide goods and services is limited and if demand exceeds the amount we can produce, there will be rising prices. That the system will respond endogenously by increasing capacity over time, i.e. by growing, doesn’t overcome the resource constraint at any point in time, a point that is clear to everybody who understands how these models work.
I could go on, and similar comments apply to other parts of the column, but there’s no reason to spend anymore time on this. But I want to mention one other thing. I hear repeatedly from supply-siders that “Keynesian” tax policy is inconsistent with long-run growth implying that taxes must be high. But there’s nothing in Keynesian stabilization policy to imply high taxes. Stabilization policy can be conducted around any average tax rate over the business cycle, it’s just lower than the target value sometimes and higher at others, but there’s nothing that says the target itself has to be one value or another. Stabilization policy is not inconsistent with growth policy and having a more stable path may promote growth rather than hinder it. It would be nice to see this misconception end because it is quite prevalent.
Bernanke went out of favor with a segment of the GOP when he opposed the NRO view on Social Security reform. Like much in the NRO presently, this is nothing more than a political hack job designed to hurt Bernanke’s chances at becoming Fed chair.
Administration Not Backing Off Private Accounts
Private accounts key to Social Security fix – Snow, Reuters: Private accounts remain integral to the Bush administration's proposed overhaul of ... Social Security ... Treasury Secretary John Snow said on Thursday. "Personal accounts are an essential component of any solution to Social Security" … Asked if the Bush administration would have to choose between ... solvency or ... personal accounts … Snow said both priorities were important. "We're going to try for the whole reform package … with personal accounts as an integral part of the final solution" ...
They aren’t backing off.
August 11, 2005
The Economist: Low Long-Term Rates Caused by Easy Money, Not Higher Saving
A working model, from The Economist print edition: When The Economist's economics editor studied macroeconomics in the 1970s, the basic model for understanding swings in demand was the so-called IS-LM framework, ... In recent years it has gone out of fashion, dismissed as too simplistic. That is a pity, for not only does the model seem more relevant than ever today, but it also casts useful light on why bond yields are so low...
[L]ong-term bond yields have fallen to historically low levels. ... The most popular explanation is that there is a global glut of savings, which has driven yields down. However, while some parts of the world, notably Asia, may save more than they need to, it is not obvious that the world as a whole is doing so. … An alternative explanation, preferred by some economists, is that bond prices, like other asset prices, have simply been pushed up by excess liquidity (ie, yields have been pushed down).
The IS-LM model helps us to understand these two opposing theories. ... The IS (investment/saving) curve represents equilibrium in product markets … The LM (liquidity/money) curve represents equilibrium in the money market … The point at which the two curves intersect is the only combination of output and interest rates (ie, bond yields) where both the goods and financial markets are in balance … The left-hand chart shows the economy in equilibrium at interest rate r1 and output Y1. If desired saving increases relative to investment (ie, there is excess saving), the IS curve shifts to the left to IS2. Interest rates fall (to r2), and so also will output (to Y2). This does not fit the current facts: last year the world economy grew at its fastest pace for almost three decades, and this year remains well above its long-term average growth rate.
The right-hand chart illustrates the alternative theory. A loose global monetary policy shifts the LM curve to the right, to LM2. Bond yields again fall, to r3, but this time output increases. In contrast to a shift in the IS curve, the economy has instead moved along the IS curve: lower interest rates stimulate global output and hence investment. This seems to fit the facts much more comfortably.
Bond yields are low largely because central banks have created too much liquidity. Despite rising short-term interest rates in America, monetary policy is still unusually expansionary. … over the past couple of years, global liquidity has expanded at its fastest pace for three decades. ... resulting in lower yields. … In fact, the two theories are not mutually exclusive. ... However, the current rapid pace of global growth suggests that excess liquidity is the prime cause of low bond yields. The snag is that central banks will eventually have to mop up the overhang of liquidity and bond yields will then rise. ... In a world of low inflation, IS-LM rides again.
In combination with this post based on a recent paper from the NBER, I believe the excess liquidity story has the upper hand in this debate and is well worth pursuing further. But I'm not ready to endorse the IS-LM framework as the best model to use in the investigation of this issue.
[Update #2: Brad DeLong also comments and notes that an inward shift in the IS curve is part of the story, as does PGL at Angry Bear.]
And in comments, I noted, like Brad, that the lack of inflation is a puzzling part of the story:
A comment noted "I always thought excess liquidity led to higher inflation..." The response:
I left a piece out that addresses that. The article says:
Why isn't excess liquidity generating inflation? The basic IS-LM model assumed that the price level was fixed, and thus its inability to explain high inflation rates in the 1970s and 1980s hastened its fall from grace. If an economy is at full employment, an increase in money leads to higher prices, not lower bond yields. Today, however, the model may be more relevant because the entry into the world economy of cheap labour in China and other emerging economies is helping to hold down inflation.
His view is that the entry of cheap labor is holding down input costs. So what has changed for the author is the emergence of global markets. But I think you raise a good question that the excess liquidity explanation must address and that's why the IS-LM model may not be the best framework for looking into this. For example, it does not capture inflation targeting and other issues very well and that is an important component of current policy.
The Mysterious Labor Market
Are We Lowering Our Standards for Job Growth?, Gene Sperling, Bloomberg: … the 207,000 gain in jobs in July beat both market expectations and was a vast improvement over typical monthly job growth during this recovery. Yet … there has been a disturbing tendency among both commentators and the news media to start using the terms ''better than expected'' and ''good'' without distinction. It seems that everyone got so used to dismal job growth -- and even job losses -- in the first 18 months of this recovery that diminished expectation led many to cheer any report that was into six digits. Consider the following: during the previous four recoveries that lasted 44 months or longer, job growth averaged … 285,000 jobs a month. But job growth in this recovery has been a fifth that rate … only 66,000 jobs a month. … I don't claim to fully understand why job growth has been so weak. … why is this job recovery weaker than all other job recoveries? ...
There may be a number of mutually reinforcing factors that have discouraged employers from bringing on new full-time workers. … we have seen increased risk and uncertainty in the fiscal health of the U.S. economy. … rising labor force competition overseas, especially from China and India. … rising costs for health insurance and benefits. … these concerns have pushed companies to go to even greater lengths to boost productivity by squeezing more out of investments in computers and other technology
Dare we call it a labor market “conundrum?” I’d rather not, I’m getting tired of that word, but it is a mystery and solving that mystery is an important task. Labor typically lags behind output in a recovery, but the lag seems to have increased even further this time. Until we understand why this has occurred, designing policies to address labor market problems will be difficult.
The Uncertainty in Forecasts Used to Assess Social Security Solvency
I first took the log of real GDP, which is standard practice, and estimated a second order autoregressive process, i.e. an AR(2):
GDP(t) = α + βGDP(t-1) + δGDP(t-2) + ε(t)
Where α, β, and δ are the parameters to be estimated and ε(t) is the error term in the regression equation. Estimating the AR(2) model with OLS for the sample period 1947:Q1 – 2005:Q2 gives:
GDP(t) = 0.0159 + 1.327GDP(t-1) - 0.328GDP(t-2)
Where the t-statistics are 1.71 for the constant, 21.3 for the estimate of β, and -5.29 for δ, and the Durbin-Watson statistic is 2.06 (yeah, I know … ).
The estimated model is used to simulate 75 years of data 1,000 times. Consider the first of these simulations. Values of GDP from 2005:Q3 through 2080:Q2 are simulated based upon the OLS estimates. Then, using the OLS estimates, the real GDP values are forecasted out-of sample and the squared deviation between the simulated value and its forecast are calculated. This is repeated 1,000 times and the mean squared deviation as well as the mean value of simulated real GDP at each forecasting step are saved. Finally, the mean value of the level of the GDP forecasts along with two standard deviation bands are plotted:
Notice the considerable uncertainty in the forecasts as the forecasts get further into the future. At 75 years ahead, the percentage error is 44% (the percentage difference between the actual value and the edge of the band, the values are 53,191.7 and 76,853.8 using the upper bound) . That means the forecast for GDP is 53,191.7 plus or minus 44%. At 40 years ahead, which corresponds to the 2042 forecast heard in the news, the forecast is plus or minus 35%. At 25 years ahead it is 26%, and at just 15 years ahead it's still 22%.
There may be a problem with solvency and there may not. With a forecast error of plus or minus 44% it’s hard to tell. But one thing for sure, anyone who tells you they know for sure a crisis is coming, even forty years ahead, is not telling the whole story.
Someone will invariably point out that this is not the model actually used to assess solvency, it is only an illustration of problems with forecasting real GDP using an AR(2), others will surely tell me of all the statistical problems in the methodology used. The point is that there is considerable uncertainty in these forecasts and that uncertainty is not unique to real GDP. Changing the model to be robust against suspected problems or forecasting other variables will not make the uncertainty go away.
Update: Solvency is debated by Dean Baker and U.S. Rep. Paul Ryan:
Ryan debates Social Security issue, by Rebekah Danaher, Beloit Daily News: U.S. Rep. Paul Ryan, R-Janesville, and Dr. Dean Baker painted two very different pictures of the Social Security crisis - or lack thereof - at a debate Tuesday … In his opening statements, Baker dismissed the Social Security "crisis" as a figment of some politicians' imaginations. … He accused Social Security reform proponents, namely President Bush, for mongering unwarranted fear over the future of the program - a future that he feels is in very little jeopardy. Though conceding that Social Security may eventually face complications, Baker claimed that it is not nearly in shambles as many Republicans are claiming. … Ryan was quick to retort with statistics demonstrating what he believes to be a much graver situation. … Claiming statistics from such sources as the Congressional Budget Office and Washington actuaries, Ryan said the unfunded debt currently owed by the government to Social Security is $11.1 trillion. …
August 10, 2005
Iraq Fuel Subsidies Create Thriving Black Market and Shortages
Subsidized Fuel Is Spirited Out of Iraq, by T. Christian Miller, LA Times: … Iraq has long subsidized gas prices, a practice that continued after the U.S.-led invasion in 2003. Iraqi gas costs about 5 cents a gallon, whereas neighboring Kuwait charges 79 cents. The difference in prices has created a thriving black market … smuggling has exacerbated a severe fuel shortage in Iraq … The Finance Ministry puts the total cost of subsidized fuel, a figure that includes direct subsidy costs as well as gas purchased to replace smuggling losses, at $6.9 billion, a staggering 28% of the country's projected GDP in 2005. That's money the Iraqi government could otherwise use for electrical, water and health projects. … U.S. and Iraqi efforts to deal with the problem have failed. … the Coalition Provisional Authority … decided that it needed to remove the subsidies … But, fearing social unrest, U.S. officials running the coalition did nothing in the end. A senior economic advisor, quoted anonymously … described the failure to remove the subsidies as "one of the worst mistakes of the occupation." ... "When the coalition handed over power in June 2004, it bequeathed to the Iraqi government a massive expense that would consume half of its budget." … Iraqi officials fear that organized crime or even insurgent groups now control large smuggling rings. "Even the state security forces are afraid of the oil mafia," said Aboud Kareem Abass, an engineer and anti-corruption activist…
This needs to be corrected somehow. For one, it provides a funding source for terrorist networks. That alone is a good reason to end the subsidies. In addition, selling oil at a loss eats up far too much of GDP, over a quarter. Also, the shortages caused by the subsidy create social unrest as people wait in long lines and so on. I don' have a good sense of the political realities involoved with gradually increasing prices over time. But the economic problems will remain until they do and the social problems that occur from giving terrorists easy access to funding and from shortages in the marketplace need to be balanced against the unrest caused by increasing prices at a measured pace. In any case, the sooner this is corrected, the better.
More Whining on Intelligent Designing…
Evolution lacks fossil link, by D. Chris Buttars, USA Today: The campaign to eliminate God from the public forum has been going on for decades, having accelerated greatly since the Supreme Court's ill-advised decision in 1963 to eliminate prayer from public schools. … The argument over classroom discussion of evolution vs. divine design is just the latest attack on everything that would mention a belief in God. … These vehement critics claim that there are mountains of scientific proof that man evolved from some lower species also related to apes. But … there has not been any scientific fossil evidence linking apes to man. The trouble with the "missing link" is that it is still missing! … The theory of evolution, which states that man evolved from some other species, has more holes in it than a crocheted bathtub. I realize that is a dramatic statement, so to be clear, let me restate: There is zero scientific fossil evidence that demonstrates organic evolutionary linkage between primates and man. … Teaching evolution is really about the determined drive … to eliminate any reference to an intelligent power in the universe. That said, could it be that the reason they can't find the missing link is that human evolution didn't happen at all? - Utah State Sen. D. Chris Buttars, R-West Jordan, is active on the evolution-education issue.
It really is very simple. Intelligent design is a religious belief, not science. Religious beliefs do not belong in public schools, particularly in science classes. Why are they trusting the government to teach something as important as their individual views on creation? Wouldn't it be better to "privatize" and teach this at home or in church?
Posted by Mark Thoma on Wednesday, August 10, 2005 at 12:33 AM in Science
August 09, 2005
Bernanke and Bush on the Housing Bubble, Tax Reform, Social Security, and Other Issues
Press Briefing by Director, National Economic Council, AL Hubbard, and Chairman, Council of Economic Advisors, Ben Bernanke, Crawford, Texas: CHAIRMAN BERNANKE: We talked some about housing. There's a lot of good news on housing. The rate of homeownership is at a record level, affordability still pretty good. The issue of the housing bubble is … whether there is a housing bubble … Housing prices certainly have come up quite a bit. But I think it's important to point out that house prices are being supported in very large part by very strong fundamentals. … we have a strong economy, we have lots of jobs, employment, high incomes, very low mortgage rates, growing population, and shortages of land and housing in many areas. And those supply-and-demand factors are a big reason for why housing prices have risen as much as they have. I think … housing prices are likely to stabilize. … But, again, I do think that the bulk of the increases are associated with strong economic fundamentals...
Part of the discussion concerned tax reform which continues to heat up. There is lots of organized action on this issue from the GOP side, there’s even a reform panel working on the problem. Democrats would, in my opinion, be well-advised to get out in front of this issue, if it isn’t too late already, and propose a revenue-neutral, simplified, yet progressive (as opposed to flat) tax structure as an alternative to the coming GOP proposal:
President Bush Calls for Permanent Tax Cuts, By Jim VandeHei, Washington Post: President Bush on Tuesday called on Congress to make permanent tax cuts enacted over the past five years and restructure the U.S. tax code soon to keep the economy growing at healthy pace. … Democrats and many Republicans oppose making all of the tax cuts permanent because it could drive up deficits …
Next, The Financial Times, reports on Bush’s defense of tax cuts and his comments on Social Security from the same news conference:
Bush defends record on growth, By Caroline Daniel, FT: President George W. Bush on Tuesday sought to defend his record at fostering economic growth … The council of economic advisers in a report on Tuesday called strong US economic growth “remarkable” and directly linked it to Mr Bush's tax relief policies. … Mr Bush appeared to downgrade personal accounts as a priority for Social Security reform and focused instead on how to address solvency concerns for Social Security as soon as possible…
I was surprised to hear that personal accounts had been downgraded so I checked the transcript. I don’t agree. It appears to me that three issues, private accounts, progressive indexing, and solvency are three things the White House will insist upon and they are all in today's remarks:
President Meets with Economic Team: And finally on Social Security … we have got to deal with problems now, to solve problems now before they place an undue restraint on our families and an undue restraint on the ability to grow our economy. And Social Security is a -- is a liability that -- it needs to be addressed now. … Part of the solution for Social Security is to make sure that the poor do not retire into poverty, to make sure that people get benefits that grow at least with the rate of inflation -- that will be the wealthier citizens get benefits growing at the rate of the cost of living -- but poorer citizens should have their benefits go up by wage increases. And that reform alone will fix a lot of the solvency issue of Social Security. And while we're fixing Social Security, I strongly believe younger workers ought to be allowed -- given the chance to, given the opportunity to take some of their own money and set it aside in a personal savings account. And that will have two effects. One, it will increase savings throughout our society, which is important to economic growth and vitality. But more importantly, it will mean workers from all walks of life will be able to own an asset that they call their own and that the government cannot take away.
Finally, here are Bernanke’s remarks on the state of the economy from the CEA report. Unsurprisingly as the administration’s economist, the view is rosy:
CHAIRMAN BERNANKE: ... It fell to me as the CEA Chairman to report to the President on the state of the economy, and I was pleased to be able to report to him that the U.S. economy is in a strong and sustained expansion at this point. I stressed for him four key indicators, which, like many other economists, I think are really central to looking at the state of the economy. First is economic growth. ... In the last couple of years, we've seen 4.1 percent real growth per year; 3.6 percent in the last year. This is a very strong rate of output expansion. Second, jobs. So far this year, we've had 191,000 jobs per month added to U.S. payrolls, … so the labor market is improving and getting stronger. Third, inflation. ... Inflation is well contained, under control. ... And, fourth, the statistic which economists really think is very important and perhaps doesn't get enough attention in the media is productivity growth. Productivity growth ultimately determines how much an economy can produce, what the living standards will be, and what wages and profits will be. The U.S. economy in recent years has been remarkable in terms of productivity... Looking back over the last four years, ... These are remarkable numbers, much higher than long-term averages, and they bode very well for the sustainability of the economy.
… There certainly are risks to the economy; two I would mention. One is high energy prices. ... But the good news is that at least so far the U.S. economy has not been slowed by the high energy prices. … and job creation has proceeded apace. The other concern ... is the rising cost of health care and health insurance. This is a major problem. … These are two issues that remain very important. But to come back to what I said earlier ... coming from where we were in 2001 and 2002, following 9/11, following the corporate scandals, this economy has turned around, and it's currently on a very strong and sustainable growth path…
Target Federal Funds Rate Raised 25 bps to 3.50%
1. More certain that output growth is robust despite high energy prices. 2. Unchanged in its perception that the labor market is gradually improving. 3. Slightly less concerned about inflation, but still sees an elevated threat.
Here's the statement:
FOMC Statement: The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-1/2 percent. The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.
Aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually. Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated. [Previous: 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 Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee 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.
I don't see anything to indicate a change in course from measured increases. The labor cost news is good from an inflation threat perspective, but that will be attributed to anchored expectations and the strength in output growth will be the main concern going forward. As the statement notes, 3.50% is still viewed as accommodative.
Slower Growth in Both Productivity and Labor Costs in 2nd Quarter
Productivity Growth Slowed to 2.2% in Second Quarter, AP: The productivity of U.S. workers rose in the April-June period at the slowest pace since last summer, the government reported Tuesday. The Labor Department said the productivity of the work force rose at a 2.2 percent rate in the second quarter, down from a 3.2 percent rate of increase in the first three months of this year. The rise in labor costs slowed in the second quarter to an annual rate of increase of 1.3 percent, far below the gains of the past nine months. That was only a modest improvement for wage-earners, but it also was a sign that inflation pressures remained in check…
While there are recent signs of improvement, the anemic growth in wages is a concern and lends support to those in favor of pause in rate hikes. Also, the large revisions show why the use of real-time data (the data available when decisions are made) as opposed to revised data (data not available until later) can matter in the econometric evaluation of monetary policy. For example, today’s FOMC decision will be based on data that could be revised later in either direction.
A September Wedding for Tax and Social Security Reform?
Snow Says Bush Meeting to Focus on Trade, By Martin Crutsinger, AP: … Snow said the administration was looking forward to re-engaging in the debate over Social Security when Congress returns in September and would also be preparing to push ahead with an effort to overhaul the nation's tax code after a presidential advisory panel makes recommendations in late September. "That will tee up the next major issue for the president - broad-based tax reform," Snow said. … While congressional Republicans have expressed doubts about getting Social Security legislation approved, Snow said: "I remain optimistic that we will get something done there. ... I think in the fall you will see us heavily engaged on the Social Security issue."…
It sounds like the Thomas approach is on the agenda. Throw in something for everyone, tax reform, social security reform, and whatever else is needed to get the votes, and pass whatever bloated piece of legislation emerges from the process. Then go home and declare victory.
Adidas and Reebok Team Up Against Nike
Nike's new nemesis, Editorial, The Oregonian: People who were put off by Nike's rough treatment of a budding young basketball star this summer got a reminder last week about why the company can seem so downright ornery at times. The Beaverton-based giant is at war … and it just got hotter with news that Nike's top two rivals are teaming up to knock it off its perch ... Adidas-Salomon AG announced it has agreed to buy Reebok International Ltd. in a $3.8 billion deal. By combining strengths, the two brands aim to grab market share from Nike. … And what does this have to do with a high school basketball player? In July, Nike abruptly dropped Oregon's prep player of the year, Kevin Love of Lake Oswego, from the prestigious Nike-funded Portland Elite Legends team. The young man's sin: playing at Reebok's summer camp instead of Nike's, held at the same time. That unforgiving -- some would say ruthless -- response struck a lot of people as harsh punishment for a 16-year-old kid. Others would say it was just business, and an accurate reflection of the enormous stakes involved in the international sneaker war.
Nike's annual sales have soared to $13.7 billion. The company toiled more than 30 years to become this wondrous marketing machine. And it didn't get there by virtue of a Mohandas Gandhi-style corporate culture. Its success is fueled by a competitive ethic so ferocious that loyalty is sternly demanded and generously rewarded, while disloyalty is swiftly punished, no matter the offender's excuse or tender age. Such values helped propel Nike into global dominance ... That will change after the Adidas-Reebok deal gains regulatory and shareholder approval. Their combined sales of $11 billion will nip at Nike's numbers. And if the two formerly rival brands mesh well, the newly enlarged Adidas-Salomon could even overtake Nike by gaining access to bigger markets and capturing some of its share. On paper, the deal looks threatening to the Oregon leader. ... But does that mean the combined new company can really challenge Nike? Market analysts say it will depend in part on the ability of Adidas-Reebok to merge two quite different corporate cultures into a new one that can kick butt. In that light, Adidas could learn from the gritty Kevin Love story. The company, after all, has a rather lame slogan, "Impossible is nothing." If it really wants to take on Nike, it'll need something a lot more bruising than that. A slogan, perhaps, like "No more Mr. Nice Guy."
I guess we can say that Love was a casualty of war.
Posted by Mark Thoma on Tuesday, August 9, 2005 at 12:15 AM in Economics
August 08, 2005
With Friends Like This ...
Poking holes in the flat tax, Michael Kinsley, LA Times: It’s true that the Republicans are the party of ideas and the Democrats are the party of reaction...
He could have made the same point by leading with something like
Republicans claim they are the party of ideas and Democrats the reactionary party...
But he chose to say the party of ideas claim is true. It’s not. We don't need any more help from Mr. Kinsley.
CBOT Fed Watch - Chance of 50 bps Rate Hike Increases to 9%
CBOT Fed Watch - August 8 Market Close - Based upon the August 8 market close, the CBOT 30-Day Federal Funds futures contract for the August 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 3-1/4 percent to 3-1/2 percent at the FOMC meeting on August 9.
In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 9 percent probability of a further 25-basis point increase in the target rate to 3-3/4 percent (versus a 91 percent probability of just a 25-basis point rate increase).
August 2: 96% for +25 bps versus 4% for +50 bps. August 3: 96% for +25 bps versus 4% for +50 bps. August 4: 96% for +25 bps versus 4% for +50 bps. August 5: 94% for +25 bps versus 6% for +50 bps. August 8: 91% for +25 bps versus 9% for +50 bps.
August 9: 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 3.50%, and a 9% chance it will increase an additional .25% to 3.75%.
A Detectable Increase in Tax Chatter
Tax Reform Alert Stage: Upgraded to Yellow
We have detected an increase in chatter on the internet regarding tax reform. Some examples of the propaganda currently circulating:
If you are in the middle or lower income groups, you are advised to keep a close eye on your wallet and to report any suspicious behavior observed in congresspeople to proper authorities.
A Note from Mankiw on the CBO Forecasts for Social Security
Macroeconomics by Greg Mankiw, 5th edition, page 213: …According to the CBO, if no changes in fiscal policy are enacted, the government debt as a percentage of GDP will start rising around 2030 and reach historical highs around 2060. At that point, the government’s budget will spiral out of control. Of course, all economic forecasts need to be greeted with a bit of skepticism, especially those that try and look ahead half a century. Shocks to the economy can alter the government’s revenue and spending…
Mankiw is warning us that the estimates are highly uncertain and that we don’t really know if there will be a problem or not. The 2060 figure is a 60 year ahead forecast. That’s the same as forecasting today’s economy in 1945. How well would you do? When you hear a forecast that far into the future, think plus or minus what? The what is a very large number.
Keep Your Fed Watch Eye on the Productivity Ball
Productivity Is the Issue of the Hour for the Fed, By Edmund L. Andrews, NY Times: … as Mr. Greenspan prepares to retire … the Federal Reserve faces a slowdown from the torrid pace of productivity in the past several years. As shown by the big jump in jobs during July … the pool of unemployed workers is dwindling and wages are rising faster than productivity. The big question for the Federal Reserve is whether the lull is simply a return to the average pace since 1995 or a return to the doldrums that prevailed from the early 1970's to the early 1990's. … If output climbs more slowly than labor costs, companies will be under pressure to raise prices. ... contributing to inflation. Productivity growth has slowed sharply in the last year, but Fed officials and most outside specialists said this was to be expected. Productivity often surges in the early part of an economic recovery, as companies rush to meet higher demand but are still too nervous to add workers, and then slows as employment picks up. … The superheated productivity, which caused anemic job growth for three years, appears to be ending. … But ... Dale Jorgenson, a professor at Harvard ... said last week, "We are experiencing productivity growth that is very high by historic standards, and there is nothing on the horizon to slow it down," The biggest risk, he cautioned, is not that innovation will slow down but that the United States is too dependent on foreign capital for its investments. "Productivity is zooming along because of the investment, but we are not financing much of this ourselves," he said.
We don’t know yet what will happen on the productivity front, it’s all speculative at this point, so keep you eyes open for signals regarding the growth of productivity.
August 07, 2005
The Winners and Losers from Revaluation of the Yuan
A Rising Yuan Won't Lift All Boats, By Eduardo Porter, NY Times: Over the last couple of years, a good number of economists, accompanied by a horde of American manufacturers, union leaders and politicians, have called on China to release the yuan's peg to the dollar. … To believe the politicians and their friends, a rising yuan … would make Chinese products more expensive in dollar terms, giving a break to beleaguered American manufacturers … And American workers … might find themselves back in the game. … But even a yuan revaluation of 40 percent wouldn't significantly improve the overall balance of trade of the United States. For that to happen, the currencies of other developing countries would have to rise in tandem. If they didn't … manufacturers would move Americans to buy their products only from low-cost countries like Bangladesh, reallocating, but not reducing, America's external shortfall. … Still, assuming against all odds that all this happened, what would the results be for the American economy? Nicholas R. Lardy, a China expert at the Institute for International Economics who has been calling for the yuan to rise, says some American manufacturing jobs could be saved. He acknowledges that it wouldn't help all industries. … Yet for manufacturers of products like semiconductors or molded plastics - which aren't so low tech that they moved overseas long ago, but are not so high tech that labor costs are of no relevance - a currency shift of 20 or 25 percent could be important. … Perhaps. Yet the long downward spiral of American manufacturing employment hasn't responded much to currency realignments. … What is virtually certain is that if the yuan appreciates substantially against the dollar and reduces the American trade deficit, some American jobs will be lost. That's because less money would flow from China into American assets. Interest rates would certainly rise. With less of a trade drag, the economy would likely risk overheating, prompting the Federal Reserve to press on the monetary policy brakes. … Indeed, economic sectors that are particularly sensitive to rising interest rates are likely to suffer most. One is the stellar performer of the current economic expansion: housing. So consider this possibility: China yields to American prodding and lets the yuan rise sharply. American manufacturers get some slack. Housing and construction go south. Somebody protect us from what we want.
This leaves out an important element, the effect of revaluation on the price of consumer goods, so let me summarize and extend these remarks. Suppose the yuan is revaluated. Then:
1. Consumers are worse off due to the rise in the price of consumer goods. If revaluation is bilateral and production moves from China to other countries, this effect may not be as large in the long-run. If the dollar devalues against other currencies generally, the effect on prices paid by U.S. consumers will be larger. 2. Borrowers (households, business, and government) are worse off due to rising interest rates which increases the cost of loans and the cost of financing government debt. Part of this is a transfer from borrower to lender, but there is a net drain as well due to debt held by foreigners. 3. U.S. manufacturers are better off, but this requires the dollar to devalue against other currencies generally, not just against a particular currency such as the yuan. 4. If businesses do better, then employment will increase as well making labor better off. 5. If employment and manufacturing do increase, there are transitional costs to consider as the article notes. Rising interest rates will cause less activity in sectors such as housing and more activity in other sectors such as (hopefully) computer chips. But during the transition unemployment could potentially increase. Nevertheless, to the extent that such rebalancing is healthy for the economy in the long-run, there is a long-run benefit that follows the short-run cost, but the cost does need to be acknowledged.
I see the benefits of revaluation, which rely mainly on the assumption that U.S. manufactures will become more competitive, as much more tenuous than the costs of revaluation such as higher priced consumer goods and increased borrowing costs, particularly in the short-run. It might help businesses compete down the road, and it might help to rebalance the economy away from housing, but it will also make goods and houses more expensive.
Japan Times Calls for U.S. to Change Its Policy Towards Iran
Olive branch to Iran overdue, By Kiroku Hanai, Japan Times: A new Iranian government under President Mahmoud Ahmadinejad will be inaugurated Aug. 4. While outgoing President Mohammad Khatami is a moderate, Ahmadinejad is a hardline conservative whose relations with the administration of U.S. President George W. Bush are likely to be tense. As this is undesirable for stability in the Middle East, it is hoped that Japan and the European Union will do their best to help avert a conflict between Washington and Tehran. In his State of the Union address … Bush named Iran, along with Iraq and North Korea, as an "axis of evil." ... Secretary of State Condoleezza Rice ... included Iran in what Washington called the six "outposts of tyranny." … It is hard to understand why the U.S. takes such a hostile approach to Iran. ... Although Iran released all the hostages 444 days after the crisis began, Washington has continued its freeze on Iranian assets in the U.S. and its economic sanctions against the country under the Iran-Libya Sanctions Act.
To justify its hostile policy toward Iran, Washington cites the lack of democracy in the country. … In the last presidential election, though, the council showed unprecedented flexibility. … Two conservatives entered the first-ever presidential runoff, in which a clergyman and ex-president lost -- results nobody had expected. Egypt … will hold its first multicandidate presidential election in September. Saudi Arabia, the most loyal U.S. ally, is also the most laggard in democratization. ... And Saudi women have no voting rights. Among the Middle East countries, Iran has some democratic elements in its political system. The Iranian revolution has promoted, among other things, the education of women. ... At government-run medical universities, women account for more than 50 percent of total enrollment. This is a great accomplishment in the Middle East, where the education of women is largely neglected.
Washington often accuses Tehran of trying to export an Islamic revolution by sponsoring foreign terrorist groups, as if it was oblivious to the fact that the U.S. Central Intelligence Agency assisted in the overthrow of the Iranian government of Prime Minister Mohammed Mossadegh in 1951. The CIA also aided the overthrow of the Chilean government of President Salvador Allende in 1973. Both governments were democratically elected. Washington's policy of labeling Iran a "rogue state" to isolate it internationally undermines the Middle East peace process. I believe the U.S. should reconsider its policy toward Iran … In an opinion poll of Tehran citizens taken in 2002, more than 70 percent of the respondents favored reconciliation with the U.S. Most Iranians presumably are fed up with the diplomatic standoff that has continued for 26 years since the Iranian revolution. ... The question is whether the U.S. is ready to show generosity as a major power toward Iran to settle the problem…
If this is how our friends view us, as a country that must be talked out of picking a fight with other countries, then whether our actions are justified or not, we are losing the political battle on the world stage. No matter how well intentioned we are, we cannot bully the entire world into changing according to our wishes. We need a new approach.
Posted by Mark Thoma on Sunday, August 7, 2005 at 01:44 AM in Politics
When Pigs Wi-Fi, By Nicholas D. Kristof, NY Times: This is cowboy country, where the rodeo is coming to town, the high school's "kiss the pig" contest involves a genuine hog, and life seems about as high-tech as the local calf-dressing competition, when teams race to wrestle protesting calves into T-shirts. But Hermiston is actually a global leader of our Internet future. Today, this chunk of arid farm country appears to be the largest Wi-Fi hot spot in the world, with wireless high-speed Internet access available free for some 600 square miles. Most of that is in eastern Oregon, with some just across the border in southern Washington.
Driving along the road here, I used my laptop to get e-mail and download video - and you can do that while cruising at 70 miles per hour, mile after mile after mile, at a transmission speed several times as fast as a T-1 line. (Note: it's preferable to do this with someone else driving.)
This kind of network is the wave of the future, and eastern Oregon shows that it's technically and financially feasible. New York and other leading cities should be embarrassed that Morrow and Umatilla Counties in eastern Oregon are far ahead of them in providing high-speed Internet coverage to residents, schools and law enforcement officers - even though all of Morrow County doesn't even have a single traffic light.
The big cities should take note, said Kim Puzey, the general manager of the Port of Umatilla on the Columbia River here. "We'd like people to say, 'If they can do it out in the boondocks with a small population, that model can be applied to highly complex areas,' " he said.
Mr. Puzey, who says wireless broadband is central to the port's operations, argues persuasively that broadband is just the next step in expanding the national infrastructure, comparable to the transcontinental railroad, the national highway system and rural electrification.
Indeed, we need to envision broadband Internet access as just another utility, like electricity or water. Often the best way to provide that will be to blanket a region with Wi-Fi coverage to create wireless computer networks, rather than running D.S.L., cable or fiber-optic lines to every home.
So if the first step was to get Americans wired, the next step is to make them wireless.
Two pioneers in that process are Portland, Ore., and Philadelphia, which are both moving toward citywide Wi-Fi Internet access. Consumers will still have to pay for broadband, but only about half as much as they do now.
Still, Portland and Philadelphia won't have their systems in place until next year. Meanwhile, the system in eastern Oregon covers a larger geographic area, is free for consumers and has been up and running for more than a year and a half.
One reason it sprang up here is that a nearby Army depot contains chemical weapons, so there is special concern about what would happen if a cloud of nerve gas escaped from the depot. That fear helped provide a pot of federal money to underwrite safety systems.
Usually, the police and fire agencies communicate just by radio, but Hermiston decided to go with a public-private partnership that established a Wi-Fi network. The police chief, Dan Coulombe, showed me the wireless computers that all police officers now carry. They can download data and receive images from video monitors - and, if nerve gas ever escaped, display the cloud's direction and speed.
Fingerprint readers are now being added to these portable devices so a police officer can almost instantly run a person's fingerprint through a multistate database. And if there's a report of a burglary, the police rushing to the scene can download floor plans of the building, live images from video monitors and information about the alarm system.
The wizard behind the system is Fred Ziari, an Iranian immigrant and Wi-Fi pioneer who runs a high-tech company in Hermiston and Portland, EZ Wireless. Mr. Ziari contracted with the local authorities to provide the Wi-Fi service, which lets consumers piggyback for nothing.
Hermiston is already starting to introduce WiMax, the next generation of technology after Wi-Fi, offering much higher speeds and greater range.
Other American towns need to follow Hermiston, not necessarily in holding "kiss the pig" contests, but in ensuring broadband Internet access as reliably as they do water or electricity. The fact is, unless you're a cowboy here in eastern Oregon, you're behind the times.
Graphs Gathered from Blogs (July 2005)
There is also a directory of links to graphs from other months.
CBOT Fed Watch - August 5 Market Close
CBOT Fed Watch - August 5 Market Close - Based upon the August 5 market close, the CBOT 30-Day Federal Funds futures contract for the August 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 3-1/4 percent to 3-1/2 percent at the FOMC meeting on August 9.
In addition, the CBOT 30-Day Federal Funds futures contract is pricing in a 6 percent probability of a further 25-basis point increase in the target rate to 3-3/4 percent (versus a 94 percent probability of just a 25-basis point rate increase).
August 2: 96% for +25 bps versus 4% for +50 bps. August 3: 96% for +25 bps versus 4% for +50 bps. August 4: 96% for +25 bps versus 4% for +50 bps. August 5: 94% for +25 bps versus 6% for +50 bps. August 8: August 9: 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 3.50%, and a 6% chance it will increase an additional .25% to 3.75%.
August 06, 2005
Calling Bush’s Bluff on Tax Cuts
Bush Says Congress Needs to Overhaul Tax Code, Social Security, Bloomberg: President George W. Bush urged Congress to make permanent the tax cuts enacted during his first term and draft legislation to bolster the Social Security program, after the lawmakers return from their August break. ''The tax relief stimulated economic vitality and growth and it has helped increase revenues to the Treasury,'' Bush said in his weekly radio address. ''The increased revenues and our spending restraint have led to good progress in reducing the federal deficit.'' …
Here’s a Small Token of Appreciation for Your Many Years of Service
Mexicans at Home Abroad, By Eduardo Porter and Elisabeth Malkin, NY Times: In recent decades, millions of working-age Mexicans have entered the United States. … a new question is beginning to worry some analysts and policy makers on both sides of the border: What will happen when the 10 million Mexicans living in the United States become too old to work? Will they retire in the United States or will they return to Mexico? … the United States is … unprepared to deal with millions of poor, aging immigrants, eking out a living without recourse to Social Security, Medicare, Medicaid or most other forms of federal assistance. … "If all these people that came here are going to stay, then there is a question of what will be the social cost," said Roberto Suro, director of the Pew Hispanic Center in Washington. "If they're only here for their working life, it's a bargain." …
So what is the cost? Michael Tanner of Cato has estimates from a government study that say the cost is very small:
Mexicans pose Social Security drain, By Stephen Dinan, Washington Times: Allowing Mexicans who pay into U.S. Social Security to collect benefits would place a long-term drain on the system since Mexican workers are less-educated and tend to have more dependents, according to a new congressional report. The report … by the Congressional Research Service (CRS), looks at the effects of a "totalization" agreement with Mexico. Right now Mexican workers who are in the United States temporarily must pay into both the U.S. and Mexican systems but cannot get U.S. benefits. Totalization would allow them to pay into just one system, and collect benefits based on the time they paid into the U.S. system. … While in the short term that may mean more money coming in, "it's a net long-term drain," said Joe Eule, chief of staff for Rep. J.D. Hayworth, an Arizona Republican who is sponsoring a resolution to block totalization. The debate lies at the intersection of two of the most contentious issues facing Congress: immigration policy and Social Security's impending financial problems. … But Michael Tanner, director of health and welfare studies at the Cato Institute, said the amount of a drain is likely to be very small. One government study puts the cost at $78 million the first year and $650 million by 2050. "It's a drop in the ocean given Social Security's problems," Mr. Tanner said. He also said that the question should not be whether a Mexican agreement is a drain, but rather what is fair.
There are high cost and low cost ways to deal with this problem. Retired illegal immigrants are going to use social services. For example, will retired illegal workers be shunted by legislation towards high cost alternatives like emergency room treatment or towards lower cost healthcare programs? Also, illegal immigrants, unless they are paid under the table, have paid into the Social Security system. So a lot of what they take out is money they have paid into the system. Is it fair to keep this “illegal alien tax” as a means of helping with solvency? The net drain of $650 million by 2050, even if largely underestimated, is small compared to the value added to our economy by these workers over their working lives. Yes, as the article notes their salaries were low and that limited the amount many paid into the system, but doesn’t that argument penalize these workers for being forced through circumstance to accept wages below the minimum acceptable level? Doesn’t it penalize them for producing goods for us at very low cost? Would we be better off if we had paid them twice as much? Like Michael Tanner, I see this as an issue of fairness. I believe allowing these workers to collect Social Security is the decent thing to do, but opinion does not win policy debates. Saving money does. Will the total cost really be smaller if retired illegal workers, who as a group struggle to survive while they are able to work, are, for example, relegated to emergency room healthcare, made worse through homelessness and poor nutrition brought about by poverty? After decades of working in our factories, mowing our lawns, cleaning our houses, and bringing us food to eat at very low cost, is it right to turn our backs on these workers? More importantly to many, is it smart economically?
I find myself in agreement with Cato on this issue. Since that's unusual, have I missed something important? Is this really about the politics of immigration rather than the narrower issue of Social Security?
August 05, 2005
Filling in the Pieces of the Yield Curve Puzzle
Savings Gluts and Interest Rates: The Missing Link to Europe, Michael P. Dooley, David Folkerts-Landau, and Peter M. Garber, NBER WP 11520: Data for world savings rates do not suggest that an aggregate glut of world savings has depressed US and international interest rates in recent years. Unusual but offsetting changes in savings rates have been limited to three regions: sharp declines in the US have been matched by sharp increases for developing Asia and the Middle East. The world saving rate has increased very little. There are two important features of this change in regional savings behavior. First, three-quarters of the increase in Asian and Middle Eastern savings has been placed in international reserves. Second, all these additional savings have been absorbed by the United States. Even if reserves are mostly placed initially in the US, we would not expect all the savings exported from these high savings regions to remain in the United States. A collapse of expected profits outside the US seems to us a compelling explanation for the US current account deficit and depressed international interest rates.
I haven’t liked the term glut because to me that term implies that the supply and demand for loanable funds are not matched, i.e. there is an excess supply at current rates, not simply that rates have fallen to clear the market. The Dooley, Folkerts-Landau, and Garber paper contains a third explanation that takes the traditional view that low long-term rates are caused by lack of profitable investment opportunities. The final hypothesis for the conundrum is the misperception of risk argument that Greenspan has been promoting. Under this view, which relies upon investor misperception of ARCH effects (periods of high volatility followed by periods of low volatility) and upon biased expectations of risk, investors are accepting risk premia on long-term commitments that are too low. Assuming irrational expectations to explain the conundrum is not a story I favor.
There are fewer pieces to the puzzle if we can rule out future economic weakness and a global savings glut as explanations, but it still isn’t clear to me exactly how the pieces fit together. If world savings has not changed, why have rates fallen? If it isn’t a supply glut, then it must be low demand, i.e. lack of profitable opportunities worldwide. Is that all it is? Is it that simple?
Update #1: There is more on this topic here and by Brad DeLong here, particularly on the excess liquididty versus global saving glut explanations of low long-term rates. See Angry Bear and William Polley also.]
Update #2: Here is a conversation from the comments (edited) I hope is instructive:
Mark, ... I have never really understood what is meant by supply and demand for loanable funds. Are we talking stock or flow variables here? Textbooks are rarely very clear on this. They often seem just to say 'demand and supply of loanable funds' and assume the meaning of this is obvious.
If by loanable funds we are talking about asset stocks then what does it mean to say excess supply? Somone has to hold what assets there are. ... Or is the argument that a high level of saving (a flow) means that to keep aggregate demand propped up central banks are pushed to set low short rates ... Which would mean treating 'supply of loanable funds' as a synonym for high savings propensities. ... Would appreciate any response you might offer.
rjw - Income is the flow of water through the bathtub and saving is the stock of water that accumulates (and this can be negative for an individual or for nations, but not for the world as a whole). The faucet is income and the drain is consumption and taxes. What’s left over accumulates in the tub as saving.
Part of that can be held as cash, or as stocks and bonds, as houses, as stamp collections, and so on, then re-liquidated later if needed.
There are two related concepts which are the inverse of each other, one is the demand for financial assets and the other is the supply of loanable funds. That is, those demanding financial assets are the same as those supplying funds to use for loans. The reverse is true too. Those supplying financial assets are doing so to get funds to use, so the supply of financial assets is the same as the demand for funds. There are two models because when you graph the asset supply and demand model the supply and demand curves have the wrong slopes so it's convenient to rename them.
So, when I think of the price of financial assets (and hence the interest rate as they are inversely related), it is with respect to the supply and demand of a stock of financial assets.
The stock will change period to period as savings are added or subtracted from wealth shifting those curves, but at any point in time the supply and demand curves are fixed and the price/interest rate moves to clear the market fairly quickly.
I hope this is helpful.
On your question at the end. If the world saving rate has not fallen, then the argument is that a low level of investment has called a drop off in demand relative to available capacity, leading to central banks setting low rates to stimulate demand? Is that the argument? ... And then low rates boil down just to accomodative monetary policy on a global scale that has spread over the yield curve (due to anticipated persistent weakness in demand? Is that what you mean by it being dead simple?
rjw - Yes, that is essentially how it works. If the supply of loanable funds is fixed as the article suggests, then weakness in the demand for loanable funds could explain low rates.
Demand depends primarily upon expected future profits for various investment opportunities (with an eye towards other factors such as existing capacity), i.e. the rate of return, relative to the cost of borrowing funds over the period until the enterprise is up and running and the loans can be repaid. So with such low rates the presumption is that the expected rates of return must be even lower (all adjusted for inflation).
It is true that foreign central banks have absorbed a lot of the supply of loanable funds thereby propping up demand. But even then rates have fallen.
Ok - so we are talking demand and supply of financial assets. And thanks for the clarification of terminology. I have a follow up question which I hope you or a commentator might tackle.
It's obvious that at any point in time someone has to hold all assets. In that sense any excess demand can only be for one type of asset over another (I decide I want more bonds and less cash - so I shift my portfolio). And here disequilibria should be short lived as prices should adjust to clear market.
So then low interest rates under this explanation come about simply because there has been some shift in the desire to hold bonds relative to cash - thereby changing the price that clears the bond markets? And people don't want to shift out of bonds into equity maybe, so all the desire for portfolio shift is funneled into demand for bonds (or - to generalize the picture - into assets like housing)
rjw has good questions. I’ll give this a shot. To start, we can divide wealth as follows
Wealth = Money + Bonds + Equities + Physical Assets
We often (but not always because whether these assets are substitutes or complements matters) lump all interest bearing assets into the “Bonds” category to simplify things. Then
Wealth = Money + Bonds + Physical Assets
We *used* to say physical assets were constant enough to ignore in the short-run, but if housing is in there we shouldn’t do that anymore, so let’s not. The equation above will serve as our wealth function.
The first cut is to decide how much liquidity (i.e. money, sometimes called speculative balances) to hold. As you note, the interest rate is a key factory here (actually expected future interest rates because capital gains matter). The other cut is to decide how to hold interest bearing assets as bonds (and perhaps bonds versus equities) or houses and other physical assets (for colleagues – I know these aren’t always separable like this, but it’s useful to break it up like this for illustration).
So main point here – the interest rate determines the division of wealth among asset categories for a *given* level of wealth.
But then what is the link here to low central bank rates? What is the conceptual link to those? I feel I'm missing a piece of the puzzle there. I also don't really see how that reasoning ties in with terminology of a savings glut - irt is not as if people want to hold fewer assets - it's just the types of assets they want to hold that has changed.
Central banks change money supplies by increasing or decreasing the supply of financial assets. It may not have changed recently, but that does not mean it wasn’t large already (the existing stock was already large).
As an aside, I suppose I could increase my 'demand' for assets (implicitly) by decreasing my spending out of income to add to my level of assets by saving more. But is that not just another way of saying that the savings rate has shifted? ... my problem is, if overall demand for assets goes up - people save more - income shifts - so supply and demand curves not stable as desire to hold assets is a function of income levels. That's what is bugging me. Does it make sense to talk about such curves in that context of changing income levels? ...
As income levels change the demand curve shifts up or down. Here’s the reasoning. With more income, there is more saving so wealth increases. With more wealth there is a reallocation over the three categories of wealth (in general all three are expected to rise, but not necessarily equally). So think of this as a shift in the supply of loanable funds (i.e. the demand for financial assets increases).
An increase in the desire to save has the same consequence on wealth, but there is an important difference. Because income has not increased, consumption must fall to compensate for the increase in saving.
Jobs Figures Support Further Rate Hikes
U.S. Economy Adds 207,000 Jobs, More Than Estimated, as Growth Accelerates, Bloomberg: U.S. employers added 207,000 workers in July, a bigger increase than expected ... The jobless rate held at 5 percent, matching an almost four- year low … Incomes accelerated last month. … The prospect of higher wages in coming months means Fed policy makers will keep increasing interest rates to contain inflation, economists said. Gains in efficiency, which have allowed companies to limit hiring, may be starting to wane...
Overall, this is a good jobs report. Barry Ritholtz dissects the numbers further and finds a few spots of weakness, but in the end comes to the same conclusion, and Dean Baker at MaxSpeak notes the increase in wages. Rates are going up.
If You Can't Take the Heat, Storm Out of the Kitchen
Novak Walks Off Live CNN Program, By Jacques Steinberg, CNN: Robert D. Novak, the syndicated columnist whose unmasking of a C.I.A. operative touched off an investigation about a possible leak, stalked off a live appearance on CNN .... About two hours later, a spokeswoman for CNN … released a statement saying that the network had "asked Mr. Novak to take some time off." Asked later in a telephone interview whether Mr. Novak was being suspended from his work at the Cable News Network, Ms. Goldberg said, "We're characterizing it as a mutual decision." …
I won't miss him one bit. If we're lucky, he'll burn the rest of his bridges.
Posted by Mark Thoma on Friday, August 5, 2005 at 12:42 AM in Politics
Remember, It’s Social Insurance
Social Security's Series of Nationwide Events Gives Individuals with Disabilities a Ticket to Work, Forbes: Social Security Associate Commissioner Sue Suter joined Social Security District Manager … Steven Helms ... to host the ninth in a series of 10 nationwide employment Conferences and Expos … A component of the Ticket to Work program, the Conference and Expos are educational employment career events from Social Security specifically created for individuals with disabilities. … Ticket to Work is a free, voluntary program that helps Social Security disability beneficiaries navigate the employment process and overcome the barriers to finding fulfilling careers. Ticket to Work connects Social Security disability beneficiaries to various programs -- from employment to vocational rehabilitation -- so they have the tools, assistance, and guidance they need to find the right job. …
In June, 2005 retired workers received 62.9% of Social Security benefits. The remaining 37.1% is distributed among disability insurance (16.9%), survivors insurance (14.0%), and spouses and children in the retirement benefits category (6.3%). Social Security is an important social safety net that is far more encompassing than just retired workers, and any discussion of reform must keep this in mind.
Eliminate Social Security and – Ta Dum – Solvency!!!
Behind the Social Security curve?, By Peter Ferrara, The Washington Times: The Democrats last week announced their own plan for personal investment accounts. Substantively, the plan is quite poor and vulnerable. But politically Republicans face real trouble if they follow the badly conceived reform plans the White House still advances. The core of the Democrats' … plan would not change Social Security whatsoever and so does nothing to solve the program's problems. … it asks workers to dig deeper into their pockets and come up with more money for another retirement plan. ... Moreover, the Democrats' add-on account outside Social Security does nothing to address Social Security's looming long-term financial insolvency. … But the serious political problem created for Republicans by this Democratic proposal is illustrated by White House insistence last week that Republicans must support so-called progressive price indexing as part of any personal account reform plan. That would substantially cut future promised Social Security benefits for today's young workers and eventually leave the great majority with a negative rate of return. So, while the Democrats support a new giveaway plan, the White House insists Republicans support a takeaway plan. The Democratic plan even provides ownership, inheritability and choice, all elements highlighted by the far-too-narrow message of some personal account reformers. In the end, the public would vastly prefer the Democratic plan over the Republicans' tiny personal accounts and large cuts in future Social Security benefits. Now the White House asks Republicans to vote for the largest cut ever in future promised Social Security benefits through price indexing, on a purely partisan basis, as no Democrats back it. … We have reached this ridiculous pass because the adult supervision we should have among Republicans is neither mentally engaged on the substance of reform nor fully exploring all alternatives. The new Democrat plan will be popular and can only be beaten by a more popular plan, not by a political suicide pact. The winning strategy for Republicans is to start with a proposal based solely on personal accounts … As those accounts expand in time, workers will get an increasingly better deal. And the Social Security deficit will be reduced to full solvency. Congressional Republicans need to send this message to the White House: We will achieve solvency by expanding the accounts over time, not by tax increases and benefit cuts…
Yep. If you eliminate the Social Security program over time and go to a purely private system it will be solvent. But I don’t think that’s quite what the public has in mind.
August 04, 2005
Clarida Still in the Running for Board of Governors
White House casting wider net for Greenspan heir, By Tim Ahmann and Caren Bohan, Reuters: The White House is not wedded to the candidates most often cited as potential successors to Federal Reserve Chairman Alan Greenspan and wants to cast a wider net, sources close to the Bush administration said on Thursday. "It's a very loose stage of gathering names and trying to think broadly about everyone who could conceivably be possible," one source said. "There is no list, per se." … While a handful of names have been discussed publicly, the process of choosing a successor is still said to be wide open. … For most of the year, speculation on his potential heir has focused on three individuals: Glenn Hubbard, a past adviser to President Bush; Harvard economist Martin Feldstein; and Fed Governor-turned-White House adviser Ben Bernanke. Sources said another former Bush adviser, Lawrence Lindsey, also has a shot. … But Lindsey's turbulent tenure at the White House National Economic Council -- he was forced out in December 2002 -- leads some people close to the administration to question whether Bush would tap him to step in when Greenspan steps down. … The "decision-makers" in this case will be a select group of the president's closest advisers. Vice President Dick Cheney, White House Chief of Staff Andrew Card and National Economic Council Director Allan Hubbard are expected to take the lead, with Bush political adviser Karl Rove and White House budget chief Joshua Bolten also weighing in. Greenspan, who is close to Cheney, is also expected to have input into the process. … The rumor mill has been churning about contenders for those positions as well. Among the names that have surfaced are former Bush adviser Randall Kroszner, former Treasury official Richard Clarida and economist and author Todd Buchholz, who advised during Bush's 2004 presidential campaign. Some people close to the administration had said they thought Clarida's chances at winning a seat had dimmed. However, one source said on Thursday Clarida was still in the running.
[Note: In a what the heck was I thinking moment, the original title of this post was "Clarida Still in the Running for Fed Chair" instead of "Clarida Still in the Running for Board of Governors." Guess I need an editor.]
The Paradox of Thrift II
Myth of national savings drives, By Samuel Brittan, Financial Times (subscription): … Today I want to tackle the myth of national savings … we have been besieged with exhortations to save more. ... The excuse ... is the supposed need to increase physical investment. Even if we accept this “need”, the case for savings drives is not made. Between the world wars Lord Keynes pointed out that an excessive attempt to save could bring about a slump. ... In today’s globalised economy there is another critique of savings drives. It is simply that a country’s investment is not limited by domestic savings ... There is … a fundamental worldwide “ex-ante” savings surplus. … In the present world conjuncture the last thing we need is for the US to start saving much more ... This would simply add to the very high Asian levels of savings and the moderately high continental European levels. It could then be difficult for real interest rates to fall enough to accommodate such a surge in world savings...
I want to add one note from the post linked above. This does not rule out attempts to increase saving as a means of increasing economic security, e.g. for retirement saving, or as a means of solving potential market failure problems in these markets. Those are separate issues.
Transfernomics: Feeding the Beast Your Children’s Dinner
In Congress, the GOP Embraces Its Spending Side, By Jonathan Weisman, Washington Post: GOP leaders this week sent House Republicans home for the summer with some political tips … Having skirted budget restraints and approved nearly $300 billion in new spending and tax breaks before leaving town, Republican lawmakers are now determined to claim full credit for the congressional spending. Far from shying away from their accomplishments, lawmakers are embracing the pork ... When the year started, President Bush made spending restraint a mantra, laying out an austere budget that would freeze non-security discretionary spending for five years and setting firm cost limits on transportation and energy bills. But now, as Congress fills in the details of the budget plan, there is little interest in making deep cuts and enormous pressure to spend. … When lawmakers return in the fall, they are almost certain to vote for more tax cuts. They also will vote on a huge new defense spending bill. But proposals for cutting entitlement programs including Medicaid have yet to pick up much support. … Last week, Congress approved transportation and energy bills that burst through the president's cost limits. Annual spending bills are inching above caps set by Congress itself in its budget plan for 2006. And a massive water projects bill passed by the House last month authorizes spending that would exceed current levels by 173 percent. … To fiscal conservatives, it is not just the total cost of the bills but also their content. Covering 1,752 pages, the highway bill is the most expensive public works legislation in U.S. history, complete with 6,376 earmarked projects, according to the watchdog group Taxpayers for Common Sense. Kern County, Calif., home of powerful House Ways and Means Chairman Committee Chairman Bill Thomas (R), snagged $722 million in projects, or nearly $1,000 per person. Los Angeles County, with clogged highways and 10 million people, will receive barely $60 per resident. … This week, House GOP leaders sent their legislators 52 pages of talking points, some addressing fiscal discipline, others touting the spending. The final page lays out 12 "Ideas for August Recess Events," none of which trumpets small government…
The tax cuts feed your children’s wealth to this generation and widen the income-gap in the process. Transfernomics. That’s the beast that’s eating up this budget.
Labor’s Wedgie Worsens
Government report shows income gap increasing, By Patrice Hill, The Washington Times: Fresh evidence emerged yesterday that the income gap is widening between wage-earners and executives and professionals … A Commerce Department report showed that incomes rose a strong 0.5 percent in June and were $23 billion more than estimated last year. But most of the gains were not in wages. Growth in business income, dividends and interest -- which goes primarily to top-income households -- accounted for most of the gains, while wages continued to stagnate. Federal Reserve Chairman Alan Greenspan and business leaders warn that the public educational system has failed to provide most workers with the math, science and technology skills needed to secure high-wage jobs. … Melinda Gates … said … "We have a crisis in the American high school system," ... "They're failing to prepare people for college. ... They cannot teach students what they need to know to hold a job." ... Former General Electric Chief Executive Officer Jack Welch maintains ... unions ... focus only on increasing teachers' wages and benefits while doing little to stem the rapid decline of educational standards and preparedness. "If I were CEO of America's public school system, I'd fight ... to get rid of public school unions. They're the bane of our children's existence," he said in remarks to the Potomac Officers Club. "I'd take them to the mat. ... It has put us behind the eight ball long-term. Until that is dealt with, we're spinning our wheels."
Teacher's unions are not the first place I would have looked for the answer to the widening income gap. The argument is that workers aren’t educated enough to compete so it must be the fault of their teachers. It couldn't be factors like parental involvement, declining school funding, the undermining of science education, rising tuition, cuts in Pell grants, peer effects, etc. And it couldn’t possibly have anything to do with those tax cuts…
Free Entry and Forced Exit from the Drug Dealing Business
My Life as a Drug Dealer - A former meth seller discusses how he got into the business—and why he doesn’t think we can win the war against it, By Dominic Ippolito, Newsweek: There are times when I still find it hard to believe, but for more than a decade, I made my living as a drug dealer. Meth, cocaine, ecstasy, pot, GHB, Special K. You name it, I had it, I sold it. Meth was a distant second to coke when I began but by the end it was by far my most popular product, accounting for half of my sales and two-thirds of my profits. It also became my personal drug of choice, and for 10 years I smoked it every day. It was because of meth that I went to prison and it took prison for me to finally quit meth. At my peak, I had over 100 customers and was clearing $200,000 a year, tax-free. I was a one-man operation: the CEO, sales staff, shipping department and bookkeeper all rolled into one. I carried two cell phones at all times, one for drug orders, the other for everything else (which wasn't much). Contrary to the image politicians and law enforcement promote, I never lurked around schools and playgrounds peddling dope to America's youth. In fact, not one of my customers was under 30, although plenty were over 50. Most of them were (and still are) hard working, productive members of society, the kind of people you'd never suspect--and rather not know--are habitual drug users. Among them, a half dozen doctors, several lawyers, two research scientists, even a police dispatcher. As my business grew, it also expanded geographically. My "sales territory" covered most of Southern California, stretching from Long Beach to Malibu to Palm Springs to San Diego and back through the wealthy beach towns of "The O.C."
Those were just my vehicular boundaries. I also used overnight delivery companies to ship drugs to select points around the country: meth to New York City and San Francisco, coke to Cleveland and Miami, ecstasy to Chicago, Special K to Atlanta. Looking back, it's not like I aspired to a life of crime ... With my GPA and high SAT score, I was told I could go to college anywhere. But leaving my nerdy clarinet behind, I chose a two-year school with a reputation for partying. It was there in 1978 that I was introduced to my first line of cocaine. I had entered the netherworld of illicit drug use. The dealing started almost by default, when I began looking for a better price than the $100-a-gram I was paying for coke and discovered I could get a full ounce--28 grams--for $1,000. I found myself selling to friends, for little or no profit. When they started pointing their friends in my direction, the charity stopped and the primordial development of a drug dealer had begun.
In the early 90's, after an attempt to settle down had ended in divorce, I began to meet women who were doing meth, not coke. ... The first time I snorted it, I thought, "Whoa!" This high was different from coke; it came on just as fast, yet I was more lucid and acutely alert. It was easy to stay up all night and still make it through the next day without falling apart. Then I tried smoking it and it was even better … They say it only takes once to get hooked on smoking the stuff, a statement that still sounds preposterous to me. But since it was all I could think about from the moment I took my first drag, who am I to dispute it? Profound changes occurred within weeks: I was drinking and sleeping less, accomplishing more, and losing weight, 20 or 30 pounds in the first few months alone. Sex became an endurance sport I couldn't get enough of. I felt great so much of the time, I couldn't even think of a downside.
But there would be a downside. … My real job couldn't be blamed … I had worked my way up to managing the claims department at a big grocery chain. But after several mergers, I was let go. ... Losing my job forced me to consider the unthinkable for the first time: dealing drugs on a fulltime basis. … At first I was deathly afraid I wouldn't make enough to survive, so I did anything I could to increase sales. I ground the cocaine so my customers didn't have to. I delivered anywhere, anytime. I gave out free drugs for new customer referrals. I even took checks. By the end of the first month, I was able to let out a sigh of relief: I had made a profit in excess of $5,000 and it seemed like I was going to make it after all...as long as I didn't get caught. Periodically, as demand dictated, I put new items on the menu; first, ecstasy, then Special K (an animal tranquilizer that is no longer available), then the notorious "date rape" drug, GHB. I sold pot for a while, but it wasn't profitable enough and it took up too much space. I paid about the same amount for meth as I did for coke--approximately $600 an ounce. But the most I could gross on the coke was $1,200 while the meth brought in $2,400. The more popular meth became, the more my profits soared. By the end of my third "fiscal year," meth sales had driven my monthly profit to an average of more than $18,000. Then, in a single moment of betrayal, my world turned upside-down. Early on my 42nd birthday, my oldest and best customer was arrested selling coke that I had sold to him. Thinking he could save his own neck, he set me up that night. I was initially charged with 11 counts of narcotics possession with intent to distribute … after 69 court appearances and $120,000 spent in my defense, I lost anyway. … Of course, I was guilty all along. I ended up serving almost 10 months in state prison and I'm about to start my ninth month on parole since release. ... I sell hair transplants now--and I'm pretty good at it--but it saddens me to think that while I have excelled at every job I've ever had, dealing drugs is the only time I felt financially secure. And what about all the money I made? I don't have much to show for it …. I'm more in debt now than when I started dealing full-time. As for prison, it was a nightmare; from the anal cavity search to the last race riot I was compelled to take part in. I also observed first-hand how prolonged meth use ravages the body, particularly teeth. I saw literally hundreds of inmates missing some or most of them. Their teeth were just gone, rotted away. … I've been asked if I think meth should be legalized, and my answer is no. Do I think the penalties are too harsh? Yes. Are we winning the war on drugs? Most of the time we're not even picking the right drug to fight. Major League Baseball and Congress are obsessed with steroids, while in basketball, it's marijuana. But ask any player in either sport whet the real problem is, and they'll tell you meth. So what do government and law enforcement do to win the war against meth? Fight another war. Shutting down 100 labs a day nationwide isn't going to make a dent, and locking up every meth user is a costly waste of time. And rehab? Nearly every meth-using inmate I met in prison had plans to go back to using as soon as they're released … This is a drug that has an insatiable pull even among people who've been off it for several years and who have a tremendous incentive to stay clean--their new-found freedom. The war against meth is complex, and I'm not sure what the answers are. But I do know that the way we're fighting it now makes it an unwinnable one.
Posted by Mark Thoma on Thursday, August 4, 2005 at 12:33 AM in Economics
CIA Trained Scorpions Do "the dirty work" in Iraq
Before the War, CIA Reportedly Trained a Team of Iraqis to Aid U.S., By Dana Priest and Josh White, Washington Post: Before the war in Iraq began, the CIA recruited and trained an Iraqi paramilitary group, code-named the Scorpions, to foment rebellion, conduct sabotage, and help CIA paramilitaries who entered Baghdad and other cities target buildings and individuals … The CIA spent millions of dollars on the Scorpions, whose existence has not been previously disclosed ... But most of the unit's prewar missions -- spray-painting graffiti on walls; cutting electricity; "sowing confusion," as one said -- were delayed or canceled because of poor training or planning ... The speed of the invasion negated the need for most of their missions, others said. After Baghdad fell, the CIA used the Scorpions to try to infiltrate the insurgency, to help out in interrogations, and, from time to time, to do "the dirty work," as one intelligence official put it. In one case, members of the unit, wearing masks and carrying clubs and pipes, beat up an Iraqi general in the presence of CIA and military personnel. … Rep. Peter Hoekstra (R-Mich.), chairman of the House intelligence committee, asked if he was satisfied with the information he received on the unit, said, "Yes -- if it existed." But he added: "We're not spending a lot of time going back and dissecting tactical programs." … Authorized by a presidential finding signed by President Bush in February or March 2002, the Scorpions were part of a policy of "regime change" in Iraq. ... After the initial combat phase of the war, the CIA used the paramilitary units as translators and to fetch supplies and retrieve informants in an increasingly dangerous Iraq … CIA control over the unit became weaker as chaos grew in Iraq. "Even though they were set up by us, they weren't well supervised," said an intelligence official. "At some point, and it's not really clear how this happened, they started being used in interrogations . . . because they spoke the local dialect" and were caught roughing up detainees, Curtis E. Ryan, an Army investigator, told a military court in Colorado ...
This statement says it all:
"We're not spending a lot of time going back and dissecting tactical programs."
Posted by Mark Thoma on Thursday, August 4, 2005 at 12:24 AM in Iraq
August 03, 2005
Good News for Gridlock Fans?
Accounts needed in Social Security plan, Bush says, By Jane Norman, Des Moines Register Washington Bureau: Personal accounts must be included in any Social Security changes developed in Congress, President Bush said Tuesday, and indicated he's looking at what could be a very long haul for the battle over the nation's retirement program. "I know it took at least five years for an energy bill," Bush said while discussing Social Security during an interview at the White House with The Des Moines Register and seven other newspapers. As for personal accounts, he said, "It needs to be part of the bill." The president said he stated his support for the voluntary personal accounts for younger workers during his campaigns in 2000 and 2004 and "I meant it."... Some Republicans are reluctant to embrace the accounts, which would allow for investment of a portion of a worker's payroll taxes, and Democrats are loudly opposed.
For me, the statement that Bush is in this for the long-haul is noteworthy and indicates an unwillingness to compromise. One way or another, this administration intends to get a bill passed that includes provisions for both solvency and personal accounts. I think both solvency and increasing national saving can be sold as valid reasons for implementing reform, but personal accounts may be a sticking point both within the GOP and between parties.
A Penny For These Thoughts Wastes a Penny
Yes Mr. Friedman, I Can Hear You Now
A Big Story, Missed, By Robert J. Samuelson, Washington Post: ...One important story we're missing today is the absence of sharply higher inflation. … Time was when an economic recovery … and this one has run 3 1/2 years -- would generate rising wages and prices that would choke the expansion … Low inflation today underlies the economy's continued resilience. It especially helps explain low long-term interest rates and, hence, the housing boom. … Even many experts are surprised by the economy's new inflation immunities. … One reason that higher oil prices haven't yet crippled the economy is that they haven't triggered a widespread jump in wages and other prices. There are many theories to explain the economy's greater inflation resistance: stiffer competition, higher productivity, spreading globalization and "slack" in labor markets. All may be partially true. … for labor-market "slack," ... unemployment is only 5 percent ... Still, companies don't seem to be bidding up wages and salaries to attract scarce workers. … One possible explanation is that there's more "slack" in labor markets than the unemployment rate suggests. Some discouraged workers may have stopped looking for jobs. ... Give all these theories their due. Still, the main reason for inflation's good behavior lies elsewhere: Expectations have changed. … The central legacy of the Alan Greenspan era at the Federal Reserve … is the suppression of ... [t]he inflationary process of the 1970s … from government policies of cheap credit and easy money that were intended to reduce unemployment. The decisive reversal of policy occurred in the early 1980s, when then-Fed Chairman Paul Volcker squeezed credit and caused a massive recession. By 1983 inflation had dropped to about 4 percent. Greenspan has sustained that progress by preempting any resurgence of inflation; … It's easier to control inflation -- and stabilize the economy -- if people don't believe that high inflation is inevitable and are automatically raising wages and prices. Little wonder that the economy has done better in the past 20 years than it did in the previous 20. … But the transformation has occurred so slowly that most Americans simply take it for granted. It's a hugely significant story, even if it's mostly ignored.
Before we declare the current policy regime a success , we need to fully understand why wages are lagging behind inflation and productivity as the economy recovers, and why the labor market continues to emit signals of weakness. I don’t believe the explanation for labor market weakness lies with inflation targeting, but we don’t yet know for sure. We also do not know for sure that the increased stability since the 1980’s (e.g. the variance of GDP has fallen) is due to monetary policy.
Thomas Friedman next:
Calling All Luddites, By Thomas L. Friedman, NY Times: I've been thinking of running for high office on a one-issue platform … I promise … America will have cellphone service as good as Japan's, provided Japan agrees not to forge ahead on wireless technology. … But don't worry - Congress is on the case. It dropped everything last week to pass a bill to protect gun makers from shooting victims' lawsuits. The fact that the U.S. has fallen to 16th in the world in broadband connectivity aroused no interest. ... The world is moving to an Internet-based platform for commerce, education, innovation and entertainment. Wealth and productivity will go to those countries or companies that get more of their innovators, educators, students, workers and suppliers connected to this platform via computers, phones and P.D.A.'s. A new generation of politicians is waking up to this issue. … Philadelphia, which decided it wouldn't wait for private companies to provide connectivity to all … made it a city-led project - like sewers and electricity. The whole city will be a "hot zone," where any resident anywhere with a computer, cellphone or P.D.A. will have cheap high-speed Wi-Fi access to the Internet. … Message: In U.S. politics, the party that most quickly absorbs the latest technology often dominates. F.D.R. dominated radio and the fireside chat; J.F.K., televised debates; Republicans, direct mail and then talk radio, and now Karl Rove's networked voter databases. The technological model coming next - which Howard Dean accidentally uncovered but never fully developed - will revolve around the power of networks and blogging. ... The party that stakes out this new frontier will be the majority party in the 21st century. And the Democrats better understand something - their base right now is the most disconnected from the network." Can you hear me now?
The whole city a hot zone. I could live with that.
Pushing a String
Greg Ip Reads the Mind of the Fed: He writes:
WSJ.com - Fed Sees Bond Market Hampering Its Steps to Keep Inflation in Check: By GREG IP: WASHINGTON -- As the Federal Reserve prepares to raise short-term interest rates again next week, officials there increasingly believe the bond market, which sets long-term rates, is diluting their efforts to tighten credit and contain inflation. The result: The longer the bond market keeps long-term rates unusually low, the further the Fed is likely to raise the short-term rates.... Fed officials say future rate moves mostly depend on what data indicate about growth and inflation. With inflation low but the economy steadily using up unused capacity, officials plan to keep raising short-term rates to... a level... between 3% and 5% that neither stimulates nor restrains economic growth.... Some policy makers worry that bond yields are being kept in check by overly complacent investor sentiment which could rapidly dissipate, pushing up mortgage rates and shaking the housing market.... The Fed is expected to raise the short-term rate to 3.5% on Tuesday. Since June of last year, the Fed has raised the Fed funds rate target from a 46-year low of 1% to 3.25%. Yet, over the same period, the yield on the benchmark 10-year Treasury bond has declined. .... If "special factors," such as increased investor confidence that inflation will remain low, or purchases of bonds by foreign central banks, are the reason for low bond yields, "the federal-funds rate probably needs to be somewhat higher than would otherwise be appropriate," Ms. Yellen said. But if the market is anticipating hard economic times, "a somewhat easier policy may be appropriate," she said. In the past month, other key Fed policy makers have come to view special factors as the likelier explanation for low long-term rates than [beliefs in future] economic weakness.... Mr. Greenspan last month strongly suggested that he thought investors may be complacent. "Risk takers have been encouraged by a perceived increase in economic stability to reach out to more distant time horizons," he said. "Long periods of relative stability often engender unrealistic expectations of its permanence and, at times, may lead to financial excess and economic stress."...
There are three hypotheses for low long-term rates in these comments, purchases of bonds by foreign central banks and increased investor confidence (e.g. Greenspan’s unrealistic expectations of stability statement) both of which point to higher rates, and the market’s anticipation of future economic weakness which would lead to lower rates. The article indicates the economic weakness explanation is not favored by the Fed.
August 02, 2005
Attempts to End Corruption and Economic Inequality in Iran May Fracture Hard-Liners
The fatal flaw in Iran's regime, By Ray Takeyh, International Herald Tribune: As Iran's hard-line president-elect, Mahmoud Ahmadinejad, prepares to assume office this week, there is a pervasive perception that the country's conservatives will finally be consolidating their power after eight years of struggle against the reformers. But rather than unifying Iran's right wing, Ahmadinejad is likely to fracture it if he acts on his pledges to bolster economic equality and end corruption. ... The contradictions that have always plagued the conservative movement are now likely to surface, making stalemate and deadlock once more the currency of Iranian politics.
Iran's most recent election was notable in that it reflected the revolt of the younger generation of conservatives who are offended by the corruption of their elders, and a hard-pressed working class who have suffered continuous economic strain. … Now that Ahmadinejad has been elected, he may find the task of carrying out his campaign promises far more difficult than he imagined. Over the past 26 years, the clerical oligarchs have constructed an economy designed to operate to their direct benefit. … the epidemic of corruption has even reached into the oil industry through a network of ostensibly private companies. … positioned … as compulsory partners for foreign investors who seek access to Iranian petroleum markets. … these companies are all owned by the clerical leaders and their families, who are not about to relinquish such easy wealth. … Outside the oil sector, the bonyads, the massive semi-government foundations with vast religious and philanthropic missions, have metamorphosed into huge holding companies that dominate the trade and manufacturing sectors while evading competition, taxes and state regulations. Ahmadinejad will find that these vast holdings, too, belong to none other than the clerical power brokers who have the institutional power to undermine his presidency, as they did with Muhammad Khatami.
Ahmadinejad is likely to prove similarly ineffective at addressing the other factors that distort Iran's economy: heavy state subsidies on key consumer goods; the job creation crisis that adds at least half a million university graduates to unemployment rolls each year; and the relatively low levels of foreign investment, which stem from the conservatives' protectionist impulses and the revolutionary ideology that continues to permeated their rhetoric and policies. The subsidies present a special problem, as preserving the political status quo requires the conservatives to avoid provoking the popular ire that would quickly ensue any significant revamping of the subsidies on gasoline and bread. Only a genuinely elected government enjoying popular support would be able to persuade a jaded public to endure the pains of profound economic reforms. … the conservatives are too implicated in the corruption of the system to restructure it. Ahmadinejad's campaign against corruption and in favor of economic equality may have made these oligarchs nervous, but they have enough power and influence to prevent him from fulfilling his pledges.
As Iran's reactionaries assume control over all levers of power, it is hard to see a new democratic dawn on the horizon. But the conservatives' strategy may contain the seeds of its own destruction. By obstructing the peaceful reform movement, the hard-liners have already deprived the Iranian people of their democratic rights; now the new regime is likely to disappoint their hopes for economic reform, too. Faced with political disenfranchisement and continued deprivation, the Iranian people may yet express their clamor for change through protest and defiance. On the eve of their most impressive power grab, Iran's conservatives may be sitting on top of the kind of smoldering public resentment that they can neither control nor appease.
We shall see.
The Paradox of Thrift
The zero-savings problem, By Chris Isidore, CNN/Money: … Even as a government report Tuesday showed the national savings rate at zero -- that's right nada -- the rise in the value of homes has given the average U.S. household a net worth of greater than $400,000, according to a separate report from the Federal Reserve. Household real estate assets have risen by just over two-thirds since 1999, and the run up has enabled consumers to spend more money than they are bringing home in their paychecks. … "[Rising home values] are making people feel they don't need to save," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute. … June was only the second month the rate was at zero since the monthly figure started being calculated in 1959. ... Strong auto sales in June played a big part in the latest read on the savings rate. The government counts the entire price of the autos purchased during the month, even though most consumers pay for vehicles over time. But even if that zero savings rate is a bit of a quirk, the trend towards lower and lower savings rates is unmistakable. In May, before the current "employee pricing" offer from automakers, the savings rate was only 0.4 percent, … As recently as 1994, the savings rate was nearly 5 percent. Go back 25 years and double-digit savings rates were the norm. … The low savings rate has kept consumers spending, which in turn has kept the economy growing. "We've backed ourselves into a very dangerous situation," said Dean Baker, co-director of the Center for Economic and Policy Research. "The economy is dependent on everyone consuming like crazy. If everyone heard my diatribe and said, 'Yeah, we better start saving,' the economy would go into a recession." …
As noted, the cost of higher saving is lower output and employment. But there is also, presumably, a benefit. More saving generally leads to more investment because it reduces interest rates, and higher investment leads to more output in the future. By giving up consumption today even more will be available in the future. But today, with interest rates already so low, the benefit of increased saving will be less than in the past since there is unlikely to be much stimulus to investment. Increasing national saving is a worthy goal, and it enhances economic security, but it may lead to reduced output and employment in the present without much compensation in terms of increased production in the future.
[Update: Please see Paradox of Thrift II as well].
AARP to Push for Reform Addressing Social Security Solvency
AARP looks to refocus retirement debate, WhoTV, Des Moines, Iowa: The nation's largest group for older Americans wants to refocus the debate over Social Security on the need to keep the retirement system afloat. While much of the debate is over diverting tax money in private savings accounts, the A-A-R-P is using town meetings to discuss solvency. At a news conference in Des Moines today, spokesman Steve Carter says keeping Social Security solvent is essential because it's becoming an increasingly important component of retirement planning, due to some troubling trends. Carter says many private pension plans are eroding, and the overall savings rate is at its lowest point in decades...
With the AARP supporting reform involving solvency provisions, it looks to me like some sort of bill will come forward. Enhancing solvency requires increasing revenues or decreasing benefits. Is it time for the Democrats to coordinate behind a particular solvency plan? The politics of this are difficult. I'm not sure what the best strategy is going forward from here given my perception that the public believes that solvency is a problem and that a reform bill is likely.
Look for the Sweatshop Label
Don't get into a lather over sweatshops, By Benjamin Powell and David Skarbek, Christian Science Monitor: San Francisco Mayor Gavin Newsom is pushing the city council to adopt an ordinance that forbids the use of municipal funds to purchase uniforms and other clothing made in "sweatshops." … colleges often adopt similar standards for clothing displaying their school logos. North American unions ... often lobby to impose working standards for developing countries similar to San Francisco's proposed ordinance. Though these efforts are intended to help poor workers in the third world, they actually hurt them. We use "sweatshop" to mean those foreign factories with low pay and poor health and safety standards where employees choose to work, not those where employees are coerced into working by the threat of violence. And we admit that by Western standards, sweatshops have abhorrently low wages and poor working conditions. However, … alternatives to working in a sweatshop are often much worse: scavenging through trash, prostitution, crime, or even starvation. Economists across the political spectrum, from Paul Krugman on the left, to Walter Williams on the right, have defended sweatshops. … People choose what they perceive to be in their best interest. ... If workers voluntarily choose to work in sweatshops … it must be because sweatshops are their best option. Our recent research - the first economic study to compare systematically sweatshop wages with average local wages - demonstrated this to be true. We examined the apparel industry in 10 Asian and Latin American countries … Not only were sweatshops superior to the dire alternatives economists usually mentioned, but they often provided a better-than-average standard of living for their workers. … In 9 of the 11 countries we surveyed, the average reported sweatshop wages equaled or exceeded average incomes and in some cases by a large margin. … Antisweatshop activists - who argue that consumers should abstain from buying products made in sweatshops - harm workers by trying to stop the trade that funds some of the better jobs in their economies. Until poor nations' economies develop, buying products made in sweatshops would do more to help third-world workers than San Francisco's ordinance. By purchasing more products made in sweatshops, we create more demand for them and increase the number of factories in these poor economies. That … raises productivity and wages, and eventually improves working conditions. …
Many economists support this position (see here for a discussion of the Worker's Rights Consortium and the Fair Labor Association). But if you've lost a job to a sweatshop, perhaps one of the newer internet types that are displacing professional workers, I suspect the economic development of another country and free trade aren’t paramount in your evaluation of the consequences of increasing the number of sweatshops.
Caution! Lobbyists at Work
Insurers Want Their Say in Social Security Debate, By Joseph B. Treaster, NY Times: … regardless of the outcome of Republican proposals to add private accounts to the system, the nation's huge life insurance industry stands to benefit from the debate over Social Security's future. Already, the debate has called attention to retirement concerns. Insurers have been increasingly focusing on selling investments for retirement and they are doing their best to capitalize on the attention. Moreover, if Congress does end up changing Social Security, there is a good chance any new law would favor the kind of investments called annuities that insurers love to sell. … [T]he insurers have strengthened their main trade association and lobbying arm, the American Council of Life Insurers, and many individual companies are working independently to win advantages for their products. Last year, the trade group alone reported spending $9.1 million on lobbying, up 54 percent from the previous year. … In making their pitch now, the insurers emphasize that their annuities can contribute to national savings and provide "a paycheck for life" similar to Social Security. They also contend that a flexible savings plan advocated by President Bush, which would probably take money away from them, would probably not increase long-term savings. And the insurers are trying to prevent the elimination of the estate tax, which many wealthy Americans now pay with the proceeds of life insurance policies. … The lobbying campaign may already be paying off. Some of the most powerful Washington leaders have been picking up on the broader issue of retirement and the woeful inadequacy of savings by most Americans…
Many Potential Pitfalls Await Greenspan’s Replacement
New Fed chairman must tread an uncertain path, By Henry Kaufman, Financial Times: When a new chairman of the US Federal Reserve assumes office next year, the transition will be greeted by great fanfare and widespread market apprehension. ... The new chairman will … be forced immediately to confront some knotty domestic and international challenges. Internationally, the new chairman will assume the role of de facto head of the world financial system. ... The International Monetary Fund, the closest thing we have to a global central bank to respond to these gyrations, is hampered by its lack of authority and cumbersome bureaucracy. So when financial crises arise, the US Fed and Treasury must shoulder much of the burden of maintaining global stability. The new Fed chairman will need to address the current economic and financial disequilibrium of the world's large economies. Although the US is outperforming most other industrial economies, it is borrowing heavily to sustain a massive wave of spending. … the new chairman must formulate a monetary strategy for an ageing economic expansion that, on the day he or she takes office, will be in its fifth year. … guiding the economy on a sustainable path ... if oil prices continue to rise. The new chairman will need to make tough judgments on the housing sector. … household debt has risen sharply, and the grave risks this poses can be minimised only by low interest rates, rising household income or a combination of the two. … For their part, financial markets will watch closely to see if the new chairman maintains the current tactical monetary approach. Under Alan Greenspan, this has consisted primarily of two tenets - measured responses to economic developments and increasing transparency in monetary policy. …
August 01, 2005
Social Security Reform Stopped by Democrat’s Radical Economists
How President Bush's Social Security Reform Died, Kevin Hassett, Bloomberg: Social Security reform is dead. … Until two weeks ago, Social Security reform was sort of dead. But now it seems to be all dead. The breakdown occurred when the administration backed away from a proposal making its way through the House of Representatives that would have introduced personal accounts without specifically restoring solvency to the system. Ben Bernanke, chairman of President ... Bush's Council of Economic Advisers, publicly signaled the White House's displeasure with such an approach. Asked if restoring solvency was an inviolable condition, Bernanke said, “Yes, I think the president will insist on maintaining the long-term solvency of the Social Security system.” The word from … up on Capitol Hill, is that this signal from the president sucked the remaining life out of the House measure. …
Another thing we learn from the demise of Social Security reform is that when it comes to economics, this is now Howard Dean's Democratic party. This completes, really, the economic radicalization of the Democrats, and it is a frightening picture -- frightening if you consider that they might run the country again some day. The fact is that the Social Security reform proposed by the president is quite moderate. … If private accounts were introduced, then you might buy a U.S. Treasury bond and hold it until retirement. ... The labels change but the economic difference is not earth shattering. In politics, one should be delighted if opponents care deeply about achieving something of relatively minor importance. … Instead, we got only obstruction. Perhaps this is because Democratic leaders don't have any novel policy ideas they would like to see implemented. Perhaps it's because the Democratic leadership is currently to the left of the Mongolians on Social Security. … Another chance for change is ahead. The president's advisory panel on tax reform will make a recommendation in the fall. Its report will kick off a debate and begin the legislative process on that key issue. Social Security solvency may well be addressed while tax reform is pursued, perhaps as early as next year. …
So when he says all dead he means until fall. Yep, that's pretty dead. And it’s all due to the “economic radicalization of the Democrats.” He must be referring, as he casts aspersions, to those of us who have been carefully separating social insurance from retirement savings (see here and here also) and discussing how to most efficiently provide for those entering their retirement years (e.g. see here and here), not those “conservative” types who want to destroy the existing Social Security system. As he says, a foot in the door towards destroying the current system is of only “minor importance” and not radical at all.
I wonder why he thinks Democrats “might run the country again some day…?” I think that too. The sooner the better.
Update: This is what the death of Social Security reform looks like:
GOP Plans August Campaign on Personal Savings Accounts, Fox News: House Republicans will campaign for a new type of personal savings accounts during the August recess and vote on them in September, the first sign of political momentum in a Social Security debate Democrats have so far brought to a standstill. Republicans call the proposed plan "grow accounts" ... The accounts would not contain stocks, only U.S.-backed Treasury bonds...
The Fed is Yellen that Rates are Going Up
Yellen Says It ‘Makes Sense’ for Fed to Raise Rates, Bloomberg: The Federal Reserve should keep raising interest rates to pull some of the stimulus out of the U.S. economy, which already is grown near its capacity, Fed Bank of San Francisco President Janet Yellen said. “Policy still appears to be somewhat accommodative,” Yellen said told community leaders in Portland, Oregon. “Given the recent inflation performance and the dwindling of slack, it makes sense to continue the process of removing that accommodation.” …A federal funds rate of 3.5 percent is at “the absolute lower end” of a range where the central bank's monetary policy neither stimulates growth nor fans inflation … Some models suggest the upper end of the range is about 5.5 percent, she said. … “I expect to see some moderation in inflation going forward,” Yellen said. “Looking at the big picture elements -- growth, employment, and inflation -- I’d say things are in reasonably good shape.” … “Given all this, it seems to me that the economy is on track to achieve price stability and “maximum employment’ -- the dual goals assigned to monetary policy by the Federal Reserve Act,” Yellen said…
Calculated Risk covers more of her remarks here and notes she is fairly upbeat about the Fed's ability to manage any fallout from problems that may arise in the housing sector.
An Educated Approach to Job Creation
Sweet home Oregon, The Oregonian: Alabama thought for sure it had the parking place for Toyota Motor Co.'s new $655 million factory and 1,300 jobs. It offered $200 million in tax breaks and other incentives. But Toyota chose to build in Ontario, Canada, which offered half the tax breaks but a better educated, more skilled workforce. Why should Oregon care? Because Oregon has Alabama's so-so schools and its poorly funded higher education system. It has the same bitter school spending fights in its legislature, and roughly the same per-student funding. Oregon, like Alabama, tries to woo business with low taxes and incentives, not a highly skilled, homegrown workforce. It is like looking in the mirror. … If Toyota were to look at Oregon and consider bringing 1,300 family-wage jobs to this state, what would it see? The only state in the country that closed its schools early during the recession. A state that provides as little public support for its universities as any in the nation. A state that still has no substantial rainy day fund to cushion schools in the next downturn. It would see a lot of what it saw in Alabama. Oregon has spent 15 years now chiseling away at its schools and universities. ... Today there is not one prominent elected official or candidate -- not one -- pushing for a major new investment in education. But there are many who still cling to the fiction that keeping the state's overall tax burden in the bottom 10 or so states will draw more business and jobs than investing in quality schools and powerful universities. If you believe that, we could sell you a place in Alabama. An empty place in Alabama.
Or an empty place in Oregon. I hope you have smarter legislators than we do.