September 30, 2005
Marginal Utility on Consumption Taxes
Marginal Utility: Coming At You From The Econoverse (Maybe): The Consumption Tax: ...A consumption tax has been a darling of long standing for some economists. The main idea, as articulated by Alan Greenspan here, is that taxing consumption as opposed to income — thereby deferring tax on saved income until it's consumed — increases saving (by lowering the price of future consumption relative to present consumption) and, by extension, investment and economic growth. ... One idea with more than a little currency is to replace the income tax system entirely with a "progressive consumption tax." This is often presented as a simplification of the income tax system in that you just subtract (net) saving off of income to obtain "consumption," probably further subtract some personal exemptions, hit the result against a tax table, and voilà, a tax return in ten lines or less. While some forms of consumption taxes are "regressive" in that they disproportionately fall on the not-rich who have little choice but to consume ... their income in order to live, the rates in a "progressive consumption tax" ... can be set to ensure that the rich pay their fair share ... Moreover, the top tax rates would specifically discourage some of the conspicuous consumption ... which drives portions of the non-rich classes to the poor house, making some forms of consumption taxation amenable ... to ... economists like Mark Thoma and Cornell's Robert Frank (author of Luxury Fever).(*)
You might ask, if this is such a damn great idea, why wasn't it implemented yesterday? There are a few candidate answers:
- Just wait. The tax reform commission launched earlier this year is due to report its findings soon, notwithstanding the various preoccupations of the Bushist "policy" shop. Given that promoting savings and growth are explicitly listed elements of its remit, its quite conceivable that consumption taxation in some form will be among the recommendations.
- There are big transition issues (also cited by Greenspan), particularly relating to the treatment of assets acquired under the income tax system. Really, any material tax reform will have some sort of transition problem, since even if the system were designed to be as distributionally neutral as possible, someone's oxen will be gored and the Flying Spaghetti Monster help the politicians who do it.
- As a replacement for income taxation, consumption taxes aren't obviously so great after all.
--------------------------- I'll make some of the case for #3... One problem is that the simplicity argument in favor of a consumption-tax replacement for the income tax can be a chimera: The simpler the consumption tax in the length-of-the-tax-form sense, the less clear it is that its economic distortions are smaller than those from a well-designed income tax. ... That measuring net savings is potentially complex is well-enough known that it's mentioned in pro-consumption tax sources like this EconLib article. The solution proffered by the article's author — a sort of unlimited IRA, ... amounts to little more than a wave of a magic wand. ... Under a consumption tax, it becomes necessary to track and net out all contributions and distributions from every possible savings vehicle. This doesn't bother me, but then again I can figure out my AMT on my own if I have to. I would predict a bonanza for tax preparers and tax software providers.
There also arises an issue of just where does consumption end and saving begin. It's not so simple. ... Nor is it necessarily easy to measure economic consumption. ... consumer "durable" goods like appliances, cars, and (in some respects) houses account for large shares of expenditures and are mostly consumed in tax periods other than the year of purchase. If the consumption tax is essentially a cash-flow tax (i.e., simpler from an accounting perspective), then it will tend to overtax durables in the year(s) of purchase, and then undertax them once they're paid off ... This could be seen variously as excessively discouraging durable goods acquisition ... Did I mention that for a given level of revenue, consumption tax rates would need to be much higher than income tax rates, other things equal, given that consumption represents a smaller tax base than income? The more economically efficient alternative of gradually taxing durable goods consumption would itself be a colossal administrative undertaking, ... Again, this is not necessarily so simple. As for the necessity argument, since a consumption tax system eliminates tax distortions affecting savings returns at the cost of increasing them (via higher tax rates) in various goods markets, the net benefits would appear to be ambiguous...
So I'm not especially inclined to buy. I'd prefer a simplified progressive income tax that traded off some of the present mess of deductions, credits, and tax-preferenced forms of income for as low a set of rates, applied to a broad income base, as will approximately balance the federal budget along 'trend' growth. (That'll require a lot more revenue than is presently being raised, in the absence of a reversion to fiscal discipline...) To be sold, I'd need convincing that any feasible consumption tax will outperform that counterfactual.
(*) ...Frank's article ... proposes an untraditional mechanism by which the consumption tax might promote savings. The progressive rate structure would tend to reduce consumption inequality which ... pushes people to spend themselves into oblivion to try to keep up with higher-income, higher-consuming peers who ratchet up general expectations of what constitutes a reasonable lifestyle. Social acceptance of financially modest consumption is, then, a collective good that's under-provided by the "market." ...Mark Thoma doesn't completely buy the collective good argument , and I'd certainly view the need for a tax remedy to the "problem" with extreme suspicion, but I'm not inclined to dismiss the relevance of the social context of consumption.
Santomero: The Fed Needs to Keep Raising Rates
Fed official expects rebound after hurricanes, by Andrew Balls, Financial Times: The Federal Reserve needs to continue raising rates in order to remove unnecessarily accommodative monetary conditions but also to demonstrate its "unwavering commitment" to maintaining stable inflation, a top Federal Reserve official said. Anthony Santomero, president of the Philadelphia Federal Reserve, said the economy was likely to bounce back after ... hurricanes Katrina and Rita, with stronger-than-expected growth next year on a boost from reconstruction and government spending. High oil prices would boost headline inflation, and contribute to higher core inflation, he said. ... "The challenge for us as a central bank is to maintain price stability and maintain our commitment to price stability so that people recognise that this is an adjustment in the price level of an important commodity, but it is not an adjustment in the inflation rate," he said.
The Fed had a dual mandate, he said: to oversee price stability and potential growth "in that order". ... Mr Santomero said the economy was growing at a healthy pace before the hurricanes ... Katrina and Rita would contribute to slightly weaker growth in the second half of this year,... but ... the drop in consumer confidence after those storms should be swiftly reversed, based on past experience. Mr Santomero said he expected a post-hurricane rebound for 2006 "as the rebuilding and increased spending builds its own expectations of further good times". He remained confident healthy growth would continue next year ... above the economy's long-term trend rate of slightly less than 3½ per cent.
The impact of high energy prices on consumer spending was a key uncertainty, he said, adding that to date income and employment growth had allowed consumers to increase spending in spite of higher energy costs. Another key question was the consumer response as the housing market cooled. Mr Santomero said that, while he remained confident ... judging the underlying strength of the economy could remain difficult for the Fed at a time when the incoming data would be distorted by the disruption on the Gulf coast, making the central bank's job very difficult. Information about the US economy during the weeks between last week's FOMC decision and the next would become “fuzzier rather than clearer”, he said, "because of the disturbance affecting the data". He said that the committee would make decisions meeting by meeting and did not have a preordained path of rate increases in mind.
His statement that "The challenge for us .. is to maintain price stability and ... our commitment to price stability so that people recognise that this is an adjustment in the price level of an important commodity, but it is not an adjustment in the inflation rate" suggests he is worried about increases in inflationary expectations. To prevent this, the Fed needs to demonstrate its "unwavering commitment" to price stability.
New Economist on Barro and the Equity Premium Puzzle
New Economist: Has Barro solved the equity premium puzzle?: It's not quite the holy grail of financial economics, but certainly one of the longest running debates has been over what is known as the equity premium puzzle - or why US stock returns are so much higher than returns on Treasury bonds. The seminal paper was by Rajnish Mehra and Edward C.Prescott's in 1985: "The Equity Premium: A Puzzle" (PDF) in the Journal of Monetary Economics. Mehra and Prescott showed it was difficult to reconcile empirical facts about equity and debt returns with reasonable assumptions about the relative rate of risk aversion and the pure rate of time preference, posing difficulties for the capital asset pricing model. A new paper by Robert Barro to this year's Minnesota Workshop in Macroeconomic Theory attempts to answer the puzzle: Rare Events and the Equity Premium (PDF). Barro's paper builds upon Thomas Rietz 1988 JME article "The equity premium: A solution", which argued that the premium could be explained by infrequent but very large falls in consumption (i.e. wars, depressions or disasters), if the intertemporal elasticity of substitution of consumption is low. Or as Brad DeLong recently put it:
Rietz's (1988) answer to the equity premium puzzle was this: a long, fat lower tail to the return distribution. A small probability of very bad things happening to stock returns could support both (a) a relatively small sample variance of returns, and (b) rational aversion to large-scale stock ownership large enough to produce the observed equity premium. The question that Rietz was unable to answer was: "What exactly are these very bad things?"
Mehra & Prescott immediately dismissed the Rietz arguments in a 1988 JME article (PDF), concluding:
Are Rietz's disaster scenarios reasonable? They are undoubtedly extreme. That such extreme assumptions are needed to account for the average returns on debt and equity we interpret as supporting our contention that standard theory still faces an unsolved puzzle.
Barro explained his 2005 paper's origins in an interview in the September 2005 issue of the Minneapolis' Fed's journal, The Region:
Mehra and Prescott were extremely critical of the Rietz analysis, and I think they managed to convince most people that low-probability disasters were not the key to the equity premium puzzle. But, although I highly value the insights in their original 1985 paper (which Mehra and Prescott like to point out was actually written in 1979), I think the arguments in their 1988 comment on Rietz were incorrect.
I had not thought much about this issue until a few months back—it's not an area that I've worked in. But when I began to study it, it seemed that low-probability disasters could be quite important. And then I found Rietz's paper, which I thought was a great insight, and I have been building on it. Frankly, I think this idea explains a lot. Of course, there is a good deal more to work out, to think about further, but I think his basic insight is correct.
Suppose that you have potential events with, say, a 1 percent annual probability, where you lose half of your capital stock and GDP. This possibility seems to be enough to get something like the observed equity premium. Moreover, this mechanism has implications for a lot of other variables, not just for the excess of the average return on stocks over the return on government bills. For example, it can explain the very low “risk-free” rate and low expected real interest rates during most U.S. wars back to the Civil War. It can also explain some of the evolution of price-earnings ratios for the U.S. stock market.
...I've looked at the 20th century history of large, short-term economic contractions as a way of motivating the general orders of magnitude for the parameters in the model. So, looking at the world wars and the Great Depression, and other depressions—for example, in Latin America and Asia in the post-World War II period—you find a substantial number of these events. If you take that whole history covering many countries over 100 years, you get some idea of the probability and potential size of these rare disasters. I show in the model that if you use these “reasonable” parameters, the theoretical results match up with empirical observations, such as the equity premium.
Brad DeLong disagrees with this line of reasoning, arguing that for Rietz to be correct:
Any macroeconomic factor to drive the equity premium must therefore be a factor that leaves the real value and real return on short-period U.S. Treasury securities unaffected. But almost all true macroeconomic disasters that could halve or do worse to the real value of equities are likely to produce at the very least rapid and substantial inflation, if not confiscatory taxes on or outright repudiation of government bonds.
An economic depression would be deflationary, surely? As for war, while one can see how capacity constraints would be inflationary, Barro argues that real bond yields were low during wartime:
...I argue that this approach can explain a lot of the real-interest-rate movements in the U.S. history—particularly why expected real interest rates were very low during the main wartime periods in the United States, including the Civil War, World War I, World War II and the Korean War.
This is a fascinating debate that will likely not conclude anytime soon. For example, Cyber Libris blog recently raised two issues about the Rietz/Barro argument:
Two intertwined things worry me though. First, the Rietz/Barro argument sounds like the quantum leap debate in physics (disclosure: My field is not physics!). A lot of the literature in the economics of risk and uncertainty has provided evidence that people usually underestimate low probability events (from Howard Kunreuther to Nassim Taleb's famous Black Swan, click here for a video of Taleb). People have a hard time moving from the "normal" to the "rare" and back. How come that things (chief among them behaviors) are not the same in the small and in the large? So, who's right? Those who believe in the Black Swan or those who don't? More work is needed and it does not relate to finance only (think of climate events etc...).
Second, University of California Philippe Jorion and Yale University William N Goetzmann have shown that when you gather more data from more markets (outside the US) you get an empirical premium that is lower than the one that has been estimated on the US market only. Question: How do you reconcile the two sets of observations and arguments? In other words, is the premium too low or too high, is it vanishing and what kind of premium level should we expect in the future?
In expositions of the equity premium, risk-free rate, and excess volatility puzzles, the subjective distribution of future growth rates has its mean and variance calibrated to past sample averages. This paper shows that proper Bayesian estimation of uncertain structural growth parameters adds an irreducible fat-tailed background layer of uncertainty that can explain all three puzzles parsimoniously by one unified theory.
Worth reading for a different perspective is the new Economists' Voice paper by Simon Grant and John Quiggin, What Does the Equity Premium Mean? The authors argue that taking the equity premium seriously implies that "recessions are extremely costly even if they don’t lower average consumption." John Quiggin writes on his weblog that:
We also show that, to the extent that the equity premium is due to various kinds of capital market failure, it provides a rationale for public ownership of some business enterprises and for a rate of return on public investment close to the real bond rate.
UPDATE: Brad DeLong comments on Barro here.
September 29, 2005
Will the Dollar Lose Its Position as the Dominant Reserve Currency?
How the dollar might lose its status as the world's main reserve currency, The Economist: Once a decade or so, economists ask whether the dollar's reign as the world's number one reserve currency might be at the start of a slow decline. ... In the past 30 years, the dollar has had four bouts of marked depreciation. ... Even so, 66% of the world's official foreign-exchange holdings are still in dollars, compared with 25% in euros, 4% in yen and 3% in pounds... And yet dollar sceptics note that this time the dollar's crown is, if not wobbly, at least skewed. America's current-account deficit, at 6% of GDP, is its highest on record; its net foreign liabilities, at 22% of GDP, are also close to an all-time high. Foreign central banks seem to have reduced their purchases of American Treasuries ... If this trend continues, other currencies could one day challenge the dollar's dominance.
History offers perhaps only one true example of a reserve-currency shift, from the British pound to the dollar. The pound was king during the era of the gold standard. But in the years after 1914, Britain switched from net creditor to net debtor, and by the 1920s the dollar was the only currency convertible to gold ... Two costly wars and two episodes of currency devaluation in Britain later, the dollar was unchallenged as the world's chief reserve currency. The likeliest pretender to the dollar's crown is the euro. Reserve currencies need to have a home economy with a large share of global output, trade and finance. ... The euro area's total trade with the rest of the world is about as big as America's; about half of this trade is invoiced in euros. The financial market of the reserve currency country must also be deep, open and well developed. America leads the euro area by most measures, but the creation of the single currency has helped to integrate Europe's financial markets.
Confidence in the value of the currency is also an important requirement, and this is where critics of the dollar have mostly taken aim. Barry Eichengreen, of the University of California at Berkeley, argues in a recent paper* that whether the dollar retains its reserve-currency role depends mostly on America's own policies. If America allows its large current-account deficit to persist and its net foreign liabilities to rise, foreigners will become less willing to hold more dollars. ... In another recent study,† Menzie Chinn, of the University of Wisconsin, and Jeffrey Frankel, of Harvard, ... use ... estimates to predict whether the euro could overtake the dollar as the world's main reserve currency. It could, but not soon. ... they reckon, the euro could become the top currency by 2024. If in addition Britain, Sweden, Denmark and all the central and eastern European countries that joined the European Union last year adopted the euro, it would supersede the dollar by 2019...
Another view, offered by Mr Eichengreen, is that the world might eventually have more than one main reserve currency. The dollar could share its status if other currencies become more attractive. ... This process, thinks Mr Eichengreen, favours the euro. He is doubtful about other candidates, notably the yuan. He argues that both Europe and America “have strong institutions, respect for property rights, and sound macroeconomic policies relative to the rest of the world.” In China, by contrast, capital controls, financial markets that are neither very liquid nor transparent, and uncertainty about property rights make the yuan an unlikely contender for decades to come...
*“Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition”. NBER Working Paper No. 11336: www.nber.org/papers/w11336 †“Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?” NBER Working Paper No. 11510: www.nber.org/papers/w11510
What is Debt Monetization? When is it Automatic? Is it a Risk?
What it is and how it works
1. Suppose the government runs a deficit. As an example, let government spending on goods and services be $10,000. For simplicity, all transactions are in cash. Let net taxes from all sources be $9,000 so there is a $1,000 deficit.
2. The government has $9,000 in cash from taxes, but needs to spend $10,000. Somehow (print money, borrow money, raise taxes, or lower spending) it must get $1,000 more.
3. Suppose it decides to borrow – issue new debt. Then the Treasury sells a government bond to someone in the private sector for $1,000. The person gives $1,000 in cash to the government and in return gets an IOU (perhaps for, say, $1,100 in one year).
4. The government now has $9,000 in cash from taxes and $1,000 it has borrowed from the public so it can now purchase $10,000 in goods and services.
5. Now let’s do the monetization step. This can happen automatically, as explained below, but for now let’s have the Fed conduct a $1,000 open market operation to increase the money supply. To do this, it cranks up the press, loads in some paper and green ink, and prints a brand new $1,000 bill. It takes the $1,000 bill and purchases a bond from the public, for simplicity make it the same bond the Treasury just issued. Then the money supply goes up by $1,000 (and may go up more through multiple deposit expansion) and government debt in the hands of the public goes down by $1,000 since the Fed now holds the bond. The increase in the money supply is inflationary.
6. What has happened? When all paper has ceased changing hands, the $10,000 in goods and services is paid for by the collection $9,000 in taxes and by printing $1,000 in new currency. The government debt simply moves from the Treasury to the Fed (in the U.S., the Fed pays for its operations from its earnings on these bonds and remits the remainder to the Treasury; I believe the remittance is weekly, but I’m not positive on that).
How can constant interest rate rules potentially cause debt monetization to occur automatically?
Suppose the Fed follows a constant interest rate rule. Further suppose an increase in government spending increases the interest rate (see here for a paper on this by Benjamin Friedman posted at the NBER site today). That is, when the government issues new debt, the supply of bonds increases lowering the price and raising the interest rate. Under these assumptions what will happen when there is deficit spending?
1. Deficit spending financed by borrowing from the private sector causes the interest rate to go up. Thus, initially two things happen, bonds held by the public (debt) increase and interest rate increases as well.
2. But the Fed is following a constant interest rate rule. Seeing the interest rate rising, what should it do? It should increase the money supply and to do so it prints money, as above, and uses it to buy bonds from the public. In order to return the interest rate to where it started, all of the debt issued in step one must be purchased with newly printed money (can you smell the fresh ink?).
3. In the end, what happens? It’s just as above, the entire deficit is financed by printing money and the debt issued by the Treasury ends up in the hands of the Fed.
This is one reason why the Fed has made so much noise lately about letting interest rates rise in the face of budget deficits. The Fed is sending a signal to fiscal authorities that it would rather let interest rates rise than monetize the debt and suffer the inflation that debt monetization brings about. So far we have been lucky in this regard. Long-term interest rates have remained low while budget deficits have increased. But if your read what Janet Yellen said yesterday, echoing remarks by other Fed officials, she is clearly concerned that this may not persist and that interest rates could rise quickly. The Fed is signaling that if the increase in interest rates is caused by budget deficits, the Fed is unlikely to intervene due to the inflationary consequences of monetization. It will allow interest rates to rise.
Is this a risk?
For me, this is one of the important considerations for the new Fed chair. I will be interested to hear the commitment of the new chair to fighting inflation even if it’s not a direct commitment to an explicit inflation target. There is every incentive for both parties to choose someone who will allow the debt to be at least partially monetized by allowing inflation to increase because this relieves congress of the responsibility for raising taxes or cutting programs. With debt monetization, government debt disappears and inflation takes its place. While the public moans at the Fed over high inflation, fiscal authorities, because the debt is monetized, are absolved of responsibility. The Fed is signaling it does not intend to monetize the deficit and I hope the choice for a new chair will maintain that commitment.
The Endangered Species Act is Endangered
Threatened and endangered, Editorial, The Oregonian: After 30 tumultuous years, the Endangered Species Act sorely needs a thoughtful, rational rewrite ...Instead, the U.S. House is bulling ahead on an ill-considered reform plan, rushing to a vote Thursday on a bill crafted largely by Rep. Richard Pombo, R-Calif., the leading critic in Congress of the Endangered Species Act. The act is "broken," Pombo says, noting that only 10 of roughly 1,300 species have recovered enough to be removed from federal protections. But ... at least all but a handful of them still exist. Only nine species have gone extinct since the act was adopted in 1973. Either way, Pombo's bill is ... ultimately ... about reducing the power of federal wildlife agencies and lifting the burden of species protections from private landowners and those who log, mine and drill in public lands. Pombo and other co-sponsors of the House bill, including Rep. Greg Walden, R-Ore., look at the existing law and see red tape, disputed science, unfair burdens on landowners and slow, imperious federal wildlife agencies. ... the House bill seeks to fix them by cutting into the heart of the act. Instead of targeted incentives to fairly compensate landowners who protect wildlife, the House bill would allow landowners to demand massive payments for lost profits from forgone uses of their land. Such a law would encourage developers to go looking for environmentally sensitive areas to propose projects and seek compensation. The bill also would ban wildlife agencies from designating "critical habitat," lands considered crucial to the recovery of the species. At least one major study has shown that endangered species with protected habitat are more than twice as likely to be recovering as species without it. Walden's views ... understandably hardened during the Klamath crisis in 2000, when irrigation water was abruptly cut off to protect endangered suckers. Anger from the Klamath incident is still driving debate over the act, even though it is hard to look at the Klamath Basin today and see a triumph of species protection over property rights. The ... Pombo bill ... is certain to pass in the Republican-controlled House. It will then fall to the Senate to negotiate a more careful reform of the Endangered Species Act, one that holds true to the act's original intent, preventing human development from jeopardizing species.
This editorial from Japan provides contrasting view to that of the House majority:
Flight of the storks, asahi.com: The release into the wild on Saturday of five Oriental white storks captured our imagination. The birds, designated by the government as special natural treasures, soared into the sky in a most impressive fashion. The last wild one of the birds died in Japan 34 years ago. But thanks to an artificial breeding program in Toyooka, Hyogo Prefecture, these graceful birds are returning to our environment. It is like a dream come true. ... The Oriental white stork is a large migratory bird that is distinguished by its white body, black wings and a thick beak. In the Edo Era (1603-1867), these storks inhabited many parts of Japan. In their heyday before World War II, about 100 storks lived in and around Toyooka. But the birds began disappearing in the era of rapid economic growth. This was because the natural environment underwent a drastic change in the postwar period. Pine groves, where the birds nest, were destroyed. Loach and frogs, on which the storks fed, vanished when farmers began draining excess water in their paddy fields early in summer or just before harvest time in the fall. Agricultural chemicals used by farmers also affected the birds' breeding ability. Returning artificially bred storks into the wild required not only advanced breeding technology but also a reinvigorated natural environment. Farmers had to abandon intensive farming methods that relied on agricultural chemicals and fertilizers to produce high annual crop yields. They even had to ensure there was water in their fallow paddy fields in winter to sustain all living creatures. Rivers also had to be cleaned and natural woodlands near populated areas had to be managed properly. Power transmission lines had to be buried underground. All these efforts require the willing participation of local inhabitants.
Some people worried that the storks would harm the rice crop. But this mind-set gradually reversed itself as people began to place greater stock in food safety and agricultural products that are free of chemicals. The rice paddies where storks feed offered proof that farmers valued the natural environment. ... The only downside might be that harvests are slightly smaller. There was even a move to cultivate rice as from farmland that welcomed back the storks. We applaud this move and think it should be emulated around the country-assuming that storks will settle all over the land. ... We believe that municipalities across the country should take a leaf out of Toyooka's book and adopt similar preservation methods to create a natural environment that is also comfortable to humans. If the five storks that flew off into the wild can adapt themselves to their new environment and pair off, we may see juvenile storks leave their nest early next summer. It is said that it takes several generations for such breeding programs to become totally successful. We truly hope that such persistent efforts will bear fruit. Storks travel far. They may appear in the area where you live. If they do, please don't disturb them. We hope you will enjoy just having them in the neighborhood.
Australian Reserve Bank Governor: Global Imbalances not Caused by U.S.
I was told to remove this speech by the media office of the Reserve Bank of Australia (RBA). I am used to policies such as these:
Unless otherwise specified on this web site, reproduction of any Federal Reserve Bank of San Francisco Information contained herein may be made without limitation as to number, provided however, that it is not distributed for the purpose of private gain and it is appropriately credited to the Federal Reserve Bank of San Francisco.
Unfortunately, the RBA is more restrictive. Apologies to readers - the speech is still available in the link above.
Benjamin M. Friedman: Deficits and Debt in the Short and Long Run
Benjamin M. Friedman, Deficits and Debt in the Short and Long Run, NBER WP 11630, October 2005: Abstract This paper begins by examining the persistence of movements in the U.S. Government’s budget posture. Deficits display considerable persistence, and debt levels (relative to GDP) even more so. Further, the degree of persistence depends on what gives rise to budget deficits in the first place. Deficits resulting from shocks to defense spending exhibit the greatest persistence and those from shocks to nondefense spending the least; deficits resulting from shocks to revenues fall in the middle. The paper next reviews recent evidence on the impact of changes in government debt levels (again, relative to GDP) on interest rates. The recent literature, focusing on expected future debt levels and expected real interest rates, indicates impacts that are large in the context of actual movements in debt levels: for example, an increase of 94 basis points due to the rise in the debt-to-GDP ratio during 1981-93, and a decline of 65 basis point due to the decline in the debt-to-GDP ratio during 1993-2001. The paper next asks why deficits would exhibit the observed negative correlation with key elements of investment. One answer, following the analysis presented earlier, is that deficits are persistent and therefore lead to changes in expected future debt levels, which in turn affect real interest rates. A different reason, however, revolves around the need for markets to absorb the increased issuance of Government securities in a setting of costly portfolio adjustment. The paper concludes with some reflections on “the Perverse Corollary of Stein’s Law”: that is, the view that in the presence of large government deficits nothing need be done because something will be done.
September 28, 2005
A Haven For Rent-Seeking Behavior
Lobbies Line Up For Relief Riches, by Jeffrey H. Birnbaum, Washington Post: With Congress dangling as much as $200 billion in hurricane related aid, lobbyists for oil companies, airlines, manufacturers and others are clamoring to get their share. ... Lawmakers are receptive to many of these requests, congressional aides said. For example, House Energy and Commerce Committee Chairman Joe Barton (R-Tex.) is moving legislation this week, much of it recommended by lobbyists, that would waive regulations to help oil companies build new refineries. ... The oil lobbyists, like so many others, are using the storms as an excuse to win long-sought legislation, even when their plans relate only tangentially to the hurricanes. Earlier this week groups as diverse as the American Institute of Architects and the American Petroleum Institute were freshening their requests for tax breaks and other favors. ... The troubled airline industry has been particularly active on the hurricane front. ... Insurers have been using Katrina as an argument for ... an extension of the Terrorism Reinsurance Act (TRIA), which provides for the government to pay a portion of the damage caused by a foreign terrorist attack over certain thresholds. ... Farmers, even those outside the disaster zone, are begging for hurricane cash. "It is important to remember that the economic impact of Hurricane Katrina is harming much more of U.S. agriculture than producers in those three states," ... The nation's for-profit hospitals are trying to persuade Congress to carve an exception into a ... law specifying that only nonprofit institutions qualify for grants from the Federal Emergency Management Agency to rebuild critical facilities after a natural calamity. ...
Who will legislators rely on for industry knowledge with so many different types of expenditures to be made so quickly?
Wikipedia: ...Collusion between firms and the government agencies tasked to regulate them can be a haven for rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market...
I say it's rent-seeking. And it seems to pay pretty well.
Yellen: There is a Bubble But Don’t Pop It With Monetary Policy
Presentation to the members of Parliament at the Conference on US Monetary Policy, by Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, The U.S Economy and Monetary Policy: ... I want to focus my remarks today on another longer-term issue, namely, the housing market ... The question is: ...Is there a house-price "bubble" that might collapse, and if so, what would that mean for the U.S. economy? To answer this question, let me begin by clarifying what I mean by the term "bubble." A bubble does not just mean that prices are rising rapidly—it's more complicated than that. Instead, a bubble means that the price of an asset—in this case, housing—is significantly higher than its fundamental value.
One common way of thinking about housing's fundamental value is to consider the ratio of housing prices to rents. ... Currently, the ratio for the U.S. is higher than at any time since data became available in 1970 ... Higher than normal ratios do not necessarily prove that there's a house-price bubble. House prices could be high for some good, fundamental reasons. ... Probably the most obvious candidate for a fundamental factor ... is low mortgage interest rates. ... While the fundamentals I've mentioned do play a role, the consensus seems to be that much of the unusually high price-to-rent ratio for housing remains unexplained. Moreover, with controversy over exactly why long-term interest rates have remained so low, we can't rule out the possibility that they would rise to a more normal relationship with short-term rates, and this obviously might take some of the "oomph" out of the housing market. So, while I'm certainly not predicting anything about future house price movements, I think it's obvious that the housing sector represents a risk to the U.S. outlook.
This brings me to the debate about how monetary policy should react to unusually high prices of houses—or other assets, for that matter. ... As a starting point, the issue is not whether policy should react at all; I believe there is quite general agreement that policy should be calibrated to the wealth effects of house prices on output and inflation. The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself. In my view, the ... decision to deflate an asset price bubble rests on positive answers to three questions. First, if the bubble were to collapse on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?
My answers to these questions in the shortest possible form are, "no," "no," and "no." ... In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock... In answer to the second question on timing, the spending slowdown that would ensue is likely to kick in gradually... That would give the Fed time to cushion the impact with an easier policy. In answer to the third question on whether monetary policy is the best tool to deflate a house-price bubble, ... For one thing, no one can predict exactly how much tightening would be needed, or by exactly how much the bubble should be reduced. Beyond that, a tighter policy to deflate a housing bubble could impose substantial costs on other sectors of the economy that would lead to equally unwelcome imbalances. Finally, it's possible that other strategies, such as tighter supervision or changes in financial regulation, would not only be more tailored to the problem, but also less costly to the economy. Taking all of these points into consideration, it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. ... But let me stress that the debate surrounding these issues is still very much alive.
The New $10 Bill and Money Flops of the Past
Colorful $10 bill coming, CNN/Money: A new $10 bill featuring color, new art and enhanced security will be unveiled Wednesday, and the government hopes it will take hold quickly as other new designs. The Department of the Treasury, Federal Reserve and U.S. Secret Service will jointly announce the bill, which they expect will enter circulation in early 2006. The redesigned $10 note -- which will still feature a picture of the nation's first Treasury Secretary, Alexander Hamilton -- is the third denomination in a new currency series that incorporates background colors and improved security features. A new $20 note was issued in October 2003, followed by a new $50 note in September 2004.
CNN/Money ran this story about currency flops of the past before the release of the new $20 in 2003:
Currency flops through the ages, by Gordon T. Anderson, CNN/Money: Remember the Susan B. Anthony dollar? It was the first U.S. currency to feature an historical female figure since the 19th century, when Martha Washington adorned a silver-backed note. Citing the cost-saving and efficiency benefits of coins over bills, the Treasury Department promoted it as "the dollar of the future." Amid great fanfare, the U.S. Mint produced nearly one billion of them between 1979 and 1981 (as well as a smaller re-minting in 1999).
The piece itself was supposed to have looked and felt different from other change. Instead, it seemed like a quarter with that funny hendecagon (an 11-sided polygon) on its face. As for the great suffragist it honored, well, more than a few wags joked about her striking resemblance to George Washington. Vast national indifference soon rendered the Anthony dollar as another quaint relic of the Seventies, like the Ford administration's WIN ("Whip Inflation Now") buttons or the AMC Pacer.
Unlike the Anthony dollar, Americans will be forced to use the new bills. So public reaction, whether vibrant or muted, really won't matter. For example, many griped when the last rollout of new bills -- the fat-head series, you might call it -- came in the 1990s. "We all pooh-poohed it, but we use it," said Stephen L. Bobbitt, a spokesman for the American Numismatic Association in Colorado Springs. "What other choice do we have?"
Money woes: a history
Over the years, America's moneymakers have had their share of disappointments and failures. Here are just a few of them:
Sacagawea dollar: In 1999, Treasury announced it would take another stab at a dollar coin. This time, it honored the Shoshone woman with the difficult name, who helped guide Lewis and Clark across the West. To distinguish it from other coins, the piece has a brass-colored coating – which rubs off with even minimal handling. Three years after its introduction, a General Accounting Office poll found that 97 percent of the nation had not used the coin within the past month, and that 74 percent could not remember ever using one.
The 2-dollar bill: The note honors Thomas Jefferson on its front, and the signers of his Declaration of Independence on the back.
The bill is so obscure that the Treasury Department's Web site contains an explanation to remind us that it is official U.S. currency, which had another series printed during the Clinton administration. "It's very popular at dog tracks and horse races," says Bobbitt. "The only thing it's good for is making a two-dollar bet."
Bare-breasted woman (part 1): In the 1890s, an "education series" of notes sought to teach Americans about science and history. An imprint about electricity, however, reminded many about the birds and the bees: the exposed left breast of a stylized goddess appeared on the bill. Outcry forced the notes to be recalled and reprinted with a model wearing clothing.
Bare-breasted woman (part 2): Long before the dollar-coin fiasco, Treasury officials apparently believed that no mistake is ever so great that it can't be made twice. The Liberty quarter, issued during World War I, also proved too risque in its first edition. This time, however, it was the right breast that saw the light of day. Again, the national decency brigade forced an expensive recall.
Another technicolor production
Of course, many Treasury Department innovations have been successes. The use of green on the currency, for example, was a happy historical occurrence, born during the Civil War years. At the time, the new science of photography had some treacherous implications. Since color photographic inks had not been invented, green was added to notes to foil counterfeiters trying to use photography to reproduce notes.
The new twenty-dollar note is also not the first time Treasury has issued multi-colored bills. In the early part of the twentieth century, the twenty bore George Washington's picture. Today, it's known by collectors as the "technicolor note," for its striking assortment of hues. The front contains yellow, red, green and black inks, and the back features a bright gold design. The technicolor was always popular, and it still is. You can buy one on eBay -- for about thirty times the face value.
Posted by Mark Thoma on Wednesday, September 28, 2005 at 01:38 AM in Economics
Yellen, Bernanke, and Greenspan
Presentation to the members of Parliament at the Conference on US Monetary Policy, by Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, The U.S Economy and Monetary Policy: ...Obviously, at the forefront of everyone's mind are the two huge hurricanes that recently struck the U.S. Gulf Coast. The human tragedy following Katrina is enormous. ... The economic consequences for the region, of course, also are enormous. ... Staring into the face of such disasters, it is natural at first to want to use every tool at hand to try to help, including monetary policy. However, it seems clear that where monetary policy can make its greatest contribution is in keeping the national economy on an even keel. ... Instead, it's appropriate to use the tools of fiscal policy—especially government spending and transfers—to address the immediate crisis.
When Hurricane Katrina hit at the end of August, the economy was actually doing reasonably well. ... above-trend growth and diminishing slack [let] the FOMC ... lift its foot off the accelerator bit by bit, gradually removing the policy accommodation ... looking ahead ... Heading my list of risks to the economy in both the near and medium-term is energy prices. ... In addition to energy prices, the huge and unsustainable current account deficit and the budget deficit pose longer-term risks to the U.S. economic outlook. Indeed, the latter is even more of an issue now, with the massive rebuilding plans for the Gulf Coast. ... Higher energy prices put U.S. monetary policy on the horns of a dilemma. On one side, the negative impact of higher energy prices on spending tends to damp economic activity, which calls for a more accommodative policy, although in this case, the rebuilding effort will provide some offset. On the other side, it adds to inflationary pressures, which calls for a tighter policy. Although the effects of Katrina and Rita will remain uncertain for some time, it appears that the most likely outcome is a significant dip in growth in this quarter and the next, ... followed by a rebound in the first half of next year as the region rebuilds. ... Going forward, the Committee will certainly continue to monitor developments closely and weigh the options carefully. One option that is clearly not on the table is allowing an unacceptable rise in inflation. It has taken many years of consistent performance for the Federal Reserve to earn the public's confidence in its commitment to price stability. ... to maintain its credibility, the Federal Reserve must deliver—again and again–on its commitment to price stability.
Next, Alan Greenspan reissues his warning about not being fooled by recent financial market stability into underestimating risks, but he also makes an interesting statement about monetary policy. He believes that the economy is largely self-correcting, even more so in recent years, and that monetary and fiscal policy have often made things worse rather than better. This implies he believes that monetary policymakers should not try and anticipate and counteract short-run or medium-run movements in output through movements in the target federal funds rate, but should instead be focused on long-run output stability through price stabilization. He also believes that self-correction works best when the economy is competitive and free of government interference in domestic or foreign markets:
Exuberance always leads to asset drops-Greenspan, by Tim Ahmann , Reuters: Asset bubbles fueled by "market exuberance" invariably burst and policy-makers cannot safely pierce them, Federal Reserve Chairman Alan Greenspan said ... In a speech in which he once again defended the Fed's decision not to deflate the late-1990s stock market bubble, Greenspan said a successful monetary policy can be a victim of its own success -- by reducing economic volatility that in turn fosters greater risk-taking. He warned that protracted bouts of big risk-taking by investors are always followed by asset-price declines ...
"That greater tendency toward self-correction has made the cyclical stability of the economy less dependent on the actions of macroeconomic policymakers, whose responses often have come too late or have been misguided," he said." "It is important to remember that most adjustment of a market imbalance is well under way before the imbalance becomes widely identified as a problem," Greenspan added.
...[Greenspan] said "fostering an environment of maximum competition" was the best way to ensure economic flexibility. In that regard, he said it was important to ward off misguided efforts to try to protect jobs through trade protectionism and other competition-inhibiting policies. "Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers," Greenspan said. "At best, it is a short-term fix at a cost of lower standards of living for the nation as a whole."
Finally, for the second day in a row saying much the same thing, Ben Bernanke, a former Fed Governor and now Chief White House Economic Adviser says what you would expect, things will turn down a bit in the short-run, but be fine in the long-run:
Impact of oil price still small: Bernanke, Reuters: High energy prices are a burden on households and could ultimately restrain economic growth but so far the impact has been modest, a top White House economic adviser said on Tuesday. "The U.S. economy is in the midst of a strong and sustainable economic expansion," Ben Bernanke.. said ... "The resilience of the economy ... is helping it to absorb the shocks to energy and transportation from the hurricanes," ... The short-term economic outlook remains dominated by Hurricane Katrina ... Bernanke said, joining other forecasters in looking for a hit to national rates of job creation and growth in the current quarter. Beyond that "recovery and rebuilding should ultimately increase growth rates and rates of job creation, perhaps by the fourth quarter and certainly in the first half...
UPDATE: Make that the third day in a row, White House´s Bernanke: no big risk of recession.
September 27, 2005
Tiptoe Through the Rebalancing Mine Field
Rebalancing Act: How to tame the thrift shift, The Economist: If the first step towards finding a solution is to agree on the problem, the world's policymakers are still a long way from solving the global imbalances. European politicians blame American profligacy, urging Mr Bush's government to cut its budget deficit. Chinese politicians echo those sentiments. Yet for American lawmakers on Capitol Hill, there is only one villain: China and its undervalued currency. The analysis in the White House is more sophisticated, but still tends to Mr Bernanke's view that America's current-account deficit is not “made in the USA”. ... All of this misses the bigger picture. The current pattern of global imbalances is the result both of thrift shifts abroad and of American actions. ... America's current rate of borrowing is excessive. Despite the advantages of having the world's reserve currency, an enviable rate of productivity growth and the world's most liquid capital markets, America cannot continue to borrow at an accelerating pace forever. More important, ... Most of that foreign money is going into consumption and housing rather than boosting investment in productive American assets. Building houses does not raise long-term economic growth in the way that equipping a factory does. And the current rate of consumption, fuelled by housing wealth, leaves many indebted consumers at risk... Unfortunately, there is little sign that anything will change very quickly...
What, then, needs to be done? For a start, recognise who has to be involved. Given the size of their saving surpluses, oil-exporting countries should be at the centre of the discussion. Yet they are rarely even invited to G8 summits and other global policy pow-wows. The rich countries have understood the importance of including China in their gatherings. ... But when politicians are discussing global imbalances, they will have to broaden the guest list further. More important, their “to do” list needs to be revised. Reducing China's saving surplus is about more than simply calling for a stronger yuan. It means creating the conditions that encourage more efficient investment and reduce the need to save quite so much. That requires more emphasis on corporate and financial reform ... It also means persuading China's government to spend more on social safety nets. ... Higher public spending—on hospitals, schools and helping the poor—will itself reduce China's national saving rate, and creating better health, education and pension systems will reduce the incentive to save so much. Japan's example suggests that there is no particular Asian propensity for thrift... Europe, too, would do well to adopt ... policy stimulus. The European Central Bank remains too reluctant to cut interest rates. Europe does not need, and cannot afford, a fiscal binge of American proportions, but the recent lesson from Japan is that if economies stagnate, government debts spiral.
If the rest of the world could do with a less puritan take on thrift, America needs to be reminded of its virtues. ... less government borrowing is still the most certain route to higher national saving. ... Convincing the American people to save more is trickier. ... There are plenty of reasons for America to carry on borrowing from abroad. It has better demographic prospects than the rest of the rich world, and indeed than many Asian emerging markets. It has nimble and productive firms. ... But the present deficit is excessive and dangerous. Left alone, it could end in a global recession, rampant protectionism, and even a disastrous financial crash. That is why policymakers need to act soon. With his “saving glut” speech, Mr Bernanke focused attention on the scale of the global thrift shift. Now, as one of Mr Bush's top economic advisers, he should persuade his boss of the importance of making the thrift shift safe.
[Note: The original article has a different picture.]
UPDATE: Guest blogger Menzie Chinn discusses current account deficits at Econbrowser.
Greenspan, Bernanke, Bies, and Moskow
Greenspan Say Speculation Adds to Home-Price Surge, Bloomberg: Federal Reserve Chairman Alan Greenspan said speculative buying may be driving housing prices and creating a risk for the U.S. economy because so many Americans rely on home appreciation to support their spending... The abundance of interest-only loans and ''exotic'' variable-rate mortgages ''are developments that bear close scrutiny,'' he said. The unconventional mortgages are letting buyers who barely qualify purchase homes at inflated prices, ... ''In the event of a widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses,'' Greenspan said. Any retraction in sales or refinancing raises the risk of an ''adjustment'' in overall spending. How much is an ''open question,'' he said… Sales of vacation houses, or homes that aren't always occupied by owners, are ''arguably at historically unprecedented levels,'' ... ''This suggests that speculative activity may have had a greater role in generating the recent price increases than ... in the past.''… Greenspan said if home purchases or refinancing declined, consumption would probably retrench and the saving rate would rise. This would also point to larger adjustments in the U.S. economy, he noted. ''Imports of consumer goods would surely decline as would those imported intermediate products that support them,'' he said. ''And one would assume that the U.S. trade and current- account deficits would shrink as well, all else being equal.''...
The Bloomberg story, however, omits this important qualifier:
Greenspan says gains offer a cushion, Reuters: …Though mortgage debt is rising, most Americans have built up so much equity in their homes that they could weather a price drop without serious harm, ... "The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices," Greenspan told the American Bankers Association. … he said some regions may be seeing unsustainable price gains. But he said that, at mid-2005, fewer than 5 percent of homeowners were highly leveraged -- which would make them vulnerable if prices fell -- on their loans.
See also Calculated Risk here on Greg Ip’s WSJ article on Greenspan's remarks and here for more on the Reuters and Bloomberg reports. Greenspan’s research paper supporting his remarks is here.
Next, Ben Bernanke, a former Fed Governor and now Chief White House Economic Adviser, on the economy after the hurricanes. Note that he says the Fed does not have to raise rates “violently,” not that rates shouldn’t go up:
Energy prices risk to US economy-Bernanke, Washington Post: High energy prices in the wake of Hurricanes Rita and Katrina pose a risk to U.S. economic growth, but inflation expectations remain well-contained, a top White House economic adviser said on Sunday. "The high energy prices are certainly burdening consumer budgets, … and certainly continued increases in energy prices are a risk for economic growth going forward," … But Bernanke … said low inflation expectations gave the Fed more flexibility than in past energy crises. "A very important factor is the fact that inflation expectations are well-controlled and well-contained, which means that the Federal Reserve, unlike the 70s, doesn't have to react violently in terms of raising interest rates to contain the second- and third-round inflationary impacts. So I remain pretty optimistic about the economy," …Bernanke said the energy markets had been in the process of recovering from Hurricane Katrina when Rita hit… "I remain optimistic that the impact on energy from these two events will be limited." ... but warned that job losses in September would be heavy and that the unemployment rate would climb a couple of tenths of a percentage point. … "(But) as the economy begins to recover, as jobs are returned and as the rebuilding process continues and strengthens over next two years or so, the effects on national GDP growth and job creation will actually be positive," he said. "Basically, I'm going to be very optimistic today about the ability of the U.S. economy to absorb these body blows, and my reason for that is that I think this is an extraordinary resilient and flexible economy."
Last, but lately by no means least, here’s Chicago Fed president Moskow and Fed Governor Bies who spoke at separate events. Both see a strong economy:
U.S. Treasuries Decline; Fed's Bies, Moskow Say Economy Strong, Bloomberg: U.S. Treasuries fell as two Federal Reserve officials said the economy remains strong after two hurricanes struck the Gulf Coast, bolstering views the central bank will keep raising interest rates. … Chicago Fed President Michael Moskow said ''the fundamentals of the economy are strong,'' and Fed Governor Susan Bies said there is ''underlying core resilience.'' A drop in crude oil to a two-week low after Hurricane Rita caused only minor disruptions at Houston-area refineries kicked off the declines in Treasuries in overnight trading. … ''It's early to see the results of Rita, but I think the fundamentals of the economy are strong,'' Moskow said … ''All of the rebuilding that's going to be required is also going to show up in the economic numbers once we get through the initial impact,'' Bies said to reporters...
UPDATE: Federal Reserve Bank of Kansas City President Thomas Hoenig signals concern over inflation:
Fed's Hoenig says must be wary of inflation, Reuters: Federal Reserve Bank of Kansas City President Thomas Hoenig said on Monday that the U.S. economy can shake off the damage of hurricanes Katrina and Rita and the Fed must focus on its primary mission of keeping inflation at bay to ensure sustainable growth. "I believe it is also important for the Federal Reserve to stay focused on its primary mission for maintaining a neutral monetary policy that is both able to contain inflationary pressures and still-balanced growth," he told a Kansas City Fed economic forum here. Hoenig noted that the consumer price index has already pushed up significantly from a year ago, thanks to high energy prices, while unit labor costs were rising and economic capacity was being absorbed by the strong U.S. economy. "When you see all three coming together you must be alert," he said. "The mission of the Fed is to be sensitive to these pressures. … Hoenig said the U.S. central bank was not ignoring the human and economic tragedy along the Gulf Coast. But monetary policy acts on the national, not regional level, and no one would thank the Fed for taking its eye off the ball and allowing inflation to get out of control. "You can end up increasing inflationary pressures that could undermine the recovery if you are not careful," he said.
There isn't much ambiguity in that statement.
Time Varying Structural Vector Autoregressions and Monetary Policy
Primiceri, Giorgio E., "Time Varying Structural Vector Autoregressions and Monetary Policy". Review of Economic Studies, Vol. 72, No. 3, pp. 821-852, July 2005 (SSRN link, July 2004 version on author website) Abstract: Monetary policy and the private sector behaviour of the U.S. economy are modelled as a time varying structural vector autoregression, where the sources of time variation are both the coefficients and the variance covariance matrix of the innovations. The paper develops a new, simple modelling strategy for the law of motion of the variance covariance matrix and proposes an efficient Markov chain Monte Carlo algorithm for the model likelihood/posterior numerical evaluation. The main empirical conclusions are: (1) both systematic and non-systematic monetary policy have changed during the last 40 years - in particular, systematic responses of the interest rate to inflation and unemployment exhibit a trend toward a more aggressive behaviour, despite remarkable oscillations; (2) this has had a negligible effect on the rest of the economy. The role played by exogenous non-policy shocks seems more important than interest rate policy in explaining the high inflation and unemployment episodes in recent U.S. economic history.
1 Introduction (This is from the July 2004 version)
There is strong evidence that US unemployment and inflation were higher and more volatile in the period between 1965 and 1980 than in the last twenty years. The literature has considered two main classes of explanations for this difference in performance. The first class of explanations (see, for instance, Blanchard and Simon, 2001, Stock and Watson, 2002, Sims and Zha, 2004) focuses on the heteroskedasticity of the exogenous shocks, which have been much more volatile in the 70s and early 80s than in the rest of the sample. The second class of explanations emphasizes the changes in the transmission mechanism, i.e. the way macroeconomic variables respond to shocks. Particular attention has been given to monetary policy. If monetary policy varies over time, this has a potential direct effect on the propagation mechanism of the innovations. Furthermore, if agents are rational and forward-looking, policy changes will be incorporated in the private sector’s forecasts, inducing additional modifications in the transmission mechanism.
Many authors (among others Boivin and Giannoni, 2003, Clarida, Galí and Gertler, 2000, Cogley and Sargent, 2001 and 2003, Judd and Rudebusch, 1998, Lubik and Schorfheide, 2004) have argued that US monetary policy was less active against inflationary pressures under the Fed chairmanship of Arthur Burns than under Paul Volcker and Alan Greenspan. However, this view is controversial. Other studies have in fact found either little evidence of changes in the systematic part of monetary policy (Bernanke and Mihov, 1998, Hanson, 2003, Leeper and Zha, 2002) or no evidence of unidirectional drifts in policy toward a more active behavior (Sims, 1999 and 2001a).
This paper investigates the potential causes of the poor economic performance of the 70s and early 80s and to what extent monetary policy played an important role in these high unemployment and inflation episodes. The objective here is to provide a flexible framework for the estimation and interpretation of time variation in the systematic and non-systematic part of monetary policy and their effect on the rest of the economy. Two are the main characteristics required for an econometric framework able to address the issue: 1) time varying parameters in order to measure policy changes and implied shifts in the private sector behavior; 2) a multiple equation model of the economy in order to understand how changes in policy have affected the rest of the economy. For this purpose, this paper estimates a time varying structural vector autoregression (VAR), where the time variation derives both from the coefficients and the variance covariance matrix of the model’s innovations. Notice that any reasonable attempt to model changes in policy, structure and their interaction must include time variation of the variance covariance matrix of the innovations. This reflects both time variation of the simultaneous relations among the variables of the model and heteroskedasticity of the innovations. This is done by developing a simple multivariate stochastic volatility modeling strategy for the law of motion of the variance covariance matrix. The estimation of this model with drifting coefficients and multivariate stochastic volatility requires numerical methods. An efficient Markov chain Monte Carlo algorithm is proposed for the numerical evaluation of the posterior of the parameters of interest.
The methodology developed in the paper is used to estimate a small model of the US economy, delivering many empirical conclusions. First of all, there is evidence of changes both in nonsystematic and systematic monetary policy during the last forty years. The relative importance of non-systematic policy was significantly higher in the first part of the sample, suggesting that a Taylor-type rule is much less representative of the US monetary policy in the 60s and 70s than in the last fifteen years. Furthermore, private sector responses to non-systematic policy (monetary policy shocks) appear linear in the amplitude of non-systematic policy actions. Turning to the systematic part of policy, there is some evidence of higher interest rate responses to inflation and unemployment in the Greenspan period. However, a counterfactual simulation exercise suggests these changes did not play an important role in the high inflation and unemployment episodes in recent US economic history. In fact, the high volatility of the exogenous non-policy shocks seems to explain a larger fraction of the outbursts of inflation and unemployment of the 70s and early 80s.
From the methodological perspective, this paper is related to the fairly well developed literature on modeling and estimating time variation in multivariate linear structures. Canova (1993), Sims (1993), Stock and Watson (1996) and Cogley and Sargent (2001) model and estimate VARs with drifting coefficients. On the other hand, multivariate stochastic volatility models are discussed by Harvey, Ruiz and Shephard (1994), Jacquier, Polson and Rossi (1995), Kim, Shephard and Chib (1998), Chib, Nardari and Shephard (2002). However, these studies impose some restrictions on the evolution over time of the elements of the variance covariance matrix. Typical restrictions are either the assumption that the covariances do not evolve independently of the variances or a factor structure for the covariance matrix. Following this line of research, Cogley (2003) and Cogley and Sargent (2003) use time varying variances in the context of VARs with drifting coefficients. However, in their model the simultaneous relations among variables are time invariant. As it will be made clear in the next section, their analysis is limited to reduced form models, usable almost only for data description and forecasting. Boivin (2001) considers the opposite case of time varying simultaneous relations, but neglects the potential heteroskedasticity of the innovations. Ciccarelli and Rebucci (2003) extend the framework of Boivin (2001) allowing for t-distributed errors, which account for non-persistent changes in the scale of the variances over time. Uhlig (1997) introduces unrestricted multivariate stochastic volatility in the context of VARs, but his model assumes that the VAR coefficients are constant. Here instead, both the coefficients and the entire variance covariance matrix of the shocks are allowed to vary over time. This is crucial if the objective is distinguishing between changes in the typical size of the exogenous innovations and changes in the transmission mechanism.
There is also a more recent literature that models time variation in linear structures with discrete breaks, meant to capture a finite number of switching regimes (see, for instance, Hamilton, 1989, Kim and Nelson, 1999, Sims, 1999 and 2001a and Sims and Zha, 2004). Discrete breaks models may well describe some of the rapid shifts in policy. However they seem less suitable to capture changes in private sector behavior, where aggregation among agents usually plays the role of smoothing most of the changes. Furthermore, even in a structural VAR, the private sector equations can be considered as reduced form relations with respect to a possible underlying behavioral model, where policy and private sector behavior are not easily distinguishable. If policy responds also to expectational future variables (instead of only to current and past ones), then also the policy equation in the VAR will be a mixture of policy and private sector behavior, determining smoother changes of the coefficients. Finally, the existence of any type of learning dynamics by private agents or the monetary authorities definitely favors a model with smooth and continuous drifting coefficients over a model with discrete breaks.
From the perspective of the empirical application, this paper is related to a large literature that analyzes changes in the conduct of monetary policy and their effect on the rest of the economy. Most of the existing academic work has emphasized the role of monetary policy in the poor economic performance of the 70s (among others, see Judd and Rudebusch, 1998, Clarida, Galí and Gertler, 2000, Boivin, 2001, Cogley and Sargent, 2001 and 2003, Lubik and Schorfheide, 2004, Boivin and Giannoni, 2003, Favero and Rovelli, 2003). This paper contrasts the most popular view and stresses the role of heteroskedastic non-policy innovations. In this respect, the conclusions are more similar to Bernanke and Mihov (1998) and Sims and Zha (2004)...
September 26, 2005
Paul Krugman: Find the Brownie
Find the Brownie, by Paul Krugman, Commentary, NY Times: For the politically curious seeking entertainment, I'd like to propose two new trivia games: "Find the Brownie" and "Two Degrees of Jack Abramoff."
The objective in Find the Brownie is to find an obscure but important government job held by someone whose only apparent qualifications for that job are political loyalty and personal connections. It's inspired by President Bush's praise, four days after Katrina hit, for the hapless Michael Brown, the director of the Federal Emergency Management Agency: "Brownie, you're doing a heck of a job." I guess it depends on the meaning of the word heck.
There are a lot of Brownies. As Time magazine puts it in its latest issue, "Bush has gone further than most presidents to put political stalwarts in some of the most important government jobs you've never heard of." Time offers a couple of fresh examples, such as the former editor of a Wall Street medical-industry newsletter who now holds a crucial position at the Food and Drug Administration.
A tipster urged me to look for Brownies among regional administrators for the General Services Administration, which oversees federal property and leases. There are several potential ways a position at G.S.A. could be abused. For example, an official might give a particular businessman an inside track in the purchase of government property - the charge against David Safavian, who was recently arrested - or give a particular landlord an inside track in renting space to federal agencies.
Some of the regional administrators at G.S.A. are longtime professionals. But the regional administrator for the Northeast and Caribbean region, which includes New York, has no obvious qualifications other than being the daughter of the chairman of the Conservative Party of New York State. The regional administrator for the Southwest, appointed in 2002 after a failed bid for his father's Congressional seat, is Scott Armey, the son of Dick Armey, the former House majority leader.
You get the idea. Go ahead, see what - or rather who - you can come up with.
Jack Abramoff is a lobbyist who was paid huge sums by clients such as casino-owning Indian tribes and sweatshop operators on Saipan. Two Degrees of Jack Abramoff is inspired by the remarkable centrality of Mr. Abramoff, who was indicted last month on charges of fraud, in Washington's power structure.
The goal isn't to find important political players who were chummy with Mr. Abramoff - that's too easy. Instead, you have to find people linked by employment. One degree of Jack Abramoff is someone who actually worked for the lobbyist. Two degrees is a powerful Washington figure who hired someone who formerly worked for Mr. Abramoff, or who had one of his own former employees go to work for Mr. Abramoff.
Grover Norquist, the powerful antitax lobbyist, is a one-degree man. Mr. Norquist was Mr. Abramoff's campaign manager when he ran for chairman of the College Republican National Committee, then became his executive director. And don't dismiss this as kid stuff: as Franklin Foer explains in The New Republic, the college Republican organization pays serious salaries and has been a steppingstone for the likes of Lee Atwater and Karl Rove.
Mr. Rove, by the way, is a two-degree man. He hired Susan Ralston, Mr. Abramoff's personal assistant, as his own personal assistant. For those unfamiliar with what that means, Ms. Ralston became Mr. Rove's gatekeeper - the person who determined who got to see the great man.
Tom DeLay, the House majority leader, is also a two-degree man. Tony Rudy, who worked for Mr. DeLay in several capacities, left to work for Mr. Abramoff.
Finally, somebody should be considered a two-degree man on account of the recently arrested Mr. Safavian, who worked for both Mr. Abramoff and Mr. Norquist, then went first to the G.S.A. and on to the White House Office of Management and Budget, where he oversaw procurement policy. But I'm not sure who gets credit for hiring Mr. Safavian.
O.K., enough joking. The point of my games - which are actually research programs for enterprising journalists - is that all the scandals now surfacing are linked. Something is rotten in the state of the U.S. government. And the lesson of Hurricane Katrina is that a culture of cronyism and corruption can have lethal consequences.
Fed Watch: Dejá Not
Thankfully, Hurricane Rita proved not to be as destructive as feared and largely spared critical refinery capacity. We can be sure the Fed breathed a sigh of relief as well – one supply shock to the nation’s infrastructure is enough for the year.
The Fed’s last statement was widely parsed, with the general feeling that Katrina left the Fed feeling more hawkish than widely expected (see Mark Thoma’s roundup of commentators). Many noted that the Fed still believes monetary policy to be accommodative, that, in addition to energy, “other costs” are now fueling inflationary pressures, and inflation expectations are now just “contained,” not “well” contained. And, of course, that the Fed expects Katrina to have minimal lasting impacts on demand.
Many, I believe, expected the Fed to be more concerned about growth prospects, especially in light of a rather sharp drop in consumer confidence. With this in mind, reread this paragraph from the FOMC statement:
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.”
Note the subtle but important shift from the beginning to the end of this paragraph. The FOMC believes that with measured removal of monetary accommodation will help meet the twin goals of sustainable growth and price stability. As always, of course, they remain data dependent. If economic prospects change, they will act to ensure price stability, not sustainable growth.
Of course, the two goals are the same if the economy is subjected to demand shocks. Supply shocks, however, are a different matter entirely. This is where I believe many have missed a key element of Fed thinking. They do not view the Katrina induced energy disruptions as a demand disturbance. They view Katrina more as a 70’s-style supply shock, with the possibility of triggering both inflation and weak – or even recessionary – growth. And I believe the Fed is explicitly saying that in such a stagflationary situation, they will choose price stability. The short run blow to growth is less important than keeping long run inflation expectations in check. Or, in other words, they believe additional tightening now will extend the length of the recovery by keeping inflation in check and avoiding more painful hikes in the future. Of course, not everyone agrees with the Fed’s position – be sure to read James Hamilton’s critique of recent policy.
Regarding data dependence, the FOMC clearly believes that Katrina will have little demand impact in the long run. That implies they will discount any negative numbers that appear to have been distorted by Katrina, with the exception of inflation numbers, a statistic the Fed is clearly nervous about. I suspect this will frustrate many analysts to no end.
More evidence of the Fed’s increasingly hawkish stance can be found in this curious report from Reuters. I wonder how much play it will get; in my mind it is important. Repeating part of what Mark Thoma posted earlier:
U.S. Federal Reserve Chairman Alan Greenspan told France's Finance Minister Thierry Breton the United States has "lost control" of its budget deficit... "'We have lost control,' that was his expression," Breton told reporters after a bilateral meeting with Greenspan. "The United States has lost control of their budget at a time when racking up deficits has been authorized without any control (from Congress)," Breton said. "… Breton said: "The situation that is creating tension today on the currency market ... is clearly the American deficit." ... Breton added that after hearing Greenspan talk about inflation: "One has the feeling -- though he didn't say so -- that interest rates will probably continue to rise slightly until his departure."...
On the surface, this is a stunning breach of etiquette. These are private conversations for internal use, not for public dissemination. In fact, it is such a breach that one wonders if Greenspan asked that his thoughts be leaked to the press in effort to make a signal he doesn’t feel he can make directly. In any event, we should likely take Breton at face value and assume he is accurately reporting his conversation with Greenspan. And the message is the clear intention to keep tightening in the face of inflationary pressures. I interpret “continue to rise slightly” as additional 25bp pops.
One of those pressures is fiscal deficit spending, with Katrina driving the latest round of profligacy (I suspect that those impacted by Rita will want their share too). It is not out of the question that Greenspan is sending a warning to Congress that he will not let the Fed be pulled into monetizing the deficit. Recall that we saw similar comments by Dallas Fed President Richard Fisher. There is a real possibility that the Fed is gearing up to lean against the wind of fiscal spending.
I continue to think that Greenspan & Co. are sending increasingly not-so-subtle messages that the days of low interest rates and easy policy are at their end. This is a message for Congress and the Administration, not just the financial markets. Indeed, something unexpected may be happening – a concerted effort to end any sense of a Greenspan-put in the markets or the economy as a whole. It will undoubtedly be interesting to watch this chapter in Fed history play out.
UPDATE (by Mark Thoma): With Greenspan's comments on the deficit over the weekend, the recent concern expressed by Dallas Fed President Richard Fisher, and this today from Chicago Fed president Michael Moskow, it is clear that the Fed is becoming increasingly concerned about the fiscal deficit. I hope to post more about this later, but here's a quick update for now:
Moskow: Fed still has room to tighten, MarketWatch: The Federal Reserve has more room to raise interest rates, the president of the bank's Chicago branch said Monday. Michael Moskow said excess capacity in the nation's economy makes removing borrowing accomodation necessary. ... Moskow said the impact from the storms in holding down output and pushing up prices probably was temporary. He will continue to monitor, in particular, government spending that came in response to Katrina. A pledge for increased outlays from President Bush and Congress led many private-sector economists to stick with or increase their 2006 economic-growth projections, despite the many uncertainties still posed by Katrina and, to a lesser degree, Hurricane Rita…
And there was also this from Fed Governor Susan Bies:
Fed's Bies warns about energy prices, MarketWatch: Higher energy prices are threatening to have a ripple effect on the prices of other goods, Federal Reserve Governor Susan Bies said Monday. "The longer the prices stay higher, the more likely there will be an impact on prices in general," Bies told reporters following an international bankers conference. Bies also said she was relieved that Hurricane Rita didn't wreak as much havoc as feared. … The Fed policymaker said she was particularly heartened that the storm didn't take a major toll on Gulf Coast energy infrastructure. … Although the impact of both hurricanes Rita and Katrina will wallop local economies for weeks or perhaps months to come, the effect on the U.S. economy should be minor, Bies said. "At this point, we're still seeing an underlying resilience in the economy," she said…
Will Changes in Consumption, Investment, the Social Safety Net, or the Exchange Rate Reduce Saving in China Anytime Soon?
The frugal giant, by Minton Beddoes, The Economist: ...[T]he world ... is still waiting for a big Chinese consumption boom. ... the Chinese are spending a lot more than they used to. ... But Chinese saving is growing even more rapidly. Since 2000, the country's overall saving rate-already the world's highest by far-has risen sharply, to nearly 50% of GDP (see chart). Even though China is investing at the staggering rate of 46% of GDP, it is still running a net saving surplus, and that surplus is still growing... and shows no signs of stopping.
...China's capacity for thrift has long perplexed economists... What is going on? Household saving is the easiest to make sense of. First, Chinese households have not changed their consumption patterns fast enough to keep up with the huge rise in their incomes. ... a large part of China's growing income has been going to the relatively small share of the population living in coastal areas. Richer people save more than poorer ones. ... Moreover, the one-child policy has made it harder for people to rely on their children as a source of support in old age, further encouraging thrift. ... A further incentive to saving is the weakness of social safety nets. Under the old economic regime many Chinese workers could count on health and pension benefits from state enterprises (the "iron rice bowl"). No longer. ... Pension coverage is low ... Health care is also getting more expensive. ... Education, too, requires deep pockets ... The relative lack of credit is another factor... consumer credit is still in its infancy. ... Like the Japanese in the 1960s, the Chinese need to save a lot because they find it hard to borrow.
And save a lot they do. Chinese household saving, at around 25% of disposable income, is astonishingly high ... But ... they were not responsible for the sharp rise in national thrift since 2000. ...China's household saving rate has been more or less steady since 2000 (see chart). The recent rise in national saving was led by ... the corporate sector. ... China's firms are now bigger savers than its households. But unlike their peers in the rest of the world, they are investing their surpluses... That splurge may well prove unsustainable. Profit growth has slowed sharply over the past year ... Slower profit growth means less corporate saving, but investment seems to be slowing even faster ... the pace of China's investment is likely to fall over the medium term...
What happens to China's national saving surplus will depend on whether China's households will save less and spend more, thus becoming the engine of the domestic economy. The example of Japan is sobering. Although Japanese households now save much less than they used to, their country never really made the shift from export-led to consumer-led growth. ... China, however, is different in important ways. Its economy is already much more open than Japan's ever was. ... And ... China seems to be shifting away from an undervalued currency far more quickly than Japan did. ... but this is likely to take several years. Although American policymakers may be clamouring for a rapid rise in the yuan, there is no sign in Beijing that the government plans anything of the sort. ... A government that depends on rapid economic growth to legitimise itself will not want to risk instability with a sudden rise in the currency, so a much stronger yuan seems an unlikely route to a quick reduction in China's saving surpluses. ... Redirecting an economy as big as China's towards domestic consumption takes time. China's saving surpluses will not last forever, but nor will they disappear overnight. And trying to move too fast can be disastrous, as the mess in Asia's other emerging markets shows.
Larry Summers or Robert Rubin for Fed Chair?
Those Clinton Years Are Looking Better Every Day, Caroline Baum, Bloomberg: While the Bush administration has been … mum on the subject of a successor to … Alan Greenspan, investors are already voicing their picks. A survey of 104 market professionals … put Ben Bernanke … in first place with 38 percent. … Martin Feldstein came in second, with 31 percent of the vote. In third place, with 11 percent, was (gulp) Robert Rubin, Clinton administration Treasury secretary par excellence… What are we supposed to make of investors' more-than-zero odds of an iconic, across-the-aisle choice? … The survey specifically asked who would be President George W. Bush's choice to succeed Alan Greenspan... It would be out of character for Republican tax-cutter Bush to appoint Democratic deficit hawk Rubin to a key economic post. For starters, Rubin stands for something. … [and his] image may be just what the Bush administration needs… Are investors onto something in imagining Bush could tap Rubin for Fed chairman? ... ''Someone who thought he could appoint … Wolfowitz to the World Bank is not going to cross the aisle to go to a Democrat.'' … My guess is that Bush will reject an academic like Bernanke for … someone with more real-world, market experience. Someone who isn't on anybody's short (and stale) list. Someone who isn't on the radar of the investors ... Someone, in short, like Bob Rubin. Calling Larry Summers? The Harvard University president and former Treasury secretary has an added appeal, having already alienated the politically correct Left.
September 25, 2005
Reducing Government Spending to Pay for Hurricane Relief Also Reduces GDP
Lawmakers differ on how to pay for relief efforts, by Aimee Tabor, The Hawk Eye: ...Grassley said he doesn't feel a tax increase is the solution for the Katrina relief. "If you raise taxes enough to pay for Katrina you'd probably add to the negative ripple effect that Katrina is having on the economy," Grassley said. "We don't want to compound that by an irresponsible increase in taxes." Congress then has two choices — it can either continue to borrow or cut spending, Grassley said...
First, during the recovery period itself, there is no need to do either, something Grassley seems to implicitly acknowledge elsewhere in his remarks. If the goal is to stimulate the economy during this period, then deficit spending (borrowing) is needed. Offsetting spending on hurricane relief with reduced spending elsewhere or increasing taxes does not provide any short-run stimulus. Arguments about long-run economic growth and tax rates are being mixed up with arguments about the level of GDP in the short-run. Once the economy has recovered, then it’s time to pay the bills. At that point either an increase in taxes or decrease in spending can be used in theory since both reduce the deficit, though in reality tax increases will be needed since spending cuts alone cannot solve our deficit problem. This is where growth considerations come into play and, though there are certainly pockets of fat in government, cuts in spending large enough to dent the deficit will reduce essential spending on infrastructure and social insurance programs and harm rather than enhance our long-run growth prospects and economic security.
The Growing Education Gap
The Education Gap, By David Brooks, NY Times: Especially in these days after Katrina, everybody laments poverty and inequality. But what are you doing about it? For example, let's say you work at a university or a college. You are a cog in the one of the great inequality producing machines this country has known. What are you doing to change that?
Let me defend universities against the implied notion that colleges aren't doing anything to address these problems. I apologize that this post is a bit "me" oriented, but Brooks struck a nerve. First, there are whole offices devoted to this problem, e.g. see here, but that by no means exhausts the available resources. On another front, I am currently Chair of the University's Scholastic Review Committee and an elected member of The Undergraduate Council. Both committees are concerned with these issues, but let me back up to the many years I chaired the University's Scholarship Committee, the committee responsible for allocating the entire pool of University scholarship money. As Chair, I had the committee reexamine each step in our process to try and identify hidden bias in the award of scholarship money. As an example, one part of our evaluation process used the number of AP courses a student completed as a measure of academic quality. However, there is a wide disparity in the number of AP courses across high schools and it varies with both the size of the high school and its demographic characteristics. To overcome this, we changed the standard to something along the lines of "The student takes full advantage of available educational opportunities" and distributed a list identifying the number of AP courses available at each high school. Some schools offered no AP courses at all and those students were no longer penalized for not having AP courses on their transcripts. In Oregon, there are a few large cities with large, high average income high schools and lot of smaller and less affluent schools spread out across the state. Subsequent data indicated that this change was successful in, as we saw it, more fairly distributing scholarship money according to merit across high schools with such varied demographics. This is not all we did, at the evaluation orientation each year we discussed these issues with regard to the evaluation process, e.g. when looking at a student's extra-curricular activities to be sure and account for circumstance and we would cite examples of how that might work, and the committee has members to specifically represent the interests of the students Brooks is writing about. The extra-curricular expectations for a single mom or an older sibling with imposed child care responsibilities are different from those of a student without such time or resource constraints. In any case, from my experience on this and other committees, I resent the implication that we do not care, are not sensitive to, or are not taking action to address these problems. We are.
Brooks goes on:
As you doubtless know, as the information age matures, a new sort of stratification is setting in, between those with higher education and those without. College graduates earn nearly twice as much as high school graduates, and people with professional degrees earn nearly twice as much as those with college degrees. But worse, this economic stratification is translating into social stratification. ... The most damning indictment of our university system is that these poorer kids are graduating from high school in greater numbers. It's when they get to college that they begin failing and dropping out...
Why is this an indictment of the university system and not our under funded primary and secondary education systems? I have no idea when assigning grades to the 50-300 people in a course what a student's economic circumstances are. I can only assign the grade the multiple choice or essay test supports and if a student fails, I can't pass them on some other basis. They need to come to college prepared and that starts long before they get to universities. Having done the University's grade inflation study and having examined high school grades as part of that process, I have my own ideas about why high school graduation rates might be rising. Take a look at the pressures and incentives current education policy gives primary and secondary schools for a start, and I've already mentioned funding issues. In any case, that we get more under privileged students coming through our doors but many fail along the way is something we do our best to address, but students need to arrive prepared and that is a social problem that extends far beyond the reach of our universities. Finally,
...I'm going to come back to this subject and write about what some colleges are doing to help these students and how most colleges are neglecting them. But let me conclude with the thought that while we have big political debates in this country about equality of results, all those on the left and right say they believe in equality of opportunity. This is where America is failing most.
I'll agree with that, equality of opportunity is essential, but I'm guessing we will disagree about the source of and solution to this problem.
UPDATE: Arnold Kling comments on this post and writes:
In my view, the issue is larger than universities' policies concerning admissions and financial aid. It concerns how universities are financed, and how this affects the distribution of income. First, consider state subsidies for universities. These are almost certainly regressive. Much of the subsidy goes to raise the rents earned by administrators and professors. Much of the rest goes to affluent students. The taxes that pay for the subsidies come from all economic classes. Second, consider university endowments. Again, they serve to increase rents of employees and to subsidize those students who attend the most elite institutions--a student population that is disproportionately affluent. Imagine instead what might happen if state funds and alumni donations funded vouchers for student tuition. Compared with reforming university finances, tinkering with admissions and scholarship policies is beside the point. It may "show that you care," but has little practical significance.
A couple of quick notes. First, I was answering the question Brooks posed, what have I done personally. If I controlled state taxes and expenditures, my approach would be different! Second, I disagree it is of little practical significance. That's not what our numbers told us, that's not what the people on the committee that work with students tell us, and if you are one of the students who gets a scholarship, it is of huge significance. Sure, we need to work on the issues Arnold identifies, but is he implying we shouldn't do this too?
One final note, we are a state institution, but our "subsidy" is 13 cents per dollar, down from around 30 cents fifteen years ago. The impact of this is that we have increased tuition to make up the difference at a rate far greater than the rate of inflation and this has reduced access. A lot of our work internally has been to counter the trends in enrollment the changes in state funding have caused and scholarships are one part of that strategy. The changes have not been insignificant. Some figures:
1990: Tuition was 23% of budget, state funded 32% of budget 2004: Tuition was 33% of budget, state funded 13% of budget
That's a big change in funding over the last 15 years and this is common across universities. The disinvestment you hear about is real and it has harmed educational access.
Greenspan Says US Budget Deficit is Out of Control
Greenspan to French Financial Minister:US lost deficit control, Reuters: U.S. Federal Reserve Chairman Alan Greenspan told France's Finance Minister Thierry Breton the United States has "lost control" of its budget deficit... "'We have lost control,' that was his expression," Breton told reporters after a bilateral meeting with Greenspan. "The United States has lost control of their budget at a time when racking up deficits has been authorized without any control (from Congress)," Breton said. "We were both disappointed that the management of debt is not a political priority today," he added. Ministers from the Group of Seven rich nations on Friday called for vigorous action around the world to curb rising imbalances in international trade and investment accounts. A decrease in the U.S. budget deficit were cited by the G7 as one way to ease those imbalances. ... Breton spoke as International Monetary Fund Managing Director Rodrigo Rato said U.S. plans to cut its government expenditures now looked ambitious in the light of huge reconstruction costs to be borne in the wake of Hurricane Katrina. Breton said: "The situation that is creating tension today on the currency market ... is clearly the American deficit." ... Breton added that after hearing Greenspan talk about inflation: "One has the feeling -- though he didn't say so -- that interest rates will probably continue to rise slightly until his departure."...
There was no indication that Greenspan drew any connection between his support of tax cuts in 2001 and the current deficit situation.
[Update: Brad DeLong also notes these comments. Tim Duy notes and interprets the breach of etiquette these comments represent.]
September 24, 2005
Insurance Capitalism and the Insurance State
The Truth Hurts, MaxSpeaks: Conservative Republican and Reagan tax honcho Bruce Bartlett testifies before the Senate Democratic Policy Committee. Teaser:
Therefore, like it or not, we must travel the same route taken by the Europeans, who long before us made peace with the welfare state and tried to figure out how to pay for it with the least negative impact on economic growth and incentives. They all imposed a broad-based consumption tax called the value-added tax as an add-on tax to all the others. I think it is only a matter of time before we are forced to do the same thing and the longer we wait the more painful it will be when it is finally done. Unfortunately, we are more than likely going to have to be forced into it by a financial crisis of some sort. It would be better to avoid that cost and deal with our fiscal situation rationally. But I see no leadership on either side that would allow that to happen.
The full statement follows.
Statement by Bruce R. Bartlett
September 23, 2005
Thank you for the opportunity to testify before you this morning. As you know, I testify as a Republican—I have served in senior political positions in Ronald Reagan’s White House and George H.W. Bush’s Treasury Department, and as executive director of the Joint Economic Committee, a cosponsor of this hearing. However, I do not represent the Republican Party or any organization with which I may be associated. I am here speaking only for myself.
I testify as someone who is very disenchanted with his party’s fiscal policy since 2001. Unlike the other witnesses, I am less concerned about the deficit per se or about the size of the tax cuts enacted over the last five years. Rather, what really bothers me is the increase in spending and expansion of government that my party has been responsible for.
I used to believe that the Republican Party was the party of small government. That’s why I became a Republican. I don’t believe that the federal government has the right to one penny more than absolutely necessary to fulfill its essential functions as spelled out in the Constitution. I think government is over-intrusive and could do what it has to do far more efficiently and at lower cost, which means with lower taxes.
Therefore, it bothers me a great deal when Republicans initiate new entitlement programs, massively expand pork-barrel spending, and show the most callous disregard for fiscal integrity. Not too many years ago, Ronald Reagan vetoed a politically popular highway bill because it contained 157 pork-barrel projects. The latest bill contained at least 5,000. Yet President Bush signed this $295 billion bill into law, despite having promised repeatedly to veto a bill larger than $256 billion.
For the life of me, I cannot understand why President Bush seems so incapable of using his veto pen. His father knew how to veto bills. He vetoed 29 of them in his four years in office. But in his first four-plus years, this President Bush has vetoed nothing. He is the first president since John Quincy Adams to serve a full term without vetoing anything. Curiously, Adams is also the only other son of a former president to become president—and his father, John Adams, didn’t veto anything, either.
When I complain about this to the White House, they tell me that it is very hard to veto bills when your party controls both Congress and the White House. But this explanation is simply implausible. Franklin D. Roosevelt had huge Democratic majorities, yet vetoed a record 372 bills. John F. Kennedy, Lyndon Johnson and Jimmy Carter also had large majorities of Democrats, yet Kennedy vetoed 12 bills during his short presidency, Johnson vetoed 16, and Carter vetoed 13.
I won’t bore this committee with numbers. You know them as well as I do. Suffice it to say that our fiscal situation is dire and growing worse by the day. My principal concern, however, is not with today’s deficits—even if they are swollen by Katrina and Rita-related emergency spending. What worries me is the retirement of the baby boom, the first of which turns 62 in 2008. I’m not saying that we are close to driving off a fiscal cliff, but clearly the implications of this event have not impacted on policymakers in any way whatsoever.
I have struggled with a way to illustrate the consequences of an aging population and its effect on the budget. This is the best I have been able to do. Social Security’s unfunded liability comes to 1.2 percent of GDP in perpetuity (1.4 percent without the trust fund)—about what is raised by the corporate income tax—according to that program’s actuaries. The comparable number for Medicare is 7.1 percent of GDP—about what is raised by the individual income tax. And remember that these figures are for the unfunded portion of these programs, so they are over and above payroll taxes.
The chilling conclusion, therefore, is that virtually 100 percent of all federal taxes, on a present value basis, do nothing but pay for Social Security and Medicare. Unless there are plans to abolish the rest of the federal government, large tax increases are inevitable.
Let me be clear that I am no advocate of higher taxes. I’m the one who drafted the Kemp-Roth bill back in the 1970’s and I have spent most of my career looking for ways to cut tax levels and tax rates. But that was predicated on an assumption those supporting tax cuts also wanted to downsize government. I never saw tax cuts as a substitute for spending cuts, but more as sugar to make the medicine go down. My ultimate goal was to reduce both taxes and spending.
Unfortunately, few in my party seem to share this philosophy any longer. For many, tax cuts have become a substitute for spending cuts. It truly amazes me how often I hear people on my side talk about cutting taxes as if this is the only thing necessary to downsize government. They seem genuinely oblivious to the fact that the burden of government is largely determined by the level of spending, not taxes. Nor do they understand that in the long-run, all spending must be paid for one way or another. Increasing spending today, therefore, absolutely guarantees that taxes will have to be raised in the future.
I am often criticized by friends on my side of the aisle for implicitly endorsing tax increases. I do no such thing. I am simply adding two and two and getting four while my friends seem to think there is some way of only getting three.
They also criticize me for implicitly abandoning the fight to cut spending and downside government. Again, I plead innocent. It is not I who has abandoned the fight, but my party. I don’t need to remind anyone here that the biggest spending increases in recent years passed Congresses with Republican majorities largely without Democratic votes. Nor do I need to remind anyone here that during the Clinton years we not only went from budget deficits to budget surpluses, but did so to a large extent by cutting spending—something my conservative friends seldom acknowledge.
Here’s the basic accounting. Defense spending fell by 1.4 percent of GDP between 1993 and 2000, and domestic discretionary spending fell from 3.8 percent to 3.3 percent. Even spending on entitlements fell for temporary demographic reasons, from 10.2 percent of GDP to 9.8 percent. Finally, interest on the debt fell, largely because of falling interest rates, from three percent of GDP to 2.3 percent. The result was an overall decline in spending of three percent of GDP, from 21.4 percent to 18.4 percent, the lowest level since 1966, before the Great Society geared up.
On the revenue side, individual income taxes rose by 2.5 percent of GDP, mainly as the result of rising incomes that pushed people up into higher tax brackets and higher capital gains taxes from the booming stock market. Corporate income taxes and payroll taxes added another 0.8 percent, for a total revenue increase of 3.3 percent of GDP. Thus lower spending and higher revenues constituted a fiscal turnaround of 6.3 percent of GDP, which explains how a deficit of 3.9 percent of GDP in 1993 became a budget surplus of 2.4 percent by 2000.
I don’t give President Clinton full credit for this performance. I think most of the credit goes to gridlock. Mr. Clinton wouldn’t support the Republican Congress’s spending and it wouldn’t support his. So for a blessed six years, government effectively was on automatic pilot. Sadly, unified government has led to an utter lack of restraint by my party that is simply inexcusable. It is extremely dismaying for me to hear House Majority Leader Tom Delay say that there is no fat in the budget and that Republicans have cut it to the bone. This is, quite frankly, ludicrous. My real fear, however, is that he may actually believe it.
I remain convinced that given the total lack of fiscal responsibility demonstrated by the Republican Party that very large tax increases are inevitable. I believe that the fiscal hole is now so large that it is unrealistic to think that we can just tinker with the tax system, as we did so often in the 1980’s, and raise enough revenue to pay for spending commitments that have been made. And under the circumstances, I have no faith whatsoever that spending will be significantly restrained—at least not by my side. They would first have to admit error and beg for forgiveness from people like me, something I don’t expect to be forthcoming any time soon.
Therefore, like it or not, we must travel the same route taken by the Europeans, who long before us made peace with the welfare state and tried to figure out how to pay for it with the least negative impact on economic growth and incentives. They all imposed a broad-based consumption tax called the value-added tax as an add-on tax to all the others. I think it is only a matter of time before we are forced to do the same thing and the longer we wait the more painful it will be when it is finally done. Unfortunately, we are more than likely going to have to be forced into it by a financial crisis of some sort. It would be better to avoid that cost and deal with our fiscal situation rationally. But I see no leadership on either side that would allow that to happen.
I don’t know when, where or how a financial crisis will develop. I only know that trends that can’t continue don’t. Since it is unlikely that the vast fiscal imbalance will be resolved with a whimper, it becomes a certainty that it will end with a bang. Among the areas ripe for triggering a crisis are a popping of the housing bubble, a crash of the dollar, a mistake by some big hedge fund, excessive tightening by the Fed and others too numerous to mention. It will take extraordinary luck and skill to avoid every boulder in the stream and I have little confidence that this administration has the personnel to even give us a fighting chance. There are too many Michael Browns at senior levels of the government today and too few Bob Rubins or Alan Greenspans.
Contrary to popular belief, I don’t think the American people are a bunch of children who only want hand-outs from the government and will only reward the party that promises them something for nothing. Experience and academic research confirm that they are more likely to support the candidate who treats the public purse with prudence and trust and not as a piggy bank to be routinely broken on a whim. In short, I think there is a political market for the party and the candidate who speaks honestly about the nature of the fiscal crisis that is looming. The payoff may not be immediate and the public trust has to be earned by more than just rhetoric. But if, as I believe, some event will eventually change the political landscape, voters will remember who spoke the truth and who mouthed the platitudes.
It’s dirty work, but someone has to do it. Since my party won’t do it, yours is going to have to. If it’s done right, your party will gain at the expense of mine and you will deserve the benefits and my party will deserve the electorate’s disdain.
Housing Bubble or Housing Froth?
Housing Markets Are Stable ... Until They're Not," Hot Property: Three top economists made a splash on the Wall Street Journal's editorial page this past Monday with a piece headlined "Bubble Trouble? Not Likely." But ... [t]hey assume, without strong evidence, that buyers in each market will continue to expect the same kind of price gains that they've averaged over the past 60 years. If you expect prices to keep rising rapidly, you'll be willing to pay a whole lot today. The market will be stable. But what if buyers in, say, San Francisco suddenly turn pessimistic about the rate of future price increases? ... If they lose faith that the market will climb steeply ad infinitum, then ... the market will tank. That's practically the definition of a popping bubble. By assuming from the start that such a thing won't happen, the authors are assuming their conclusion. ... I spoke with Todd Sinai ... co-author on the paper ... Sinai defended the paper. He said ... hot cities like San Francisco are pretty much built-up, so people are competing to live there by outbidding each other ... That ... can continue as long as there are rich people in other parts of the country who would really rather live in San Francisco. I'm not so sure. It feels to me like San Francisco, San Diego, Los Angeles, New York, Miami, Boston, and other costly markets are pricing themselves out of reach. ... If they stop expecting rapid house appreciation, their willingness to pay will fall. And the market could drop rather suddenly. The authors certainly didn't persuade me that there's no bubble.
Goldman Sachs Economist on the Bubble, Hot Property: Just got off the phone with Jan Hatzius, a Goldman Sachs economist who has written extensively on the housing market. He gave me permission to post a research note ... he wrote ... about the same academic study that I questioned in a post yesterday. Hatzius says he's not sure I'm correct that the authors of the study assumed their conclusion. His criticisms are different. The biggest one is that the authors ended their analysis too soon--last year--missing the further inflation of housing prices since then. Here's what he wrote:
Bubble Trouble? Probably Yes
Monday's Wall Street Journal featured an op-ed by Christopher Mayer and Todd Sinai, two academic real estate analysts, who argue that worries about a housing bubble are overblown. ... Himmelberg, Mayer, and Sinai (HMS) calculate the total cost of owner occupation as the sum of interest, depreciation, property taxes, and a risk premium for taking on house price risk, and then adjust these costs for the tax deductibility of mortgage interest and property taxes as well as a term for expected capital gains. They call the resulting measure 'imputed rent,' divide it by an index of actual rents, and set the resulting ratio equal to 1 for the average of the 1980-2004 period. They then argue that a metropolitan housing market is overvalued relative to its own history when the ratio is above 1 and undervalued when the ratio is below 1. Their main result is that 31 out of their 46 metropolitan housing markets had values below 1 as of 2004. Of the markets usually considered 'hot,' New York, San Francisco, and Phoenix had values below 1, while Boston, Los Angeles, and Washington DC, had values just marginally above 1; only Portland, San Diego, and Miami showed some cause for concern. HMS conclude that there is no evidence for a general housing bubble, and not even much evidence for a localized bubble.
What do we make of this analysis? Of course, HMS are right that interest rates matter for valuing capital assets such as residential homes. ... But ... on the narrower point, namely whether house prices are out of line with rents and interest rates, we are somewhat skeptical ... First, the results are sensitive to minor changes in the assumptions ... For example, HMS assume that households require a constant risk premium of 2 percentage points for owning instead of renting, and that they expect the rate of capital gains to be equal to the 1940-2004 average for their metropolitan area. Of course, it is impossible to know whether these or any other assumptions about unobservable concepts such as risk premia or expectations are correct. ... the precise choice of numbers can make a qualitative difference to the results... Second, the analysis uses annual data that end in 2004. This is unfortunate, because the case for an outright housing bubble was still quite weak as of 2004 but has grown much stronger since then. ... Thus, an analysis along the lines of the HMS paper that used more up-to-date inputs would probably come to a considerably more cautionary conclusion.
Of course, comparing the economic costs of owning with the economic costs of renting is not the only way of adjusting house prices for changes in the fundamentals, including interest rates. Our own preference remains with an 'affordability' concept that asks what percentage of their disposable income households must expend to cover mortgage payments on the median-priced home. This approach not only relates house prices to incomes -- compared with rents, probably a more meaningful comparison for most US households residing in the suburbs -- but it also recognizes that the vast majority of households are unable to borrow as much as they want and therefore cannot engage in the theoretically 'pure' arbitrage considerations assumed by HMS. As we described in detail in the May-June Pocket Chartroom, housing affordability is deteriorating quickly. ... For example, the National Association of Realtors -- not an organization known for excessive bearishness on the housing market -- reports that their US affordability index now stands at the lowest level since 1991. Thus, housing valuations are stretched, and are becoming more stretched the longer the current boom continues.
Thanks to Jan Hatzius for allowing us to reproduce the above note.
Do Sticky-Price RE Models Capture Inflation Dynamics Better Than Traditional Phillips Curve Models?
...existing rational expectations sticky-price models fail to provide a useful empirical description of the inflation process, especially relative to traditional econometric Phillips curves of the sort commonly employed for policy analysis and forecasting.
which is not good news for advocates of the New Keynesian model. Here's the paper by Rudd and Whelan that will be presented at this conference sponsored by the Federal Reserve Board and The Journal of Money, Credit, and Banking:
Modeling Inflation Dynamics: A Critical Survey of Recent Research, by Jeremy B. Rudd and Karl Whelan: 1 Introduction Robert Solow (1976) once observed that “any time seems to be the right time for reflections on the Phillips curve.” However, right now seems to present a particularly appropriate moment to take stock of the empirical evidence on inflation dynamics. Recent years have seen an explosion in empirical research on inflation, with most of it related to the so called “new-Keynesian” Phillips curve, which has provided a modern take on the traditional Phillips curve relationship by deriving it from an optimizing framework featuring rational expectations and nominal rigidities. That the current conference has taken its inspiration from the 1970 Federal Reserve conference on “The Econometrics of Price Determination” also seems appropriate because, like now, the 1970s witnessed an intense debate over the theoretical and empirical underpinnings of a popular econometric model of inflation. And, like now, these debates largely revolved around the merits of what appeared to be a new paradigm for understanding the behavior of inflation and the macroeconomy.1
In this paper, we offer a selective and critical review of recent developments in the theoretical and empirical modelling of U.S. inflation dynamics. We ... are not attempting to provide a comprehensive summary of the huge amount of research devoted to this topic ... Rather, we hope to shed light on a couple of key issues: first, how are inflation expectations formed; and second, what is an appropriate empirical measure of inflationary pressures. ... [O]ur survey will reflect the answers to these questions that we have proposed in our earlier work.2 In particular, our research has suggested a number of reasons to be skeptical about the new-Keynesian framework that is bidding to become the new benchmark model for inflation analysis. More generally, we discuss some reasons to doubt some of the stronger implications of the rational expectations hypothesis for the modelling of inflation. In that sense, our work connects back to many of the themes of the 1970 conference, and it is with those earlier debates that we begin.
We start by reviewing the origins of the Phillips curve and the debates over the accelerationist version of the model introduced by Friedman (1968) and Phelps (1967). We discuss the important critiques of econometric Phillips curves made by Sargent (1971) and Lucas (1972a), and trace how this led to the development of the modern “new-Keynesian” Phillips curve. We outline how, despite their apparent similarity, the accelerationist and new-Keynesian models turn out to have very different implications for monetary policy and for econometric modelling and forecasting.
The paper next provides an empirical assessment of the new-Keynesian Phillips curve. This is a structural model, designed to be capable of explaining the behavior of inflation without being subject to the Lucas critique, but it is well known that it generates extremely counterfactual predictions when traditional output gaps (based on naive detrending procedures) are used as a measure of inflationary pressures. However, in recent years it has become widely accepted that an alternative approach, which substitutes labor’s share of income in place of detrended output, is theoretically superior and yields a good empirical model of inflation dynamics. We argue that the theoretical case for this approach—which was advocated in an influential paper by Gali and Gertler (1999)—is quite weak, and that the labor’s share version of the new-Keynesian model actually provides a very poor description of observed inflation behavior. This failure of the model extends along two dimensions: first, labor’s share fails to provide a good measure of inflationary pressures; and second, this version of the model cannot account for the important role played by lagged inflation in empirical inflation regressions.
We also review the evidence relating to the so-called “hybrid” class of new-Keynesian models, which add a dependence of inflation on its own lagged values to otherwise purely forward-looking models. These models are often viewed as striking a compromise between the need for rigorous microfoundations of the sort underlying the pure new-Keynesian model and the need for reasonable empirical fit; thus, they have commonly been adopted for use in applied monetary policy analysis. Gali and Gertler’s conclusion that rational forward looking behavior plays the dominant role in these models is widely cited as a stylized fact in this literature. We provide an alternative interpretation of the empirical estimates obtained from these models, and argue that the data actually provide very little evidence of an important role for rational forward-looking behavior of the sort implied by these models. Finally, we end with a brief discussion of the properties of reduced-form econometric Phillips curves. The importance of lagged inflation in these models has led to them being criticized as being especially susceptible to the Lucas critique. As we show, however, this potential shortcoming of these models seems to be relatively unimportant in practice.
9 Conclusions The history of science provides many examples of theories that everyone knew were true, until they turned out to be false. At various points in history, intelligent people knew that the world was flat; knew that the sun revolved around the earth; and knew that there was an exploitable long-run tradeoff between inflation and unemployment. Today, one can meet many researchers who know that the new-Keynesian Phillips curve provides a good model of the inflation process once one uses a suitable proxy for real marginal cost; who know that forward-looking rational behavior dominates price setting; and who know that the U.S. inflation process has fundamentally changed in the last twenty years because of a shift in how monetary policy has been conducted. We hope the evidence presented in this paper will give at least some interested researchers cause to check these conclusions more fully against the available evidence.
At the start of this paper, we posed two fundamental questions about inflation: first, what is a suitable measure of inflationary pressures; and second, how are inflation expectations formed. Regarding the former issue, we believe the evidence presented here militates strongly against the use of labor’s share of income as a useful proxy for inflationary pressures. In general, we find very little evidence for a strong link between inflation and current or expected values of this variable. Just as important to note in this context is the often forgotten fact that traditional output gaps remain highly significant predictors of inflation in reduced-form econometric regressions.
Regarding expectations formation, we do not wish to overstate the implications of these results for the merits of the rational expectations hypothesis. What we can say with some confidence is that the current class of popular rational expectations models fail to work well with either traditional output gaps or with labor’s share of income serving as a proxy for real marginal cost. But this does not rule out the possibility that the rational expectations approach might better fit the data with an alternative proxy for this hard-to-measure concept.
All that said, we believe there is little evidence that structural modelling of inflation in a rational expectations framework provides a clearly superior approach relative to traditional models of inflation dynamics. Reduced-form econometric models of inflation are surprisingly stable, and these models remain useful tools for forecasting. This may be because simple models of adaptive expectations, as described by Friedman and Phelps, still provide decent approximations to reality. Or it could instead be that existing rational expectations mechanisms do not capture the richness of how expectations are formulated in the real world. Further research on how expectations evolve and interact with the policy environment—such as recent work by Sargent (1999) and Orphanides and Williams (2005)—may well prove useful in advancing our understanding of these vital questions.
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1As Solow (1968, p. 3) also noted, “. . . the theory of inflation seems to make progress by way of a series of controversies. It is not uncommon for economics, or even for natural science, to proceed in this adversary manner, but I rather think it is especially characteristic of the analysis of inflation.”
2See Rudd and Whelan (2003), (2005a), and (2005b).
E. J. Dionne Jr.: Fiscal Policy is Stupid
Fiscal Policy: Why 'Stupid' Fits, by E. J. Dionne Jr., Washington Post: Hurricane Rita heads inexorably westward, threatening to add to the human and financial costs of Hurricane Katrina. And when it comes to taxes and spending, Washington acts as if nothing is happening. True, a group of very conservative Republicans issued a list of program cuts ... under the imposing name "Operation Offset." The cuts that the Republican Study Committee proposed have won their sponsors praise for making "tough choices." … it's hard to give the fiscal conservatives too much credit, since they would cut $80 billion from Medicare and $50 billion from Medicaid over five years and suggest reductions in school lunches, rent subsidies for the poor and foreign aid, among other things. The idea seems to be that to help Katrina's poor and suffering victims, other poor and suffering people will have to sacrifice.
Nonetheless, permit me to offer a little cheap grace on these conservatives. At least the Operation Offset crowd has produced this list of cuts and forced its own leaders to disown them. The exchange showed how fundamentally stupid our budget policies have been over the past five years -- and, yes, I'll defend that strong word. Here's a fact getting far too little attention: The cost this year alone of the Bush tax cuts enacted in 2001 and 2003 comes to $225 billion. ... [T]he revenue lost because of tax cuts ... this year without any congressional action would more than pay the costs of Katrina recovery. Why describe our government's fiscal policies as "stupid," rather than, say, "ill-advised" or "misguided"? … our current budget policies are built not on honest coherence but on incoherence or, even worse, a dishonest coherence. The president and members of Congress always insist that they are fiscal conservatives who believe in balanced budgets. Yet their actions bear no relationship to their words, and labels such as "conservative" have no connection to their policies. Our federal purse strings are in the hands of fiscal radicals. I'd have much more respect for these guys if they just came out and said: "... All we really care about are passing tax cuts -- and popular spending programs that get us reelected so we can enact more tax cuts." Not very politic, I'll grant you, but honest. Vice President Cheney came as close as anyone to this form of honesty when he spoke in support of the tax cuts … "Reagan proved deficits don't matter" and that Republicans owed themselves more tax cuts. … Which brings us back to that word "stupid." My dictionary tells me it means not only "lacking in ordinary intelligence" but also "dazed" and "stupefied." The crowd running our government is dazed and stupefied by a theory that sees throwing ever-larger sums to the wealthy in the form of tax cuts as so good, right and important that all the ordinary rules of finance and economics can be thrown out the window. If it was already stupid to pursue more tax cuts once the country decided to wage a large war on terrorism, it is supremely stupid to stay on the same course now that Katrina has added to our fiscal burdens and Rita, God help us, threatens to add more. Or maybe it's the rest of us who should be called stupid if we keep taking these guys at their word…
This won't get fixed until voters show they care.
The Economist: Global Saving and Investment
What causes people to save and invest?, The Economist: At first sight, the idea of a “saving glut”—an excess of saving over investment—seems odd. According to the economics textbooks, saving and investment are always equal. ... And indeed that is true for the world as a whole, but it is not true for individual countries. ... the amount an individual country saves does not have to be the same as the amount it invests. The difference between the two is the amount borrowed from or lent to foreigners; this is called the current-account deficit or surplus... Moreover, whereas it is true that at a global level saving must equal investment, the fact that saving and investment end up in balance does not mean that ... households and individuals ... desire to save and invest in equal measure. ... Actual saving and investment must be equal. Desired saving and investment may not be.
Most of the time, ... If people's desire to save exceeds their desire to invest, interest rates will fall so that the incentive to save goes down and the willingness to invest goes up. Across borders, exchange rates have a similar effect. ... But there is some uncertainty about how smoothly these adjustments are made. Classical economic theory suggests that interest rates automatically bring saving and investment into a productive balance. The central principle of Keynesianism, however, is that this alignment between saving and investment is not always automatic, and that a misalignment can have serious consequences. ... The modern consensus is that both classical and Keynesian theory can be right, but over different time frames. In the long term, saving and investment will be brought into line by the cost of capital. But in the short term, firms' appetite to invest is volatile, and policymakers may need to step in to shore up demand. Thus, although saving and investment are equal ex-post, economic theory leaves plenty of room for an ex-ante saving glut...
What might change people's desire to save or invest? ... The most influential theory of household saving is the “life-cycle hypothesis” ... It suggests that people try to smooth consumption over their lifetime: they save little or nothing when young but more in their middle years if they have a good income. They then draw down those savings in retirement. ...demographic shifts and economic growth are the most important drivers of thrift. Another theory suggests that people save for “precautionary reasons” ... This implies that people will save more if their income is variable. It also suggests that they will be more inclined to save if they have no access to credit. A third possibility is that people save because they want to leave assets to their children, either because they love them or as a way to bribe the children to look after their parents in old age. ... the bequest theory of thrift suggests that savings might not actually be drawn down in retirement. A final possibility is that people save in response to their government's actions. This theory, known as “Ricardian equivalence”, suggests that people save more if government saves less because they expect higher taxes later on. How well do these theories fit with what has actually happened in the past? ... in general, the following factors seem to play a role:
•Demographics. ...Saving rates do rise when the ratio of children in the population falls (as in China), and decline when the proportion of pensioners rises (as in Japan). Given that the world's population as a whole is ageing ... global saving should currently be rising. •Economic growth. Especially in poorer countries, saving rates rise as economies grow. That is probably because people do not adjust their consumption patterns as quickly as their income rises... •Terms-of-trade shock. If a country's exports suddenly go up in price, its saving rate tends to go up too, at least temporarily. Oil exporters, for example, put on a saving spurt if oil prices rise. This effect also helps to explain the recent increase in saving in many emerging economies. •Financial development. As an economy's financial system becomes more developed, saving rates tend to fall because people find it easier to borrow. ... It suggests that saving rates may be lower in countries with more sophisticated financial systems, such as America. •Capital gains. In rich countries ... If the stock market or house prices rise, people feel richer and save less. A study by the OECD published late last year suggests that housing wealth has a bigger effect on saving than financial wealth... •Fiscal policy. In some countries, people do appear to behave as Ricardian equivalence theory suggests: they save more when budget deficits expand, perhaps because they expect higher taxes in the future, although private-sector saving rises by less than the rise in budget deficits. The big exception is America, where the impact of fiscal deficits on private saving appears to be weakest.
Some of these factors work in opposite directions ... But there are indications that in rich countries the biggest disincentives to saving have been capital gains and the ability to borrow. ... In emerging markets, on the other hand, the most powerful factors pushed in the opposite direction. Fast economic growth and increases in government saving, thanks partly to terms-of-trade shocks, have increased total national saving. ... If there is a glut of saving, it is likely to be found in emerging economies and oil-exporting countries.
...In theory, firms should invest if the expected return on their investment exceeds the cost of the capital they are using. In the short term, firms need to worry about the state of overall demand. But in the long term, returns on capital depend on how much capital an economy already has, how productively it is used, and how fast the workforce is growing. If there is little capital available or the workforce is growing rapidly, firms would usually expect a high return on investment. The evidence supports these theories, up to a point. ... However, in recent years these statistical relationships have failed to hold. Both in rich countries and in emerging economies (except China), investment levels have been lower than economists had expected at the levels of interest and growth rates prevailing at the time. Much of Mr Bernanke's saving glut is due to this unexpectedly low rate of investment. ... several “structural” explanations have gained support:
•Demographics. A young and growing workforce boosts the level of investment, just like a mature workforce boosts the saving rate. ... But although demographics are important, they change slowly. It is hard to ascribe the recent sharp drop in investment demand in regions such as Japan or East Asia to demographic change alone. •Declining capital intensity. Firms in rich countries may not need to invest as much as they used to because the share of capital-intensive industries in their economies is shrinking. ... But [this] does not explain investment busts in poor countries. •Deflation of capital-goods prices. In recent years prices of capital goods have fallen sharply relative to prices of other goods and services, thanks largely to cheaper computers, so companies are able to achieve the desired level of real investment for a smaller outlay. ... This may help to explain some of the recent weakness in investment, particularly in rich countries. But it is unlikely to last. ... More important, computers depreciate more quickly than other capital goods, so eventually firms will need to invest more to maintain the same level of net investment. •The rise of China. This may have prompted a geographic shift in global investment patterns. ... But investment flows to China from America, Europe and Japan are not yet big enough to explain the sluggish investment in those countries...
In sum, none of these explanations for a structural, global decline in investment is altogether convincing. To understand the pattern of global saving and investment properly, you have to look in detail at what is going on within the world's main saving and borrowing countries. The best place to start is the biggest net saver of all, Japan.
More to follow...
September 23, 2005
Is There a Global Saving Glut? If So, Will it Persist?
The great thrift shift, by Zanny Minton Beddoes, The Economist: On March 10th 2005, Ben Bernanke ... argued ... the world might be suffering from a “global saving glut”. The phrase immediately caught on. ... The idea's appeal lies in the way it ties together two of the most vexing questions about today's economic landscape: why are interest rates so low? And why can America borrow eye-popping amounts from foreigners with seeming impunity? ... A “global saving glut” could explain both oddities. ... His suggestion that the causes of global imbalances lie elsewhere conveniently deflects attention from monetary and fiscal decisions ... It suggests that Mr Greenspan's loose monetary policy and George Bush's tax cuts are not responsible for the imbalances in the world economy. That may seem a little self-serving, coming from a man who has subsequently moved from the Federal Reserve to become chairman of Mr Bush's Council of Economic Advisers.
Taken at face value, the notion of a global saving glut is not borne out by the facts. “Glut” suggests an unusually large amount, as in a summer glut of strawberries. In fact, figures published in the IMF's latest World Economic Outlook show that the rate of global saving as a proportion of global output, measured at market exchange rates, has mostly been heading downhill over the past 30 years, with a particularly steep plunge between 2000 and 2002 (see chart 1)...
But Mr Bernanke's argument is more subtle. He is saying that low interest rates imply too much saving relative to the amount people want to invest, and that the ... discrepancy is concentrated outside America. ... [E]ven with the saving rate falling, there could be a glut of thrift if ... the demand for investment ... was falling even faster. The important factors in the equation, therefore, are shifts in the appetite for investment as well as in the geography of thrift. On both counts the world has seen big changes. Traditionally, most of the saving ... is done by households, whereas most of the investing tends to be done by firms. But in the past few years firms have become net savers as their profits have exceeded their investments. That change has been most pronounced and long-lasting in Japan, where corporate saving soared after the bubble economy collapsed in the early 1990s. Burdened with bad debts ..., Japanese firms have been net savers for a decade. The late 1990s saw a similar shift in many emerging Asian economies, where corporate investment plunged after the Asian financial crisis. After the stockmarket bubble burst in 2000, American and European firms' investment also fell. Although American firms began investing again a couple of years ago, the level of corporate investment is still relatively low, given how strongly the economy—and profits—have been growing. Firms in industrial countries as a whole are still saving more than they invest, despite record profits (see chart 2). The only significant country bucking the trend is China, where investment has been rising sharply. But saving has been growing faster still.
A weak appetite for investment might help explain low interest rates, but not the rising imbalances between America and the rest of the world. To understand those, two other factors have to be considered: differences in countries' economic structures, and differences in policymakers' reactions to the investment bust.
America is at one extreme. ... Between 2001 and 2003, America enjoyed its biggest fiscal stimulus of the post-war period, and short-term interest rates were slashed. Declining interest rates fuelled a boom in house prices, encouraging people to borrow against their properties. Economic growth remained strong and the current-account deficit soared. ... To protect exports and to build up vast war chests of reserves, many East Asian governments kept their currencies cheap for years after the financial crises. Firms stayed reluctant to invest, the saving surpluses remained large and the foreign-exchange reserves piled up. Japan and Europe lie between those two extremes. ... In short, a good part of the rising imbalances of the past few years can be explained by a series of investment busts—after periods of overinvestment—and sharp differences in the way policymakers responded to them. But particularly since 2000, two other factors have also become important: more saving in China, and the soaring price of oil.
China's investment rate, at 46% of GDP, is the world's highest by far ... but its saving rate has been rising even faster. ... The country has kept its currency cheap and exported ever more capital to the rest of the world. At the same time, high oil prices have brought a financial windfall to the world's oil exporters which so far they seem to have chosen to save rather than spend. As a group, the oil-exporting countries are now the biggest counterparts to America's current-account deficit (see chart 3).
These shifts have ... had important and unusual consequences. The first is that capital now flows primarily from poor countries to rich countries. ... The second consequence is that outside China, less saving by households rather than investment by firms has become the engine of global economic growth. ... consumers, particularly American ones, are content to become ever more indebted. That willingness appears closely related to the rapid rise in house prices across much of the globe. These patterns are a long way from historical norms. Can they last? In the long term, the answer is clearly no. Household saving cannot keep on falling, and America's foreign borrowing cannot keep on rising. The question is when and how the tide might turn.
One camp argues that the saving glut Mr Bernanke has identified is a temporary and largely cyclical phenomenon. ... But a growing group of analysts now suggests that the “saving glut” is the result of long-term structural shifts and is likely to last for years, perhaps decades. ... If the “saving glut” really is here to stay, there are two main possibilities. The first is that America's consumers will continue to barrel along and the imbalances between America and the rest of the world will increase further. The second is that Americans themselves will start saving again, perhaps because the housing market falters ... With the rest of the world still determined to save too, that would send the global economy into a tailspin. This survey will try to determine whether the shifts that have caused the “saving glut” are likely to be temporary or more long-lasting. It will conclude that the recent shifts in global saving and investment patterns are not permanent, but nor are they likely to be reversed overnight. ... Nudging global saving and investment patterns into a healthier balance will require new thinking, both inside and outside America. Policymakers bear more responsibility for the thrift shifts, and the global imbalances, than Mr Bernanke cares to admit.
More to follow...
Krugman: Crisis in Confidence
The Big Uneasy, by Paul Krugman, NY Times: Although Hurricane Katrina drowned much of New Orleans, the damage to America's economic infrastructure actually fell short of early predictions. Of course, Rita may make up for that. But Katrina did more than physical damage; it was a blow to our self-image as a nation. Maybe people will quickly forget the horrible scenes from the Superdome, and the frustration of wondering why no help had arrived, once cable TV returns to nonstop coverage of missing white women. But my guess is that Katrina's shock to our sense of ourselves will persist for years. America's current state of mind reminds me of the demoralized mood of late 1979, when a confluence of events - double-digit inflation, gas lines and the Iranian hostage crisis - led to a national crisis of confidence.
Start with economic confidence. The available measures say that consumer confidence, which was already declining before Katrina hit, has now fallen off a cliff. ... It's true that gasoline prices have receded from their post-Katrina peaks. But even if Rita spares the refineries, a full recovery of economic confidence seems unlikely. ... Then there's the war in Iraq, which is rapidly becoming impossible to spin positively: ... Most Americans say the war was a mistake; a majority say the administration deliberately misled the country into war; almost 4 in 10 say Iraq will turn into another Vietnam. And many people are outraged by the war's cost. The general public doesn't closely follow economists' arguments about the risks of budget deficits, or try to decide between competing budget projections. But people do know that there's a big deficit, that politicians keep calling for cuts in spending and that rebuilding after Katrina will cost a lot of money. They resent the idea that large sums are being spent in a faraway country, where we're waging a war whose purpose seems increasingly obscure.
Finally, fragmentary evidence - like a sharp drop in the fraction of Americans who approve of President Bush's performance in handling terrorism ... suggests that the confluence of Katrina and the fourth anniversary of 9/11 has caused something to snap in public perceptions about the "war on terror." In the early months after 9/11, America's self-confidence actually seemed to have been bolstered by the attack: the Taliban were quickly overthrown, and President Bush looked like an effective leader. ... But now that more time has elapsed since 9/11 than the whole stretch from Pearl Harbor to V-J Day, people are losing faith. Osama, it turns out, could both run and hide. It's obvious from the evening news that Al Qaeda and violent Islamic extremism in general are flourishing.
And the hapless response to Katrina, which should have been easier to deal with than a terrorist attack, has shown that our leaders have done virtually nothing to make us safer. And here's the important point: these blows to our national self-image are mutually reinforcing. The sense that we're caught in an unwinnable war reinforces the sense that the economy is getting worse, and vice versa. So we're having a general crisis of confidence. It's the kind of crisis that opens the door for dramatic political changes ... who will provide leadership, now that Mr. Bush is damaged goods?
Does Structural Change Explain the Sluggish Employment Growth in Recent Recoveries?
Chart 1 - Payroll Job Growth during Recoveries
Sources: U.S. Bureau of Labor Statistics; authors' calculations.
Note: The shaded area indicates the length of the 2001 recession.
Chart 2 - Contribution of Temporary Layoffs to the Unemployment Rate
Sources: U.S. Bureau of Labor Statistics; authors' calculations.
Note: Shaded areas indicate periods designated recessions by the National Bureau of Economic Research.
Chart 5 - Share of Total Employment in Industries Undergoing Cyclical Changes and in Industries Undergoing Structural Changes
Sources: U.S. Bureau of Labor Statistics; authors’ calculations
The Glittering Eye: Carnival of the Liberated
My anniversary with Carnival of the Liberated: a year in the Iraqi and Afghani blogosphere, Glittering Eye: It’s been a year since I took over editorship of the Carnival of the Liberated for Dean Esmay. ... I’ll keep on doing it as long as Dean lets me. ... The year has been enormously eventful for Iraq, the Iraqi bloggers, the Iraqi blogosphere, and the blogosphere as a whole. In this post I’m going to recap the year briefly. ... There are now two Afghan bloggers blogging from Afghanistan: Afghan Lord and Afghan Warrior. That’s two more than we had last year at this time. Thanks, guys. It takes enormous courage to do what you’re doing. Keep up the good work. I hope there are a lot more of you by this time next year.
It’s been a year of upheaval for Iraq and the Iraqi blogosphere. Many of the core Iraqi bloggers when I started editing the Carnival aren’t posting anymore; others have taken their places. Some have left the country: Ahmed of Life in Baghdad and Rose of Diary from Baghdad (husband and wife) have moved to Dubai where Ahmed has found work. Khalid Jarrar of Tell Me a Secret left the country after his ordeal. I believe he is in Jordan. This isn’t a good trend. If the best and the brightest leave Iraq it will be that much more difficult to rebuild the country. Some bloggers have returned to Iraq. Salam Pax, the original Iraqi blogger, has returned to Iraq and is posting again. His observations on the new constitution have been particularly good. neurotic iraqi wife has joined Hubby in the Green Zone and is working to build the new Iraq. But she’s discouraged and posts infrequently these days.
To my mind the most significant issues and events of the year for the Iraqi blogosphere were the U. S. elections, the Battle of Fallujah, the Iraqi election, the deteriorating security situation in Baghdad and Mosul, the arrest of Khalid Jarrar, the tragedy of the A-Imma Bridge, and the new constitution.
The U. S. Election
Iraqi bloggers split along party lines on the subject of the American presidential election. Those most hopeful about the possibilities of a free and democratic Iraq were relieved, even overjoyed. Here’s what Firas Georges of Iraq and Iraqis wrote:
I have come back from Basra yesterday, filled with happiness about the American election result which I stayed awake all night to follow for the first time of my life. I am still busy to finish my accumulated work here in Baghdad and wanted to congratulate the Americans with the re-election of President George W. Bush for another four years.
The Mesopotamian wrote:
Friends, tears came twice to these old eyes yesterday; once in sadness, and once in happiness.[…]
The second time they were tears of emotion and happiness. As I saw the American people turn out in record numbers, to say their word. And it seems to be the word of defiance and courage. Despite all the propaganda and the feverish campaign, the American people have proved something very important, although the final conclusion still seems to be not official, but every indication is that this is only a matter of little time. This is a most significant and far reaching event. It was most gratifying to see the discomfiture and hardly disguised rancor of Al Jazeera commentators as the results started to take a definite direction. I believe that this outcome and the record turn out have largely for their motivation the considerations that we have in common and which I mentioned in my previous posts.
Not all Iraqi bloggers felt that way. Those most closely affiliated with the old regime and those most opposed to the Occupation were bitter. The Great Iraq wrote:
You deserve no better- I couldn’t wish worse on you if I tried. He represents you perfectly… and red really is your color. It’s the color of the blood of thousands of Iraqis and by the time this four-year catastrophe in the White House is over, tousands of Americans, likely.
Abu Khaleel of Iraqi Letters, IMO the most thoughtful of anti-Occupation Iraqi bloggers, comments:
As an Iraqi, although I have to respect the choice of the American people expressed through a democratic process, I don’t have to be happy about it!
To me it means an approval of “pre-emptive wars”, of taking the “war to the enemy camp” (which means me, my family and my country), of more chaos in Iraq, of Abu Ghraib, of Halliburton; of the bombings and killings, of incompetence, of continued neo-con influence, of unilateralism, of disregard to world opinion, of trying to dominate the world instead of leading it, of more religious antagonism, of more animosity towards Europe and of the ascendancy of fear over hope.
The Fallujah Campaign
Opinion in the Iraqi blogosphere was sharply divided on the Battle of Fallujah. Rose of Diary from Baghdad was sad about it but realized it was a long time coming:
I think Fallujah needed a campaign similar to this long time before the terrorists and gangs strengthened themselves and made large cells and killed many innocent people. Maybe if they did it before they might have made it less bloody with less casualties and without destructing the whole city and driving away thousands of people from their homes and forced them to live in tents without source of heat in this cold weather. As I heard from people living in Fallujah, they had enough from those terrorists , but they could not do any thing against them because the terrorists would kill them with their families. I heard that some of the terrorists forced many families to have them at their homes and I heard that many of those families were killed during some attacks by the US forces. And that’s why the people of Fallujah want to put an end to it.
The Mesopotamian took a similar view:
It does not please any Iraqi to see any city or town in our country suffering the kind of fate that seems to await unfortunate places like Falujah and Ramadi; but whose fault is it really? Were not the people in the town given every chance to reform their ways and stop sabotaging their own country, only to have the place hijacked by extremists who turned the place into a safe haven for killers, kidnappers, be-headers and suicide bombers exported to Baghdad and elsewhere? Extremists turned the place into a Taliban like hell where ordinary people were subjected to the most ignominious and cruel treatment, and I refer you to the few reports that came out from inside the town, and also to the letter from Dave (link on the side bar) where he reports incredibly, that some of the residents are asking the American forces to bomb their own houses which have been occupied by terrorists.
Riverbend saw only senseless barbarity:
The mosque strewn with bodies of Iraqis- not still with prayer or meditation, but prostrate with death- Some seemingly bloated… an old man with a younger one leaning upon him… legs, feet, hands, blood everywhere… The dusty sun filtering in through the windows… the stillness of the horrid place. Then the stillness is broken- in walk some marines, guns pointed at the bodies… the mosque resonates with harsh American voices arguing over a body- was he dead, was he alive? I watched, tense, wondering what they would do- I expected the usual Marines treatment- that a heavy, booted foot would kick the man perhaps to see if he groaned. But it didn’t work that way- the crack of gunfire suddenly explodes in the mosque as the Marine fires at the seemingly dead man and then come the words, “He’s dead now.”
neurotic iraqi wife, September 2004:
When HUBBY had his first vacation over a month ago now, he asked what would I like for him to get me from Iraq, apart from the Saddam watch(which I never got), I told him please get me Iraqi earth, Iraqi soil. And here it is right infront of me, the earth, the earth of my beloved country Iraq.
So my Iraqi Earth, I only ask from you one thing, and that is to please protect all the innocent lives on your soil and above all, protect my HUBBY who just for your sake left his angelic(NOT) WIFE and came to you. You are the only thing that can bring him back to me into my loving arms…….My Iraqi Earth……
neurotic iraqi wife, August 2005:
I ve lost hope in the future of Iraq. I know many of you will find this distrubing but this is generally my own views and what I came to realize by being here. Im sorry, but the free democratic Iraq we all are hoping for wont take place, not now, not in 5 years not even in 10 years unless we get a real government who cares sincerely about the Iraqi people. Iraq needs someone who is honest yet firm, someone who is caring, yet strong. Someone who really is serious in building a country and reviving the people.
I don’t think we Americans, far away from carbombs and fear and death, can really understand what the Iraqis have been going through day after day, month after month. I hope we never shall. But when you read the Iraqi bloggers day in and day out it’s pretty clear that the security situation there has really worn them down.
Iraqi blogger arrested!
Without question the greatest cause célèbre of the year in the Iraqi blogosphere was the arrest of Khalid Jarrar. On July 12, 2005 Khalid Jarrar of Tell Me a Secret was arrested by the Iraqi secret service. His brother, Raed, posted about it here. He was detained, questioned, and released almost two weeks later. Khalid told his own story here. In the meantime it caused an enormous stir in the Iraqi blogosphere, particularly among the younger bloggers. They organized, started letter-writing campaigns, and encouraged others to lobby for his release. It was horrible and frightening but, in retrospect, a pretty proud moment for the Iraqi blogosphere. The Tragedy of the Bridge One of the most posted-on events of the year for Iraqi bloggers was the tragedy that took place on the A-Imma bridge in Baghdad on August 31. Here’s how Iraq the Model reported it:
Today Baghdad is witnessing a tragic disaster; hundreds have died and more were injured when huge crowds of pilgrims heading to the shrine of Imam Kadhom caused the fence of the A’imma bridge to collapse pushing people to fall into the Tigris river.
The news is still uncertain about the cause and casualty toll of this disaster but sources in the ministry of health say that around 640 people were killed in the incident.
The government is to blame for a large deal of the incident as they should have arranged sufficient safe pathways for the passage of the crowds especially that such ceremony had been practiced by Iraqis for so many years.
Our condolences to the families of the victims, may God give them patience.
During the time of the Sunni regimes like Saddam regime the rulers used to prevent the Shiites from commemorating their festivals for the same reasons which caused Haron to kill Imam Mosa Al-Kadhem.
The exact and same reasons of the black and hatred ideology caused the Wahabi terrorists to program today’s event. First they were firing rockets over the crowds away from the bridge then they pushed a thug between them over the bridge who shouted ‘terrorist, terrorist; there is bomber over the bridge ‘. The people when heard that run to catch him. The others tried to run away. Whether or not there was a suicidal or not the tool of death reached about 900 people.
The Interim Iraqi government should bear its own responsibility for this and there should be investigation to punish those who were unable to prevent such tragedy.
A Glimpse of Iraq provided context and background.
This story, taking place as it did at roughly the same time as the events surrounding Hurricane Katrina were unfolding on the U. S. Gulf Coast, received less attention than it deserved from the U. S. press and blogosphere. Make no mistake: this is an important story. Fear and rumors have reached the point in Iraq at which imaginary terrorists can kill more innocents than real ones do. As I see it the only real solutions to this are peace and security there and, unfortunately, those are probably some time away.
The New Constitution
For the last several months many of the Iraqi bloggers have commented on the new Iraqi constitution with a mixture of reactions. Iraq the Model and Salam Pax have done particular service in this area in some cases live-blogging the deliberations or providing hour-by-hour commentary. Here’s Iraq the Model’s post on the final discussion session with updates at 1:00pm, 1:10pm, 2:10pm, 2:55pm, 3:35pm, and 4:10pm. Salam Pax did the same thing on August 22 with a whopping 12 updates. Here’s his take on the final product:
The Shia want Shiastan, the Kurds already have Kurdistan and they have both signed a draft, which they think is agreeable to both groups. It is the rest who are being left out and are now trying really hard to fight for the scraps these two groups are throwing at them. And please don’t forget that the ignored groups include secular Arabs who are not really welcome in Kurdistan and won’t find a home in Shiastan.
What the Kurds and the Shia Coalition (grouped around the Iran friendly SCIRI) want is a weak central government which they can easily bypass and start forming their own happy states.
But where do I go?
A poster on Friends of Democracy had a similar take: the new form of government in Iraq is Kilmen Eedeh Ileh (do whatever you want).
Riverbend and The Mesopotamian weighed in today on the constitution and I linked to their posts in this week’s Carnival of the Liberated.
We don’t honestly know yet whether the new constitution will be accepted or rejected or whether, if accepted, it will be successful in preserving an Iraq worth liberating. But that will largely be up to the Iraqis.
I’m looking forward to the next year of Carnival of the Liberated and lots more Iraqi and Afghan bloggers and reading many more great posts. May the next year bring us all peace, prosperity, and freedom.
Cross-posted to Dean’s World
September 22, 2005
The Social Security Blame Game Begins
Santorum takes Bush to task over Social Security strategy, by Maeve Reston, Post-Gazette: Frustrated by Congress' failure to move on ... Social Security problems, Sen. Rick Santorum yesterday said ... the White House had made a "fundamental error" in handling its public relations campaign... Santorum, R-Pa., said he had struggled to understand President Bush's decision to come out "right after the campaign ... with this mandate that you're going to change the sacred cow of the [political] left, who've just been energized beyond belief. You've just defeated your opponent, and, you know, you take a 3-iron to the beehive ... You go out there and whack the beehive, and you wonder why all these bees are buzzing around your head. And not only do you whack the beehive, but then you don't do anything [more] for two months." Santorum … said that as soon as White House officials told him that they were going to roll out Social Security reform initiatives in 2004, he urged them to construct a plan on the order of a presidential campaign, believing that "it was bigger than anything we've tried to do." In an interview ... last evening, Santorum said he "pleaded" with administration officials to develop and launch a strategy to convey the issue's importance to the public immediately, and even to forgo Christmas breaks to ensure that a plan was in place. But the White House preferred to wait until Bush's State of the Union address Feb. 2, a strategy that made it difficult for GOP senators to build support for Social Security changes among their constituents, Santorum said. Foes of the reforms "didn't waste" the holiday breaks, he said. "They started hammering on the president, basically starting to tear this apart in December. What [the White House] needed to do immediately was what they did three months later, which was to lay out the problem and get ahead of the curve. "It's the old thing in politics: ... we sat back and let our opponents define us and define the issue," he said. "We were just playing catch up the whole time, and that was the fundamental error."… Santorum said he was continuing to getting mixed signals from House GOP leaders about whether they will move on reform legislation in the near future...
The Galveston Hurricane of 1900
"Nature will win if we decide that we can beat it."
There is an interesting and detailed account of the devastating 1900 hurricane that struck Galveston in Reference.com, including unheeded warnings to erect a seawall that might helped save some of the estimated 8,000 lives that were lost:
Galveston Hurricane of 1900 The Galveston Hurricane of 1900 made landfall on the city of Galveston, Texas on September 8, 1900. It had estimated winds of 135 miles per hour (217 km/h), making it a Category 4 storm on the Saffir-Simpson scale...
The death toll has been estimated to be between 6,000 and 12,000 individuals. The number most cited in official reports is 8,000, giving the storm the third-highest number of casualties of any Atlantic hurricane, after the Great Hurricane of 1780, and 1998's Hurricane Mitch. The Galveston Hurricane of 1900 is to date the deadliest natural disaster ever to strike the United States...
The city The city of Galveston at the end of the 19th century was a booming metropolis with a population of 38,000. Its position on the natural harbor of Galveston Bay along the Gulf of Mexico made it the center of trade in the state of Texas. With this prosperity came a sense of complacency. A quarter of a century earlier, the nearby town of Indianola on Matagorda Bay was undergoing its own boom and was second to Galveston among Texas ports. Then in 1875, a powerful hurricane blew through, nearly destroying the town. Indianola was rebuilt, but a second hurricane in 1886 caused residents to simply give up and move elsewhere. Many residents of Galveston took the destruction of Indianola as an object lesson on the threat posed by hurricanes. Galveston was a low, flat island, little more than a giant sandbar along the gulf coast. They called for a seawall to be constructed to protect the city, but their concerns were dismissed by the majority of the population and the city's government. Since its formal founding in 1839, the city of Galveston had weathered numerous storms, which the city survived with ease. Residents believed any future storms would be no worse than previous events. In order to provide an official meteorological statement on the threat of hurricanes, Galveston Weather Bureau section director Isaac Cline wrote an 1891 article in the Galveston News in which he argued not only that a seawall was not needed to protect the city, but that it would be impossible for a hurricane of significant strength to strike the island. The seawall was not built, and development activities on the island actively increased its vulnerability to storms. Sand dunes along the shore were cut down to fill low areas in the city, removing what little barrier there was to the Gulf of Mexico.
Origins The storm's origin is a bit murky due to the limited observation ability at the end of the 19th century. Ship reports were the only reliable tool for observing hurricanes at sea, and because wireless telegraphy was in its infancy, these reports were not available until the ships put in at a harbor. Like most powerful Atlantic hurricanes, the 1900 storm is believed to have begun as a Cape Verde-type hurricane - a tropical wave moving off the western coast of Africa. The first formal sighting of the hurricane's precursor occurred on August 27, about one thousand miles (1,600 km) east of the Windward Islands when a ship recorded an area of "unsettled weather". Three days later, Antigua reported a severe thunderstorm passing over, followed by the hot, humid calmness that often occurs after the passage of a tropical cyclone. By September 1, US Weather Bureau observers were reporting on a "storm of moderate intensity (not a hurricane)" southeast of Cuba.
Warning signs The year was going well for Galveston. The Texas Heroes Monument was dedicated on April 21, the anniversary of the Battle of San Jacinto. Cotton season opened on September 1, and Galveston had become the largest cotton port in the country. Labor Day came on September 3 with a parade of dockworkers and cotton stuffers.
On September 4, the Galveston office of the US Weather Bureau began receiving warnings from the Bureau's central office in Washington, D.C. that a "tropical storm" had moved northward over Cuba. The Weather Bureau forecasters had no way of knowing where the storm was or where it was going.
Conditions in the Gulf of Mexico were ripe for further strengthening of the storm. The Gulf had seen little cloud cover for several weeks, and the seas were as warm as bathwater, according to one report. For a storm system that feeds off moisture, the Gulf of Mexico was enough to boost the storm from a tropical storm to a hurricane in a matter of days, with further strengthening likely.
The storm was reported to be north of Key West on September 6, and in the early morning hours of Friday, September 7, the Weather Bureau office in New Orleans, Louisiana issued a report of heavy damage along the Louisiana and Mississippi coasts. Details of the storm were not widespread; damage to telegraph lines limited communication. The Bureau's central office in Washington, DC ordered storm warnings raised from Pensacola, Florida to Galveston.
By the afternoon of the 7th, large swells from the southeast were observed on the Gulf, and clouds at all altitudes began moving in from the northeast. Both of these observations are consistent with a hurricane approaching from the east. The Galveston Weather Bureau office raised its double square flags; a hurricane warning was in effect.
The ship Louisiana encountered the hurricane at 1pm that day after departing New Orleans. Captain Halsey estimated wind speeds of 150 mi/h.
Weather Bureau forecasters believed the storm would travel northeast and affect the mid-Atlantic coast. Cuban forecasters disagreed, saying the hurricane would continue west. One Cuban forecaster predicted the hurricane would continue into central Texas near San Antonio.
Early the next morning, the swells continued despite only partly cloudy skies. Largely because of the unremarkable weather, few residents heeded the warning. Few people evacuated across Galveston's bridges to the mainland, and the majority of the population was unconcerned by the rain clouds that had begun rolling in by mid-morning.
Local legend has it that Isaac Cline took it upon himself to travel along the beach and other low-lying areas warning people personally of the storm's approach. This is based on Cline's own reports and has been called into question in recent years.
Cline's role in the disaster is the subject of some controversy. Supporters point to Cline's issuing a hurricane warning without permission from the Bureau's central office. Detractors (including author Erik Larson) point to Cline's earlier insistence that a seawall was unnecessary and his belief that an intense hurricane could not strike the island.
Washington, D.C. Sept. 9, 1900 To: Manager, Western Union Houston, Texas
Do you hear anything about Galveston?
Willis L. Moore Chief, U.S. Weather Bureau
The last train to reach Galveston left Houston on the morning of the 8th at 9:45 am. It found the tracks washed out, and passengers were forced to transfer to a relief train on parallel tracks to complete their journey. Even then, debris on the track kept the train's progress at a crawl.
The ninety-five travelers on the train from Beaumont weren't so lucky. They found themselves at the Bolivar Peninsula waiting for the ferry that would carry them, train and all, to the island. When they arrived, the high seas forced the ferry captain to give up on his attempt to dock. The train attempted to return the way it had come, but rising water blocked its path.
By early afternoon, a steady northeastern wind had picked up. By 5 pm, the Bureau office was recording sustained hurricane force winds. That night, the wind direction shifted to the east, and then to the southeast as the hurricane's eye began to pass over the island.
One of the last messages that reached the mainland was from Cline at 3:30 pm, reporting "Gulf rising, water covers streets of about half of city." After that, the telegraph lines were cut.
The highest measured wind speed was 100 mi/h (160 km/h) just after 6 pm, but the Weather Bureau's anemometer was blown off the building shortly after that measurement. The eye passed over the city around 8 pm. Maximum winds were estimated at 120 mi/h at the time, but later estimates placed the hurricane at the higher Category 4 position on the Saffir-Simpson Hurricane Scale. The lowest recorded barometric pressure was 28.48 inHg (964.4 hPa), considered at the time to be so low as to be obviously in error. Modern estimates place the storm's central pressure at 27.49 inHg (930.9 hPa).At the Bolivar Lighthouse, ten refugees from the Beaumont train took refuge with two hundred residents of Port Bolivar. The eighty-five that stayed with the train died when the storm surge overran the tops of the cars.
By 11 pm, the wind was southerly and diminishing. On Sunday morning, a 20 mi/h breeze off the Gulf of Mexico greeted the survivors as they put aside the terror of the storm. The skies were clear as they realized what horror the cleanup would be.
The storm continued on, and was tracked into Oklahoma. From there, it continued over the Great Lakes, and passed north of Halifax, Nova Scotia on September 12. From there it travelled into the North Atlantic where it disappeared from observations.
Houston, Texas 11:25 P.M. Sept. 9, 1900
To: Willis Moore Chief, U.S. Weather Bureau
First news from Galveston just received by train which could get no closer to the bay shore than six miles where Prairie was strewn with debris and dead bodies. About two hundred corpses counted from train. Large Steamship stranded two miles inland. Nothing could be seen of Galveston. Loss of life and property undoubtedly most appalling. Weather clear and bright here with gentle southeast wind.
G.L. Vaughan Manager, Western Union, Houston
At the time of the 1900 storm, the highest point in the city of Galveston was only 8.7 feet (2.7 m) above sea level. The hurricane had brought with it a storm surge of over 15 feet (4.6 m), which washed over the entire island. The surge knocked buildings off their foundations, and the surf pounded them to pieces. Over 3,600 homes were destroyed, and a wall of debris faced the ocean.
As awesome as the damage to the city's buildings was, the human cost was even greater. Due to the destruction of the bridges to the mainland and the telegraph lines, no word of the city's destruction was able to reach the mainland. At 11am on the 9th, one of the few ships at the Galveston wharfs to survive the storm, the Pherabe, arrived in Texas City on the western side of Galveston Bay. It carried six messengers from the city. When they reached the telegraph office in Houston at 3am on the 10th, a short message was sent to Governor Joseph D. Sayers and President William McKinley: "I have been deputized by the mayor and Citizen's Committee of Galveston to inform you that the city of Galveston is in ruins." The messengers reported an estimated five hundred dead. This was considered to be an exaggeration.
The city of Houston knew a powerful storm had blown through, and had made ready to provide assistance. Workers set out by rail and ship for the island almost immediately. Rescuers arrived to find a city destroyed. Eight thousand people had lost their lives, a fifth of the island's population. Most had drowned or been crushed as the waves pounded the debris that had been their homes hours earlier. Many survived the storm itself, but died after several days trapped under the wreckage of the city, with rescuers unable to reach them.The bodies were so numerous that burial was not a viable option. Initially, the dead were taken out to sea and dumped. However, the currents of the gulf washed the bodies back onto the beach, so a new solution was needed. Funeral pyres were set up wherever the dead were found. In the aftermath of the storm, pyres burned for weeks.
More people were killed in this single storm than have been killed in the over three hundred hurricanes that have struck the United States since, combined, as of 2005.
Rebuilding Survivors set up temporary shelters in surplus US Army tents along the shore. They were so numerous that observers began referring to it as the "White City on the Beach". Others constructed so-called "storm lumber" homes, using salvageable material from the debris to build shelter.
By September 12, the first post-storm mail was received at Galveston. The next day, basic water service was restored, and Western Union began providing minimal telegraph service. Within three weeks, cotton was again being shipped out of the port.
Prior to the Hurricane of 1900, Galveston was considered to be a beautiful and prestigious city and was known as "the New York of the South." Only the nation's wealthiest were allowed to live there. Many people say that had it not been for the hurricane, Galveston would today be one of the nation's largest and most beautiful cities. However, development shifted north to Houston, which was enjoying the benefits of the oil boom. The dredging of the Houston Ship Channel in 1909 and 1914 ended Galveston's hopes of returning to its former state as a major industrial center.
Protection To prevent future storms from causing destruction like that of the 1900 hurricane, many improvements to the island were made. The first three miles (4.8 km) of the 17 foot (5.2 m) high Galveston Seawall were built beginning in 1902 under the direction of Henry Martyn Robert. An all-weather bridge was constructed to the mainland to replace the ones destroyed in the storm.
The most dramatic effort to protect the city was its raising. Dredged sand was used to raise the city of Galveston by as much as 17 feet (5.2 m) above its previous elevation. Over 2,100 buildings were raised in the process, including the 3000 ton St. Patrick's Church. The seawall and raising of the island were jointly named a National Historical Civil Engineering Landmark by the American Society of Civil Engineers in 2001.
In 1915, a storm of similar strength and track to the 1900 hurricane struck Galveston. The 1915 storm brought a 12 foot (4 m) storm surge which tested the new seawall. Although 275 people lost their lives in the 1915 storm, this was a great reduction from the thousands that died in 1900.
The Galveston city government was reorganized into a commission government, a newly devised structure where the government is made of a small group of commissioners, each responsible for one aspect of governance. This was prompted by fears that the existing city council would be unable to handle the problem of rebuilding the city.
Today Galveston is considered the playground of Houston. Homes and other buildings that survived the hurricane have been preserved, and give much of the city a Victorian look. The seawall, since extended to ten miles (16 km), is now an attraction itself, as hotels and tourist attractions have been built along its length in seeming defiance of future storms.
The last reported survivor of the Galveston Hurricane of 1900, Mrs. Maude Conic of Wharton, Texas, died November 14, 2004 at the claimed age of 116. (However, census records indicate she was younger than that).
Modern observation and forecasting help ensure that if another storm of similar strength threatens Galveston, the city will not be caught by surprise.
"Nature will win if we decide that we can beat it."
— Bill Read, NWS Galveston, Isaac's Storm documentary
Posted by Mark Thoma on Thursday, September 22, 2005 at 04:14 AM in Economics
Using Fiscal Policy to Stabilize the Economy
Furthermore, in stabilization policy, it’s also not possible in the long-run to use both government spending and taxation at opposite points in the business cycle. That is, suppose you cut taxes during the bad times, then cut spending during the good times to pay it back. That will work for a recession or two, a hurricane or two, but it won’t work forever because eventually there will be nothing left to cut out of government. The opposite will not work forever either. If you increase spending during the bad times then increase taxes during the good, the size of government will grow indefinitely over the long-run. In more graphic form:
G↑ (rec) → T↑ (boom) → G↑ (rec)→ T↑ (boom) → G↑ (rec) → T↑ (boom) → bloated government
T↓ (rec) → G↓ (boom) → T↓ (rec)→ G↓ (boom) → T↓ (rec) → G↓ (boom) → no government
These two policies, or some combination of them (increase G and cut T in recessions, do the opposite in booms) are sustainable:
G↑ (rec) → G↓ (boom) → G↑ (rec) → G↓ (boom) → G↑ (rec) → G↓ (boom) → sustainable size of government
T↓ (rec) → T↑ (boom) → T↓ (rec) → T↑ (boom) → T↓ (rec) → T↑ (boom) → sustainable size of government
The Democrats are accused of adopting the first strategy and bloating the government. The Republicans claim to adopt the second strategy to shrink government, but they’ve bloated government themselves (take the second line and change it to T↓ (rec) → G↑ (boom) → etc., a clearly unsustainable path). Neither party seems willing or able to use either the third and/or the fourth lines as a means of stabilizing the economy. We are seeing that now, and maybe even less stable budgetary variations. The WSJ and other members of the GOP seems to advocate T↓ (rec)→ T↓ (boom) → etc. which, without cuts in G, cause deficits rise no matter how much they claim otherwise.
There are, of course, lots and lots of variations on these basic chains of events, e.g. to adjust the size of government the first or second strategies can be adopted temporarily, and you hope lawmakers would put all their cards on the table as they do so whichever direction government size is to be adjusted. But fiscal policy that is sustainable in the long-run, through recession after recession, natural disaster after natural disaster, war after war, has to adopt some combination of the third and fourth lines. Simply cutting taxes whenever and wherever possible gets us into the predicament we are now in. But those who try and adopt responsible budget practices face stiff opposition:
A GOP Tax Increase?, WSJ: ...Markets have begun to get rattled in the last couple of days, both in fear of further damage in the Gulf region from Hurricane Rita, and in response to the bad ideas that are starting to flow fast and furious from Congress. These include ... a revival of the oil "windfall profits" tax. ... But the worst news is that a handful of GOP Senators think a tax increase is needed to pay for Katrina spending. ... some GOP Senators are suggesting that they should redo reconciliation and drop the capital gains and dividend tax cuts. ... We can understand why some Democrats would want Republicans to repudiate their own tax policies. But why Republicans would want to join in this act of masochism is a mystery. President Bush has ruled out tax increases to finance Katrina relief, but we hope someone in the White House is telling him what members of his own party are doing in the Senate. Katrina has already done enough damage, without the political class compounding it with policy blunders.
The political climate makes it unlikely, but some combination of the third and fourth lines during the recovery period is the best way out of our budget predicament. There are certainly places government can be cut or made more efficient. But cuts alone aren't enough and tax increases of one sort or another are also needed.
A Selection of Timely Views
Voters' Remorse on Bush, by Bob Herbert, NY Times Columnist: Maybe, just maybe, the public is beginning to see through the toxic fog of fantasy, propaganda and deliberate misrepresentation that has been such a hallmark of the George W. Bush administration, which is in danger of being judged by history as one of the worst of all time. Mr. Bush's approval ratings have tanked as increasing numbers of Americans worry that their president, who seems to like nothing better than running off to his ranch to clear brush and ride his bike, may not be up to the job. ... Reality is caving in on a president who was held aloft for so long by a combination of ideological mumbo-jumbo, the public relations legerdemain of Karl Rove and the buoyant patriotism that followed the Sept. 11 attacks. ...Remember, there was already a war going on when Katrina came to call. I've always believed that war is a serious matter. But the president was on vacation. Dick Cheney was on vacation. And Condi Rice was here in New York taking in the sights and shopping for shoes. That Americans were fighting and dying on foreign soil was not enough to demand their full attention. ... So it's no wonder it took a good long while before they noticed that a whole section of America had been wiped out in a calamity of biblical proportions. ...Americans are finally catching onto ... the utter incompetence of this crowd. And ... that incompetence has bitter consequences. The body count of Americans killed in Iraq has now passed 1,900, with many more deaths to come. But ... The White House hasn't the slightest clue about what to do. So the dying will continue. ... Mr. Bush never sent enough troops to get the job done, and he never provided enough armor to protect the troops that he did send. Thin-skinned, the president got rid of anyone who had the temerity to suggest he might be wrong ... Here at home, even loyal Republicans are beginning to bail out on Mr. Bush's fiendish willingness to shove the monumental costs of the federal government's operations - including his war, his tax cuts and his promised reconstruction of the Gulf Coast - onto the unsuspecting backs of generations still to come. There is a general sense now that things are falling apart. ... This is what happens when voters choose a president because he seems like a nice guy, like someone who'd be fun at a barbecue or a ballgame. You'd never use that criterion when choosing a surgeon, or a pilot to fly your family across the country... the next time around, voters need to keep in mind that beyond the incessant yammering about left and right, big government and small, Democrats and Republicans, is a more immediate issue, and that's competence.
Next, David Brooks:
Kerry and Edwards, 2005, by David Brooks, NY Times columnist: John Kerry and John Edwards ran for office together and they lost together, and they both gave major speeches about Katrina this week, but there the similarity ends. The two men might as well live in different worlds. Kerry began his speech by making the point that Bush and his crew are rotten. He then went on to make the point that Bush and his crew are loathsome. In the third section of the speech, Kerry left the impression that Bush and his crew are evil. Now we all know people so consumed by hatred for George Bush that they haven't had an unpredictable thought in five years, but in Kerry's speech one sees this anger in almost clinical form... All reality flows back to Bush. All begins with Bush, ends with Bush, is explained by Bush and is polluted by Bush, cursed be thy name...
John Edwards's speech had a different feel. Edwards took some hard shots at Bush, some of them deserved, but having left Washington after the election, Edwards is not so obsessed with power struggles. In his talk he roamed outward and spoke about the complexities of actual life. He mentioned that the typical white family has about $80,000 in assets, while the typical Hispanic family has about $8,000, and the typical African-American family has about $6,000. That's an astonishing gap. ... He concluded with a series of policy recommendations fit for the post-welfare-reform world. No conservative would agree with all of them, but nobody could fail to find them interesting. ... Edwards proposed a series of policies designed to encourage work, to encourage responsibility, to help the poor build assets. The Kerry-Edwards contrast is characteristic of the argument that now divides the Democratic Party. On one side are those who believe that the party's essential problem is with its political style. The Republicans win because they are simply rougher, so the Democrats must be just as tough in response. They must match Karl Rove blow for blow. ... On the other side are those who believe that the Democratic defeats flow from policy problems, not from campaign style or message framing. They don't believe that Democrats can win wrapped in their own rage... For them, the crucial challenge is to come up with policies more in tune with voters. Kerry speaks for the first group, which believes in more partisanship, and Edwards for the second, which believes in less. I have discussions with my Democratic friends over whether the party will snap back to Clintonite centrism after the polarizing Bush leaves town. Some think yes. I suspect no...
For what it’s worth, I think it’s both. Democrats can be tougher advocates of well formulated, rational, innovative policy.
Divine Coincidence is Unlikely
"Real Wage Rigidities and the New Keynesian Model," Olivier Blanchard and Jordi Gali, September 9, 2005: Abstract Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model, the absence of non trivial real imperfections. We focus on one such real imperfection, namely real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation-unemployment relation found in the data.
Issues in IMF Reform
How to reform the IMF, New Economist: The International Monetary Fund, once the pre-eminent multilateral financial institution, faces an identity crisis. How to make it strong and effective again? Ahead of this weekend's World Bank-IMF annual meeting, the Institute for International Economics has organised a one-day Conference on IMF Reform. A 93 page background paper for tomorrow's event, by Edwin M Truman, is now available: International Monetary Fund Reform: An Overview of the Issues (PDF). Truman argues that "the IMF is in eclipse" and "consequently, the world is worse off. Despite the considerable reforms over the past decade, more should be done." But simple measures won't not enough - reform is needed across a range of areas:
No single step or magic formula will restore the IMF to its prior position as a highly respected institution. Effective reform of the IMF must encompass many aspects of the IMF’s activities—where it should become more as well as less involved. Over the past decade, a large number of changes in the international financial architecture and in the IMF’s operations have been put in place. Those reforms have not been sufficient to restore the IMF to the center of today’s international monetary and international financial system, assuming that was the intentions of the reformers. Successful reform of the IMF must engage the full spectrum of its members. The IMF should not focus primarily on its low-income members and the challenges of global poverty. It should not focus exclusively on international financial crises affecting a small group of vulnerable emerging market economies. Instead, it must be engaged with each of its members potentially on the full range of their economic and financial policies emphasizing primarily those policies that impact the functioning of the global economy.
A major priority is IMF governance. An equally important priority is to upgrade the IMF’s role in the international monetary system. In addition, improvements should be made in IMF lending operations, and the IMF must be pulled back from becoming just another development financing institution. The IMF’s financial resources will soon need to be augmented.
September 21, 2005
Grassley: Katrina Killed Social Security Reform for This Year
Grassley: Social Security reform will wait, by Jane Norman, Des Moines Register: Ongoing battles in Congress over hurricane relief, tax cuts and spending likely mean that proposals to revamp Social Security are dead until next year, Senate Finance Committee Chairman Charles Grassley, R-Ia., said Tuesday. Grassley ... acknowledged that putting the debate off until 2006 and a midterm election year means it would be "very difficult" to accomplish any major changes, including the voluntary personal accounts for Social Security championed by President Bush. But Grassley ... said that Social Security will have to take a back seat this fall to hurricane-related legislation and possibly prolonged negotiations over the budget and tax cuts. "If we're going to adjourn by Thanksgiving, it's probably not going to be handled this year," said Grassley … He said he has heard little from other committee members about Social Security in recent weeks...
Wooden stake or not, it sounds like next year will bring the return of the living dead ("They're back...They're Hungry...And they're NOT vegetarian").
The Economist: Central Banking is Hard
Reluctant party-poopers, The Economist: William Mcchesney Martin, a past chairman of America’s Federal Reserve, famously observed that the job of a central banker is to “take away the punch bowl just when the party is getting started”. Unsurprisingly, this often generates quite a bit of hostility from the party-goers, who would prefer a few more shots of low interest rates ... This accounts for the tendency of many central bankers ... to err on the side of easy money, resulting all too often in double-digit inflation. Of course, if the party gets out of hand, and the house is wrecked, the central banker can expect to come in for plenty of censure, even from those who were previously begging him to give them just one more for the road. After the excesses of the 1970s, and the hangover of the early 1980s, ... Twenty years on, most developed countries seem to have built a solid reputation for inflation-fighting... And yet this is a worrying time to be a central banker. Though global economic growth is strong and inflation tame, powerful imbalances are building beneath the surface, and they threaten to throw the world economy off course. The fight against inflation is, it turns out, just one battle in a wider war.
…the Fed’s Alan Greenspan … now finds himself deep in uncharted waters. After cutting short-term interest rates to just 1% to help ease the country out of the 2001 recession, he has been raising them at a measured pace, trying to keep the economy from overheating. The Fed’s hawkish credibility, along with cheap goods from China and other low-wage countries, has helped to keep consumer-price inflation relatively tame despite exceptionally loose monetary policy. Asset-price inflation is another story. … America’s … housing market looks decidedly frothy. Consumers … are dangerously overstretched and vulnerable to any change in interest rates. A sharp correction in the housing market could give the economy convulsions. There are similar worries in Britain … The Bank of England left rates unchanged this month, but with fears growing that economic expansion will fall short of expectations, it may soon have to choose between fighting inflation and staving off Britain’s first recession in over a decade.
The Fed may well face the same tough choice. Hurricane Katrina roared into already tight oil markets, damaging much of America’s oil-pumping and -refining capacity, and another hurricane, Rita, threatened to wreak more havoc along the Gulf coast this week. … this has led to renewed talk of stagflation, a central banker’s worst nightmare. ... So far, there is little evidence of real danger. But given that higher energy prices generally boost inflation and shrink demand, it is not unreasonable to worry about the future.
Yet Mr Greenspan and Mervyn King, the Bank of England’s governor, have it easy compared with Jean-Claude Trichet, the head of the ECB... Mr Trichet presides over a currency zone more diverse than America’s, but without the fiscal stabilisers that help smooth over regional variations. In 2004, Portugal’s economy grew by 1%, Ireland’s by almost 5%, but both had the same nominal interest rate. This has the perverse effect of giving higher real ... interest rates to slow-growing, low-inflation countries, and lower real rates to booming economies with rapid inflation—precisely the opposite of what a sound monetary authority would prescribe. … Moreover, the euro area as a whole has grown slowly ... Critics say that the ECB, which has left interest rates unchanged at 2% for more than two years, is paralysed, unable to look beyond its inflation-fighting mandate to deal with Europe’s economic malaise.
The reality is more complicated. The euro area’s economic woes have much more to do with tight fiscal policy and structural rigidities in its markets ... Real interest rates have actually been near zero in the euro area for much of the past two years, making monetary policy relatively loose. ... And the ECB, like its American and British counterparts, must contend with high oil prices pushing up the inflation rate and hindering growth. In Asia, too, central bankers are having to deal with the fallout of higher oil prices. ... China’s central bank faces a different set of problems. To keep the yuan cheap enough to subsidise China’s massive export industries, it has had to buy billions of dollars and pour them into American bonds. The longer this goes on, the more vulnerable the bank is to a fall in the value of the dollar, ... But fears of the domestic political unrest that might occur if the export sector faltered keep the bank from reducing its exposure to the dollar. Moreover, the massive currency operations create domestic inflationary pressure, which the bank struggles to contain given the primitive state of China’s financial markets. No matter where you are, it seems, being the central banker is no party.
By getting its fiscal house in order and coming up with a credible plan to reduce the deficit, the U.S. could do a lot to ease global economic uncertainty.
IMF: US Must Raise Taxes to Eliminate Fiscal Imbalance
IMF seeks US tax rises to meet fiscal problems, by Andrew Balls, FT: The International Monetary Fund has said that the Bush administration's plans to halve the US fiscal deficit over four years are too modest and called for tax increases to tackle longer-term fiscal problems. In its annual report on the US economy, the IMF said that even if the administration's target of halving the deficit over four years was achieved, the deficit and government debt would still be too high in the face of the added burden on Social Security and Medicare created as “baby boomers” start to retire. The report, released late on Friday, said the US should consider measures for broadening the tax base for households and businesses, including a federal sales tax or VAT, and higher taxes on energy use. … The IMF has stressed in other recent reports that the US budget deficit and reliance on foreign capital are a big source of risk in the international economy, and could prompt a disorderly decline in the dollar. … It said that budget discipline would be aided by restoring pay-as-you-go (PAYGO) budget rules, used during the 1990s, which required that spending increases or tax cuts be offset elsewhere in the budget…
Katrina is a non-recurring budget item, at least let’s hope so. It will be used as a reason to eliminate programs with recurring commitments, and perhaps pork and non-recurring items as well, but even then it won’t be enough to solve the problem. Program cuts alone will not do it. For those who say that’s incorrect, all I ask is that you put an explicit and politically feasible list of program cuts on the table to back up your claim.
The Global Dearth of Investment
Don’t blame the savers, The Economist: …America’s fiscal profligacy … contribut[es] to the imbalances that currently threaten the health of the world economy. That is precisely the verdict of the newly released chapter on savings and investment in the International Monetary Fund’s World Economic Outlook. The document highlights the danger posed by the world economy’s heavy dependence on ravenous American consumers to snap up exports from the rest of the world. To be sure, it is hard to be too gloomy. … world GDP is still growing at an above-average clip. ... But dark clouds have been gathering on the horizon for some time. Emerging-market economies, particularly in Asia, are running high current-account surpluses, keeping their economic fires stoked with a steady stream of exports, especially to America. In mirror image, America’s current-account deficits have soared past 5% of GDP. Household savings have dwindled to negligible levels as Americans have run down assets and taken on debt to keep the spending binge going. Yet if the American consumer falters, as things stand now, the rest of the world will tumble too. Moreover, economists are increasingly worried that America’s economic health … rests on a housing market that looks decidedly bubbly. … But if economists are agreed that America’s debt levels are dangerous, they cannot agree on whom to blame. … the government’s profligate budget deficits … which run down national savings. …[or] … spendthrift consumers, … the frothy housing market, and … a “global savings glut” … pouring excess capital from abroad, particularly Asia, into America’s financial markets...
America is not the only country where savings have fallen. Worldwide savings began declining in the late 1990s, hitting bottom in 2002. They have recovered only modestly since then. The drop is mainly due to industrial countries, where savings and investment have been on a downward trend since the 1970s... Savings in emerging markets and oil-producing countries have risen over that period, but not enough to reverse the trend. So why the sudden talk of a savings glut? ... The IMF report offers an explanation. What the world is suffering from is not so much a savings glut as an investment deficit, in both rich and poor countries. In emerging markets and oil-exporting nations, still feeling the lingering effects of the Asian financial crisis of 1997-98, demand for capital has failed to keep up with supply. Scrimping consumers have instead sent their money to the West. The IMF’s figures suggest that this is not as irrational as it seems. … investments in emerging markets are riskier, because their economies tend to be more volatile and their institutions weaker. Moreover, … the IMF’s analysis suggests that the internal rate of return ... in emerging markets has been very poor over the past decade, even before currency risk is taken into account. But investment has fallen in the rich world too: the rivers of capital have flowed not directly into businesses but into markets for consumer and government credit, where they are presumably doing little to increase the recipient economy’s ability to repay the loans in the future… So what is the cure? Lower savings rates in emerging markets? That would be a disaster, according to a new report from the World Bank … Like the World Bank, the IMF does not think lower savings rates in developing countries are the answer. It identifies several other things that could make a difference: higher national savings in the United States, an investment recovery in Asia, and an increase in real GDP growth in Japan and Europe. Easy to say, difficult to pull off. Raising interest rates would, the IMF concedes, have only a limited effect on America’s savings rate. Balancing the budget would do more, but there seems to be little political will to tell Americans they must pay for their government programmes. Across the Atlantic, European governments are finding it hard to make the kind of structural reforms that could boost their sluggish growth rates, and the European Central Bank has remained unwilling to provide monetary stimulus by cutting rates. Nor has Japan’s government, despite the signs of fledgling recovery, yet found a formula for boosting its long-term growth rate. It is easier to diagnose the illness than effect a cure.
Searching for the GoogleNet
I, for one, welcome...oh, you know the rest, by Ian, Truck and Barter: Looks like Google's getting ever-closer to a rumored "GoogleNet": a wifi system stretched over the country, giving free access for the price of living through directed advertising. And if you ever use Local.Google.Com, you'll get an idea of just how directed it could get. ("Click here to get directions to the biggest clothing sales going on withing 1.5 miles of you!") Google has been busy buying up dark and underused fiber-optic backbone infrastructure, and has now rolled out its wifi system across San Francisco, complete with a free (beta) secure access program...
Thomas Friedman: Use Gas Tax to Move the U.S. Toward Energy Independence
Bush's Waterlogged Halo, by Thomas Friedman, NY Times: Following President Bush's speech in New Orleans, many U.S. papers carried the same basic headline: "Bush Rules Out Raising Taxes for Gulf Relief." The president is planning to rely on "spending cuts" instead to pay for rebuilding New Orleans. Yeah, right - and if you believe that, I have some beachfront property in Biloxi I'd like to sell you. The underlying message of all these stories is that the Bush team sees no reason to change course in response to Katrina.
I beg to differ. Katrina deprived the Bush team of the energy source that propelled it forward for the last four years: 9/11 and the halo over the presidency that came with it. The events of 9/11 created a deference … That deference is over. If Mr. Bush wants to make anything of his second term, he'll have to do his own Nixon-to-China turnaround, reframe the debate and recast the priorities of his presidency. He seems to think that by offering to spend billions of dollars to rebuild one city, New Orleans, he'll get his leadership halo back. Wrong. Just throwing more borrowed money at New Orleans is not leadership. Mr. Bush needs to frame a new agenda ... And what should be the centerpiece of a policy of American renewal is blindingly obvious: making a quest for energy independence the moon shot of our generation. The president should have done that on the morning of Sept. 12, 2001. The country was ready. But the president whiffed. Katrina - nature's 9/11 - has given him a rare do-over. Imagine - I know it is a stretch - that the president announced tomorrow that he wanted an immediate 50-cents-a-gallon gasoline tax - the "American Renewal Tax," to be used to rebuild New Orleans, pay down the deficit, fund tax breaks for Americans to convert their cars to hybrid technology or biofuels, fund a Manhattan Project to develop alternatives for energy independence, and subsidize mass transit systems for our major cities. And imagine if he tied this to an appeal to young people to go into science, math and engineering for the great national purpose of making us the greenest nation on the planet, to help liberate us from dependence on the worst regimes in the world for our oil …
Americans will change their long-term energy habits, and companies will develop green products, only if they are certain the price of gasoline will not go back down. A gasoline tax … and stronger regulation would force U.S. companies to innovate in what is going to be one of the most important global industries in the 21st century: green technologies. By coddling our auto and industrial companies when it comes to mileage standards and the environment, all the Bush team is doing is ensuring that they will be dinosaurs and that Chinese, Japanese and Indian companies will take the lead in green technologies … Look what Jeff Immelt, the C.E.O. of G.E., said: "America should strive to make energy and environmental practices a national core competency and by doing so, create exports in jobs. ..." Setting the goal of energy independence, along with a gasoline tax, could help to solve so many of our problems today - from the deficit to climate change and national security. And Americans would pay it if they thought the extra money was going to renew America, not Iran, and not just New Orleans. And if the Texas-oilman president became the energy-independence president - now, that would snap heads and make this a truly relevant presidency. No way, you say. Probably right. But either Mr. Bush does a Nixon-to-China or his next three years are going to be a Bush-to-Nowhere.
September 20, 2005
FOMC Raises Target Rate 25 bps to 3.75%
For immediate release
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 percent.
[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.]
Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.
While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.
[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.]
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.
[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.]
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting...
[Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern...]
When the minutes are released, it will be interesting to see how much disagreement there was regarding the rate increase during the discussion, particularly since it's traditional for the committee to support the proposal as a group even when there are individual differences regarding policy. But as it stands, the message is to expect more rate increases in the future unless incoming data change the committee's current economic outlook.
[UPDATE: William Polley comments here. David Altig at macroblog weighs in here. New Economist is here. Tim Duy's Fed Watch prior to the meeting 9/18, 9/13, 9/5, and 8/30. Washington Post, NY Times, CNN Money, Bloomberg, WSJ]
UPDATE: The Washington Post notes evidence in the symbolic vote to raise the discount rate to 4.75% (see the press release) in order to maintain a 1% spread relative to the target federal funds rate that five bank presidents appear to have been willing to let the target rate stand at 3.5%:
Fed board member Mark W. Olson voted against the move, saying he preferred to leave the rate unchanged -- the first dissent on the committee since June 2003. More members came to the meeting open to Olson's position; only seven of the 12 regional Fed banks had requested a similar quarter-percentage point increase in the largely symbolic discount rate to 4.75 percent -- a sign that five banks would have been content with no increase in the funds rate either.
As David Altig at macroblog notes, this needs to be interpreted with caution.
UPDATE: Macroblog notes further discussion:
The statement parsed, at The Big Picture. The Capital Spectator sees the possibility of more of the same, and deeper trade deficits as a result. William Polley thinks "5% by summer is a real possibility." The Skeptical Speculator does its usual fine job of putting things in an international perspective. The Prudent Investor says the FOMC's press release "the confident and complacent tone of previous statements". Forex Rate Currency News characterizes the rate increase as "sheer relief".
Understanding the Tax Reform Debate
I’m happy to report that it appears to be a straightforward presentation of the economics of tax reform. The presentation is balanced, non-technical, understandable, and it touches on all the issues surrounding reform such as efficiency, equity, transition costs, simplicity, transparency, administratibility, and so on. In fact, it might be good reading for the president and congress. Here are a few passages:
Federal borrowing has advantages and disadvantages that vary depending on economic circumstances. Borrowing, in lieu of higher taxes or lower government spending, may be viewed as appropriate during times of economic recession, war, or other temporary challenges. Federal borrowing might also be viewed as appropriate for federal investment, such as building roads, training workers, and conducting scientific research, that contributes to the nation’s capital stock and productivity. If well chosen, such activities could ultimately help produce a larger economy. However, if not well chosen, such spending could displace more productive private sector investments.
Federal borrowing also can impose significant costs and risks. Borrowing for additional spending or lower taxes for current consumption improves short-term well-being for today’s workers and taxpayers, but does not enhance our ability to repay the borrowing in the future. In the near term, federal borrowing also absorbs scarce savings available for private investment and can exert upward pressure on interest rates. Over the long term, federal borrowing that restrains economic growth will also restrain the standard of living of future workers and taxpayers.
Regardless of the assumptions used, reasonable long-term simulations indicate that the problem is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. While entitlement reform as well as mandatory and discretionary spending cuts will likely be needed to close the longterm financial gap, the structure of the tax system should also be part of the debate as policymakers grapple with the nation’s long-term fiscal challenge. As part of this process, consideration could be given to improving taxpayer compliance and enforcement efforts, expanding the tax base, increasing current tax rates and tax rates on future generations, or a combination of these.
And, from another section on efficiency considerations:
Work versus leisure: Taxes—both income and consumption taxes—can affect the decisions that people make about how much time to devote to work or leisure in two ways. First, taxes may increase the incentive to work because workers must work more to maintain their after tax income. Second, taxes may reduce the incentive to work because workers earn less from an additional hour of work. The net effect may be no change to the overall supply of labor. However, even in this case, there is still an efficiency cost, which is determined by the second effect. By reducing hourly after tax earnings, income and consumption taxes distort decisions about how many hours to devote to work or leisure. Empirical research generally shows that at least for primary wage earners, decisions about labor force participation are not very responsive to taxes. However, decisions about labor force participation by secondary wage earners have been shown to be more responsive to changes in the tax system.
There are other tables, figures, and explanations as well. For example, here’s where taxes come from, like it or not:
Here's who pays at the federal level:
And here is where the money goes and how it has changed over time. According to this, the main feature evident over time is the conversion of national defense into Social Security, Medicare, and Medicaid. Whether that is good or bad will vary according to who you ask:
The document also talks about popular and, I suppose, unpopular tax reform proposals:
Though I'd quibble in places, all in all it is a useful guide to understanding the issues surrounding the tax reform debate.
The US-North Korea Arms Deal: Why Now?
China's role in North Korea talks, Simon World: After years of failed talks, finally agreement is reached with North Korea over its nukes. The onus remains on the North Koreans to live up to their end of the bargain, but that's by the by. Far more interesting is what happened to force the issue? Why now? The North Koreans are lavishing praise on their Chinese hosts. China's leadership remains petrified of a collapse of North Korea and the massive influx of refugees likely should that happen. Nor did it fancy the alternative of a potential American led invasion, leading to American troops literally on the border. China has always held the whip hand in the talks. For example China supplies most of North Korea's electricity at friendly rates. Having North Korea annoy the Americans served as a useful foil for China and it kept Japanese and South Korean minds focussed on the threat from the North Koreans rather than any possible threat from China. But more recently both America and Japan have started viewing the potential strategic threat from China as a seperate issue from the Korean one. The North Korean problem turned from an asset to a liability. So China saw the light, so to speak, and realised a resolution of the Korean nuclear issue was also in its interest. It doesn't hurt that this makes the Chinese look like world statesmen and foreign policy players (albeit in their own backyard), just as negotiations over the UN Security Council and talks about China's emerging superpower role are all the rage. It's no co-incidence that as soon as China got serious about the nuclear talks, so did North Korea. The key question is whether China can make the North Koerans deliver on their promises given the deserved scepticism that abounds.
Further Reading: Chris has a good summary of various reactions to the North Korea deal. Sean says Japan isn't entirely happy with the results. North Korean talks leave questions unanswered. The full text of the statement at the end of the talks.
Everything You Ever Wanted to Know About the FOMC, and More…
Come with Me to the FOMC , Lawrence H. Meyer:…Now some historical background. The Federal Reserve Act, passed in 1913, was "virtually devoid of policy prescriptions" and there were, in particular, no guidelines for the conduct of open market operations. The role of the Federal Reserve was viewed as more passive than active. The emphasis was on the provision of currency and reserves to meet seasonal demands and on assisting the banking system to accommodate the needs of commerce and business … the discount rate and the discounting of eligible bank loans were the central tools of the Federal Reserve in the early days.
The impetus for open market operations was the experience in the early 1920s when bank rediscounting had declined to a very low level and the Federal Reserve Banks needed another source of revenue to cover their costs of operation. The Federal Reserve … does not receive an appropriation from the Congress. Instead, it earns enough from its operations to cover its expenses and returns any surplus to the Treasury. We credit Treasury on a weekly basis. In the absence of revenue from its rediscounting operations, the Reserve Banks began to purchase government securities…
As they came to appreciate the need for coordination … they established, beginning in 1922, a series of committees to manage and coordinate these operations. The committees, initially consisting of five Federal Reserve Bank Governors (the equivalent today of Federal Reserve Bank Presidents), made recommendations about open market operations which were then subject to the approval of the Board of Governors. However, even if approved by the Board, the Reserve Banks were not required to carry them out. Very messy, very cumbersome, and very unsatisfactory--though, in practice, the Reserve Banks did, in most cases carry out the operations recommended by the committee and approved by the Board.
After a lengthy debate, the Congress decided to establish the FOMC in its present form in 1935. The Reserve Banks were thereby required to carry out the operations as directed by the FOMC. ... The FOMC is a mix of Presidential appointees--the seven Governors--and Reserve Bank presidents who are selected by their respective Boards of Directors subject to approval by the Board. The Boards of Directors of the Reserve Banks have nine members, six of whom are selected by the member commercial Banks in the respective Districts and the remaining three are selected by the Board of Governors. The FOMC is therefore a blend of a national board and regional input of private and public interests…
Now, he moves on to the detailed look at an FOMC meeting (I cut pages and pages out of this, such as what day documents arrive at his house, but I should warn you that it's still pretty long):
So come with me to the FOMC.
It is 9 am on one of eight days, usually Tuesdays, during the year when the FOMC meets. The Federal Reserve Act mandates that there be at least 4 meetings each year and the number of meetings has varied from 4 to 19 over the years. Since 1981, the FOMC has met 8 times each year. Meetings generally begin at 9 am and continue until about noon to 1 pm. Twice each year, prior to the Humphrey-Hawkins report and testimony, the FOMC meets over a two-day period. But I am getting ahead of myself. Our first meeting will be of the one-day or more precisely one-morning variety...
I will never forget the first time I entered the Board room to take my place around the table. Each member appreciates the heavy responsibility the Committee has for the economic well-being of the country and the importance of their personal participation in this process. ... Serving on the FOMC is, without question, the most important responsibility I could have for which this career has prepared me.
As you enter the Board room, you will undoubtedly be struck by the impressive size of the oval table--27 feet ½ inch long and 10 feet 11 inches at its widest point. Members of the Committee and staff are milling around, greeting each other, but generally not talking much shop at this point. Just before 9 am everyone moves to their respective chairs, just as the chairman, Alan Greenspan, walks in to take his place at one end of the table. The Chairman, by the way enters from a door that connects to his office, one of the perks of being Chairman. I, on the other hand, have had to walk down the long corridor to enter through the main door of the Board room.
To the Chairman's right is the Deputy Secretary of the FOMC. To the right of the deputy secretary is the President of the Federal Reserve Bank of New York ... The remaining Governors of the Board sit in a pre-established order. Just so they don't get it wrong, their names appear on plaques on the chairs. ... The Reserve Bank presidents then sit around the table in a prescribed order that no one can seem to remember the logic for.
Only five of the presidents vote at a given meeting. The voting members are established at the beginning of each year. Initially, the Banks were separated into three groups of two and two groups of three, with one representative from each group selected by their boards of directors. In practice, that meant a rotation of each bank, some every other year and some every third year. But the New York Bank's position was deemed so important … that the President of the New York Fed was, in practice, always selected as a voting member of the FOMC. The unfortunate President of the Boston Fed, the other member of that two-group, therefore, never got to vote. That was, after some experience, judged to be unfair to Boston and the Congress amended the law in 1942 to make the New York Bank a permanent member of the FOMC and to put the Boston Bank into one of the other groups, leaving three three-groups and one two-group to govern rotations of the remaining eleven presidents.
Senior staff of the Board and of the New York Federal Reserve Bank sit at the far end of the table. I will introduce them as they participate in the meeting. In addition, sitting in chairs around the outer walls of the room are additional staff from the Board and the Reserve Banks. Each President, except for the one from New York, is accompanied by one staff member, usually the Bank's Director of Research. The New York delegation includes, in addition, two officers from the Open Market Desk and the Committee's Deputy General Council. Additional senior staff at the Board attend the meetings also. It is rare that any of these attendees speaks at the meeting, although there are specialists in key areas that are there in case they might be needed. Access to the FOMC meeting as well as to the material presented to the Committee in preparation for the meeting is carefully and strictly limited…
The Chairman calls the meeting to order and we are under way. The green light goes on in front of the deputy secretary, indicating that the meeting is being recorded. The first order of business is approval of the minutes of the previous meeting. ... Quite often, small changes are made in advance of the meeting. The minutes are then almost always routinely accepted by vote at the start of the meeting.
The first substantive agenda item is a presentation by the Manager of the System Open Market Account at the Federal Reserve Bank of New York ... His presentation covers developments in the domestic financial and foreign exchange markets and provides details of open market operations and any foreign exchange rate intervention during the period since the last FOMC meeting. … Up next is the Director of Research and Statistics at the Board … who presents the Board staff's forecast. He may share the honors with the Director of the Division of International Finance, … especially when international developments are particularly important in shaping the economic outlook, as has been the case from the onset of the Asian crisis…
The forecast is put together by a group of about 25 staff members, beginning about 10 days before the FOMC and usually concluding the Wednesday before the meeting. It is circulated at the Board early on Thursday and arrives at the Reserve Banks during that day. It is a judgmental forecast, constructed with the help of a variety of equations … The staff appreciates that its role is not to forecast or prejudge the policy decisions of the Committee. ... The forecast … reflects the staff's assessment of how the economy will evolve in the absence of any change in policy today or at subsequent meetings over its forecast horizon, which typically includes the remainder of the current year and the following year. This can be a very effective device for making decisions about policy. The FOMC gets the staff's view of what will happen if there is no change in policy and if they judge this outcome both credible and unsatisfactory, they have the necessary motivation for action to change policy. However, on those occasions where it appears clear that a constant funds rate would be greatly at variance with the Committee's objectives, the staff will incorporate into the forecast some judgment about the change in the funds rate over the forecast horizon.
Whose forecast is this? …it is very clear today that the forecast is the staff's independent judgment. That judgment is, to be sure, influenced, as is appropriate, by ongoing discussions with the members of the Board and the less frequent discussions with the FOMC. But the fact is that there are really twenty forecasts on the table, as it were, at an FOMC meeting. Each President comes with his or her own forecast, developed by the economic staff of that Bank. Each of the Governors comes with his or her own implicit or explicit forecast. None of the other forecasts is put together in so much detail, by so large a staff, and represent as many hours of careful work as that by the Board staff. Neither the Chairman nor the other members of the Board interfere with the staff's exercise of its important responsibility to use its best judgment to provide all the members of the FOMC with a careful forecast.
…At the conclusion of the presentation on the staff forecast, the Chairman asks if there are any questions for the staff. Most of the questions will come from the Reserve Bank presidents because, as I just noted, the Governors have already had the opportunity to raise questions with the staff … At the conclusion of the questions, we begin the first of two go-rounds, the core of the meeting. Each member of the FOMC presents his or her own views on the outlook in the first go-round. The current practice is that Bank presidents generally go first, because they have information that the governors do not have--information about developments in their own regions. The presidents, in addition to having regional information, also tend to have real-time information about consumer spending, business investment, and wage and price developments, for example, gathered from speaking to firms in their Districts. ... The presentations are generally about five minutes long and focus on a few key points that the Committee member feels are of importance to the policy problem of the moment. The presentations do not offer detailed alternative forecasts, compared to the staff, but Committee members often seek to position themselves relative to the staff forecast--stronger or weaker growth, higher or lower inflation, etc.
How the chairman participates in the meeting has changed over time, depending on the preference of the incumbent. Alan Greenspan does not participate in the outlook go-round.
There is not much in the way of exchanges between members of the Committee during this process. Each member speaks, then gives way to the next. Many speak from a prepared text or a detailed outline, although there is a more than an occasional effort by each member to relate his or her remarks to what has gone before. Still, the process is not one of discussion but of a series of self-contained, only sometimes interrelated, presentations.
At the end of the outlook go-round, it's time for a coffee break. … The Committee is now reassembling to hear the presentation on policy options by the Director of Monetary Affairs, currently Don Kohn, who, by the way, also serves as Secretary of the FOMC. The policy options were detailed and circulated to the Committee in advance in a document called the Bluebook … Don Kohn's discussion will outline policy options, with the emphasis on the plural. He will not recommend a particular course of action to the Committee. Rather he will offer options and provide a coherent rationale for each of the options offered. This has not always been the practice, however… The Bluebook might discuss as many as three options. Option A is always a decline in rates. Option B is always no change in the target funds rate. And option C is always an increase. Depending on the circumstances, the Bluebook may explicitly offer only two options. That is, in cases where it appears clear that the decision will either be to hold rates constant or to increase them, the staff will not offer an option of a decline. No matter. The FOMC is free to make any decision it wants, whether or not the staff has identified that option. In addition, the staff options will also indicate an amount of change--typically 25 basis points or 1/4 percentage point, but sometimes 50 basis points.
The second policy decision that will be made at the meeting is more subtle--a decision between what is referred to as a symmetric and asymmetric posture. This involves two issues. First, is there only a remote chance for a change in policy or a somewhat greater chance for a change in policy in the period between this and the next meeting? A symmetric directive implies less chance of a move during the inter-meeting period than an asymmetric directive. Indeed, some would interpret an asymmetric directive as providing more of a license for the Chairman to change policy during the period between meetings, while a symmetric policy is more limiting of the Chairman's discretion. But … in any case, the FOMC, at least this FOMC, will expect to be consulted--in the form of a telephone conference call--in advance of any policy move. A second interpretation of the directive is information on whether the next policy move is more likely to be up than down. This is like a reminder to the Committee that a policy action might be in the offing…
After the staff presentation of policy options, the Chairman offers Committee members the opportunity to question Don Kohn on issues related to his discussion of the policy options. Then we are ready for the second go-round, this one on policy. The difference in this case is that the Chairman goes first. He will lay out his view of the outlook and then bridge to his policy prescription. This presents the link from the earlier outlook discussion to the current policy decision and it gives the Chairman the opportunity to lead the Committee, both toward the position he is advocating and toward a consensus. This is followed by each of the members, in no prescribed order… laying out views on the policy decision, commenting on both the target funds rate and whether the posture should be symmetric or asymmetric. When the decision is quite clear, there may be very little discussion during this go-round with members mainly indicating their agreement with the position recommended by the Chairman. In cases where the decision is less clear, there will be individual presentations. Many differing views are presented in the outlook go-round and, where circumstances justify it, in the policy go-round. There is encouragement for each member to clearly present his or her own perspective.
Now the critical moment is approaching, the time to vote. Here two traditions come into play. The first is that the Chairman is always expected to be on the winning side of a policy vote. There has not been a case within memory where the Chairman has not been on the winning side of a policy vote at the FOMC. The Chairman is likely to have a good idea of how Governors are leaning, even before the meeting. Board members discuss the appropriate course of policy on occasion at their regular weekly meetings … especially on those occasions preceding FOMC meetings. In addition, the economic and policy situation naturally comes up in informal individual discussions between Board members. Moreover, as all the FOMC members give their views on the economy during the first part of the meeting, the outlook go-round, one can often infer their likely vote--though there are surprises from time to time.
A second tradition is to try to reach a consensus on the policy decision. It is quite common for there to be differences of opinion and yet a unanimous vote. This would be the case, for example, where the question was one of timing rather than of principle. Unanimous votes are common. One or two dissents are not unusual, but more than two dissents at a meeting are rare.
Because of these two traditions--that the Chairman is always on the winning side of a vote and that the Committee strives to reach a consensus--the Chairman's presentation at the start of the policy go-round is so important. It is the key moment, other than the vote itself at the meeting. There is a special sense of anticipation here because the Chairman often will provide some new data or some new insight in support of his position. Indeed, the Chairman is the most likely of the Committee members to challenge the group with a new way of thinking about recent developments. The Chairman presents a very forceful and clear argument for a specific policy recommendation. The recommendation, nevertheless, might be more decisive in the direction and size of the move than with respect to whether the posture should be symmetric or asymmetric. The focus of the comments that follow are why members agree, would prefer another course but can accept, or strongly disagree with the Chairman's recommendation.
When the policy go-round has been completed, the Chairman summarizes his sense of the consensus. For example: No change in the funds rate (option B) and a symmetric directive. Next the directive to be voted upon is read by the deputy secretary, conforming to the outcome of the discussion. The directive identifies the target funds rate and whether policy is symmetric or asymmetric...
Now it's time for the deputy secretary to poll the Committee. The Chairman votes first, the Vice Chairman second, and then other voting members vote in alphabetical order. This is the first and only occasion when the Reserve Bank presidents are treated differently depending on whether or not they are voting at that meeting. Up until that point, all have participated on equal terms in the discussions. Of course, when the chairman gives his sense of the consensus, he is assessing the consensus of Committee members only.
Finally, if there is a change in policy, it will be announced, at 2:15 pm that afternoon. The announcement indicates the new intended federal funds rate and also provides a brief rationale for the policy change. The Committee has delegated the wording of the announcement to the Chairman, but he will read it to the Committee and take account of members' suggestions. If there is no policy change, the announcement is simply, "The meeting ended at 12 noon. There is no further announcement."
What I have covered is really the mechanics of the meeting. But there are subtle issues of interest that I want to turn to now. One of them concerns setting the stage for subsequent meetings and decisions. I've described the discussion as focused on whether or not to change the federal funds rate at the current meeting. But, speaking for myself, a major part of my presentation focuses on subsequent meetings and decisions. Decisions to change policy have a way of evolving from one meeting to the next. The seeds are sown at one meeting and harvested at the next. I listen intently to the input of the other Committee members, but I am mainly gathering input into the formation of my decision for the next meeting. And, in my presentations, I am trying to emphasize the factors I believe will shape the decision at the next meeting. Thus the FOMC process must be thought of in this dynamic sense. One meeting helps to shape the decision of the next meeting.
... The … issue this raises is whether the Chairman controls the outcome to the point where no one else on the Committee matters. While this is clearly an exaggeration, it would be just as silly for me to respond: "What do you mean? I have one vote, just like the Chairman." This is true, of course, technically. But the reality is that the Chairman in general and a highly respected Chairman like the present one has a disproportionate influence on the outcome. Many members will voice some disagreement in the go-rounds with the Chairman's view of the outlook or policy recommendation, but many of those will vote with the Chairman in the end. That partly reflects the importance of consensus and it partly reflects the respect accorded the Chairman. But there is a limit to how the Chairman's influence can be extended and a good Chairman never oversteps this boundary. A good Chairman sometimes has to lead the FOMC by following the consensus within the Committee.
Let's take a quick look in on a two-day meeting. The two-day meetings occur in February and July … We will take a brief look in at a typical February meeting. It begins differently from all the other meetings. The Chairman opens the meeting by calling for nominations for Chairman of the FOMC for the coming year. The procedure is then to turn the meeting over to the next most senior Board member--or the Vice Chair of the Board if there is one--for the election process. You see, the Federal Reserve Act does not automatically make the Chairman of the Board of Governors the Chairman of the FOMC. When the senior Board member asks for nominations, there is typically a couple of seconds of silence. We like to make the Chairman squirm a little, just at the thought that the Committee might have the audacity to nominate someone else. But, that thought quickly passes, and someone nominates the Chairman, who is then unanimously elected Chairman. Next, the Chairman, relieved of course at his close victory, asks for nominations for Vice Chairman ...You may now know more than you ever wanted to know about the FOMC...
Medicare and Disability Insurance
What Did Medicare Do (And Was It Worth It)?, Amy Finkelstein and Robin McKnight, NBER WP 11609: We study the impact of the introduction of one of the major pillars of the social insurance system in the United States: the introduction of Medicare in 1965. Our results suggest that, in its first 10 years, the establishment of universal health insurance for the elderly had no discernible impact on their mortality. However, we find that the introduction of Medicare was associated with a substantial reduction in the elderly’s exposure to out of pocket medical expenditure risk. Specifically, we estimate that Medicare’s introduction is associated with a forty percent decline in out of pocket spending for the top quartile of the out of pocket spending distribution. A stylized expected utility framework suggests that the welfare gains from such reductions in risk exposure alone may be sufficient to cover between half and three-quarters of the costs of the Medicare program. These findings underscore the importance of considering the direct insurance benefits from public health insurance programs, in addition to any indirect benefits from an effect on health.
Here’s the paper by Amitabh Chandra and Andrew A. Samwick. As you read this, keep in mind that this is the value of disability insurance over and above a stylized version of the current system. It can also be viewed as the value of assistive technology--something that helped people continue working without having to take Disability insurance as we currently have it:
Disability Risk And The Value Of Disability Insurance, Amitabh Chandra and Andrew A. Samwick, NBER WP 11605: We estimate consumers’ valuation of disability insurance using a stochastic lifecycle framework in which disability is modeled as permanent, involuntary retirement. We base our probabilities of worklimiting disability on 25 years of data from the Current Population Survey and examine the changes in the disability gradient for different demographic groups over their lifecycle. Our estimates show that a typical consumer would be willing to pay about 5 percent of expected consumption to eliminate the average disability risk faced by current workers. Only about 2 percentage points reflect the impact of disability on expected lifetime earnings; the larger part is attributable to the uncertainty associated with the threat of disablement. We estimate that no more than 20 percent of mean assets accumulated before voluntary retirement are attributable to disability risks measured for any demographic group in our data. Compared to other reductions in expected utility of comparable amounts, such as a reduction in the replacement rate at voluntary retirement or increases in annual income fluctuations, disability risk generates substantially less pre-retirement saving. Because the probability of disablement is small and the average size of the loss — conditional on becoming disabled — is large, disability risk is not effectively insured through precautionary saving.
September 19, 2005
Greg Ip: Don’t Worry, Greenspan is Replaceable
Don't Worry About Post-Greenspan Era: Central Banking Itself Has Been Elevated, by Greg Ip, WSJ: …As Mr. Greenspan's retirement approaches in January, anxious investors wonder: Can anyone reproduce his record? A glance at Australia and elsewhere suggests that the answer is yes. While the U.S.'s economic performance has been superb during the Greenspan era, it isn't unique. "Very similar results have been attained elsewhere," says Stanley Fischer, a former Citigroup executive who runs Israel's central bank. A review of nine major countries' economic performance, based on data compiled by Global Insight Inc. … shows that Australia, Canada, the United Kingdom and Spain have done as well or better than the U.S. in reducing inflation and unemployment since 1987. However, only Australia and Spain have grown faster overall, and the U.S. has enjoyed the most stability -- just five quarters of negative economic growth during that period.
Whatever qualities have made the Greenspan Fed successful, many other central banks appear to share them. This means that President Bush probably doesn't have to find a Fed chairman with Mr. Greenspan's eclectic mix of smarts, intuition and rigor, to continue his success. It does mean that choosing someone outside the mold of a modern central banker is risky. What explains central banks' widespread success? In the past two decades, central banking has become a "much more professional, technical job," says Alan Budd, who served in the British Treasury and the Bank of England during the 1990s and is provost at Oxford University's Queen's College. "It's not just a question of taking the politics out, but of putting the economics in." The Bank of England adopted inflation targets, regular policy meetings and inflation reports in 1992 … Australia, Britain and Canada adopted numerical inflation targets in the early 1990s, a step the Fed has declined to take. Debate rages among academics about their value. …
Other countries' good performance doesn't diminish Mr. Greenspan's achievements. Because of the U.S.'s overwhelming influence on world growth and financial markets, it is unlikely other countries could have done so well had the U.S. performed badly... And Alan Blinder, a former Fed vice chairman, says other central bankers have learned from Mr. Greenspan... [Rory Robertson, an economist at Macquarie Bank in Sydney] … says foreigners don't generally like Mr. Bush's foreign or fiscal policies but have taken comfort that "someone smart and sensible is running the Fed." Foreign investors want the next chairman to be a "straight up-and-down central banker type." The candidate who most closely fits that description, he says, is Ben Bernanke, a former Fed governor and monetary scholar who is Mr. Bush's economic adviser. Investors, he says, "know how he thinks."
The Changing Age Distribution of the U.S. Population 1950-2050
This brings up issues I want to think about further. For example, as I assume others have noticed, with a larger and larger fraction of the population moving into the asset liquidation phase of their life-cycle, how is the saving rate affected? How much of the change in the saving rate in recent years is attributable solely to changes in the age-distribution of the population? What other changes in economic behavior might this bring about?
UPDATE: Some of you asked about population pyramids, though as shown below by the projected 2050 population distribution it no longer looks much like a pyramid. If you click through to the census site listed above there is a dynamic version of the population pyramids showing the changes from 1950-2050. Here are static versions spaced 25 years apart available at the Census site:
Posted by Mark Thoma on Monday, September 19, 2005 at 12:30 AM in Economics
Housing Bubble Trouble? Not if There’s No Bubble
Bubble Trouble? Not Likely, by Chris Mayer and Todd Sinai, WSJ Commentary: For the past several years, Chicken Littles have squawked that the sky -- or the ceiling -- is about to fall on the housing market... Yet basic economic logic suggests that this apparent ... bubble is anything but. Even in the highest-price cities, housing is, at most, slightly more expensive than average. Here's why: ... The annual cost of owning, not the price of the house itself, is what homebuyers should (and do) consider when contemplating a purchase. And when comparing the cost of owning with annual rent … annual cost is the right measure to use. That cost is simply the net cash outflow required to own a house for a year... We ... computed annual housing costs for 46 housing markets from 1980 to 2004 in a study due to be published this fall in the Journal of Economic Perspectives. Our findings are striking. In none of the hottest housing markets did the ratio of the cost of owning to rent in 2004 exceed the average over the sample period in their own market by more than 13%... the ratios in the other oft-cited "bubble" cities such as Boston, L.A., New York and San Francisco were no more than 3% above their long-run averages. A similar pattern arises when we compare a city's cost of housing to its mean family income. By contrast, in the late '80s, immediately prior to the large house-price declines of the early '90s, the ratio of the annual cost of owning to rent peaked 52% above the long-run average in San Francisco and New York. Boston and L.A. topped out, respectively, at 37% and 42% above the long-run average. ... Portland and Miami, and to a degree San Diego, are cities where we have a nascent concern...
The number one reason the current cost of owning differs so much from the price of a house is the historically low level of real, long-term interest rates. ... At a lower cost-per-dollar of housing, families are willing to spend more for a house, bidding up prices. ... We obviously don't think the sky's the limit for house prices. But when you combine the annual cost concept with recent growth in rents and incomes, today's pricing looks justifiable in most of the U.S. Despite all the talk of a bubble, we find little evidence that house prices are being bid up based on unreasonable expectations of future price growth. ... Of course, the same logic that says today's market price of housing is reasonable also implies that house prices are especially sensitive to real, long-term interest rates. In the absence of an offsetting increase in housing demand, an unanticipated rise in real mortgage rates could cause appreciable declines in house prices. For this reason we don't think speculation is justified in the housing market -- gambling on above-average capital gains is simply an interest-rate bet.
I need to get my hands on this paper because I must be missing something. This is not their only or their primary argument, but I don’t see why renting is the right opportunity cost to use to measure to cost of housing. For example, suppose that the owning to renting ratio is $1200/$1000, or 1.2. Now let both prices double but all other prices remain the same. Then the ratio is $2400/$2000 and the relative price is still 1.2 – housing is no more expensive in terms of renting. But, in terms of, say, food and clothing, housing in general (i.e. owning or renting) is a lot more expensive. I also don't see why, at least theoretically, speculation can't cause both prices to rise in proportion during a bubble. However, the other measure they use, the cost of owning relative to income, does not have this problem and it shows a similar trend to that reported for the owning to renting ratio. And their conclusions regarding the real interest rate agree, as noted above, with other analysts who note the sensititvity of prices to interest rates.
September 18, 2005
Fed Watch: What Will Be the Fed’s Message?
The Fed looks set to hike rates on Tuesday, with the markets pricing in at least an 86% probability of another 25bp pop. More interesting (assuming no surprises) will be the statement. The Fed will be walking a fine line on this one so as not to seem indifferent to those suffering from Katrina. In the end, I believe they will acknowledge but downplay Katrina’s impact while maintaining expectations of additional rate hikes. I think inflation fears will trump slowdown concerns at this next FOMC outing.
Friday, we learned that images of Katrina’s devastation and higher gas prices likely conspired to depress the confidence numbers. I will turn to that topic later. What I think is most important for policy is the sharp rise in inflation expectations, from 3.1% to 4.6%. And this comes right after two regional manufacturing indexes that both experienced sharp rises in the prices paid component. So now you have the combination of inflation pressures in the system AND an expectation of sharply higher prices among economic agents. Simply put, this is a conservative central banker’s worst nightmare.
Here is how I believe the Fed sees the story prior to Katrina: Despite rising energy prices, the impact on core-inflation has been muted (see also James Hamilton here), although at the higher end of their comfort range. The fundamental reason core-inflation is in check is because the Fed has withdrawn monetary accommodation in an effort to hold expectations at bay. Yes, I know that this makes the Fed sound like they think they are all powerful, but, well…you know.
Now, after Katrina, inflation expectations may have come unglued. Furthermore, consider this: Assuming the survey accurately represents inflation expectations, prior to Katrina, the real fed funds rate was 0.4%. After Katrina, the real rate is now negative 1.1%. In other words, policy just became a lot more accommodative, and the neutral point shifted up more than 100 bp! That is nothing short of a big leap, and whether it is temporary or not remains to be seen (gasoline prices have headed lower, but higher home heating costs are expected this winter). I think that the Fed will want to make sure this is a temporary inflation expectations reading, and that means higher rates. David Altig notes that the previous outlier in inflation expectations was a short-lived but sharp drop following 9/11. It is worth remembering that the Fed followed the attacks with aggressive rate cutting. Wouldn’t the appropriate strategy now be the opposite?
As for the rest of last week’s numbers, by and large I think they will leave the Fed with the feeling that inflation pressures are a threat; manufacturing may have slowed a bit but will soon expand under the duel influence of reconstruction and low inventories; and jobless claims have risen as expected, but this is largely a temporary and regional issue. I know this may sound “cold,” but the Fed does not make policy for specific regions or industries. They make policy for the nation as a whole.
But what about consumer confidence? The UMich Index saw a dizzying slide in September (WSJ subscription only) from 89.1 to 76. The question, however, is to what degree Katrina and gasoline impact consumers’ willingness to spend. This is different from the ability to spend. Consumers may be unhappy because the basket of goods they can purchase has shrunk (or is increasing more slowly), but that doesn’t mean they stop spending. Indeed, non-auto retail sales gained 1% in August – an annualized rate of over 12%! Even if a big chunk of that gain was gasoline, the will to spend remains intact.
A more concerning event would be for consumers to be scared into abruptly raising their savings rate. So far, we have seen little evidence that households want to hold onto a bit more of their paycheck. And even if they did, to what extent would that really change Fed policy? To be sure, many would be calling for the Fed to stop and even reverse course, but higher savings rates will be a necessary part of the rebalancing that (I believe) the Fed expects will happen at some point. Remember, the US is currently consuming roughly 6.4% (the current account deficit) more goods and services than it produces. I doubt anyone at the Fed believes such a situation can continue indefinitely.
In practice, I suspect that rebalancing will require slower demand growth to eliminate this gap – implying a risk that the Fed will raise rates higher in a deliberate attempt to hold growth lower than at any time in recent memory. I think this will come as a surprise to many, but in my opinion the Fed has been sending signals left and right that a change is coming. And, if estimates of potential growth are falling as well, as I read into San Francisco Fed President Janet Yellen’s speech last week, that change may be coming sooner than expected.
UPDATE [by Mark Thoma]: Bloomberg’s John M. Berry: Rates are Going Up, Long-Run Target Higher than Before Katrina
The CBOT did not report the probability that the federal funds target will be raised on Friday for reasons I am unsure of, but John Berry of Bloomberg reports it as 94%. He believes the Fed will raise rates and indicate further rates are to be expected. In addition, though he expects some change in the language from the minutes, he does not expect the language to change substantially. Finally, he believes the overall impact of Katrina is to raise the interest rate target that will ultimately be viewed as neutral by the Fed:
Fed Will Raise Rates and Indicate More to Come, John M. Berry, Bloomberg: Federal Reserve officials are set to raise their target for the overnight lending rate tomorrow, and financial markets have gradually accepted that the devastation from Hurricane Katrina won't deter them. Trading in 30-day federal funds futures contracts on Sept. 16 indicated that investors accord a 94 percent probability that the target would be raised by a quarter-percentage point, to 3.75 percent, compared with only a 6 percent probability of no change. On the other hand, there has been widespread speculation that officials will make some significant changes in the forward- looking portion of the statement that will be issued at the end of the Federal Open Market Committee meeting. … there are good reasons to expect no change at all in that key paragraph in tomorrow's statement. … removing the word ''accommodation'' would imply that officials believe they have raised their overnight rate target as much as their need to. … Given the level of inflation pressures in the economy, intensified by surging energy prices, that's a very unlikely conclusion for Fed officials to make at this point. Second, what would the message to the markets be if the word ``measured'' were removed? That officials were preparing to pause in their drive to move the overnight rate target to the so-called neutral level? Or that they were contemplating a 50 basis-point move at their November meeting? … the degree of inflation pressure would argue against a wording change that could be interpreted as pointing to a pause. Finally, it isn't at all likely that the balance of risks portion of the statement would be changed. … What will change in tomorrow's statement is that the paragraph explaining how the committee views current economic conditions … In other words, the officials are going to describe how they expect the economy to evolve in the wake of the hurricane. … they are likely to say … that the overall impact on the U.S. economy will be ''transitory'' and ''temporary.''… No one, including Fed officials, knows how high the overnight rate target eventually will go. It's very likely that the responses in the marketplace and in the halls of government to Katrina will make that point higher than it otherwise would have been.
UPDATE [by Mark Thoma]: Rates Falling in UK? Here's some news indicating rates are headed in the opposite direction in the UK. This is just for information, I don't mean to imply it will influence the Fed's rate decision:
Rate cuts predicted if growth in UK falls short, by Chris Giles and Scheherazade Daneshkhu, FT: There is a “serious risk” that economic growth will fall short of the Bank of England's forecast, forcing further interest rate cuts, Stephen Nickell, a member of its monetary policy committee, has told the Financial Times. … Mr Nickell's views are in line with those expressed in a speech on Friday by David Walton, another committee member. Together they suggest that a significant proportion of the MPC is feeling uncomfortable about its August growth forecast... Mr Nickell said he saw few signs that inflationary expectations had risen, in spite of high oil prices...
UPDATE [by Mark Thoma]: From Bloomberg:
The following are the results of the survey, conducted from Sept. 13 to Sept. 16.
Drop Sept. 20 Dec. 31 Dec. 31 Firm Measured? Target Target 10-Yr Yield ABN Amro No 3.75% 4.00% 4.25% BNP Paribas No 3.75% 4.25% 4.50% Banc of America No 3.75% 4.00% 4.45% Barclays Capital No 3.75% 4.25% 4.50% Bear Stearns No 3.75% 4.25% 5.00% CIBC World Markets No 3.75% 3.75% 4.05% Citigroup N/A 3.75% 4.00% 4.25% Countrywide No 3.75% 4.00% 4.70% CSFB No 3.75% 4.25% 4.15% Daiwa No 3.75% 4.00% 4.55% Deutsche Bank No 3.75% 4.25% 5.00% Dresdner Yes 3.75% 3.75% 4.10% Goldman Sachs N/A 3.75% 4.00% 4.20% HSBC Yes 3.50% 3.75% 4.00% JPMorgan Chase No 3.75% 4.25% 4.75% Lehman Brothers No 3.75% 4.25% 4.70% Merrill Lynch Yes 3.50% 4.00% 4.25% Mizuho No 3.75% 4.00% 4.60% Morgan Stanley N/A 3.75% 4.00% 4.35% Nomura No 3.50% 3.75% 4.25% RBS Greenwich No 3.75% 4.25% 4.90% UBS Securities No 3.50% 4.00% 5.00% Median 4.48%
UPDATE [by Mark Thoma]: CBOT Fed Watch: Chance of 25 bps Hike is 92%
The chance of a 25 bps rate hike at the next FOMC meeting, according to the market's assessment at today's close, has fallen slightly from 94% on Friday to 92% today:
CBOT Fed Watch: Based upon the September 19 market close, the CBOT 30-Day Federal Funds futures contract for the October 2005 expiration is currently pricing in a 92 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3-1/2 percent to 3-3/4 percent at tomorrow’s FOMC meeting (versus an 8 percent probability of no rate change):
September 13: 18% for No Change versus 82% for +25 bps. September 14: 16% for No Change versus 84% for +25 bps. September 15: 14% for No Change versus 86% for +25 bps. September 16: 6% for No Change versus 94% for +25 bps. September 19 8% for No Change versus 92% for +25 bps.
September 20: FOMC decision on federal funds target rate.
All Around the Carpenter’s Bench, Pop! Goes the Bubble…
Pop Goes the Bubble? Maybe It's Time to Cheer, by Daniel Akst, NY Times Commentary: ...Now that home prices in some markets are showing signs of moderating, lamentations are rising from all sides about the many bad things that may happen... Unfortunately, all of this hand-wringing tends to distract from the essential truth about soaring home prices, which is that they are a bad thing... the housing bubble never loved you. The bubble is not even your friend. In fact, the very best thing you can say about the passing of this particular bubble is "good riddance."
What's so bad about skyrocketing home prices? ... First, they make life awfully difficult for people who aren't already homeowners and do little for people who are, because selling one inflated house only to buy another affords little profit. ... it probably also suppresses other kinds of saving and encourages excessive debt. And it has helped addict global producers to American consumerism, because it gives Americans the confidence - and in many cases the wherewithal - to spend some of the inflated value of their homes. ... Sky-high home prices also divert too much capital into home building from potentially more productive uses. And these prices fuel risky, not especially useful speculation in residential real estate. ... Excessive home prices divert human capital as well. The National Association of Realtors had 1.1 million members at the end of 2004, up from 766,560 in 2000. It's hard to believe that such an increase would have occurred if there had been no housing bubble. Finally, wouldn't it be better for society ... if people could buy a home without resorting to ... loans ... that are risky for borrowers and lenders alike? ... High home prices may contribute to social and economic inequality by making ... it nearly impossible for people without enormous incomes to afford homes in places with the kind of desirable school systems that can help put children onto a higher earnings trajectory.
But if inflated home prices are bad, isn't the end of a housing bubble worse? Not necessarily. There is always pain associated with market adjustments... The Federal Reserve, through its monetary policy of low interest rates, has propped up real estate prices for years. Other government policies, from zoning to building codes, are doing likewise... If prices moderate, maybe we won't gobble up open space as quickly. Lower prices will clearly deter some speculators, who will put their money to work elsewhere. And some of those real estate brokers will find something else useful to do. Best of all, people at dinner parties and soccer games will have to find something more interesting to talk about. That alone makes the end of the housing bubble a good excuse to break out the Champagne.
Even though he wants to break out the Champagne, somehow I don't picture Daniel Akst as a throw caution to the wind and let's party kind of guy.
The Glut of Men
More Boys Than Girls, by Rodger Doyle, Scientific American: [T]he sex ratio ... [is generally]... defined as the number of males per 100 females... Before World War I, immigrants, who tended to be predominantly male, kept the ratio high. Restrictive legislation in the 1920s and the Great Depression of the 1930s reduced the influx to a trickle. Beginning in the 1940s, lung cancer and cardiovascular disease, both of which affected men far more than women, resulted in an increasing proportion of females. The rise in the ratio since 1970 has resulted from a greater reduction in mortality among males than females. ... The rising sex ratios of the past few decades means that American women of mating age are becoming, for the second time in U.S. history, a scarce commodity in the marriage market, although over the foreseeable future they will not be as rare as in earlier times...
Number of men per 100 women in the U.S.
Posted by Mark Thoma on Sunday, September 18, 2005 at 12:34 AM in Economics
September 17, 2005
CNN/Money's List of Riskiest Mortgage Arrangements
Just how crazy are crazy mortgages? Check these out:
- How it works: In the first three to 10 years, your payments cover only interest, not principal.
- The risk: When the interest-only term is up, your payments could increase so much that you can't afford your mortgage.
- Right for you if...You plan to move before the term ends, or you can count on earning more money soon.
Option- or flexpayment ARM:
- How it works: You choose what to pay every month: the standard principal and interest, only interest or a minimum that's less than what's needed to cover the interest.
- The risk: If you make minimum payments, the rest of that month's interest is tacked on to the loan balance , so you could easily end up owing more than your home is worth.
- Right for you if...You need the flexibility to make smaller monthly payments once in a while -- but only once in a while.
40-year fixed mortgage:
- How it works: You pay the loan off over 40 years instead of the usual 15 or 30.
- The risk: You will pay more interest over the term of the loan. Plus, it takes a loooong time to build equity.
- Right for you if...You can't afford a shorter-term loan but don't want to take on a lot of interest-rate risk.
- How it works: By taking out two loans (a traditional mortgage and a home-equity loan or line of credit for the 20 percent down payment) you can avoid private mortgage insurance.
- The risk: If the price of your house drops, you have no equity cushion, leaving you at risk of owing more than your home is worth.
- Right for you if...You have money saved for a down payment but fall a little short of 20 percent.
No-doc or low-doc loan mortgage:
- How it works: This loan lets you borrow without proving you meet the usual income requirements and, in some cases, without documenting your income at all. Most lenders expect you to have a credit score of at least 620.
- The risk: Borrowing more than you can afford. Plus, depending on your credit score and how much documentation you provide, the rate may be one-half to three points higher than an equivalent full-doc loan.
- Right for you if...You don't earn enough to qualify for a normal loan (say, if you're starting a business), but you know you won't have trouble making the mortgage payments.
Here's the table showing geographic regions with new-home buyers with interest-only and option payment ARMs in the first six months of 2005:
In these hot markets, about half of today's home buyers are resorting to creative financing.
|Metro area||% Buyers with nontraditional loans|
|Santa Cruz/Watsonville, Calif.||55|
A Glut of Delightful Cynicism
Cynic's Delight: The Glut of Asian Savings Looks for New Bond Markets: James Carville is supposed to have once said:
I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter… but now I want to come back as the bond market. You can intimidate everybody.
It seems that Asian policy makers are taking his advice to heart. The Asian Bond Market Initiative (ABMI), a cooperative effort on the part of the Asean + 3 finance ministries and the Asian Development Bank (ADB), is actively trying to mobilize Asian savings through new and improved domestic capital markets. Domestic Asian bond markets have been growing like gangbusters in recent years, and as they grow ever more deep, liquid and sophisticated, they will provide opportunities for Asian savers to invest at home. Given that the Asian demand for US Treasuries has been propping up the dollar and keeping US interest rates low, the rise of Asian bond markets has profound ramifications for the global economy, and dollar exchange rates and US interest rates in particular. The recent efforts to promote capital markets across the Pacific are, admittedly, starting from a low level and have many hurdles to overcome. But concerted efforts from government ministries and financial institutions are starting to yield results. The size of domestic bond markets across East Asia have tripled since 1997, and corporate issues have grown at an 18% annual pace. The total amount outstanding of local currency denominated bonds in East Asia reached 44% of GDP last year, up from just 19% in 1997.
While the development of modern capital markets makes good economic sense in and of itself, much of the impetus for the current efforts stems from the Asian financial crisis of 1997 and a growing awareness that Asian savings could be put to better use at home, funding improved infrastructure and capacity expansions. One of the primary causes of the 1997 Asian financial crisis was the lack of domestic bond markets in East and Southeast Asia. ... One way of avoiding forced currency devaluations is, of course, to hold on to large amounts of hard currency reserves. This was certainly one of the lessons learned by Asian policy makers after ’97 and explains their eagerness to buy so many US Treasury bonds. But the crisis also brought home the need for increased regional cooperation and more sophisticated capital markets. Both the Chiang Mai Initiative, a series of bilateral swap arrangements designed to enhance foreign exchange reserves, and the Asian Bond Market Initiative (ABMI), were outgrowths of the response to the ’97 crisis. Going forward, domestic bond markets in Asia face a number of challenges. ... ABMI will not achieve its goals overnight. But in the medium to long term, deep and liquid capital markets in East Asia could fundamentally reshape the international financial landscape and provide a mechanism for unwinding the global savings imbalance...
Cato's Proposed Budget Cuts to Offset Spending on Katrina
Katrina recovery costs to raise deficit, CNN/Money: President Bush's advisers said Friday billions of dollars needed to rebuild New Orleans and the Gulf Coast will be borrowed and will raise the deficit, but Bush still wants to extend tax cuts... "There's no question that the recovery will ... add to the deficit," said White House economic adviser Allan Hubbard, while stressing it is a one-time cost. At the same time, he said, Bush wants to extend tax cuts that were a hallmark of his economic recovery plan but which Democrats would like to end because of the impact on the budget deficit. "The last thing in the world we even need to be thinking about is raising taxes. A strong economy is what is going to pay for rebuilding the affected areas," Hubbard said.
Bush said directly that programs would be cut to pay for the spending (Bernanke too). In case you were wondering what Bush had in mind for cuts to offset spending on Katrina, one possibility is Cato's plan. Take a close look and see what you think. Then remember this only covers a third or less of the projected spending for Katrina (62 out of the 200 billion), and less than one sixth of the 400 billion dollar overall deficit projected by Cato. So, at best, this is only covers a third of the spending on the recovery from the hurricane, but at least we finally have a few cards on the table:
Proposed Budget Cuts to Offset Katrina Spending
Annual savings in $billions
|Farm subsidies: cut in half||$10.6||Wasteful and have negative environmental and trade effects|
|NASA: cut in half||$7.9||NASA is obsolete with the arrival of private manned space flight|
|Energy research and subsidies||$6.2||Private sector responsibility|
|Subsidies to airports||$5.8||Airports should be privatized as in dozens of major foreign cities|
|Community development grants||$5.4||Projects such as parking lots and sidewalks are a local responsibility|
|USAID (foreign aid)||$4.7||Duplicates Bush Millennium Challenge Corporation foreign aid agency|
|Army Corps of Engineers||$4.6||Civilian activities should be privatized or devolved to the states|
|Homeland security grants||$4.2||Homeland security grants to states have been mired in scandal|
|Foreign economic aid||$2.7||Foreign economic aid does not work|
|Rural subsidies||$2.5||Wasteful and unfair to urban taxpayers|
|Bureau of Indian Affairs||$2.4||BIA is scandal-plagued. Tribes earn $19 billion annually from gambling|
|Davis-Bacon Act: repeal||$2.0||Repeal Davis-Bacon and the Service Contract Act to cut federal costs|
|Air traffic control||$1.6||"Privatize air traffic control as in Canada and Britain"|
|Trade adjustment assistance||$1.0||Unneeded giveaway that is in addition to unemployment insurance|
|Amtrak||$0.4||Privatize the rail system|
|Source: Chris Edwards and Stephen Slivinski, Cato Institute, based on Budget of the U.S. Government, FY2006.|
Where will the remaining 1oo billion or so come from for Katrina, and where will the cuts be made to cover a couple of hundred billion more to eliminate the remaining deficit? And remember, as explained here, an increase in taxes of one dollar does not harm those affected by the hurricane any more than a one dollar decrease in government spending.
September 16, 2005
Read His Lips: No New Taxes!
Bush Rules Out Tax Increases to Pay for Hurricane Recovery, By David Stout, NY Times: President Bush ruled out tax increases to pay for hurricane and flood recovery today, saying instead that federal spending would have to be cut to help the Gulf Coast recover. "We got to maintain economic growth, and therefore we should not raise taxes," Mr. Bush said. ... The president did not go into detail ... on what programs he sees as likely candidates for spending cuts. He said the White House Office of Management and Budget would work with Congress to see not only where to cut but "to maintain economic growth and vitality" as well as help in the long recovery along the Gulf of Mexico. ... Heated discussions between the White House and Congressional leaders, including some Republicans, over how to pay for the recovery effort now seem inevitable. Some Republicans were worrying publicly about the rising federal deficits even before Mr. Bush pledged a huge federal role in the recovery ... and before his "no new taxes" pledge today. The ranks of Republicans include more than a few "deficit hawks" who expressed fears - well before the military campaign in Iraq, let alone the natural disaster in the Gulf Coast region - that spiraling deficits might have to be paid for far into the future...
[Update: Vox Baby also comments.]
Fed Governor Olson: No National Housing Bubble, only Froth
Fed's Olson Urges Care With 'Novel' Home Mortgages, Bloomberg: Federal Reserve Governor Mark Olson urged U.S. lenders to use care with "non-traditional'' types of home mortgages such as interest-only and adjustable-rate loans, because some borrowers will be ''severely challenged'' to repay them if interest rates rise. Olson didn't discuss monetary policy or the economic outlook ... His comments on mortgages echo remarks by Fed Chairman Alan Greenspan in July that he is "concerned'' about some types of "exotic'' mortgages, such as loans that let a borrower pay no principal for a period. ... Olson told reporters afterward that ''we do not see a national bubble'' in home values." What we have noticed is the rate of appreciation in values in some markets is clearly unsustainable and in some markets we've seen what the chairman referred to as 'froth,' '' Olson said. ''It seems likely the rate will at least plateau and in some places could even decline.''
I suppose it's worth pointing out, without attaching too much significance to it, that he is warning about potential problems from higher interest rates in the future.
Federal Reserve Governor Olson Says Banks in New Orleans are Healthy
...The Federal Reserve Bank of Atlanta also reminded the depository institutions it serves that ... the discount window was and is available to assist them in meeting their liquidity needs. ... At this time, we have not seen evidence of significant funding difficulties or problems in balance-sheet management. ...the banking industry on the whole has shown resilience and flexibility in its response to this challenging situation. While the challenges have by no means passed, banks appear to be taking the appropriate actions to provide their customers with access to much-needed cash and banking services...
A Fistful of Talk on the German Election
Once In Another Lifetime, by Edward: Former UK prime minister Harold Wilson coined the phrase ’a week is a long time in politics’. Well I don’t know about a week, but two months certainly is. Back on July 12 Doug Merrill was wryly posting about “Things You Can Do When You’re 20 Points Up in the Polls”. Maybe he’d now like to do another one about things you can’t do when you’ve just lost your overall majority. I think Merkel’s face tells it all, we’re now back with Fassbinder and deeply ensconced in ’fear eats the soul’ territory. Whatever the outcome on Sunday, this will surely have to go down as one of the worst run political campaigns in recent history. As Tobias was suggesting to me at the weekend, maybe somewhere deep down inside they just don’t want to win.
CDU: Screwing up on purpose?, by Tobias Schwarz: Ok, now that Edward has already mentioned it, I might as well explain in a little more detail what I meant by saying that “on some level, the CDU might be afraid to win.”
Last Saturday evening, strolling through Stockholm’s Gamla Stan, Edward asked me about my gut feeling concerning the outcome of the German election next week. I told him that, while it was rather entertaining, this campaign has also been confusing - and confused - in many ways, particularly when looking at the CDU. And I believe the confused and confusing campaign the CDU is conducting is even more an expression of the way the German establishment is puzzled about the way ahead than the fact that Schröder “called” the elections a year too early, too early for any of his reforms to have any perceptible impact on the economy, not even in the West.
...[T]he CDU’s super-majority in the upper federal chamber, the Bundesrat that will make a CDU chancellor more powerful with respect to the state premiers even of her own party than has been the case in a long time ... means that there are no more institutional excuses for a chancellor presiding over a CDU-FDP coalition from next Sunday on. A Chancellor Merkel, once elected by the Bundestag, would indeed be much more bound to do what she promised than most politicians like. That ... made many within her party realise that calls for radical reforms are no longer simply opposition politics. They may actually get what they called for, and many suddenly realised that they were - to put it this way - apprehensive about what exactly they would do to the country by doing what they said they wanted all along.
Citing Ronald Reagan is one thing when there are no institutional consequences, it is something entirely different in a campaign that has, despite being fought almost entirely on economic issues, brought back the notion that there is more to the German economic future than the internalisation of social externalities. It is one thing to believe that radical labour market reforms will right many of the wrong incentives, that the gains from ridding an obscure tax code from transaction costs will create a more just tax system, and to actually be faced with the prospect of having to do so. The CDU realizes right now, governance matters, the state matters. Certainly, Schroeder and the SPD’s campaign have been quick to spin the images from New Orleans and the CDU’s internal debate about a “flat tax” (that is not really a flat tax) that was brought into the debate by Merkel’s nomination of Paul Kirchhof, a professor and former constitutional judge, who has pursued tax reform as a pet project for years…
Last year, there was a movie called “How to get rid of a guy in ten days” - this year’s CDU campaign is a collection of amateur mistakes that is reminiscent of a potential screenplay for the film “how to lose a non-surplus-coalition majority within two weeks.” It’s not that the CDU is not attempting to win in the sense that they do not want to govern. They do. But I think many of them, certainly within the league of state premiers would be relieved with the prospect of a “grand coalition”. One without Kirchhof, with more labour market reforms, but a less radical model of tax reform, and a new, less bureaucratic, model of health reform designed to include non-wage income into the public health redistribution system. In some sense, in her political need to be more reformist than the rest, Merkel may have been forced to outrun the CDU’s rank and file, whose conservative instincts may have been reactivated at the “wrong moment”, offering her internal - not just the external - opposition an opportunity to attack her.
That’s why I think the CDU’s campaign is as bad, confusing and confused as it is. And I’m not even talking about their posters…
The New Krugman Deal
Not the New Deal, By PAUL KRUGMAN, New York Times: Now it begins: America's biggest relief and recovery program since the New Deal. And the omens aren't good. It's a given that the Bush administration, which tried to turn Iraq into a laboratory for conservative economic policies, will try the same thing on the Gulf Coast. The Heritage Foundation, which has surely been helping Karl Rove develop the administration's recovery plan, has already published a manifesto on post-Katrina policy. It calls for waivers on environmental rules, the elimination of capital gains taxes and the private ownership of public school buildings in the disaster areas. And if any of the people killed by Katrina, most of them poor, had a net worth of more than $1.5 million, Heritage wants to exempt their heirs from the estate tax.
Still, even conservatives admit that deregulation, tax cuts and privatization won't be enough. Recovery will require a lot of federal spending. And aside from the effect on the deficit - we're about to see the spectacle of tax cuts in the face of both a war and a huge reconstruction effort - this raises another question: how can discretionary government spending take place on that scale without creating equally large-scale corruption?
It's possible to spend large sums honestly, as Franklin D. Roosevelt demonstrated in the 1930's. F.D.R. presided over a huge expansion of federal spending, including a lot of discretionary spending by the Works Progress Administration. Yet the image of public relief, widely regarded as corrupt before the New Deal, actually improved markedly. How did that happen? The answer is that the New Deal made almost a fetish out of policing its own programs against potential corruption. In particular, F.D.R. created a powerful "division of progress investigation" to look into complaints of malfeasance in the W.P.A. That division proved so effective that a later Congressional investigation couldn't find a single serious irregularity it had missed. This commitment to honest government wasn't a sign of Roosevelt's personal virtue; it reflected a political imperative. F.D.R.'s mission in office was to show that government activism works. To maintain that mission's credibility, he needed to keep his administration's record clean.
But George W. Bush isn't F.D.R. Indeed, in crucial respects he's the anti-F.D.R. President Bush subscribes to a political philosophy that opposes government activism - that's why he has tried to downsize and privatize programs wherever he can. (He still hopes to privatize Social Security, F.D.R.'s biggest legacy.) So even his policy failures don't bother his strongest supporters: many conservatives view the inept response to Katrina as a vindication of their lack of faith in government, rather than as a reason to reconsider their faith in Mr. Bush. And to date the Bush administration, which has no stake in showing that good government is possible, has been averse to investigating itself. On the contrary, it has consistently stonewalled corruption investigations and punished its own investigators if they try to do their jobs.
That's why Mr. Bush's promise last night that he will have "a team of inspectors general reviewing all expenditures" rings hollow. Whoever these inspectors general are, they'll be mindful of the fate of Bunnatine Greenhouse, a highly regarded auditor at the Army Corps of Engineers who suddenly got poor performance reviews after she raised questions about Halliburton's contracts in Iraq. She was demoted late last month. Turning the funds over to state and local governments isn't the answer, either. F.D.R. actually made a point of taking control away from local politicians; then as now, patronage played a big role in local politics. And our sympathy for the people of Mississippi and Louisiana shouldn't blind us to the realities of their states' political cultures. Last year the newsletter Corporate Crime Reporter ranked the states according to the number of federal public-corruption convictions per capita. Mississippi came in first, and Louisiana came in third.
Is there any way Mr. Bush could ensure an honest recovery program? Yes - he could insulate decisions about reconstruction spending from politics by placing them in the hands of an autonomous agency headed by a political independent, or, if no such person can be found, a Democrat (as a sign of good faith). He didn't do that last night, and probably won't. There's every reason to believe the reconstruction of the Gulf Coast, like the failed reconstruction of Iraq, will be deeply marred by cronyism and corruption.
Showdown at the Social Security Corral
Social Security Legislation Could Be Shelved, by Jonathan Weisman, Washington Post: National Republican Congressional Committee Chairman Thomas M. Reynolds will recommend to the House Republican leadership that the party drop its effort to restructure Social Security, at least for this year, House Republican aides confirmed yesterday. ... House and Senate leaders had already pushed off consideration of cuts in taxes and entitlement spending until the end of October. President Bush's tax reform panel has delayed release of its recommendations. Now, Social Security legislation, which already faced a steep uphill climb, might be shelved indefinitely. Senate Republican leaders had decided they could not move on Social Security until the House did. But with the Senate at a stalemate, House political strategists want to pull back as well. .. Reynolds (R-N.Y.) made his stand in a showdown with House Ways and Means Chairman Bill Thomas (R-Calif.), according to two witnesses. At a committee luncheon Wednesday, Thomas told panel members he was pushing forward with broad retirement security legislation that would include measures to strengthen private pensions, promote personal savings and add private investment accounts to Social Security. Reynolds then stood to say he would recommend to the leadership that it do no such thing. Thomas would not comment on the events. ... Carl Forti, a spokesman for the National Republican Congressional Committee, said he could not confirm the ... But he did not deny the report. ... David John, a proponent of Social Security private accounts at the conservative Heritage Foundation, said Reynolds's views are well known but hardly the last word...
The Potlatch, Wampum Inflation, and the Prohibition Against Currency in the Colonies
Who knew a steel drill could cause inflation? Let’s start with the definition of a potlatch:
Potlatch: A ceremonial feast among certain Native American peoples of the northwest Pacific coast, as in celebration of a marriage or accession, at which the host distributes gifts according to each guest's rank or status. Between rival groups the potlatch could involve extravagant or competitive giving and destruction by the host of valued items as a display of superior wealth.
Let me take the dictionary definition a little further. The word potlatch comes from a Nootka word meaning “giving,” passed from the Chinook jargon into the speech of all of the tribes of the Pacific Northwest. There is more than one creation myth for the potlatch ceremony which often lasted over several days, but the Quillayute ( link has two other myths) myth, which involves girls secretly making arrows, disguising themselves as boys, shooting a bird the boys could not hit, and then presenting the feathers as gifts is notable (see “Indian Legends of the Pacific Northwest” by Ella Clark). Here’s more on money in North America through colonial times:
Money in North American History, From Wampum to Electronic Funds Transfer, Roy Davies: The Potlatch, Gift Exchange and Barter: Money is often, mistakenly, thought to have been invented simply because of the inconvenience of barter. In fact the development of money was due to many causes and even barter itself often had important social functions in addition to its purely economic purposes. The potlatch ceremonies of Native Americans were a form of barter that had social and ceremonial functions that were at least as important as its economic functions. ... This form of barter was not unique to North America. Glyn Davies points out that the most celebrated example of competitive gift exchange was the encounter, around 950 BC, of Solomon and the Queen of Sheba. "Extravagant ostentation, the attempt to outdo each other in the splendour of the exchanges, and above all, the obligations of reciprocity, were just as typical in this celebrated encounter, though at a fittingly princely level, as with the more mundane types of barter in other parts of the world."
Wampum - Monetary Uses by Native Americans and Settlers: ...Whereas the Incas in Peru had reached a high level of civilization without the use of money, in Mexico the Aztecs and Mayas used gold dust (kept in transparent quills) and cocoa beans (kept for large payments in sacks of 24,000) as money. The best known form of money among the native Americans north of Mexico was wampum, made out of the shells of a type of clam. However its use was not confined to the coastal states but spread far inland, e.g. the powerful Iroquois amassed large quantities by way of tribute. Wampum's use as money undoubtedly came about as an extension of its desirability for ornamentation. Beads of it were strung together in short lengths of about 18 inches or much longer ones of about 6 feet.
Wampum came to be used extensively for trade by the colonists as well as the natives, e.g. in 1664 Stuyvesant arranged a loan in wampum worth over 5,000 guilders for paying the wages of workers constructing the New York citadel. Like more modern forms of money, wampum could be affected by inflation. Some tribes such as the Narragansetts specialized in manufacturing wampum (by drilling holes in the shells so that the beads could be strung together) but their original craft skills were made redundant when the spread of steel drills enabled unskilled workers, including the colonists themselves, to increase the supply of wampum a hundredfold thus causing a massive decrease in its value. A factory for drilling and assembling wampum was started by J.W. Campbell in New Jersey in 1760 and remained in production for a hundred years.
Forms of Money in use in the American Colonies: The British colonies in north America suffered a chronic shortage of official coins with which to carry out their normal, everyday commercial activities. An indication of the severity of this shortage and of the resultant wide variety of substitutes is given by the fact that during 1775 in North Carolina alone as many as seventeen different forms of money were declared to be legal tender. However, ... all these numerous forms of means of payment had a common accounting basis in the pounds, shillings and pence of the imperial system. The main sources [of] colonists ...l money ... fall into five groups.
1. Traditional native currencies such as furs and wampum which were essential for frontier trading with the indigenous population but thereafter were widely adopted by the colonists themselves, e.g. in 1637 Massachusetts declared white wampum legal tender for sums up to one shilling, a limit raised substantially in 1643.
2. The so-called "Country Pay" or "Country Money" such as tobacco, rice, indigo, wheat, maize, etc. - "cash crops" in more than one sense. Like the traditional Indian currencies these were mostly natural commodities. Tobacco was used as money in and around Virginia for nearly 200 years, so lasting about twice as long as the US gold standard.
Unofficial coinages, mostly foreign, and especially Spanish and Portuguese coins. These played an important role in distant as well as local trade. Not all the unofficial coins were foreign. John Hall set up a private mint in Massachusetts in 1652 and his popular "pine-tree" shillings and other coins circulated widely until the mint was forced to close down in 1684.
3. The scarce but official British coinage.
4. Paper currency of various kinds, particularly in the colonies' later years.
The first State issue of notes (in north America) was made in 1690 by the Massachusetts Bay Colony. These notes, or "bills of credit". were issued to pay soldiers returning from an expedition to Quebec. The notes promised eventual redemption in gold or silver and could be used immediately to pay taxes and were accepted as legal tender. The example of Massachusetts was followed by other colonies who thought that by printing money they could avoid the necessity to raise taxes.
5. Another early form of paper money used in north America was "tobacco notes". These were certificates attesting to the quality and quantity of tobacco deposited in public warehouses. These certificates circulated much more conveniently than the actual leaf and were authorized as legal tender in Virginia in 1727 and regularly accepted as such throughout most of the eighteenth century.
In addition to the State issues, a number of public banks began issuing loans in the form of paper money secured by mortgages on the property of the borrowers. ... One of the best examples was the Pennsylvania Land Bank which authorized three series of note issues between 1723 and 1729. This bank received the enthusiastic support of Benjamin Franklin who in 1729 published his Modest Enquiry into the Nature and Necessity of a Paper Currency. His advocacy did not go unrewarded as the Pennsylvania Land Bank awarded Franklin the contract for printing its third issue of notes.
Gradually the British government began to restrict the rights of the colonies to issue paper money. In 1740 a dispute arose involving a "Land Bank or Manufactury Scheme" in Boston, and the following year the British parliament ruled that the bank was illegal in that it transgressed the provisions of the Bubble Act of 1720 (passed after the collapse of the South Sea Bubble - one of the most notorious outbreaks of financial speculation in history). Restrictions were subsequently tightened because some colonies, including Massachusetts and especially Rhode Island, issued excessive quantities of paper money thus causing inflation. Finally, in 1764 a complete ban on paper money (except when needed for military purposes) was extended to all the colonies.
September 15, 2005
Bernanke: Hurricane Effects Transitory, Will Need to Cut Programs to Reduce Deficit
Bernanke sees brief Katrina hit on US economy, Reuters: Hurricane Katrina will hurt the U.S. economy in the short term, but bright long-run prospects mean the Bush administration can push ahead with its reform agenda, a top White House economic adviser said on Thursday. "In the shorter term, the devastation wrought by Hurricane Katrina will have a palpable effect on the national economy," White House economic adviser Ben Bernanke said in prepared remarks for delivery at the National Press Club. But he also said the private sector forecast healthy long-run growth. ... Bernanke said the budget deficit would rise in the short term as a result. But he stressed that as much of the money as possible should be offset through future spending cuts. "What we need to do is consider the President's budget proposal and be more aggressive in cutting duplicative or unnecessary programs," he told reporters after the speech. ... Bernanke, a former Federal Reserve governor who is regularly mentioned as a potential successor to Federal Reserve Chairman Alan Greenspan, offered no estimate of how much growth he thought might be erased by the storm, ... "In particular, the virtual shutting down of the Gulf Coast economy will leave its imprint on the national rates of job creation and output growth, especially in the third quarter," he said. But rebuilding of the area should add to growth "perhaps by the fourth quarter and certainly in the first half of next year." He said that while energy refining and distribution facilities were hard-hit, progress was being made on repairing them while supplies from the government's Strategic Petroleum Reserve were easing the pinch. ... Bernanke said the White House intends to continue pursuing policies that make the economy able to withstand shocks and that will keep growth on track. "These policies include making tax relief permanent, reducing the budget deficit by limiting spending, strengthening retirement and health security through efforts like Social Security reform ... and enhancing energy security,"...
CBOT Fed Watch: Chance of 25 bps Rate Hike increases to 86%
CBOT Fed Watch: Based upon the September 15 market close, the CBOT 30-Day Federal Funds futures contract for the October 2005 expiration is currently pricing in an 86 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3-1/2 percent to 3-3/4 percent at the FOMC meeting on September 20 (versus an 14 percent probability of no rate change):
September 13: 18% for No Change versus 82% for +25 bps. September 14: 16% for No Change versus 84% for +25 bps. September 15: 14% for No Change versus 86% for +25 bps. September 16: September 19
September 20: FOMC decision on federal funds target rate.
Tax Cuts Are Katrina Relief, by Mallory Factor, NRO: Hurricane Katrina wrought a devastating human tragedy. The White House and congressional leaders are rightly rushing to help. But they should not do so at the expense of the free-enterprise agenda… The politically correct notion that it is insensitive to continue with vital pro-growth policies in the aftermath of Katrina hurts the nation generally and has an adverse impact on the people most in need of help. Promoting economic growth and prosperity is important, now more than ever... In the last two years, the economy has grown by about $1.5 trillion, which is a tribute to President George W. Bush’s 2003 tax cuts. Keeping that pie growing will make it possible to offer more to New Orleans... In fact, [we] should go further by adding some form of immediate death-tax relief to the reconciliation bill. … Policymakers should reject the notion that high taxes are needed to pay for reconstruction. Even a generous disaster-relief package is little consolation to a person who can’t find work when the economy falters... We are now committed as a country to generously and compassionately rebuilding the hurricane zone and replacing what was lost. The price tag will be high, perhaps as high as $200 billion. That’s real money, and we need a healthy, growing U.S. economy to help pay for it... With rapid economic growth, a price as high as $200 billion is more affordable... This is not the time for ... high tax rates, including the expiration of the 2003 tax cuts. This is not the time to destroy family farms and businesses ... It is not inconsiderate to underscore the vital need for policies promoting economic growth and prosperity in the wake of tragedy. It would be inconsiderate not to.
Yapping About Money: The Stone Money of Yap
Federal Reserve Bank of Cleveland, Island Money, by Michael F. Bryan: ...In this Commentary, I … consider… the unique and curious money of Yap, a small group of islands in the South Pacific. … For at least a few centuries leading up to today, the Yapese have used giant stone wheels called rai when executing certain exchanges. The stones are made from a shimmering limestone that is not indigenous to Yap, but quarried and shipped, primarily from the islands of Palau, 250 miles to the southwest.
The size of the stones varies; some are as small as a few inches in diameter and weigh a couple of pounds, while others may reach a diameter of 12 feet and weigh thousands of pounds. A hole is carved into the middle of each stone so that it may be carried, either by coconut rope strung through the smaller pieces, or by wooden poles inserted into the larger stones. These great stones require the combined effort of many men to lift. Expeditions to acquire new stones were authorized by a chief who would retain all of the larger stones and two-fifths of the smaller ones, reportedly a fairly common distribution of production that served as a tax on the Yapese. In effect, the Yap chiefs acted as the island’s central bankers; they controlled the quantity of stones in circulation. …
The quarrying and transport of rai was a substantial part of the Yapese economy. In 1882, British naturalist Jan S. Kubary reported seeing 400 Yapese men producing stones on the island of Palau for transport back to Yap. Given the population of the island at the time … more than 10 percent of the island’s adult male population was in the money-cutting business. Curiously, rai are not known to have any particular use other than as a representation of value. The stones were not functional, nor were they spiritually significant to their owners, and by most accounts, the stones have no obvious ornamental value to the Yapese. If it is true that Yap stones have no nonmonetary usefulness, they would be different from most “primitive” forms of money. Usually an item becomes a medium of exchange after its commodity value—sometimes called intrinsic worth—has been widely established...
Precisely how the value of each stone was determined is somewhat unclear. We know that size was at best only a rough approximation of worth and that stone values varied depending upon the cost or difficulty of bringing them to the island. For example, stones gotten at great peril, perhaps even loss of life, are valued most highly. Similarly, stones that were cut using shell tools and carried by canoes are more valuable than comparably sized stones that were quarried with the aid of iron tools and transported by large Western ships. The more valuable stones were given names, such as that of the chief for whom the stone was quarried or the canoe on which it was transported. Naming the stone may have secured its value since such identification would convey to all the costs associated with obtaining it...
Consider the case of the Irish American David O’Keefe from Savannah, Georgia, who, after being shipwrecked on Yap in the late nineteenth century, returned to the island with a sailing vessel and proceeded to import a large number of stones in return for a bounty of Yapese copra (coconut meat). The arrival of O’Keefe (and other Western traders) increased the number and size of the stones being brought back to the island, and by one accounting, Yap stones went from being “very rare” in 1840 to being plentiful—more than 13,000 were to be found on the island by 1929. No longer restricted by shell tools and canoes, the largest stones arriving grew from four feet in diameter to the colossal 12-foot stones that are now a part of monetary folklore. Yet the great infusion of stones did not inflate away their value. Since the stones of Captain O’Keefe were obviously more easily obtained, they traded on the island at an appropriately reduced value relative to the older stones gotten at much greater cost. In essence, O’Keefe and other Westerners were bringing in large numbers of “debased” stones that could easily be identified by the Yapese.
While it’s clear that the Yap stones have value for the Yapese, can the stones really be called money? The answer, of course, depends upon how you define money. If you rely on a standard textbook definition, you’d describe money in terms of its functions, for example, “Whatever is used as a medium of exchange, unit of account, and store of value.” Certainly, Yap stones performed at least one of these functions quite well—they were an effective store of value (form of wealth). But every asset—from bonds to houses—stores value and is not necessarily labeled money.
To be called money, at least according to the textbook definition, an asset must serve two other functions. It must be a medium of exchange, meaning that it can be readily used either to purchase goods or to satisfy a debt, and it must be a unit of account, or something used as a measure of value. Yap stones were not the unit of account for the islands. Pricing goods and services in terms of the stones would probably have been difficult for the average islander. ... According to Paul Einzig, prices on the islands were set in terms of baskets of a food crop, taro, or cups of syrup, staples that would be easy for a typical islander to appreciate. Furthermore, there is some question whether Yap stones were commonly used as a medium of exchange. To be used in exchange, an item must possess certain characteristics—it must be storable, portable, recognizable, and divisible. Certainly, the stones were storable; they can still be found in abundance on Yap, and they have maintained their purchasing power reasonably well over time (particularly compared with other fiat monies, including dollars). And while it is sometimes claimed that Yap stones suffer as an exchange medium because they lack portability, this may not be completely accurate. In the case of the larger, more easily identified stones, physical possession is not necessary for the transfer of purchasing power. Those involved in the exchange need only communicate that purchasing power has been transferred…
But while storability and portability may not have limited the use of these stones as a medium of exchange, the other two characteristics—recognizability and divisibility—probably did. The stones were primarily used in exchanges between Yap islanders. … Yap historically did not have close cultural ties with any of its trading partners and trade with off-islanders was somewhat infrequent, the stones did not facilitate transactions on these occasions. When transacting with other islands, the Yapese used woven mats (a common exchange medium throughout the South Pacific), while trade with Westerners often involved an exchange of coconuts. Even on the island, the indivisibility of the stones necessitated the use of other items as media of exchange for most transactions. Most rai are highly valued: By one account, a stone of “three spans” (about 25 inches across) would have been sufficient in the early twentieth century to purchase 50 baskets of food or a full-sized pig, while a stone the size of a man would have been worth “many villages and plantations.” Obviously, these stones do not change hands very frequently, since expenditures of such magnitude are rare. For more ordinary transactions, the Yapese either used pearl shells or resorted to barter. Clearly the stones of Yap do not fit neatly within the textbook definition of money…
But … what role do the stones play and how is that role similar to that played by dollars?... [T]he stones, particularly the larger ones, acted as markers, changing hands in recognition of a “gift.” Stones were often merely held until the gift was reciprocated and the stone could be returned to its original owner. For example, islanders wishing to fish someone’s waters might do so by leaving a stone in recognition of the favor. After an appropriate number of fish were given to the owner of the fishing waters, the stone would simply be reclaimed. Occasionally a stone was “exchanged” when one tribe came to the aid of another, say for support against a rival tribe or in celebration of some event. But the stone would reside with the new tribe only until such time as aid of a similar value could be given in return. The stones, then, act as a memory of the contributions occurring between islanders. Anthropologists refer to this as a “gift economy,” where goods aren’t traded as much as they are given with the expectation of a comparable favor at some later date. So Yap stones serve as a memory of one’s contributions on the island. … But this raises an intriguing question. If the stones of Yap were merely markers and nothing more, why did the Yapese expend such great resources to carve them out of the mountains of Palau and carry them all the way back to their island? Wouldn’t any marker work just as well? It may be that the Yap chiefs did not have sufficient “credibility” to simply decree an object’s value. That is, the Yapese may have needed some assurance that the object on which value has been assigned could not be easily replicated for the mere benefit of the issuer...
CPI, New Jobless Claims, and Inventory Reports Released
[Update - adds statements from WSJ]
In evaluating these data note that the effects of Hurricane Katrina are not in most of these data since it didn’t hit until very late in the month. Thus, inflation readings and jobless claims are both likely to rise further this month. Given the Fed’s belief that it has very little power to affect employment conditions in the short-run, a task Janet Yellen said must be handled with fiscal policy, and the underlying price pressures due to higher energy costs, I still expect rates to go up t the next meeting. But it will be interesting to see the extent to which recent events and data alter the accompanying statement. I expect the data dependent nature of further rate increases to be noted.
Update: From the WSJ:
In other economic news released Thursday:
• The Philadelphia Federal Reserve reported little growth in its region in September and broadening price pressures. The bank's index measuring such growth dropped to 2.2 from 17.5 in August and 9.6 in July. Economists had expected a reading of 13 this month. The bank's new-orders and employment indexes turned in their worst performances since April 2003 and September 2003, respectively.
• The New York Federal Reserve reported that its index measuring manufacturing activity in the New York region dropped to 16.97 in September from 23.04 in August. The bank said the data were collected between Sept. 1 and Sept. 14, after Hurricane Katrina hit the Gulf Coast. Economists had expected a reading of 16.8. New orders and unfilled orders declined, while readings on employment, shipments and prices paid increased. • U.S. business inventories unexpectedly shrank in July as sizzling car sales helped clear out auto showrooms and lots. Inventories dropped 0.5%, the biggest drop in nearly two years, to a seasonally adjusted $1.271 trillion, after remaining flat in June, the Commerce Department said Thursday. It was the largest decrease since stockpiles contracted at the same rate in August 2003. Economists had expected a more modest 0.2% drop. Business sales advanced 1.1% to $1.012 trillion, after a revised 0.8% increase in June. The inventory-to-sales ratio eased to 1.26 from 1.28.
Posted by Mark Thoma on Thursday, September 15, 2005 at 09:45 AM in Economics
The Institute of International Finance Worries About Global Imbalances
G7 leaders urged to act on global imbalances, by Andrew Balls and Chris Giles, Financial Times: The world’s largest banks and financial institutions ... urged the leaders of the global economy to act together to reduce “increasingly worrisome” global economic imbalances.
The Institute of International Finance also called on the Group of Seven leading industrialised countries to add China, India, Russia and Brazil to its ranks... In its twice-yearly open letter to finance ministers and central bank governors, the IIF said Hurricane Katrina should remind the world of the global economy’s vulnerability to shocks. “Existing imbalances and the increasing seriousness of the energy situation pose risks to the sustainability of a healthy growth environment and deserve the special attention of policymakers and market participants,” ... The tone of the IIF’s letter indicates that private sector financial institutions are increasingly concerned about rapidly growing trade deficits in the US with corresponding surpluses in Europe, Asia and among oil exporters. For the past two years finance ministers and central bank governors of the G7 leading economies have regularly exhorted fiscal retrenchment in the US ... and greater flexibility in exchange rates in countries where it is lacking...
The recent talk of increasing deficits
Grassley compared spending for hurricane recovery to the steps taken after terrorist attacks, when Congress simply spent what was necessary. "In that instance you don't worry about the debt," Grassley said in a conference call with Iowa reporters...
and reducing taxes
"I can assure you that the House Ways and Means Committee has not abandoned trying to extend the dividend tax cut and the capital gains tax cut. We think that is critical. We have not given up on that," Rep. Jim McCrery, a Louisiana Republican, told a news conference.
cannot help the perception of growing risk expressed by the IIF. One additional note. The letter also urges the Fed to use caution in imposing further rate increases in light of Katrina, though the letter does note the Fed should be mindful of inflation.
Financial Reform in China
New Economist: Next steps for China?: Somewhat overlooked last week was an interesting piece by Eswar S. Prasad, Next Steps for China, in the latest issue of IMF magazine Finance & Development. He argues that financial sector reform is a crucial element of a long-term growth strategy for China:
The exchange rate regime is just one piece of the broader reform agenda in China. The [paper] ...assesses what China needs to do to ensure the durability of its economic expansion by addressing the looming issues of financial sector reform and the need to bolster balanced domestic-led growth.
On investment, Prasad comments:
Growth is undoubtedly a wonderful tonic. But there is a potential dark side associated with the fact that a significant portion of this growth in recent years has come from investment, with rising fixed investment becoming the main driver of output growth since 2001 (see Chart 3). A good chunk of this investment is likely to prove unproductive from a long-term perspective. Even building bridges to nowhere can raise output in the short term but is hardly a good use of resources. For it is ultimately consumption rather than investment or even output that is a true measure of economic welfare.
The piece is quite short, but includes some impressive charts - such as the one shown. See also the China country focus chartset in the same issue.
[Bloomberg report on China's fixed investment growth of 27.4 percent in the first two quarters.]
Health Insurance Costs Continue to Outpace Inflation
Health Insurance Outpaces Inflation, Raises by Albert B. Crenshaw, Washington Post: The cost of health insurance for working Americans climbed 9.2 percent this year, the lowest rate of increase since 2000 but still far ahead of both general inflation and workers' pay increases, according to a nationwide survey by the Kaiser Family Foundation. On average, health insurance for a family cost $10,880 this year, with the employer paying $8,167 and the worker $2,713... The total cost almost exactly matches the total annual earnings of a person working full time at the minimum wage... For a single worker, the average cost totaled $4,024, with $3,413 paid by the employer and $610 by the employee, the survey found.
At the same time, the proportion of employers providing health insurance continued its steady decline, falling to 60 percent this year from 69 percent five years ago. Most of the decline was among very small companies ... noting that less than half -- 47 percent -- of firms with three to nine workers now offer medical coverage to their employees... Absent plan changes, Mercer said, employers project a rise of about 10 percent next year. Kaiser's Altman cautioned that the recent slowdown in increases should not be a cause for any great optimism. "I would say, don't be fooled by the moderation in the rate of increase. We've seen these dips before, and history teaches us they have a way of bouncing back,"...
Altman and others who have watched cost-containment efforts over the years have seen such ideas as managed care burst onto the scene and appear to bring costs to heel. But each time, the new strategy has lost effectiveness, and costs resumed their seemingly inexorable climb. The current "next big thing" is what has been dubbed "consumer-driven" health care, which combines high-deductible insurance with a fund that the individual can use to cover routine costs. In these arrangements, consumers are allowed to accumulate unspent money in the fund, giving them, theorists argue, an incentive to shop and eliminate unnecessary spending. The Kaiser survey found much interest in these types of arrangements but, so far, little actual participation. … "There absolutely is growing interest in consumer-driven arrangements," Altman said, but with the small number of workers enrolled in them, "it's impossible to make a judgment about their effect on health care cost...
I Have *Got* to Have One of These!
Gillette Is Betting That Men Want an Even Closer Shave, by Claudia H. Deutsch, New York Times: ...The people at Gillette have a ... challenge: persuading men that they need to buy yet another new shaving system. Yesterday, Gillette unveiled Fusion (manual) and Fusion Power (battery operated), a wet-shaving system with a lot more bells and whistles than the company's Mach3Turbo and M3Power, currently the top-selling shavers. It also announced a line of shaving creams and gels to go with the new razors... Much is at stake. According to Gillette, American men spent about $1.7 billion on blades and razors last year, and another $300 million on shaving creams and gels. Globally, shaving products accounted for more than $10.4 billion in sales. [Fusion Power jpg]
Gillette will spend a lot to get the word out... "Mach3 will remain No. 1 for the first few years, but Fusion will become our flagship brand," Mr. Kilts said. This is the first time Gillette has introduced a full line of razors and accouterments at once, and marketing experts agree with the decision. "Hats off to these guys; they're offering metrosexual nirvana," said Gary M. Stibel, principal and founder of the New England Consulting Group, a marketing consulting firm in Westport, Conn. "You get a five-bladed razor any way you want it, with power, without power. You get the gel and grooming products to go with it. Men will credit the whole system for a better shave."
Maybe so - but do men really need a better shave than Mach3 provides? Mr. Hoffman is certain they do. Noting that 60 percent of the men who tested the Fusion razors preferred them to the Mach3, he predicts that Fusion will be a "billion-dollar product" by 2008. But marketing experts, while applauding Gillette's willingness to eat into Mach3 sales, are not so sure. "It is an incredibly hard decision, to cannibalize your own leading brand, even when you know that someone else will do it to you if you don't … how much better do men really think their shaving experience needs to be?"... Both Fusion models have five blades instead of Mach3's three, and they are spaced 30 percent closer than are Mach3 blades … The Fusion models have a "Precision Trimmer" blade on the back of the blade cartridge, to be used to trim sideburns or shape facial hair. … Fusion Power gets more techie. Its cartridges - which will also fit on the manual version - have a super-thin coating that Gillette says provides for an even closer shave. And while it runs on conventional AAA batteries, it incorporates an electronic chip to regulate voltage and otherwise ensure that the "shaving experience" is consistent as the battery drains. It even turns itself off...
Posted by Mark Thoma on Thursday, September 15, 2005 at 12:15 AM in Economics
September 14, 2005
Cato Calls for Leadership from Fiscal Authorities
Only leadership can defuse US fiscal time-bomb, by Jagadeesh Gokhale, commentary, FT: Alan Greenspan recently warned that monetary policy “cannot ignore the potential inflationary risks inherent in our current fiscal outlook . . .” He also said: “I assume that [fiscal] imbalances will be resolved before stark choices again confront us and, if they are not, the Fed will resist any temptation to monetise fiscal deficits.” ... Unfortunately, the “stark choices” fiscal policymakers would face if they fail to resolve the growing fiscal imbalance will eventually confront the Fed. Why? Because continued high deficits and growing debt will drain the economy of investible resources. It will also reduce foreign lenders’ confidence in US ability to resist the temptation to inflate away the real value of growing federal debt – much of which is held abroad. That may lead them to divert their savings from US shores, further draining domestic investment.
If that happens, ... domestic unemployment will increase and political pressure on the Fed to stimulate economic activity will grow. Direct monetary stimulus entails purchasing more Treasury debt for cash to keep interest rates lower than would be consistent with an “inflation neutral” level – precisely the action Mr Greenspan abjures. So the question remains: how long can his successor continue serving the price-stability goal and ignore calls for direct action? ...
Managing the public’s inflation expectations has been Mr Greenspan’s quintessential skill. ... However, and here is the really hard question, does performing such a superb job of managing inflation expectations while maintaining price stability exacerbate the problem by allowing the nation’s fiscal imbalance to grow? ... By allowing fiscal policymakers to prolong their “no tax-hikes” versus “no-spending-cuts” ... Greater confidence in the ability of monetary policy to mop up problems created by fiscal profligacy may be enabling the very irresponsible fiscal policies ... Ultimately, defusing the fiscal time-bomb will require sustained leadership directly in federal fiscal management.
We've seen this game between the fiscal and monetary authorities before. I’m sure I disagree with Cato as to how to solve the deficit problem, but that aside I too worry about the pressures to monetize the debt in coming years. That’s why I think it is appropriate and necessary for the Fed chair to discuss the implications of budget deficits and this is another place where, in my opinion, more leadership is needed.
*Debt monetization occurs when the Fed prints money and uses it to purchase government debt from the private sector. It's equivalent to printing money to finance government expenditures.
Retail Sales and Industrial Production Reports Released, Doubts Expressed About Using Capacity Utilization to Measure Slack
Katrina Makes Impact on Industrial Output, by Martin Crutsinger, AP: Industrial output rose only slightly in August as Hurricane Katrina severely cut back production of petroleum and chemicals along the Gulf Coast.
The Federal Reserve reported Wednesday that industrial output rose a tiny 0.1 percent last month … as Katrina … forced sharp cutbacks in oil and natural gas extraction in the Gulf of Mexico and also depressed output at refineries and chemical plants in the areas hit by the hurricane. Without the adverse effects of the hurricane, industrial output would have been 0.3 percentage points higher, the Fed estimated.
A second report on retail sales showed that the economy was weakening even before Katrina struck. The Commerce Department said that retail sales plunged by 2.1 percent in August, the worst showing in nearly four years … The weakness came from a big 12 percent plunge in auto sales. Excluding autos, retail sales rose by 1 percent, but much of the strength came from a huge rise in gasoline prices. … The 2.1 percent drop in total retail sales last month was the largest decline since a 2.9 percent plunge in November 2001, the period following the 2001 terrorist attacks. The worry is that consumer confidence could be jolted this time around … The biggest increase in spending in August occurred at service stations, a 4.4 percent increase that reflected gasoline prices that have soared past $3 per gallon in many parts of the country. Without the big jump in spending at gasoline stations, retail sales would have fallen an even bigger 2.8 percent last month as demand faltered in many sectors...
I disagree with the last sentence. It essentially says demand was higher because prices were higher. If the money had not been spent at service stations, it likely would have been spent somewhere else. Had gas prices and prices generally been lower, quantity demanded would increase, not decrease.
Increased globalization raises questions about traditional policy concepts and tools... We are pondering whether traditional measures of capacity utilization have much meaning in an increasingly interconnected economy. We wonder whether our traditional domestic gauges of slack in the economy are adequate in a world where new technologies made or used overseas make certain U.S. factors of production obsolete. And if we don’t have a good handle on effective capacity, how can we measure how much of that capacity is being utilized?...
In any case, the industrial production and retail sales reports will catch the Fed’s attention. And somewhere it should be noted that these are monthly data which can deliver very noisy signals about the economy.
Update: Here's another view from The Financial Times:
...But a separate report from the Commerce Department showed robust consumer activity before the storm struck. Retail sales dropped 2.1 per cent in August - more than had been expected - but excluding the volatile auto sector, sales were actually up 1 per cent, double what economists had expected. Year-on-year, sales are up 9.5 per cent, or an even stronger 11 per cent excluding autos. Most major categories showed rises, but much of the gain came from a 4.4 per cent jump in receipts at petrol stations as energy prices continued to climb. Petrol sales are up 31 per cent year-on-year, according to ActionEconomics. Alan Ruskin, research director at 4Cast economic consultancy, said the fact that rising energy costs - and the feed through to higher pump prices - had not yet damped consumer spending was a positive sign. "The data continue to fit with a view that the Fed will not pause come September 20, and will likely continue tightening in November as well," he added.
Posted by Mark Thoma on Wednesday, September 14, 2005 at 10:08 AM in Economics
FT: Rates Are Going Up, But Fed Unsure What to Say
US Federal Reserve set to raise rates again, by Andrew Balls, Financial Times: The US Federal Reserve is set to press ahead with its campaign of raising interest rates at its meeting next week, in spite of the economic impact of Hurricane Katrina. But there is expected to be intense discussion of whether substantial changes to the wording of the accompanying policy statement are needed. Fed officials are reasonably relaxed about the hurricane's impact on national measures of production and consumer spending and employment. A small dip in the second half of the year is expected to be recovered during the reconstruction effort.
Within the Fed, there is considerable scepticism about the need for the “compassionate” pause in the tightening campaign that some politicians have called for following the devastation in New Orleans and the surrounding region caused by Katrina. An important subject of discussion will be whether the Fed should drop its characterisation of monetary policy as “accommodation” and whether it should maintain its guidance that it is likely to continue raising the federal funds rate at a “measured” pace...
Dual Banking in the U.S.
Chartered Banking (1781-1838): At the very beginning of our banking history, American banks ... were ... supervised by the market. But--in contrast to other countries--our banking system evolved the dual structure that so distinguishes our country from others. Those seeking to circulate bank notes in the United States in our earliest days usually sought a ... charter ... almost solely at the state level. Entry into the banking business was far from free. Indeed, by the early 1800s chartering decisions by state authorities became heavily influenced by political considerations. ... The regulation and supervision of early American banks were modest and appear to have been intended primarily to ensure that banks had adequate specie reserves to meet their debt obligations, especially obligations on their circulating notes...
Free Banking (1837-1863): The ... intense political controversy over the charter renewal of the Second Bank of the United States, and the wave of bank failures following the panic of 1837 led many states to reconsider their fundamental approach to banking regulation. In particular, in 1838 New York introduced a new approach, known as free banking, which in the following two decades was emulated by many other states. ... The perception of the free banking era as an era of "wildcat" banking marked by financial instability and, in particular, by widespread significant losses to noteholders also turns out to be exaggerated. ... Nonetheless, it is fairly clear that the strength of banks varied from state to state, with regulation and supervision uneven.
As a consequence mainly of the panic of 1837, the public became aware of the possibility that banks could prove unable to redeem their notes and changed their behavior accordingly. Discounting of bank notes became widespread. Indeed, between 1838 and the Civil War quite a few note brokers began to publish monthly or biweekly periodicals, called bank note reporters, that listed prevailing discounts on thousands of individual banks...
National Banking (1863-1913): During the Civil War, today's bank structure was created by the Congress. It seems clear that a major, if not the major, motivation of the National Bank Act of 1863 was to assist in the financing of the Civil War. But the provisions of the act that incorporated key elements of free banking provide compelling evidence that contemporary observers did not regard free banking as a failure. These provisions included free entry and collateralized bank notes. The 1863 act introduced competition to state banks, but in 1864, the Congress adopted an important amendment which called for taxing the issuance of state bank notes. It is not clear if the intention was to assure only one kind of currency or to force the states out of the banking business. But whatever its purpose, with the tax on notes the number of state banks fell from about 1,500 in 1864 to 250 by the end of the decade.
Any forecast at that time would quite reasonably have concluded that state banks would become historic relics. Such a projection, however, would have been quite wrong... Forced to find a substitute for notes, state banks pioneered demand deposits. Within ten years after the note tax, state banks had more deposits than national banks--a lead maintained, I might add, until 1943. By 1888, only 20 years after the low point, there were more state banks than national banks (approximately 3,500 vs. 3,100), a lead maintained to this day...
But why have we allowed dual banking to persist? Here's Richard Fisher, president of the Dallas Fed, on that question as well as some specifics on dual banking in Texas:
...America’s dual banking system dates back to the National Bank Act of 1864, which gave the country national banks alongside existing state-chartered banks. Texas had to wait a bit longer for a dual banking system. ...[T]he 1845 state constitution specified that “no corporate body shall hereafter be created, renewed or extended with banking or discounting privileges.” This provision remained in the 1876 constitution, so for decades Texans had access only to nationally chartered banks and private banks. It was not until a constitutional amendment was approved in November 1904 that state banks came into existence in Texas... Today, the state-chartered banking system is competitive and strong. As of June 30, 330 of the 637 Texas banks had state charters. In the past three years, 13 of the 23 newly chartered commercial banks—or 57 percent—chose state charters. The dual banking system provides ... for decentralization of authority. As Chairman Greenspan has said, banks’ freedom to choose their regulator is a key protection from the potential for unreasonable regulatory behavior. The doctrine of choice creates a healthy dynamic among regulators. Under the dual banking system, state-chartered banks have fostered many innovations, resulting in an ever-widening array of products and services. State banks pioneered demand deposits, and a state-chartered bank introduced the NOW account. The first banks to offer variable-rate mortgages and home-equity loans came under state regulation...
So, he gives two reasons for dual banking, one perhaps a consequence of the other. First, it promotes competition among regulators which avoids unreasonable and excessive regulation. Second, by having competition in the banking system (here’s an example) and the additional freedom that dual regulation allows, financial innovation has been implemented in large part by state banks, and that has helped develop the financial services industry.
Cato Presses for the DeMint and Ryan Social Security Reform Bills
The Personal Lockbox: A First Step on the Road to Social Security Reform by Michael D. Tanner, Cato: With President Bush’s call for comprehensive Social Security reform bogged down in the morass of partisan politics, many reform advocates have suggested starting the process with smaller steps. Recently, Sen. Jim DeMint (R-SC), Rep. Jim McCrery (R-LA), Rep. Paul Ryan (R-WI), Rep. Sam Johnson (R-TX), and others have proposed legislation to rebate Social Security surpluses to workers in the form of contributions to personal accounts. ... The Senate legislation (S1302) and House proposal (HR3304, known as GROW for Growing Real Ownership for Workers) are designed to prevent Congress from spending the surplus, which would allow individual workers to save that money toward their own retirement. ... GROW and S1302 are not -- and should not be -- the final word for Social Security reform. The proposals do little to address Social Security’s looming insolvency. The accounts would be only temporary, expiring once the surplus was exhausted. A more comprehensive approach would still be needed. However, S1302 and GROW represent an important down payment on larger reforms to come. Full Text of Policy Analysis no. 550 (PDF, 134 KB)
So far, the White House has not publicly signaled a change in its stance, but with the changing political climate the White House may need the support of this group. But even with White House support, the current prospects for this legislation look slim.
Presidents Bush and Jintao Talk about U.S.-China Trade
China pledges steps to ease US frictions, Reuters: President Hu Jintao acknowledged U.S.-Chinese trade frictions ... and promised President George W. Bush to try to ease a trade imbalance that is of growing concern in Washington. ... The two leaders met at a time of strains between their governments over China’s growing economic power. China’s trade surplus with the United States was $10 billion in August, the third highest on record... Pirating of goods such as computer software and compact discs by Chinese companies has long been a source of concern in Washington. ... Hu promised to work on ways to prevent infringement of such rights -- a statement welcomed by U.S. officials. Bush told Hu that Beijing’s recent move to loosen its exchange rate was a “good first step” but more should be done...
We shall see. There’s a few steps we could take here too. We’ll see about that too. [Bloomberg article here]
Good News from the Port of New Orleans
Port Comes Back Early, Surprisingly, by Keith L. Alexander and Neil Irwin, Washington Post: The Port of New Orleans began unloading its first cargo ship ... months sooner than was predicted, a sign that disruption to the nation's shipping capacity may be less severe than originally forecast.
After the storm, port officials figured it would take six months to resume service in New Orleans and at facilities throughout the Gulf Coast. Importers scurried to reroute ... commodities, and Midwest farmers worried that they wouldn't be able to ship their grain to the rest of the world during the harvest... But Tuesday, the port was coming back to life, with electrical power restored to parts of the facility by late afternoon. ... Gary P. LaGrange, chief executive of the port, said he expects it to be at 80 percent of capacity within three months. The Port of South Louisiana and Port Fourchon, on the Gulf Coast, have also partially restored service, and the Port of Pascagoula, Miss., expects to resume service by early October, according to the American Association of Port Authorities. ... That doesn't mean the economy is in the clear ... there are no guarantees that [progress] will continue at this pace, analysts said. ... Nonetheless, the work at the Port of New Orleans proceeded at full speed Tuesday ... The faster-than-expected reopening came about through some bureaucratic arm-twisting, coordination between groups, and a careful focus on the most urgent areas for repair, said LaGrange and outside analysts. "They're moving at light speed," said C. James Kruse, director of the Center for Ports and Waterways at the Texas Transportation Administration. "It's been an example of good cooperation between federal agencies and the port authority, and an action plan to get to the critical things first and fix other problems later." ... The port also collaborated with the dockworkers' union, the International Longshoremen's Association, to bring in workers from other ports. LaGrange said it was necessary because most Port of New Orleans employees were forced to leave the area and could not be located. And state police are guarding the access roads from hijackers, and agreed to give truck drivers delivering goods to and from the port clearance to deliver their loads...
Update: After good news on the Port of New Orleans, bad preliminary news on natural gas production:
US natural gas production ‘crippled for months’, by Sheila McNulty, FT: Three weeks after Hurricane Katrina struck one of the world’s most important natural gas producing regions, 35 per cent of Gulf of Mexico production remains off-line, and analysts say gas production there will remain “crippled for months”... Some analysts predict natural gas prices will average $12 per thousand cubic feet this winter – double the cost last winter. ... Last week the Industrial Energy Consumers of America trade association asked Congress to remove environmental barriers to new areas of production. They note that while high petrol prices have hurt consumers by increasing transportation costs, high natural gas prices have a stronger impact because they raise the cost of heating while also affecting industrial competitiveness and jobs. ... Alternatives to natural gas could come under pressure as well. ... Much will depend upon the state of the four refineries believed to be most damaged. There has been little information so far, but analysts suspect they suffered extensive damage and will be shut for months. ... Deepwater assessments remain preliminary ... but companies are reporting more than 37 shelf platforms destroyed and 12 others significantly damaged. Several natural gas processing plants have suffered direct damage, and outages could last for months...
Posted by Mark Thoma on Wednesday, September 14, 2005 at 01:17 AM in Economics
September 13, 2005
And the Hours are Better Too...
I know you wanted me to be a doctor ever since I was a little boy, but take a look at this!
[From the WSJ: "Wage Winners and Losers"]
Individual experience may vary.
Posted by Mark Thoma on Tuesday, September 13, 2005 at 03:06 PM in Economics
CBOT Fed Watch: Chance of 25 bps Rate Hike is 82%
CBOT Fed Watch: Based upon the September 13 market close, the CBOT 30-Day Federal Funds futures contract for the October 2005 expiration is currently pricing in an 82 percent probability that the FOMC will increase the target rate by at least 25 basis points from 3-1/2 percent to 3-3/4 percent at the FOMC meeting on September 20 (versus an 18 percent probability of no rate change):
September 13: 18% for No Change versus 82% for +25 bps. September 14: September 15: September 16: September 19
September 20: FOMC decision on federal funds target rate.
I will update these probabilities daily.
Radio Economics: The Economic Impact of Katrina
Barry Ritholtz and Dr. Mark Thoma discuss the economic impact of Katrina. Topics discussed include the expected impact on inflation, interest rates, unemployment, Bush's tax cuts, the budget deficit and national debt, and whether the Fed will monetize the debt.
Posted by Mark Thoma on Tuesday, September 13, 2005 at 12:33 PM in Economics
Fed Watch: To Hike or Not – That is the Question
The next FOMC meeting is just a week out, and market participants still lack a firm consensus on the path Greenspan & Co. will choose, but, as reported by David Altig, the tide has turned in favor of those who see another rate hike in the near future. In a similar vein, this quote from Saturday’s Washington Post likely summarizes the Fed’s thinking at this point:
If Federal Reserve policymakers had to vote today, they'd probably raise short-term interest rates a notch out of concern that Hurricane Katrina could harm the U.S. economy more by boosting inflation than by slowing growth.
I would have to agree. Recent Fedspeak and data give little reason to believe that the FOMC is ready to change course, despite Katrina. While not discounting the real suffering of those affected by this disaster, Fed officials appear to be more worried about inflationary pressures rather than weak demand.
The much awaited speech by Chicago Fed President Michael Moskow was decidedly hawkish (see Mark Thoma here). Perhaps more interesting was San Francisco Fed President Yellen’s speech, which was widely viewed as less hawkish than Moskow (see William Polley here). I tend to agree; Yellen appeared more cautious than her Chicago colleague. But some little noted commentary places Yellen in a different light (I can’t take credit for spotting this; it was passed on to me by a contact). Take a look at Yellen’s previous speech on July 29. On that day Yellen thought:
A final factor impacting the inflation outlook is the degree of slack in the labor market. Right now, the unemployment rate is relatively low: at 5 percent it’s near most estimates of the so-called natural rate. But other measures—such as the employment-population ratio, a survey of job market perceptions, and industrial capacity utilization—suggest that some slack still remains.
Just a few weeks later, AFTER Hurricane Katrina, Yellen has a different view:
As we assess the likely behavior of wage pressures going forward, we must also factor in the influence of slack in labor and product markets. The decline in the unemployment rate to 4.9 percent in August, coupled with some improvement in measures such as the employment-population ratio and industrial capacity utilization, suggest that while a "whisker" of slack may still remain, we probably can't count on slack to hold inflation down.
Placing these paragraphs side by side, it appears that Yellen has reassessed the degree of slack remaining in the economy – and her conclusion is undeniably more hawkish. Likewise, from July 29:
Looking at the big picture elements—growth, employment, and inflation—I’d say things are in reasonably good shape. Over the past two years, the nation’s output growth has been pretty steady, averaging just over four percent; this is solidly above trend, which, by most estimates, is around three and a quarter to three and a half percent.
Beginning on the real side of the economy, the nation's output growth has averaged about three and one-half percent over the past year, a rate that is moderately above trend, which is now probably around three to three and a quarter percent.
Yellen appears to have settled on the lower estimate of potential growth, possibly a result of slowing productivity growth. Indeed, just a day earlier, we were greeted with news that second quarter productivity was revised downward and labor costs revised upward. This shift in Yellen’s language is subtle but important as it again suggests Yellen sees less slack in the economy compared to just a few weeks ago. So, in a nutshell, while Yellen may appear less hawkish than Moskow, she appears more hawkish than before Katrina, suggesting an increased willingness to stick with the current policy of “measured increases.”
Monday we also heard from Dallas Fed President Richard Fisher in something of a surprise speech. Everyone needs to take a look at this speech. I expect many different opinions. Simply put, Fisher is shaping up to be the most enigmatic Fed official in recent memory. Recall that Fisher first broke onto the scene with his famous proclamation that the Fed is in it “eighth inning” as far as rate hikes are concerned. It soon became clear that the remainder of the FOMC did not share this view. Now, according to Bloomberg:
The Dallas Fed said as recently as Friday that Fisher would not be making any public appearances this week. Bank spokesman James Hoard said the speech was given at 1:30 p.m. local time in Austin, Texas, at a private event that wasn't open to the public or reporters.
Turns out Fisher spoke quite a bit about the economy, and it became necessary to post his speech on the Dallas Fed website. He sounds like he is ready to pause:
When it comes to Katrina and the U.S. economy, my inclination is to read, listen and watch and not rush to judgment about how the disaster will impact the economy or how monetary policy ought to respond.
This caution, however, does not stop him from listing a litany of reasons to expect little economic impact:
You might recall that a powerful earthquake struck Kobe, Japan’s second largest port, in January 1995, causing $110 billion in damage to a city that handled 30 percent of the nation’s trade. In addition to killing 5,500 and leaving 300,000 homeless, the quake destroyed 75,000 buildings and damaged another 200,000. It took two years to rebuild. The impact on the Japanese GDP, however, wasn’t all that big.
The hurricane’s damages, as we all know, were significant in absolute terms—estimated at up to $200 billion. We’ve all seen television footage of thousands of destroyed and damaged buildings. Up close, it looks overwhelming. But it is important to bear in mind that Katrina’s estimated physical losses amount to only a third of a percentage point of national wealth.
Among the American economy’s strengths are its size, diversity, interconnections and resiliency. I fully expect the economy to rebound from this disaster—as it did after the Sept. 11, 2001, terrorist attacks. And the Northridge, California, earthquake in 1994. And Hurricane Andrew in Florida in 1992.
And he is not sure what to think about inflation:
It is clear, however, that a period of price volatility cannot be avoided for energy and other commodities processed, stored and transported along the Gulf Coast and the mighty Mississippi. The headlines have been full of news about gasoline climbing above $3 a gallon, although crude oil prices have already receded from their peaks. The massive effort to rebuild the Gulf Coast will create additional demand for lumber, steel, cement and other building materials. With so many prices in flux, our inflation measures will be tricky to read over the coming months.
I find this somewhat remarkable. Given that he clearly sees rising prices, how exactly are inflation measures tricky to read? Interestingly, Fisher also has a message (threat?) for Congress and the President:
While uncertainty surrounds Katrina’s effects on economic growth and core inflation, one thing is clear: Congress and the executive branch are acting swiftly to provide emergency funding for the affected areas. So far, the federal government has authorized more than $62 billion for recovery efforts. I have asked my staff to carefully monitor this spending. Obviously, the political authorities, not the Federal Reserve, have the power of the purse. I pray they act wisely. With the nation’s already large fiscal deficits, I personally believe it would be ill-advised for the Fed to monetize any fiscal profligacy.
Fisher clearly does not want the Fed to accommodate fiscal deficits – it is almost as if he is saying that if the Fed continues to raise rates, Congress and the President have only themselves to blame.
There are some other fun bits to Fisher’s speech, but I will leave additional parsing to others. Here is my take on Fisher: He is a dove, pure and simple. He would stop raising rates yesterday if he could. But he recognizes that he is a maverick voice on the FOMC, and consequently tries to stick to the party line, which would be, in my opinion, to downplay the impact on economic activity and play up the inflation story. But his heart just is not in it.
The other key insight into Fed policy comes from the Beige Book, which last week reported that prior to Katrina, all districts except Boston saw increased economic activity, tightening labor markets, modest wage gains but rising benefit costs, and, possibly most importantly:
Higher energy costs were reported by almost all Districts, and energy-intensive industries were able to pass some of these costs on to consumers in the Atlanta, Boston, Cleveland, Chicago, Kansas City, Minneapolis, Philadelphia, and San Francisco Districts.
Granted, all of this is pre-Katrina. But I imagine that anecdotal evidence collected today would have the tone of that in today’s Wall Street Journal article, “Manufacturers Gear Up After the Storm.” Notably:
But while rebuilding hurricane-ravaged regions will eventually mean more orders, it's also bringing more immediate supply glitches and rising prices, particularly for petroleum-based raw materials. Certain manufacturers are building inventory of steel, plastic resins and cardboard boxes and such stockpiling could eventually lead to even higher prices in the near term. The result is an uneven picture, as certain manufacturers gear up to produce more, while also facing negative cost and supply-related fallout from the storm.
What an accurate description of the Fed’s conundrum. While some demand pressures fell (at least temporarily – energy prices are pulling back from their highs) as a result of Katrina, others look poised to strengthen, all in the background of higher prices from a shock to the nation’s productive infrastructure. Sounds to me like the recipe for higher rates.
Of course, there is time between now and next week for incoming data to sway the Fed. But I suspect that data will have to be significantly out of line with expectations to steer the Fed from its current course. Of course, I have trouble calling a rate hike a sure thing – simply too much uncertainty at this point. As I see it, the mostly likely reason for a pause at this point is to take an opportunity to wait for more data.
I think, however, that the Fed will find this a weak excuse to pause. Fedspeak (at least 3 out of 4) so far has shown concern for tight labor markets and rising energy costs – a signal that FOMC members are looking to get ahead of price pressures. So considering the way the Fed tends to look at the economy, and the possible inflationary pressures resulting from Katrina, the Fed is mostly likely poised to pull the trigger again next week, despite the devastation in the Gulf.
The Gap Inc. Abolishes Clicks
New Approach From Gap to Cut Down on Clicks, by Bob Tedeschi, NY Times: Are Gap Inc.'s new Web sites good enough to make up for the fact that the company turned away thousands of customers and millions of dollars in business while it got them up and running over the last two weeks? The answer appears to be yes, analysts said, thanks to a spate of promising innovations on Gap.com, BananaRepublic.com and OldNavy.com. In fact, the big question is how long it will take for competitors to catch up, and at what price.
…Gap's sites, which were shut down in late August and reopened to limited numbers of customers over the following two weeks, went far in solving what she called the "too many clicks" problem. For instance, when women browse Gap.com's T-shirt section, they do not have to click to a new page to see details about the 16 shirts … Rather, when they put the cursor over an item … they are invited to click on a "quick look" link for the shirt. That link yields a pop-up window that shows a model wearing the shirt alongside swatches of the colors it is available in. Mouse over any swatch, and the shirt takes on its hue - and the window tells you what sizes are in stock. … Toby Lenk, president of Gap Inc. Direct … said the mouse-overs and pop-up windows eliminated the need to bounce the shopper off her browsing path each time she needed information. … "In the old world, it'd take dozens of clicks to hack through pull-down menus for size, color, style," Mr. Lenk added. "Nobody had figured out how to let someone put together an outfit and buy off one page. It's just very hard to do."
Mr. Lenk declined to say how much revenue the company lost by shutting out customers for a couple of weeks, but it was probably in the millions of dollars, given that the Direct division's sales last year were $500 million. … The disruption would have been avoidable had the company merely been changing Web sites, Mr. Lenk said, but because it was overhauling all the back-office systems used to track inventory and manage promotions, among many other functions, a seamless transition was impossible. "I can't say we haven't lost a customer, but it's a small price to pay for where we're going to go," he said... Gap wrote its own software for all the major behind-the-scenes systems and all features the consumer sees on its sites. … The go-it-alone approach has raised as many eyebrows as the decision to shut down the sites. Indeed, Ms. Johnson, from Forrester, said Gap's home-grown strategy "completely flies in the face of every retail technology trend out there." She said companies that did not cobble together software from e-commerce specialists typically handed off their electronic retailing business entirely to specialists like Amazon.com and others. "All the companies that have home-grown systems are doing everything they can to ditch them," Ms. Johnson said.
But Mr. Lenk said the company had little choice. … One advantage of building the systems without the help of vendors is that the Gap Web sites may enjoy the competitive advantages of their new features longer than they would have otherwise, because the people who built the features work for the company. Still, e-commerce technologists pride themselves on their innovative abilities, and Gap's new features could appear on its rivals' sites with unsettling speed and perhaps improved reliability, since the e-commerce software vendors have had years to work the bugs out of their systems…
Posted by Mark Thoma on Tuesday, September 13, 2005 at 12:33 AM in Economics
DeMint and Ryan Hope to Revive Social Security Reform
DeMint to revisit Social Security, By Lauren Markoe, The State.com: U.S. Sen. Jim DeMint is behind a GOP plan to breathe life into the Social Security debate… Republican House leaders say they are ready to bring it to a vote as early as this month. However, the aftermath of Hurricane Katrina and the death of U.S. Supreme Court Chief Justice William Rehnquist could delay action on the issue and others before Congress. ... DeMint worked the phones this summer, calling congressional colleagues to make sure the idea didn’t lose steam. “... We’re planning on moving on this bill,” said U.S. Rep. Paul Ryan, R-Wis., a member of the House Ways and Means Committee. … Ryan is a sponsor of the House version of what he and DeMint call the “Stop the Raid” bill. ... “For me it’s good policy, but it also looks like good politics,” said DeMint, ... If it doesn’t pass there, DeMint reasons, it will at least expose members of Congress as unwilling to address Social Security. Democrats aren’t necessarily looking at such a vote as a potential source of embarrassment. “I would be proud to vote against that bill,” said U.S. Rep. Jim Clyburn, D-S.C...
Until the White House signals it will get behind this bill, and so far that hasn't happened, I don’t see it going beyond the hopes of its sponsors, particularly in light of Hurricane Katrina’s aftermath.
Did the San Francisco Earthquake Cause The Panic of 1907?
Real Shock, Monetary Aftershock: The San Francisco Earthquake and the Panic of 1907, Kerry Odell and Marc Weidenmier (RePec, NBER, Paper): Abstract The Panic of 1907 is an important episode in American financial history because it led, in part, to the creation of the Federal Reserve. Although much has been written about the crisis, little has been said about its underlying causes. This study identifies the San Francisco earthquake and its subsequent conflagration as the proximate cause of the panic. London fire-houses insured San Francisco during this period. The payment of claims by British insurance companies following the quake and fire produced a large capital outflow in the fall of 1906, forcing the Bank of England to nearly double interest rates and discriminate against US trade bills. These actions pushed the US into a recession and made markets vulnerable to shocks that otherwise would have been transitory in nature. World financial markets crashed in October 1907 with the collapse of the Knickerbocker Trust Company in New York.
Pollution Sparks Outrage and Riots in China
China's Rising Tide of Protest Sweeping Up Party Officials, by Edward Cody, The Washington Post: The first thing villagers noticed was the mud. Silt gradually thickened the waters of the Chaoshui River, they recalled, and before long fouled the rice paddies that provide them a meager but dependable living here in the rugged hills of central China. By the beginning of this year, the fish had disappeared and the once-pristine water turned black. Women could no longer do the family laundry along the banks. Then, as the weather warmed this spring, the villagers said, children started coming down with skin rashes after taking a dip. The reason their river was going bad … was that scores of mines containing an industrial metal known as molybdenum had started operating in the hills upstream...
Repeatedly, the villagers complained to county authorities, demanding that the mines be shut down or brought under control. But with mineral prices shooting up, the lure of profits was too much to resist. Thousands of small-scale miners -- some with permits, others sneaking in to work at night -- kept raking the mountainsides for ore and flushing what they did not need into the Chaoshui. In May, the enraged villagers gave up on the government and decided to organize a raid on the mines. Over several frenzied hours, the wiry villagers used farm tools and their bare hands to destroy more than 200 mining sites, defying a local policeman who tried to rein in their fury. What was remarkable about the raid was that the village Communist Party secretary and elected village chief declined to intervene, revealing a crack in the iron discipline traditionally enforced by government security organs and the party apparatus. In the nearby village of Guideng, just three weeks earlier, another mob tore down mining facilities, in this case a pollution-spewing refinery for another metal, vanadium. They also reported passive complicity on the part of the Communist Party secretary and elected leader. And now a group of irate village leaders in this remote region have gone a step further, moving from passive complicity to active support of the peasant cause. In a rare act of open defiance, the village leaders have joined forces against the central government in an unauthorized organization. They have threatened to resign en masse if authorities fail to take swift action. Unless something is done soon, the leaders said in a protest letter to Premier Wen Jiabao, more peasant violence will follow.
…The two eruptions of peasant violence in the hills near here offer a glimpse of a much larger wave of popular unrest. Thousands of protests break out every year in China's cities and villages, even though such demonstrations are prohibited. The protests have become a major concern for President Hu Jintao's government... The village party chiefs and elected leaders here have not played their assigned role of enforcing government authority because of a shared outrage that the county and provincial officials charged with protecting the environment have not protected the rivers, peasants said...
These dramatic hills, gashed by deep gorges through which rivers rush down toward the mighty Yangtze, seem like an unlikely site for conflict. … But mining has changed things drastically in the last few years. ... The magnesium, molybdenum and vanadium buried here have sparked the equivalent of a gold rush, bringing economic growth but also pollution. … The region's main stream, the Qingshui, whose name means "clear water," has in the last three years turned from limpid to oily black. Yellowish foam was seen floating on the surface where the river snakes down from the hills. Local authorities… reported the Qingshui contains unhealthy levels of magnesium and chromium. Hua, the village leader… is defying the party. He has recruited more than 30 other village leaders into an association, prohibited because it has not received approval from the Communist Party. They have named it the Leading Group of 100,000 People Living Along the Qingshui River Protecting Our People's River… But Hua and his friends … have almost given up hope...
The 4,000 residents of Guideng village have built their simple homes on a hillside sloping lazily toward the Qingshui River. ... About 3,000 feet away from Guideng, just above the river on a steep hillside, three vanadium refining factories rose up and started operations at the beginning of April. ... Villagers said the river-bound runoff was not what got them riled. Rather, it was that the three factories, each with a row of 14 smelting ovens and a brick chimney, sent up a powdery sediment along with their smoke. Villagers said their eyes hurt and their lungs got congested. … About 100 villagers, upset because chest congestion forced several dozen middle school students to miss classes, marched on the factory soon after it opened. The peasants said the owner, Yang Changjun, … reassured them that the smoke and sediment were not harmful. Doubting his word, the villagers sought out local township officials, who also said the powder was not dangerous. When the villagers protested that people were getting sick, "they didn't pay any attention," recalled Su, the village elder. … About 100 villagers visited the factories … on April 19, making threats over the sediment and trading insults with the guards. By then, it was becoming clear something would have to be done. Talk of a raid began. "I am not going to oppose you if you destroy these factories, but I won't support you, either," the villagers quoted their village head, Liu Qian, as saying … Three days later, … an estimated 600 farmers from Guideng and neighboring villages joined forces and attacked the factories…
In nearby Xiachaoshui, villagers seethed over the wildcat molybdenum mining operations on the upstream hillsides. The water used to flush out valuable ore, they found out, entered the porous, rocky terrain and seeped into streams that feed the Chaoshui, making the cherished waterway a channel of mud and poisonous chemicals. Repeated complaints to government officials brought no response, villagers complained. … The villagers planned an assault. … the crowd amounted to about half the village's 1,000 residents by the time it got moving …. Nearby villages joined in as people moved toward the mountainside. The villagers, now amounting to nearly 1,000, rushed into the mining sites shortly before noon, using hammers and shovels to tear down tarpaulin shelters and smash the washing and sifting equipment used to separate molybdenum from the dirt…
By midafternoon, the destruction stopped, although hundreds of other sites still dotted neighboring hillsides. Tired and still angry, the farmers moved on to Minle, hoping that now their complaints would be taken more seriously. The farmers told two deputy mayors that more sites would be destroyed unless the mining operations were shut down within a week, Yao recalled. The officials responded by calling the farmers examples of "Three Nothing-Left," an insulting reference to Japanese soldiers during World War II whose policy, Chinese say, was "kill until nothing is left, burn until nothing is left and loot until nothing is left." By the end of a long shouting match, however, the officials said they understood the farmers' anger…
- cut taxes.
- cut spending.
- increase taxes.
- increase spending.
- hope the Fed monetizes the debt.
- put your head in the sand and do nothing.
- blame it on the other party.
- use Enron style accounting to hide the problem.
- hope the Bank of China catches fire and all those U.S. bonds burn up.
Write down the letter(s) that best describe(s) your intended course of action.
The Size of Government over Time
Expenditure Components as a Percentage of GDP
[These data are from the last slide of a PowerPoint presentation for chapter 18 of Economics by McEachern at this site. The textbook is not one I've used.]
The graph in the textbook that is the source of these data presents this as though the yellow area is the government spending percentage and makes the point that the percentage of GDP arising from government expenditures declines slightly over time while the consumption percentage increases slightly over time. But that's not quite correct, though the picture does not change much when this is accounted for.
Expenditure Components as a Percentage of GDP
According to these data the size of government as measured as a percentage of GDP has remained relatively stable over time rather than falling. However, these data do not support the claim that government has grown substantially larger over the last four decades as is often claimed...
Freddie Mac Asks Lenders to Return Mortgage Payments to Katrina Victims
Freddie Mac offers temporary relief, CNN/Money: Government housing agency Freddie Mac is suspending mortgage payments for borrowers affected by Hurricane Katrina and is planning to return some payments to cash-strapped storm victims. ...
[T]he three-month suspension of mortgage collections applies to every borrower with a single-family home mortgage held by Freddie Mac in areas designated as major disaster zones. ... The suspension applies regardless of the condition of the victims' homes... The Mortgage Bankers Association estimates that up to 360,000 loans valued at up to $48 billion could be directly or indirectly impacted by the storm, although it is not clear how many of those loans are owned by Freddie Mac... [Lenders] can extend the suspension period for Freddie Mac-owned mortgages up to a full year on a case-by-case basis, depending on the borrower's specific circumstances ... Freddie Mac also authorized ... lenders to return to borrowers payments on Freddie Mac-owned mortgages already made for September but not yet reported to the government agency...
I also wonder what will happen to renters who have signed a lease. If the house payment is suspended, will rental payments still be collected?
The article did not give a breakdown of the loans covered by Freddie Mac, so let me add this, originally from the WSJ:
...the Mortgage Bankers Association said. Fannie Mae and Freddie Mac ... own or guarantee around half of the $8.3 trillion of U.S. residential mortgage debt outstanding... Based on the experience of past hurricanes ... neither company is likely to face major losses. The credit risk on most mortgages that aren't backed by Fannie, Freddie or the Federal Housing Administration is borne by holders of so-called nonagency mortgage securities. Mortgage analysts at UBS AG in New York released a report this week estimating that less than 1 percent of the amounts due on loans backing such securities are in the ZIP Codes most affected by Katrina.
September 11, 2005
Where Your Money Doesn't Go
Posted by Mark Thoma on Sunday, September 11, 2005 at 05:22 AM in Economics
A Brief History of the U.S. Payments System
The Evolution of Payments in the U.S.: Paper vs. Electronic, by Anthony M. Santomero, President FRB Philadelphia: Historically, U.S. banks tended to provide services — including payments services — to the broad spectrum of people and businesses... In early America, the geographical expanse of the country encouraged a fragmented system where state banks issued their own notes. Entry into the banking business was relatively easy, but bank branching was very restricted. Banks were prohibited from branching outside their home state, and in many states, branching was restricted still further. As a consequence, a region would be served by a relatively large number of banks, but there were no banks operating nationwide.
To effect transactions, people paid one another with paper checks drawn on their bank or paper currency notes issued by their bank. The banks would then clear these checks and notes among themselves. As you might imagine, with so many individual banks spread out across such a big country, effecting transactions outside the local area was cumbersome. Thus, banks would discount the value of deposited checks or notes based on the cost of presenting it to the “drawn on” bank for payment and some assessment of its creditworthiness. The farther away the bank, the less familiar its financial condition, and the greater the transportation cost associated with clearing the instrument — so the greater the discount...
By the turn of the 20th century, it was clear that the U.S. needed a better integrated national payment system. One of the main reasons Congress established the Federal Reserve System in 1913 was to create a national clearing system in which checks could exchange at par value. To achieve this, the Federal Reserve offered check clearing services free of charge to banks that joined the Fed System. However, the Fed did not become the sole provider of check clearing services, despite offering its services for free. First of all, not all banks chose to join the Fed System, primarily because of some of the regulatory implications. In addition, large correspondent banks offered smaller respondent banks an array of services including check clearing. Also, banks could take advantage of local and national clearing house arrangements. Nonetheless, the Fed established a large market presence, providing a baseline level of national check clearing services accessible to all banks, large and small, anywhere in the country. Thus, the Fed contributed to the viability of both the paper check and the small community bank.
In the 1960s and 1970s, U.S. banks and the Fed applied advances in technology to check processing, increasing the efficiency of their operations. Banks found the paper check payments business to be profitable, and consumers were quite comfortable and confident in their use of checks. In short, checks were the dominant form of noncash payment, and there was little momentum for change in the payments system. In the early 1970s, the Fed introduced its Automated Clearing House, known today as Fed ACH. To date, ACH has not developed into the dominant form of electronic payment, in part, because, traditionally, only banks — not individuals — could initiate ACH payments... While Fed ACH has had some success as a means to effect, and convert, routine payments, it was the credit card that proved most instrumental in moving payments from paper to electronics at the point of sale. As we all know, the credit card actually was the first ubiquitous consumer-based electronic payments instrument to emerge. Credit cards were introduced in the 1950s, and their use grew rapidly over the next three decades.
The infrastructure of credit cards in the U.S. is, or at least has traditionally been, fairly simple. The two major credit card associations, Visa and MasterCard, operate nationwide and are not subject to the anti-trust laws that prohibited collaboration among banks. ... In the 1990s, when the tech boom made information processing and telecommunications more powerful and less expensive, credit card companies were well-positioned to take full advantage of these developments... Of significance for the future, this technology has made the credit card a viable means of payment for e-commerce as well. Some card issuers even offer free consolidated bill payment on their sites, incorporating a variety of settlement mechanisms.
After the credit card, the debit card is the second most popular electronic instrument for making retail payments in the U.S. today. The debit card arrived on the scene relatively recently — during the 1980s. But since its arrival, growth in usage has been dramatic. At first, the debit card emerged as ... automated teller machine (ATM) systems, but then it moved beyond being solely a mechanism to access currency... bank customers had the option to simply present the card to the merchants and have their bank account debited directly. It was not long before the credit card networks responded to the growing use of these cash access cards with debit card products of their own. Visa and MasterCard already had an infrastructure in place for processing credit card transactions at the point of sale. They leveraged that infrastructure to establish offline debit card networks. Indeed, purchase volumes with these so-called “signature” debit cards are greater than those of the original “PIN-based” cards...
Santomero continues his talk and discusses what is expected to happen to the payments system in the future here.
How Fast are Debit and Credit Cards Replacing Checks?
The Evolution of Payments in the U.S.: Paper vs. Electronic, by Anthony M. Santomero, President FRB Philadelphia: The tide is turning in our nation’s payments system. ... hard evidence came last December ... electronic payments, for the first time ever, had trumped the paper check in terms of transactions. It appears our nation’s pattern of payments is finally evolving ... from one based on paper checks to one based on electronics...
According to the Fed’s most recent study, only about 45 percent of all U.S. noncash retail payments are made by paper check, with payment cards and Automatic Clearing House (ACH) accounting for the remainder of retail payments. And at current growth rates, credit cards and debit cards will both individually surpass the paper check in terms of total annual transactions by 2007. This is quite a change! The once dominant check is finally giving way to electronics in the U.S. payments system. .... [D]ebit cards in general seem to be leading the migration away from cash and checks, and toward electronic payments. ... Indeed, the growing popularity of debit cards seems to be part of a broader phenomenon. Last year, Visa announced that for the first time ever, its global debit sales volume surpassed its credit sales volume. Looking ahead, most experts expect that retail payments will continue moving away from cash and paper checks toward electronic instruments. Today these include credit cards, debit cards, and ACH, but other payments mechanisms are also finding their way into the payments structure... [W]hile the private sector is shifting retail payments away from paper-based instruments and toward electronic ones, history tells us that people’s payment habits change gradually. Only when people are comfortable with, and confident in, a payment structure are they willing to accept it. As a result, the paper check is likely to be with us for some time...
He also discusses the history of the payments system which is in a separate post.
Posted by Mark Thoma on Sunday, September 11, 2005 at 12:51 AM in Miscellaneous
September 10, 2005
Recent Jobless Recoveries
Accounting for the Jobless Recoveries, by Paul Gomme, FRB Cleveland: What It All Means The cyclical dynamics of employment … can now be analyzed through the lens of the job finding and job-separation probabilities. Over the typical postwar U.S. business cycle, the job-finding probability starts to fall several months before the business cycle peak, whereas the job separation rate stays pretty much unchanged. The declining job-finding probability is reflected in a slowdown in employment growth before the peak. As the economy moves into recession, the job-finding probability continues to fall while the job-separation probability rises. Both factors contribute to the drop in employment. After roughly 12 months, the job-finding probability starts to rise and the job-separation probability starts to fall. Now, both factors serve to raise employment.
During the 1990–91 recession, both probabilities followed the typical experience, except that the job-finding probability remained low for at least 36 months after the business cycle peak. Because this is the only apparent difference, it would seem the job finding probability is at the core of the first so-called jobless recovery. The … job-finding probability is the primary driver of the employment declines during the 2001 recession (that is, in the months immediately after the business cycle peak). Like the 1990–91 recession, the force driving the second jobless recovery was the job-finding probability. ... [T]he job-finding probability … seems to have behaved differently from the previous postwar business cycle experience. Bear in mind that the behavior of both firms and the unemployed influence the job-finding probability…
Insured Commercial Banks in the U.S. from 1934-2004
It is not clear whether this is headed to a model like Canada or the UK with a few large banks dominating the system, or to an outcome with a couple of hundred banks, or to an outcome with several thousand banks. There is disagreement on this point. There is also disagreement about whether this is cause for concern. Some argue there are important economies of scale to nationwide banking (e.g. high fixed costs of modern information technology, spreading default risk geographically) while others worry about anti-competitive behavior. But in any case, over the next ten years, the market share of banks with less than 100 billion in assets is expected be cut in half while those with assets over 100 billion are expected to more than double. Though disagreement exists, most analysts believe that even after the consolidation period has ended the banking industry will remain highly competitive. I'd be interested in other perspectives.
The Next Heavyweight Champion of Banks, by Julie Creswell, NY Times: This is a tale of two really, really big banks. Both are heavyweights in financial services with trillions of dollars in assets and billions in market capitalizations. Both offer a cornucopia of products and services to consumers and large corporate customers. Both have exhibited voracious appetites in recent years, gobbling up competitors to establish themselves as megabanks with coast-to-coast and even international reach. On the surface, the two financial giants, Citigroup and Bank of America, have business models that appear to be very similar. But there are significant differences. While Citigroup chased after the higher-fee businesses from corporations in the late 1990's, Bank of America focused on the more staid, boring business of serving retail customers. That bet seems to have paid off. ... While it is still the nation's largest bank with $1.48 trillion in assets and a $240 billion market value, Citigroup these days seems stuck. ... Bank of America, from its base in North Carolina, is acting like the Citigroup of old. ... Some on Wall Street are fascinated by the role reversal. "Citigroup has been so traumatized by the events of the last five years that it is no more the wild-eyed risk taker," said Richard X. Bove, an analyst at Punk Ziegel & Company. "We're seeing one company shrink while the other expands. It's only a matter of time before Bank of America is bigger than Citigroup." ...
I agree with PGLs comment - I see no need for concern over monopoly power in this industry, but as I said, I'd be interested in opposing arguments.
Antitrust Suit Filed Against Realtor Group
Antitrust Lawyers Go After Realtors, by Kirstin Downey, Washington Post: The Justice Department's antitrust division yesterday sued the National Association of Realtors, alleging that the powerful trade group is using its online multiple listing service policies to restrict competition from discount brokers offering lower prices…
In the lawsuit, filed in the U.S. District Court in Chicago, where the Realtors have their headquarters, the government alleged that the association -- particularly its traditional broker members -- has sought to maintain a "policy that restrains competition from brokers who use the Internet to more efficiently and cost effectively serve home sellers and buyers." According to the federal filing, when real estate industry leaders developed their policy in 2003, …. The working group that formulated the listings policy understood that the right to opt-out would limit competition … members of the group said the opt-out right would be "abused beyond belief" as traditional brokers withheld listings from competitors. Albert A. Foer, president of the American Antitrust Institute, said … "This Justice Department is not trigger-happy," ... "They don't bring a lot of antitrust cases or operate in an anti-business mode, so chances are that they've thought it out very carefully." "It's great," said Peter Sealey, a professor of marketing at the University of California at Berkeley who has followed the issue. The policies "are a clear conspiracy and restraint of trade. This is long-overdue law enforcement."
Some of us believe in markets so much that we want to see the broken ones fixed.
Governors Object to Administration's Forest Policy
A Light in the Forests, editorial, NY Times: The Bush administration has largely succeeded in its systematic effort to roll back environmental protections for America's national forests. It has weakened agreements to protect old-growth trees in the Pacific Northwest, persuaded Congress to adopt an industry-friendly plan for fire suppression and overhauled rules governing forest management in ways that erode safeguards not only for the forests but also for the endangered species that live there.
Now, however, a rebellion is brewing ... Western governors are challenging ... the decision to repeal a popular rule ... to protect nearly 60 million acres of remote national forest from commercial development. The attorneys general of California and New Mexico and the governor of Oregon have filed a suit charging that the administration failed to conduct necessary environmental reviews before imposing the new rule. They argued further that the rule would endanger "the last, most pristine portions of America's national forests," leading to excessive logging and destroying essential watersheds. The lawsuit followed complaints from other governors, including Republicans, that the new rule would saddle them with impossible administrative burdens... Now that the governors have spoken, there seems to be no reason to further indulge the commercial interests of a few timber companies.
You won't convince me that commercial interests are worth losing our national forests, not after living here and seeing what would be lost. There are enough bald mountains around here as it is.
And If You Believe That...
Snow sees US cutting budget gap despite hurricane, Reuters: The White House can reach its goal of cutting the U.S. budget deficit despite rising costs of rebuilding areas of the Gulf Coast crushed by Hurricane Katrina, Cabinet officials said on Friday as they toured the region. "While this will elevate spending levels for '06 ... we're going to stay on track with the president's deficit-reduction program," U.S. Treasury Secretary John Snow told reporters in Houston ... "You can't attack the economy by taxing the people that are in this tent providing jobs," DeLay, a Texas Republican, told reporters ... "If you raise the taxes on these people, you might not have the jobs to provide, so the tax cuts are incredibly important," DeLay said.
Expanding HUD to Help the Poor
Housing the Poorest Hurricane Victims, Marginal Revolution: Ed Olsen at the University of Virginia, one of the country's leading researchers on housing, sent me the following proposal to immediately expand HUD's Section 8 Housing Choice Voucher Program. It's a brilliant proposal that needs attention at the highest levels of government. Pass it on.
HOUSING THE POOREST HURRICANE VICTIMS By Edgar O. Olsen What the people displaced by Hurricane Katrina need most now is housing.
Hundreds of thousands of families are now living in temporary housing and shelters, sometimes little more than tents, throughout the south central region. These families cannot wait for new housing to be built. Fortunately, new construction is not necessary to solve the immediate problem. Enormous numbers of vacant units in the region are available for immediate occupancy by families with the ability to pay rent — and a simple expansion of HUD’s largest housing program would provide even the poorest families with the means to rent these units.
The rental vacancy rate in the United States is at a historically high level. For all metropolitan areas as a group, it is over 10 percent. The largest metropolitan areas in the south central region have some of the highest vacancy rates – 15.6 percent in Houston, 14.4 percent in San Antonio, 12.8 percent in Dallas, 12.2 percent in Memphis, 13.1 percent in Birmingham and 18.5 percent in Atlanta. Vacancy rates for smaller metropolitan areas and non-metropolitan areas are also at historically high levels. In short, many rental units in the south central region and throughout the country are available for immediate occupancy by people with the ability to pay the rent.
Fortunately, no new federal program is required to match families suddenly needing housing with an existing stock of vacant apartments. The United States government already operates a program that would enable low-income families to pay the rent for these units. The Section 8 Housing Choice Voucher Program currently serves about two million families throughout the country. It enables participants to occupy privately owned units renting for up to, and somewhat above, the local median rent. Enormous numbers of vacant units could be occupied immediately by families with these housing vouchers.
Congress could show its bi-partisan resolve to respond to this emergency housing crisis by acting promptly to authorize a sufficient number of additional Section 8 vouchers to serve the poorest hurricane victims.
Since many victims have had to travel quite a distance to obtain temporary shelter and many will have to move further from New Orleans to obtain permanent housing within a reasonable time, these vouchers should be available to any public housing agency in the country to serve families displaced by the hurricane. To avoid delays in getting assistance to these families, the vouchers should be allocated to housing agencies on a first-come-first-served basis and any low-income family whose previous address was in the most affected areas should be deemed eligible. We should not take the time to determine the condition of the family’s previous unit before granting a voucher.
Getting the poorest displaced families into permanent housing is an urgent challenge. It requires bi-partisan support for Congress to act promptly, quick action by HUD to generate simple procedures for administering these special vouchers, and housing agencies in areas of heavy demand to add temporary staff to handle the influx of applications for assistance. Even with the best efforts of all parties, the proposed solution will not get all the low-income families displaced by Hurricane Katrina into permanent housing tomorrow. However, it will be much faster than building new housing for them. And it will show them that the federal government cares about their plight and is working to do what it can to help.
September 09, 2005
Mankiw on "Divine Coincidence" in Monetary Policy
Comments on “Separating the Business Cycle from Other Economic Fluctuations,” by Robert E. Hall, N. Gregory Mankiw, Jackson Hole Conference, August 2005: In most academic studies of optimal monetary policy, a central bank is assumed to have two main objectives. ... keeping inflation low and stable ... [and] ... keeping the economy’s output of goods and services close to its potential—or, equivalently, keeping unemployment close to its natural rate. ... Optimal policy ... often takes the form of a Taylor rule. The central bank is supposed to set the short-term interest rate as a function of inflation and the deviation of output from potential. Bob Hall’s paper takes aim at the practical application of this framework. He argues for three related but distinct propositions.
First, he claims that it is difficult to estimate potential output, especially contemporaneously. Second, he argues that potential output exhibits substantial high-frequency variation, so the normal presumption that it follows a smooth trend is suspect. Third, he suggests that modern theories of the labor market call into question the very concept of the natural rate of unemployment and thus potential output. The bottom line from these arguments is that central bankers should be wary when their staff of economists produces estimates of potential output and the output gap and that they should avoid relying on these estimates when setting monetary policy. The alternative is to focus almost exclusively on the other variable in their objective function—the rate of inflation.
I agree with Bob’s first argument completely. The natural rate of unemployment and potential output are extraordinarily difficult to estimate. ... This means that central bankers should be suspicious of any estimate of the natural rate. ... Bob’s second claim is that potential output exhibits significant high-frequency variation. I find this conclusion less compelling. ... I am not suggesting that I know that potential output follows a smooth trend, as is so often assumed. ... But I don’t think the kind of calculations presented in this paper shed much light on how substantial the year-to-year fluctuations in potential output really are.
The third line of argument that Bob pursues in this paper is the suggestion that the whole distinction between the natural rate of unemployment and cyclical unemployment is misguided. From my perspective, this part of the paper is half-baked. This is not to say that the argument is wrong, only that it is insufficiently developed to evaluate it with much confidence. ... In the end, I agree with Bob that monetary policymakers should take estimates of potential output and the natural rate of unemployment with more than a grain of salt. But I am disinclined to sign on to his suggestion that we reject the textbook approach to economic fluctuations...
This brings me to the policy question: If we cannot estimate potential output or the natural rate of unemployment, what are monetary policymakers to do? The obvious alternative is to focus exclusively on inflation, as some inflation-targeting central banks are now doing. Such a regime of pure inflation targeting would seem to be inconsistent with the Fed’s dual mandate of being concerned about both price stability and full employment. ... however, that this is not necessarily the case. In some modern theories of the business cycle, a monetary policy that aimed exclusively at stabilizing the price level would achieve, as a by-product, stabilization of output at its potential level. Olivier Blanchard has called this fact the “divine coincidence.” If the divine coincidence is actually true, it would conveniently solve the conundrum raised in this paper, for the central bank would not need to measure potential output in order to keep actual output at potential. It would only need to stabilize prices.
Let me spend a few minutes explaining why the divine coincidence might be true. Consider first shocks to the aggregate demand for goods and services. Expansionary demand shocks tend to push prices up and output above potential; contractionary demand shocks put downward pressure on prices and depress output below potential. Because the price level and the output gap are moving in the same direction, a monetary policy that stabilizes one will automatically stabilizes the other. In other words, a central bank that follows a policy of pure inflation targeting will, as a desirable side effect, insulate output from shocks to aggregate demand.
Now consider shocks to productivity. A positive shock to productivity ... puts downward pressure on prices and tends to increase output. A central bank committed to pure inflation targeting would respond with more expansionary policy, increasing output further. ... [R]emember that the positive productivity shock also raises potential output. In many standard models, these two effects exactly balance. ... if the central bank keeps the price level on target, output and potential output will increase by exactly the same amount in response to a positive productivity shock. Once again, stabilizing prices automatically stabilizes output at potential. You can now see why Blanchard calls this the divine coincidence.
Is this coincidence true in the world, or just an artifact of some oversimplified macroeconomic theories? The literature on this topic not sufficiently developed to give a definitive answer, but my guess is that it is more likely an artifact... [If] supply shocks are not simply shifts in productivity but also represent shifts in how distorted the economy’s production process is ... then it turns out that the divine coincidence does not arise. In this case, monetary policymakers face a trade-off between stabilizing inflation and stabilizing the output gap. Whether this kind of supply shock is an important feature of the world is, I believe, a crucial unanswered question.
So what does all this mean for the practice of central banking? Unlike Bob, I am not ready to give up on concepts such as potential output and the natural rate of unemployment. But I agree with him that we measure these concepts poorly and that this fact suggests increased emphasis on measures of inflation. Some might argue for an exclusive focus on inflation, but I don’t see the current state of monetary theory as necessarily supporting such an extreme view. In the end, central bankers have little choice but to look at all the data, apply a healthy dose of skepticism, and muddle through.
Japan Looks West and Sees North-South
America's sorrow: Katrina shows U.S. has a 'North-South problem.' editorial, The Asahi Shimbun: It is too early to assess the total damage unleashed by Hurricane Katrina, which devastated areas around New Orleans... The evacuation of those stranded in flooded areas is proceeding slowly. ... Many of those without the means or a destination of escape are black citizens. It seems that in the United States, poverty and race are intertwined. The social ills that underlie American society are profound and sad. Those realities have been on show for all to see... The United States has long been openly proud of its ideals as a country of freedom. Equal opportunities of success for everyone were cherished, and a helping hand of philanthropy was to be offered to those who are less fortunate. The world looked up to this image of an ideal America, but the ideal now seems to be faltering. U.S. troops are still in Iraq, where conflict and confusion reign. Bomb attacks have spread to Madrid, London and elsewhere. The United States has talked about "democratization of the Middle East" and "war against terror" as its goals, but it is hard to see what has been achieved...One of the breeding grounds of terror is the "North-South problem" between rich and poor countries. This latest natural disaster has proved that the United States has a homemade "North-South problem" within its borders. The United States started the war against Iraq in face of strong international opposition, and thus lost much of the global empathy it had gained with the 9/11 attacks. For the United States to regain the respect it seeks as a country of liberty and freedom, it behooves the country to solve its domestic "North-South problem." New Orleans, the cherished mecca of jazz, has been ravaged by the hurricane, and now aid is beginning to arrive, not just domestically, but from about 100 countries. No country can survive in isolation. We urge President George W. Bush to put his energies into resolving the problems inside and outside his country with compassion...
National Guard Troops in New Orleans Face Tough Conditions in Relief Effort
Daily miseries complicate relief mission for Oregon Guardsmen in New Orleans, Harry Esteve, The Oregonian: NEW ORLEANS -- In a city without power or running water, meeting the basic needs of more than 1,700 soldiers and airmen has become an exercise in cunning, brazen "borrowing" and head-shaking frustration for the Oregon National Guard.
The soldiers work in relentless heat and humidity, stomping through trash-filled streets and mucky flood residue. Bleach spray and bottled hand cleaner keep bacteria away. "I've seen better days, sir," sweat-soaked Pfc. John Clevenger of the 41st Brigade Combat Team responded when asked how he was faring. Clevenger, 19, of Keizer has been sleeping in the open and hasn't had a shower since he arrived Saturday.
The extraordinary logistical challenges facing the Oregon Guardsmen and thousands of other soldiers patrolling the streets illustrate the extent to which the city's infrastructure has been smashed beyond recognition. As the final detachment of about 500 soldiers rolled in Thursday, the ability to care for them took on a new urgency. Private contractors, who usually handle tasks such as trash disposal or sewage control, are swamped, and with only a handful of New Orleans businesses operating on the outskirts of town, there is no place to buy equipment.
Austere conditions come with the job. But the chronic lack of sanitary facilities, combined with frequent contact with contaminated floodwaters, worries Sgt. Maj. Brunk Conley, who spends hours working the logistics of housing what has become the largest Oregon National Guard mobilization since World War II. "These guys have been to Kuwait, Iraq, Afghanistan, so they're used to hard living," Conley said. "But this is much more challenging. We have no creature comforts whatsoever." In Iraq, soldiers sleep in air-conditioned tents, shower nightly if they choose and eat from a well-stocked mess tent. In New Orleans, showers have yet to materialize. The only escape from the heat comes with nighttime breezes, and the food comes in prepackaged military rations, called meals ready to eat.
Regardless, Guard troops kept a steady pace Thursday. As floodwaters receded by more than a foot, patrols from the 1186th Military Police Company, based in Milton-Freewater, drove into areas of the city previously accessible only by boats, which the Oregon Guard lacks. They brought out 18 evacuees, including a 2-year-old who had been holed up in an attic with her parents. They also found a body.
Timing has hampered Oregon's preparedness. The first plane carrying Oregon troops and cargo left last Friday, less than 48 hours after the unit was called to duty. They flew to New Orleans with little more than their clothes, cots and weapons. Commanders hoped some supplies would be available locally while they waited for their equipment. But so did 40,000 other Guard troops who have swarmed to the area, overwhelming local efforts to provide necessities. Units have resorted to bartering, begging and sometimes stealing from each other.
The biggest problem, Conley said, has been a severe shortage of portable latrines. For the first three days, Oregon troops had none. The usual solution is to dig a trench, but that proved unworkable in a city where the water table lies inches below the surface. Three latrines showed up on the fourth day. "We got them in the middle of the night," said Capt. Trent Klug, commanding officer of the 1186th Military Police Company, encamped at an evacuated convent. "Let's just leave it at that."
Guard troops have established makeshift bases throughout a sprawling section of northeast New Orleans, which is their area of operations. Troops bed down in a nunnery; a dark, cavernous warehouse full of zinc ingots; an upscale fine arts college across the street; and a Coast Guard armory. Like Pvt. Clevenger, most sleep in the open. On Wednesday night, swarms of mosquitoes attacked, and soldiers draped their cots in netting and lit bug-repellent torches.
"This is about creativity and ingenuity," Brig. Gen. Doug Pritt, commander of Oregon Guard forces in Louisiana, told his staff at a briefing Thursday. The meeting was held in the art school library. Soldiers had carefully covered the shelves in canvas and paper to minimize damage. Much like the residents who refuse to leave the flood-stricken city, Oregon troops have grown adept at prying what they can from their surroundings.
City buses, abandoned during the storm and trashed by looters, have been restored and used by troops to ferry evacuees to safety. Oregon soldiers struck a deal with a tire mechanic to fix flats on their Humvees. In exchange, the soldiers take him ice, a rare commodity in New Orleans. Conditions are likely to improve over time. With each day, more generators are brought on line, fans have begun turning, and the number of latrines has grown. "If you believe in evolution, then things are getting better," said Lt. Col. Bradley Kohn of the 41st Brigade. "Things are trickling in."
Harry Esteve: 503-221-8226; email@example.com
What Are Poverty Statistics Telling Us? (Why Oh Why Can't The AEI Read Brad DeLong Edition)
Broken Yardstick, by Nicholas Eberstadt, New York Times: The most widely quoted federal statistic on deprivation and need in modern America is the "poverty rate" ... According to the latest poverty rate estimates … poverty rates for American families and children were likewise higher last year than three decades earlier. … So why did that poverty rate report end up mostly buried deep inside daily papers? Maybe because many news editors, like policymakers in Washington, know the dirty little secret about the poverty rate: it just isn't any good. Truth be told, the official poverty rate not only fails to calculate trends in impoverishment with any precision, it even gets the direction wrong.
Truth be told indeed. Here’s Brad DeLong on similar claims made recently in the Washington Post by Jonathan Weisman:
Why Oh Why Can't We Have a Better Press Corps? (Don't Believe Jonathan Weisman Department), Brad Delong: Today the Census Bureau reports:
...There were 37.0 million people in poverty (12.7 percent) in 2004, up from 35.9 million (12.5 percent) in 2003.... The Midwest was the only region to show an increase in their poverty rate.... The South continued to have the highest poverty rate...The percentage of the nation’s population without health insurance coverage remained unchanged ... The percentage of people covered by employment-based health insurance declined...
Yesterday in the Washington Post's Jonathan Weisman told his readers that they shouldn't believe the Census Bureau:
Measuring the Economy May Not Be as Simple as 1, 2, 3: 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.
What reasons does Weisman give to support the lead of his article--to support his warning that we should not believe the numbers in today's report?
… 6. Successive White Houses have stuck with the simple to calculate and interpret Orshansky poverty measure rather than move to a more accurate but less transparent measure.
… 9. "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."
…Weisman's reason (6) is a reason to report and consider a range of different poverty-level estimates and concepts, and to be cautious in interpreting reported levels of poverty. But it is not a reason to dismiss the trends and movements in poverty over time that the Census Bureau reports... Only reason (9) is truly cogent in the way that Weisman claims: differences in regional and local costs of living do make comparisions of regional and local poverty estimates unreliable, and do channel less federal poverty-support money to people living in high-cost areas. The conclusion we should draw? Don't believe Jonathan Weisman. When Weisman says, "Don't believe the numbers" the Census Bureau released today on "poverty... income... and the number of Americans still lacking health insurance," he is not playing it straight. The numbers are quite good. The biases in their levels are relatively small. And they are accurate indicators of changes, trends, and patterns.
The conclusion we should draw? Don’t believe Nicholas Eberstadt when he tells us not to believe the poverty statistics.
"They'd Throw a Party for a Dog's Birthday"
My New Orleans, by Thomas A. Sancton, WSJ Commentary: Watching the apocalyptic images of New Orleans on television is like witnessing the fall of Pompeii -- the collapse of a mythic civilization in the face of an all-powerful and unforgiving nature. In my case, I am also watching the destruction of the urban roots and sinews that shaped my early life. ... the French Quarter, the teeming riverfront, the mansions of the Garden District, the luxuriant oak-lined elegance of St. Charles Avenue, the splintery back-of-town neighborhoods where jazz was born and where the jazz people created a unique cultural gumbo of spicy food, hot music and joie de vivre that was the best antidote to adversity.
I have had trouble sleeping. ... I worry about all the friends and relatives whose fates I do not yet know. And I worry for the tens of thousands of my homeless compatriots, black and white, whose helpless agony and anger have been on 24-hour display via the world-wide media. But what troubles me at least as much as the human drama is the agony of the city itself. Every city is special to its inhabitants, but New Orleans is special to the whole world. As Mayor Ray Nagin said during one of the softer moments of his now-famous tirade on WWL radio, "When you mention New Orleans anywhere around the world everybody's eyes light up." It evokes images of graceful Old World architecture, Mardi Gras parades, incomparable restaurants, steamy jazz clubs, paddle-wheel riverboats -- and a hedonistic lifestyle dedicated to good times, good eating and genteel decadence. The late Danny Barker, a local jazz banjoist and guitarist, once summed it up to me in these words: "New Orleans people are unique, man. Somebody goin' to jail? Give him a party. Somebody died? Give him a party. They'd throw a party for a dog's birthday..."
There is a darker side to New Orleans, too ... the yawning gap between the haves -- those with cars and SUVs to flee in -- and the have nots -- the overwhelmingly black masses huddled in the Superdome and outside the Convention Center, with nowhere else to go and no way to get there. These are the images that have made my European friends shake their heads and tell me that the world's most powerful democracy looks today like a helpless Third World nation that inspires more pity than compassion. Apart from the baffling slowness of relief efforts, these images translate a disturbing reality about the city: Black people comprise more than two-thirds of the local population, and one-third of them live below the poverty line. Even more troubling is the rampant criminality that has long reigned there ... New Orleans has the nation's highest per capita murder rate -- 10 times the national average -- and one of its highest levels of narcotics use... I think of that, too, when I lie awake at night. What happened to the dreams of civil rights, equality and integration that so many of us embraced in the 1960s...
I was lucky enough in my youth to have an extraordinary New Orleans experience. As a white middle-class boy and aspiring clarinetist, I went through a decade-long apprenticeship alongside some of the city's legendary old black jazz musicians. They taught me about their music, of course, but more than that they taught me about their world, their neighborhoods, their laughter and anger, their fears and disappointments, their courage in the face of poverty and prejudice, sickness and death. Most of all, they taught me their humanity. They called themselves "the mens."
The images that haunt me most today are memories of those wonderful people ... and of the times and places I discovered at their side. There was Preservation Hall ... now known the world over, but at that time a one-room hole-in-the wall frequented by a cult-like handful of traditional jazz fans. The place smelled of dust and cigar smoke and sweat, and the steamy heat of New Orleans floated in the air like a warm, wet blanket. My father took me there one summer night in 1962. I immediately fell in love with the music, the people and the atmosphere. It was then that I decided to become a jazz musician...
My New Orleans apprenticeship also took me into the neighborhoods where white people rarely ventured in those Jim Crow days when racial segregation was still the law in Louisiana. That's where the city's legendary brass bands -- the Eureka, the Olympia, the Tuxedo -- would wind their way through the narrow streets trailing a "second line" of dancers wielding painted umbrellas and cans of Dixie beer. The parades would go past rows of sagging shotgun houses -- single-story wooden structures with all their rooms in a straight line -- where the old folks would sit on their front steps and clap their hands to the pulsing beat. ... Today, most of those low-lying black neighborhoods are under water. Many of the houses have collapsed or floated off their foundations. In the massive rebuilding ... I can't imagine anyone pouring major investments into recreating low-rent property for the poor, so where will those huddled masses go? Will renewal and gentrification push them out of the city whose culture they did so much to shape?...
New Orleans was probably never as idyllic ... as many ... imagined it to be. But it was a special city, a magical city, a city of dreams. It will be rebuilt, of course; many of the best-known landmarks will be lovingly restored, the port will welcome ships from around the world, and a busting metropolis named New Orleans will once again stand along the banks of the Mississippi. After all, the city came back from two devastating fires in the 18th century and a yellow fever epidemic in the 19th. But as I watch the aerial shots of those submerged neighborhoods, with their checkerboard of ruined rooftops, and the debris of a thousand, thousand lives floating in the putrid water, I know that the city, as I knew it, will never be the same.
Posted by Mark Thoma on Friday, September 9, 2005 at 03:24 AM in Miscellaneous
Monetary Policy and the Brainard Principle
Zakovic, Stan, Rustem, Berc and Wieland, Volker, "Stochastic Optimization and Worst-Case Analysis in Monetary Policy Design" (April 2005). CEPR Discussion Paper No. 5019, [Author website version]:
Abstract In this paper, we compare expected loss minimization to worst-case or minimax analysis in the design of simple Taylor-style rules for monetary policy using a small model estimated for the euro area by Orphanides and Wieland (2000). We find that rules optimized under a minimax objective in the presence of general parameter and shock uncertainty do not imply extreme policy activism. Such rules tend to obey the Brainard principle of cautionary policy-making in much the same way as rules derived by expected loss minimization. Rules derived by means of minimax analysis are effective insurance policies limiting maximum loss over ranges of parameter values to be set by the policy-maker. In practice, we propose to set these ranges with an eye towards the cost of such insurance cover in terms of the implied increase in expected inflation variability.
*Brainard, W. (1967). "Uncertainty and the effectiveness of policy," American Economic Review, 57, pp 411-425.
Time Finds Discrepancies in FEMA Director’s Resume
How Reliable Is Brown's Resume? A Time investigation reveals discrepancies in the FEMA chief's official biographies, by Daren Fonda and Rita Healy: ... President Bush nominated Michael Brown to head the Federal Emergency Management Agency (FEMA) in 2003... But how well was he prepared for the job? ... an investigation by Time has found discrepancies in his online legal profile and official bio, including a description of Brown released by the White House at the Time of his nomination in 2001 to the job as deputy chief of FEMA...
Before joining FEMA, his only previous stint in emergency management, according to his bio posted on FEMA's website, was "serving as an assistant city manager with emergency services oversight." The White House press release from 2001 stated that Brown worked for the city of Edmond, Okla., from 1975 to 1978 "overseeing the emergency services division." In fact, according to Claudia Deakins, head of public relations for the city of Edmond, Brown was an "assistant to the city manager" from 1977 to 1980, not a manager himself, and had no authority over other employees. "The assistant is more like an intern," she told Time. ... " ... In response, Nicol Andrews, deputy strategic director in FEMA's office of public affairs, insists that while Brown began as an intern, he became an "assistant city manager" with a distinguished record of service. "According to Mike Brown," she says, "a large portion [of the points raised by Time] is very inaccurate."
Brown's lack of experience in emergency management isn't the only apparent bit of padding on his resume, which raises questions about how rigorously the White House vetted him before putting him in charge of FEMA. Under the "honors and awards" section of his profile at FindLaw.com ... he lists "Outstanding Political Science Professor, Central State University". However, Brown "wasn't a professor here, he was only a student here," says Charles Johnson, News Bureau Director in the University Relations office at the University of Central Oklahoma ... "He may have been an adjunct instructor," says Johnson, but that title is very different from that of "professor." ... As for the honor of "Outstanding Political Science Professor," Johnson says, "I spoke with the department chair yesterday and he's not aware of it." Johnson could not confirm that Brown made the Dean's list or was an "Outstanding Political Science Senior," as is stated on his online profile. Speaking for Brown, Andrews says that Brown has never claimed to be a political science professor, in spite of what his profile in FindLaw indicates. "He was named the outstanding political science senior at Central State, and was an adjunct professor at Oklahoma City School of Law."
Under the heading of "Professional Associations and Memberships" on FindLaw, Brown states that from 1983 to the present he has been director of the Oklahoma Christian Home, a nursing home in Edmond. But an administrator with the Home, told Time that ... there was a board of directors until a couple of years ago, but she couldn't find anyone who recalled him being on it. According to FEMA's Andrews, Brown said "he's never claimed to be the director of the home. He was on the board of directors, or governors of the nursing home." However, a veteran employee at the center since 1981 says Brown "was never director here, was never on the board of directors, was never executive director. He was never here in any capacity. I never heard his name mentioned here."
The FindLaw profile for Brown was amended on Thursday to remove a reference to his tenure at the International Arabian Horse Association, which has become a contested point...
— With reporting by Jeremy Caplan, Carolina A. Miranda/New York; Nathan Thornburgh/Baton Rouge; Levi Clark/Edmond; Massimo Calabresi and Mark Thompson/Washington
Posted by Mark Thoma on Friday, September 9, 2005 at 02:34 AM in Politics
"Eventually, There Will Be a Price to Pay"
America's housing boom is causing an enormous misallocation of resources, The Economist: The past few years have seen simultaneous housing booms in an unusually large number of countries. However, according to The Economist's global house-price indices, in the second quarter of this year the pace of increase slowed in most places, compared with a year ago (see table). In only two of the 20 countries covered have prices accelerated significantly this year: the United States and Denmark.
The sharpest drop in annual house-price inflation over the past year has been in Britain (from 19% to 2%). Australia, New Zealand and South Africa have also seen a marked slowdown ... By contrast, America's housing market remains red hot... Even Alan Greenspan ... now seems to agree that American homes look overvalued and that there is a risk that prices could fall. A common counter-claim is that house prices are sticky downwards: the national average has never fallen year-on-year. But ... in the past 20 years as many as 63 out of 299 metropolitan areas studied have seen house prices fall by 10% or more over periods of at least two years. ... The popular argument that high house prices are justified by low interest rates has ... been stretched to its limit...
On the surface, America's housing boom looks more modest than those elsewhere. Since 1997 prices have risen by only half as much as in Britain. On the other hand, the property boom has probably caused a bigger misallocation of resources in America because of the response of borrowers, savers and investors ... housing accounted for an astonishing 50% of GDP growth in the first half of this year, reckons David Rosenberg, chief economist at Merrill Lynch. Since 2001 more than half of all private-sector jobs created have been in housing-related industries... The American economy's addiction to housing leaves it exposed not only to a cooling of property prices, but also to long-term costs. ... it diverts resources away from more productive sectors and by fuelling consumer spending it exacerbates America's economic imbalances. Eventually, there will be a price to pay.
Posted by Mark Thoma on Friday, September 9, 2005 at 12:24 AM in Economics
September 08, 2005
Truth in Advertising
San Francisco Fed’s Yellen Sees Inflation Risk Ahead
Fed's Yellen says US economy doing reasonably well, Reuters: The best thing the Federal Reserve can do in the wake of Hurricane Katrina is to ensure the stability of the national economy, San Francisco Fed President Janet Yellen said on Thursday. After 10 consecutive increases in benchmark interest rates, even before Katrina "the conduct of monetary policy had reached a challenging phase," Yellen said ...
"The greatest contribution monetary policy can make is to keep the national economy on an even keel," ... "Monetary policy, unfortunately, has little scope to cushion the immediate economic fallout from such a severe and sudden blow to a region." Core inflation seems "relatively well contained" for now, but faces risks to the upside from both energy prices and the labor market, she said. The U.S. jobless rate dropped to 4.9 percent in August, and other measures such as the employment-population ratio have improved recently. "While a 'whisker' of slack may still remain, we probably can't count on slack to hold inflation down," Yellen said. Meanwhile, central bankers are trying to navigate the twin tides of higher oil prices -- the potential for negative impacts on spending and higher inflation, Yellen said. "Higher oil prices may be partly passed through to core inflation at least for a time," she said.
[Update: MarketWatch report - There is more of an emphsasis on how policy depends upon incoming data. Rueters says Treasuries fall after speech. Full text of speech. William Polley comments that overall the speech seems less hawkish than Moskow's comments yesterday.]
[Update: This statement from the speech is worth highlighting because some of the discussion surrounding monetary policy has forgotten about the long lags that exist between the implementation of policy and its subsequent effects (see here for estimates of the lags involved). I understand the call for the pause was in as much for the psychological impact as for the actual direct short-run economic effects. But to the extent that the psychological impact relies upon a misunderstanding of the lags involved, I don’t think the Fed will be swayed by this argument. Instead, they will explain the limitations:
Monetary policy, unfortunately, has little scope to cushion the immediate economic fallout from such a severe and sudden blow to a region, because monetary actions can't be directed at a particular area of the country, and their effects take time to be felt. It is fiscal policy—government spending and transfers—that is necessary to address the immediate needs of the affected areas.
Bernanke on the Short-Run and Long-Run Economic Effects of Katrina
Bernanke Says Katrina to Have 'Palpable' Impact on U.S. Economy, Bloomberg: The U.S. economy will suffer short- term setbacks in the aftermath of Hurricane Katrina, although growth may rebound next year as rebuilding accelerates, said Ben Bernanke, chairman of the White House's Council of Economic Advisers. ''In the shorter term, the devastation wrought by hurricane Katrina will have a palpable effect on the national economy,'' Bernanke said … ''The virtual shutting-down of the Gulf Coast economy will leave its imprint on the national rates of job creation and output growth in the third and fourth quarters, while recovery and rebuilding should increase growth rates in the first half of next year,'' he said. … Bernanke said energy prices may begin to moderate. ''Near- horizon futures prices for gasoline have already begun to moderate, and retail prices should follow them down very soon,'' he said… ''Thus far at least, the growth effects of energy price increases appear relatively modest.''
Posted by Mark Thoma on Thursday, September 8, 2005 at 01:08 PM in Economics
The Consumer Driven Economy
This image released by the British Museum shows a hoax cave painting of a primitive man pushing a supermarket trolley which was on display in the British Museum. The work was planted by an anonymous "art terrorist" called Banksy... (05/23/05 AP Photo/British Museum/HO) (credit)
Posted by Mark Thoma on Thursday, September 8, 2005 at 12:15 PM in Economics
Post Katrina Grain Movements on the Lower Mississippi River
Mississippi River Export Grain Industry Recovering From Hurricane Katrina, USDA, Sept. 7, 2005: Agriculture Secretary Mike Johanns today reported that government and industry are working together to quickly restore normal export grain movement along the lower Mississippi River for the upcoming peak shipping season.
Despite substantial damage to waterways and grain handling facilities, assessments are near completion, cleanup is underway, ships again are moving and a majority of elevators in the region are resuming operations at reduced levels of activity. "I am encouraged by the resumption of grain movement along the Mississippi River just one week after grain transportation was virtually halted by Hurricane Katrina," said Johanns. "Clearly, there is much work to be done but I am confident that remaining obstacles will be overcome to resume all activity in a timely manner. We are assuring our international customers that we expect minimal disruptions." There are 10 export elevators in the surrounding New Orleans area and 3 "floating rigs" that do not have storage capacity but can load 30,000 to 60,000 bushels of grain per hour from river barges directly on to ocean-going vessels or ocean-going barges. In total, these elevators have a storage capacity of approximately 53 million bushels of grain with a capability of loading 970,000 bushels per hour when fully operational. The operational capacity of the elevators and floating rigs is estimated at 63% as of today, with vessel restrictions (arrivals and departures), slower barge movements and limited staffing minimizing full utilization of loading capacity. Ships are again moving in the channel. The focus now is on restoring power to facilities, ensuring adequate staffing, and reinstalling navigational aids to ensure safe passage. The U.S. Department of Agriculture (USDA), Department of Transportation (DOT), Army Corp of Engineers, Coast Guard, and Department of Homeland Security are working closely with industry to address these needs with the expectation that shipping will rapidly be returned to normal levels.
Also, the latest weekly Grain Transportation Report is out (all reports, latest report). While most of the data in the report end just before the hurricane hit, there is a brief summary at the beginning relating to the hurricane, and some post hurricane data are in the report. It notes, for example, that "The United States exports approximately one-quarter of the grain it produces. On average, it includes nearly 45 percent of U.S.- grown wheat, 35 percent of U.S.- grown soybeans, and 20 percent of the U.S.- grown corn. Approximately 55 percent of these U.S. export grain shipments departed through the Mississippi Gulf region in 2004."
Posted by Mark Thoma on Thursday, September 8, 2005 at 10:08 AM in Economics
"The Highest Degree of Arrogance"
The Theory of Moral Sentiments, Part VI, Section II, Chapter 2: The man of system … is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder. Some general, and even systematical, idea of the perfection of policy and law, may no doubt be necessary for directing the views of the statesman. But to insist upon establishing, and upon establishing all at once, and in spite of all opposition, everything which that idea may seem to require, must often be the highest degree of arrogance.
Sources of Uncertainty in Monetary Policy
Monetary policy in uncharted territory, Professor Otmar Issing, Stone Lecture, November 2003: 2. The forms of uncertainty How does monetary theory suggest central banks should deal with uncertainty? The answer is dependent on the particular form of uncertainty... First, there is uncertainty on prevailing economic conditions ... like the output gap, equilibrium real interest rates, or various measures of excess liquidity - and … [about] the shocks driving observed economic developments. By and large, the recent literature seems to consider this source of uncertainty as easy to deal with ... [Second] monetary theorists speak of model uncertainty. This … can take the form of ... imperfect knowledge of the parameters which characterise ... any particular model. Brainard's ... conservatism principle is probably the most widely quoted result on how to deal with parameter uncertainty. A large body of recent evidence, however, has pointed out that conservatism is not a robust outcome. An aggressive, rather than cautious, response to inflationary shocks ... is advisable when there is uncertainty on the exogenous degree of inflation persistence.
...But this is not the end of uncertainty. A third class of uncertainty is that due to ... reaction of economic agents and financial markets to its own policy decisions and announcements. Conversely, economic agents may be unsure about the precise motivations and actions of central banks and other economic agents. In the realm of monetary policy, the level of uncertainty .. is … inversely related to central bank credibility. Luckily, in this field we do have some robust policy results. … A firm response to inflationary shocks is also necessary, especially if agents take into account the possibility that the anti-inflationary determination of the central bank may wane over time. Finally, the announcement of a monetary policy strategy also contributes to dispel uncertainty on the actions of the central bank.
This notes that there are situations where an aggressive response to inflation is optimal, e.g. when inflationary expectations begin to drift upward as actual inflation is allowed to rise over time. Currently, the market's expectation that the Fed may pause can be interpreted as markets believing the Fed will pay more attention to the potential for falling output than to rising prices in coming months. The Fed may want to correct this perception to avoid higher inflationary expectations (though this report implies that not all Fed officials believe a pause translates into higher inflationary expectations so long as the reasons for the pause are properly communicated). For example, here are recent comments from Chicago Fed president Michael Moskow:
Putting it all together, ... If we indeed start to see a string of higher inflation numbers, people may begin to expect permanently higher inflation. Such expectations could become self-fulfilling if they become built into the behavior of households and businesses. And this would have adverse effects on longer term economic performance. If this occurred, the Fed would need to respond accordingly in order to restore price stability.
This implies that any sign of an upward drift in inflationary expectations will bring about a policy response to re-anchor expectations at the target level.
Tax Reform Panel Postpones Meetings
Tax Reform Panel Postpones Meetings on September 8th And 15th: Senators Connie Mack and John Breaux, Chairman and Vice-Chairman of the President's Advisory Panel on Federal Tax Reform, today announced the Panel will postpone the meetings originally scheduled for Thursday, September 8, 2005 , at 9:00 am ... and Thursday, September 15, 2005 , at 10:00 am ... These meetings will be rescheduled and announced at a later date. "There is mutual agreement among the Chair, Vice-Chair, Panel members, Treasury Department and the White House to postpone our two upcoming meetings," said Jeffrey Kupfer, the Executive Director of the President's Advisory Panel on Federal Tax Reform. "In addition, we are having ongoing discussions to determine when the Panel's final report will be delivered to the Treasury Secretary."
To Raise or Not to Raise?
Katrina Stirs Up Rate Dilemma As It Hits Growth, Lifts Prices, by Greg Ip, Wall Street Journal: ...Federal Reserve Chairman Alan Greenspan faces an unusually delicate challenge in deciding whether Hurricane Katrina should force a pause in the Fed's 14-month campaign to raise interest rates. The storm has hurt near-term economic growth prospects, which normally would call for lower interest rates, but it also has elevated prices and potential inflationary pressure, which normally would call for higher interest rates. The question facing Mr. Greenspan and his colleagues is: Which is the dominant concern?...
Fed officials say they will see how markets and the economy behave between now and their next meeting on Sept. 20 before deciding what action to take. ... Fed officials haven't ruled out a pause but disagree with some of the rationales circulating on Wall Street. They dispute that raising rates would appear unseemly so soon after a national tragedy. They agree there will be a hit to economic growth, but some also believe inflationary pressures will be aggravated by higher energy prices. But officials also believe that if they pause, they can use the accompanying statement to keep the option of resuming rate increases on the table... But several Fed officials reject this argument. They believe it is a mistake for the Fed ever to subordinate its goals of low inflation and maximum growth to political considerations. Moreover, they fear that pausing for noneconomic reasons actually could undermine confidence by suggesting the Fed is more worried about the economy than it actually is... Fed officials say there may be additional effects if sharply higher gasoline prices seriously erode consumer confidence. They will have little firm data on Sept. 20, and pausing would give them time to collect some. Some officials say they could give that as a rationale in the accompanying statement, while signaling an intention to keep raising rates once they're confident the impact is transitory. If the pause turns out to have been unnecessary, the Fed could make up for it with half-point rate increases later. ... But for some Fed officials, Katrina merely has amplified concerns they already had that higher energy prices were working their way into underlying inflation. While higher oil prices might reduce growth, "there is also a risk on the inflation front, and the risk is higher now than it was a year ago," Federal Reserve Bank of Chicago President Michael Moskow said yesterday. With the economy running close to capacity, businesses are more likely to pass higher energy costs on to other goods and services ... If inflation accelerates, it could become embedded in workers' and companies' wage-and-price behavior, he said. "The Fed would need to respond accordingly in order to restore price stability."
One final note. If you play the expectations game hard enough, you can tell whatever story you need to support your position. I’ve heard that lowering rates will increase confidence due to the stimulus it will provide. Here we also hear that lowering rates will signal the Fed is worried about the economy and cause pessimism. I expect the Fed to stick to its view of the output, employment, and inflation fundamentals rather than trying to outguess the public and set policy according to how it thinks the policy will be interpreted.
The White House Tells Refiners to Skip Scheduled Maintenance
Bush calls for fuel output boost, Financial Times: The White House has told US refiners to postpone all scheduled maintenance in a drive to maximise petrol and diesel production as the administration raised its oil price forecasts on Wednesday in the wake of Hurricane Katrina... Washington has also told refiners to stop producing ultra-clean diesel to increase petrol output.
A Louisiana refiner said: “The White House said, ‘Forget about [ultra] low-sulphur diesel. We need gasoline and diesel. We need you working 100 per cent’.” ... But postponing maintenance, during which a refinery runs at reduced capacity, can be a costly and dangerous gamble. Some of the industry’s worst accidents have been blamed on such delays. Jamal Qureshi, market analyst at consultancy PFC Energy, said: “It does expose the potential for safety problems. But you don’t have a choice.” ... In the Gulf of Mexico on Wednesday, four large refineries were still shut, while two were working at reduced rates. Many refineries are still difficult to reach. Oil companies and contractors have hired barges to house their workers and move their equipment, and are using boats normally employed to take tourists to see alligators. The port of New Orleans is set to resume commercial operations to load and unload vessels as early as on Friday.
Given how high energy prices are right now, if a refiner still decides maintenance is needed, should we exert pressure on the refiner to abandon those plans given the current circumstances? It sounds like refiners are already scrambling to maximize output independent of the White House. I don't mind the suggestion that firms do everything possible to provide needed energy supplies right now, I just find it interesting that the White House does not trust the market to meet that need without its centralized direction.
Monetary Policy Under Uncertainty
Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape. Alan Greenspan (2003)
Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models, Andrew T. Levin, Alexei Onatski, John C. Williams, Noah Williams, NBER WP 11523, August 2005: [Free July 14 version on author website]
Abstract We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data, and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.
1 Introduction Eight years ago, two Macroeconomics Annual papers - Goodfriend and King (1997) and Rotemberg and Woodford (1997) - played a central role in stimulating a burgeoning research program regarding the monetary policy implications of macroeconomic models with explicit microeconomic foundations.1 This research program incorporates two crucial elements compared with more traditional monetary policy analysis. First, reflecting the influence of the Lucas (1976) critique, the emphasis on explicit microeconomic foundations is intended to ensure that the resulting structural equations are reasonably invariant to the choice of monetary policy. Second, this research follows the standard public finance approach of determining the policy regime that maximizes household welfare and then evaluating the performance of alternative policies relative to this benchmark.
After initially focusing on small stylized models, this line of research has subsequently proceeded to analyze micro-founded macroeconometric models that incorporate an expanded set of nominal and real rigidities and hence can be matched more closely to observed aggregate data. For example, Christiano, Eichenbaum, and Evans (2005) (henceforth CEE) specified a dynamic general equilibrium model with a number of distinct structural features: staggered wage and price setting with partial indexation; habit persistence in consumption; endogenous capital accumulation with higher-order adjustment costs; and variable capacity utilization.2 Smets and Wouters (2003a) (henceforth SW) later applied full-information Bayesian methods to estimate essentially the same specification (augmented by a larger set of structural disturbances), and found that the model is competitive with an unrestricted Bayesian VAR in terms of goodness-of-fit and out-of-sample forecasting performance.3
In this paper, we investigate the design of monetary policy when the central bank faces uncertainty regarding the true structure of the economy. Of course, a long-established literature has considered this topic using traditional structural macroeconomic models, building on the seminal work of Brainard (1967).4 Nevertheless, recent analysis of small stylized micro founded models has demonstrated that the implications of uncertainty can be markedly different when the policymaker's goal is to maximize household welfare, because the welfare function itself depends on the specification and parameter values of the model.5
By using a micro-founded macroeconometric modeling framework, we can examine the policy implications of several aspects of uncertainty that may be more difficult to consider in a small stylized model. First, by applying Bayesian methods, we can use the posterior distribution of the model parameters to determine whether simple rules that perform well in the baseline economy are robust to parameter uncertainty, that is, to the range of parameter values that are reasonably consistent with the observed data. Second, we can gauge the degree of innovation uncertainty by evaluating the extent to which the policy conclusions are sensitive to alternative assumptions regarding the nature and incidence of the structural shocks to the model. Finally, we can explore the implications of specification uncertainty by changing specific features of the model such as the role of money balances or the structure of nominal contracts.6
As the baseline specification for our analysis, we use a micro-founded macroeconometric model similar to those studied by CEE and SW. Applying a Bayesian procedure to estimate this model with postwar U.S. data, we set the baseline values of the model parameters using the mean of the posterior distribution. We employ Lagrangian methods to determine the optimal policy under commitment in the baseline economy. Finally, we use second-order perturbation to solve the model and compute the level of welfare under the optimal policy as well as for alternative simple rules.7
We find that a simple interest rate rule that responds solely to nominal wage inflation and the lagged interest rate yields a welfare outcome that nearly matches that under the fully optimal policy.8 Because this rule only involves observable variables and does not require a measure of the output gap, the natural rate of interest, or forecasts of variables, the rule can be implemented without assuming that the policymaker knows the correct specification of the model or the true values of the model parameters.
The near-optimality of the simple wage stabilization rule is directly attributable to the overriding importance of nominal wage inertia in determining the welfare costs of aggregate fluctuations in the baseline economy. This inertia reflects the relatively long duration of nominal wage contracts as well as the nearly-uniform degree of indexation to lagged inflation. Furthermore, under our baseline specification of Calvo-style contracts with an exogenous probability of reoptimization, many wage contracts remain in effect much longer than the one-year average duration. Thus, as emphasized by Erceg, Henderson, and Levin (2000), stabilizing aggregate wage inflation helps alleviate the degree of cross-sectional dispersion in real wages and thereby minimizes the associated inefficiencies in employment of differentiated labor services and in the allocation of leisure across households.
The simple wage stabilization rule is remarkably robust to parameter uncertainty and innovation uncertainty and to some modifications of the baseline model specification. For example, this rule yields near-optimal performance throughout the empirically relevant range of values of the model parameters, a finding consistent with our earlier work regarding the relatively minor importance of this type of uncertainty.9 The performance of the wage stabilization rule is also relatively insensitive to various assumptions regarding the nature and incidence of the innovations and to augmenting the model to incorporate monetary frictions.
Nevertheless, the policy implications can be quite sensitive to alternative specifications of the wage contracting mechanism. In particular, the welfare costs of nominal wage variability are much smaller when wages are determined by Taylor-style contracts with the same average duration as in our baseline specification of Calvo-style contracts.10 Thus, the simple wage stabilization rule is no longer nearly optimal, and better welfare outcomes are provided by other simple rules that respond to price inflation and real economic variables. Of course, as Hall (this volume) emphasizes, neither Calvo-style nor Taylor-style contracts provide the ideal microeconomic foundations for the determination of nominal wages and employment. Thus, our results should be interpreted as highlighting the extent to which additional research regarding the structure of labor markets is likely to have substantial benefits for the design of monetary stabilization policy.
1 Other early examples include Levin (1989), King and Wolman (1999), McCallum and Nelson (1999), and Rotemberg and Woodford (1999). For a thorough presentation of this approach as well as a comprehensive bibliography, see Woodford (2003). 2 Christiano, Eichenbaum, and Evans (2005) also documented the importance of these structural features in generating a model-implied response to a monetary policy shock consistent with that of an identified vector autoregression (VAR). More recently, Altig, Christiano, Eichenbaum, and Linde (2004) have extended the model to incorporate firm-specific capital accumulation and have analyzed its behavior in response to productivity shocks, while Christiano, Motto, and Rostagno (2004) incorporate a banking system and capital market frictions in their study of the Great Depression. 3 See also Smets and Wouters (2003b) as well as the papers cited in Section 3 below. 4 See McCallum (1988), Craine (1979), Soderstrom (2002), Rudebusch (2001), Taylor (1999a), and Brock, Durlauf, and West (2003). Robust control methods have also been used in investigating monetary policy under uncertainty; see Hansen and Sargent (2003), Onatski and Stock (2002), Onatski (2000), Giannoni (2002), and Tetlow and von zur Muehlen (2002). 5 See Levin and J. Williams (2004), Kimura and Kurozumi (2003), and Walsh (2005). 6 We do not explicitly consider the policy implications of uncertainty about the current state of the economy; for recent analysis of this issue, see Orphanides (2001), Croushore and Stark (2003), Svensson and Woodford (2003), Aoki (2003), Orphanides and Williams (2002), and Orphanides and Williams (2005). 7 The optimal policy regime and optimized simple rules have previously been studied in micro-founded macroeconometric models by Onatski and N. Williams (2004), Levin and Lopez-Salido (2004), Laforte (2003), and Schmitt-Grohe and Uribe (2004). 8 While we focus on simple interest rate rules in this paper, an alternative approach is to specify a simplified objective function for the central bank, as in the literature on flexible inflation targeting; see Svensson and Woodford (2004) and Giannoni and Woodford (2004). Although not reported here, our preliminary analysis suggests that stabilizing a wage inflation objective may also perform well in terms of welfare. 9 See Levin, Wieland, and J. Williams (1999), Levin, Wieland, and John C. Williams (2003), Levin and J. Williams (2003), and Onatski and N. Williams (2003). 10 See Erceg and Levin (2005).
September 07, 2005
Chicago Fed President Moskow Says Rates Must Increase to Ease Inflationary Pressure
Moskow Says Rising Prices Require 'Appropriate' Fed Response, Bloomberg: Rising inflation pressures need to be addressed with ''appropriate'' increases in interest rates, even though Hurricane Katrina may temporarily slow the rate of growth the rest of this year, Federal Reserve Bank of Chicago President Michael Moskow said.
''I'm concerned about core inflation running at the upper end of the range that I feel is consistent with price stability,'' Moskow said ... ''Even without an increase in inflation expectations, it will take appropriate monetary policy to keep inflation well contained.'' Moskow is the second voting member of the Federal Open Market Committee who has suggested that interest rates are likely to rise after Hurricane Katrina if inflation pressures continue to build. Philadelphia Fed president Anthony Santomero said Aug. 31 that a ''measured pace'' of rate increases ``will continue to be appropriate.'' … An assessment of Katrina's impact on the national economy will involve ''a number of judgment calls'' by the Fed, Moskow said. ''It is very difficult to say how the national economy will be affected,'' he added. Katrina is clearly worse than other natural disasters, such as 1992's ... ''The impact on the economy will depend on the extent of the damage to the energy refining and distribution systems, shipping infrastructure, and other critical components that affect the national economy,'' Moskow said. ''An important aspect of this is the time dimension -- how long it will take to make the repairs needed to resume operations.'' Economic effects ''can be mitigated by how businesses outside of the area adapt to the disruptions,'' he added. Economic data on such adaptations is lacking … ''Rising oil prices may reduce economic growth,'' Moskow said. They could also feed through and raise prices of non-energy products and services, Moskow said. ''So there is also a risk on the inflation front, and the risk is higher now than it was a year ago,'' Moskow said. ''Because the economy is running nearer to potential, unfavorable cost developments are more likely to pass through to core inflation.'' … Moskow … has never dissented against the FOMC majority in policy votes.
Interesting. Janet Yellen from the San Francisco Fed speaks tomorrow.
[Update: Yellen's comments.]
Politicians Say Fed Should Pause Rate Hike Campaign
U.S. Lawmakers Urge Fed to Hold Interest Rates Steady Sept. 20, Bloomberg: U.S. lawmakers from both parties are urging the Federal Reserve to forgo raising interest rates at its Sept. 20 meeting to help consumers and businesses recover from the destruction of Hurricane Katrina.
''The economy's doing well,'' said Senator Orrin Hatch, a Utah Republican. ''There's no reason to raise interest rates at this point.'' Senate Finance Committee Chairman Charles Grassley, an Iowa Republican, said … that a pause in the Fed's cycle of rate increases ''would probably bring some confidence to people that are concerned about the overall economy'' following Hurricane Katrina. ... ''In this environment I would think it would be tough to raise interest rates,'' Senator Mel Martinez, a Florida Republican who is a member of the Banking Committee, said yesterday. ... Senator Richard Durbin, Democrat of Illinois, said, ''I'd be very careful'' about raising rates. ''It strikes me that if you are fearful of a recession or a downturn because of this disaster, raising interest rates would be even more restrictive.'' ... Those urging a pause in the rate increases include Democrat Paul Sarbanes of Maryland and Republican Michael Crapo of Idaho, both senators who sit on the Banking Committee, and Representative Melvin Watt of North Carolina, the chairman of the Congressional Black Caucus. ''We don't need anything else slowing the economy,'' Watt said in an interview. Other lawmakers, including Senator Charles Schumer of New York, said they trust Greenspan to make the right decision. ''I have a lot of faith in Greenspan,'' said Schumer, a New York Democrat who also sits on the banking panel. ''He's been on the money just about all the time.''
Hatch's statement that the Fed should pause because the economy is doing well is, well, let's just say it's not very persuasive. It’s interesting that nearly everyone uses the term “pause” rather than “stop.” That says something about long-term expectations regarding economic growth.
Grassley: Social Security Now Fourth or Fifth on Agenda
Social Security reform 'off radar'?, by Amy Fagan, The Washington Times: With two Supreme Court vacancies and a massive hurricane-relief effort dominating the agenda now, senators said they don't think they will act on Social Security legislation this year …
"It's off the radar," said Sen. Gordon H. Smith, Oregon Republican, adding that hurricane relief is much more important now, and Social Security is an issue "we'll eventually deal with" down the line, though not likely this year. "Social Security? I think not much is going to happen there this year," agreed Sen. Judd Gregg, New Hampshire Republican. ... "I can't imagine President Bush is going to go back to it," Sen. Richard J. Durbin, Illinois Democrat, said of Social Security. ...clarifying that he meant not the near-future agenda at least. Senate Finance Committee Chairman Charles E. Grassley, Iowa Republican ... conceded the issue now ranks about fourth or fifth on his agenda. His top priorities now are crafting Hurricane Katrina relief legislation, helping fellow Judiciary Committee members fill the Supreme Court vacancies, dealing with must-pass spending bills, addressing budget-reconciliation legislation, and then tackling Social Security. ... Behind the scenes, rank-and-file House Republicans are divided on whether or not it's wise to act now...
All the King's Horses, and All the King's Men
Osama and Katrina, By Thomas L. Friedman, New York Times: On the day after 9/11, I was ... interviewed by Israeli TV. The reporter asked me, "Do you think the Bush administration is up to responding to this attack?" ... I answered: "Absolutely..." ... I was not alone in that feeling, and as a result, Mr. Bush got a mandate, almost a blank check, to rule from 9/11 that he never really earned at the polls. Unfortunately, he used that mandate not simply to confront the terrorists but to take a radically uncompassionate conservative agenda - on taxes, stem cells, the environment and foreign treaties...
Well, if 9/11 is one bookend of the Bush administration, Katrina may be the other. If 9/11 put the wind at President Bush's back, Katrina's put the wind in his face. If the Bush-Cheney team seemed to be the right guys to deal with Osama, they seem exactly the wrong guys to deal with Katrina - and all the rot and misplaced priorities it's exposed here at home. These are people so much better at inflicting pain than feeling it, so much better at taking things apart than putting them together...
An administration whose tax policy has been dominated by the toweringly selfish Grover Norquist - who has been quoted as saying: "I don't want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub" - doesn't have the instincts for this moment. Mr. Norquist is the only person about whom I would say this: I hope he owns property around the New Orleans levee that was never properly finished because of a lack of tax dollars. I hope his basement got flooded. And I hope that he was busy drowning government in his bathtub when the levee broke and that he had to wait for a U.S. Army helicopter to get out of town.
The Bush team has engaged in a tax giveaway since 9/11 that has had one underlying assumption: There will never be another rainy day... You knew that sooner or later there would be a rainy day, but Karl Rove has assumed it wouldn't happen on Mr. Bush's watch - that someone else would have to clean it up. Well, it did happen on his watch. ...Katrina ripped away the argument that we can cut taxes, properly educate our kids, compete with India and China, succeed in Iraq, keep improving the U.S. infrastructure, and take care of a catastrophic emergency - without putting ourselves totally into the debt of Beijing. ...Well, the party is over. If Mr. Bush learns the lessons of Katrina, he has a chance to replace his 9/11 mandate with something new and relevant. If that happens, Katrina will have destroyed New Orleans, but helped to restore America. If Mr. Bush goes back to his politics as usual, he'll be thwarted at every turn. Katrina will have destroyed a city and a presidency.
Posted by Mark Thoma on Wednesday, September 7, 2005 at 12:33 AM in Politics
Robert Reich and The Physiocrats
We are all familiar with international barriers, quotas, tariffs and the like, but what about internal barriers, what are those? One example, one that is a big local issue here right now, are enterprise zones and living wage laws. There are designed to attract business to the area, and ensure they pay good wages when they get here. Sounds good if it works. But what happens when governments in each area begin their own campaigns to attract their share of the business? The end result is a myriad of laws that firms must navigate in their decision making – a firm may face substantially different tax structures in each potential location – and with each new law or regulation in each area, the problem grows more difficult. This impedes entry and exit, impedes the free flow of resources between sectors and limits the economy's performance. As I read the Reich commentary, the Physiocratic school of thought came to mind. The Physiocrats were important precursors to Adam Smith and believed the heavy government intervention associated with mercantilist (Colbertiste) policies limited economic performance. The Physiocrats did not last long, a couple of decades prior to 1776 is all, but their ideas that markets work best when governments intervene the least, i.e. when a government has a laissez-faire attitude, still resonate today.
According to the Physiocrats, only one sector in the economy, agriculture, is capable of producing a surplus and that surplus is a gift of nature. In order to produce the largest possible surplus, the flow of resources must be unimpeded. Government interfered with the free flow of grain through the imposition of internal tariffs, labor migration was restricted, there were all sorts of government restrictions which the Physiocrats viewed as interfering with natural law and limiting the ability of the agricultural sector to produce a surplus. In addition, since government produces no surplus of its own, it is a parasite interfering with the natural order. Thus government, while necessary, needs to be kept as small as possible:
The Physiocrats, The History of Economic Thought Website: The physiocrats were a group of French Enlightenment thinkers of the 1760s that surrounded the French court physician, François Quesnay. The founding document of Physiocratic doctrine was Quesnay's Tableau Économique (1759). The inner circle included the Marquis de Mirabeau, Mercier de la Rivière, Dupont de Nemours, La Trosne, the Abbé Baudeau and a handful of others. To contemporaries, they were known simply as the économistes.
The cornerstone of the Physiocratic doctrine was François Quesnay's (1759, 1766) axiom that only agriculture yielded a surplus -- what he called a produit net (net product). Manufacturing, the Physiocrats argued, took up as much value as inputs into production as it created in output, and consequently created no net product. Contrary to the Mercantilists, the Physiocrats believed that the wealth of a nation lies not in its stocks of gold and silver, but rather in the size of its net product.
The Physiocrats argued that the old Colbertiste policies of encouraging commercial and industrial corporations was wrong-headed. It is not … worthwhile for the government to distort the whole economy with monopolistic charters, controls and protective tariffs to prop up sectors which produced no net product and thus added no wealth to a nation. Government policy, if any, should be geared to maximizing the value and output of the agricultural sector.
But how? French agriculture at the time was still trapped in Medieval regulations which shackled enterprising farmers. Latter-day feudal obligations -- such as the corvée, the yearly labor farmers owed to the state -- were still in force. The monopoly power of the merchant guilds in towns did not permit farmers to sell their output to the highest bidder and buy their inputs from cheapest source. An even bigger obstacle were the internal tariffs on the movement of grains between regions, which seriously hampered agricultural commerce. Public works essential for the agricultural sector, such as roads and drainage, remained in a deplorable state. Restrictions on the migration of agricultural laborers meant that a nation-wide labor market could not take shape. Farmers in productive areas of the country faced labor shortages and inflated wage costs, thus forcing them to scale down their activities. In unproductive areas, in contrast, masses of unemployed workers wallowing in penury kept wages too low and thus local farmers were not encouraged to implement any more productive agricultural techniques.
It is at this point that the Physiocrats jumped into their laissez-faire attitude. They called for the removal of restrictions on internal trade and labor migration, the abolition of the corvée, the removal of state-sponsored monopolies and trading privileges, the dismantling of the guild system, etc…It is interesting to note that the Physiocrats defended their laissez-faire policy conclusions not by pragmatic arguments about improving agricultural production, but rather by mystical views about the role of the government in their ordre naturel. The Physiocrats, unlike many of their contemporaries, continued to view the State as a parasitical entity. It lives off the economy and society, but it is not part of it. Government has no prescribed place in the ordre naturel. Its only role is to set the laws of men in a way that permits the God-given laws of nature to bring the natural order about. Any attempt by the government to influence the economy against these natural forces leads to imbalances which postpone the arrival of the natural state and keep the net product below what it would otherwise be. A general laissez-faire policy …[was] the speediest, least distortionary and least costly ways of arriving at the natural state.
…The policy measures advocated by the Physiocrats went very much against the interests of the nobility and the landed gentry (however much they claimed to have their interests at heart). But because Quesnay was the private physician to Madame de Pomapadour, the mistress of Louis XV, the Physiocratic clique enjoyed a good degree of protection in the French court. … The Physiocrats' own style did not help their case. Their pompousness, their mysticism about the ordre naturel, the affected, flowery way in which they wrote their tracts, their petty "cliquishness", their unrestrained adulation and worship of Quesnay -- whom they referred to as the "Confucius of Europe", the "modern Socrates" -- irked just about everybody around them. Even those who ought to be their natural allies, such as Voltaire, Diderot, Rousseau and de Mably, despised the Physiocrats with a passion. In a letter to Morellet regarding his upcoming Dictionnaire, the otherwise good-natured David Hume expressed his disdain for them thus:
"I hope that in your work you will thunder them, and crush them, and pound them, and reduce them to dust and ashes! They are, indeed, the set of men the most chimerical and most arrogant that now exist, since the annihilation of the Sorbonne." (Hume, Letter to Morellet, July 10, 1769)
Adam Smith killed them with faint praise, arguing that the Physiocratic system "never has done, and probably never will do any harm in any part of the world" (Smith, 1776).
…Although the Physiocratic system was accused of being "mysticism parading as science", the truth was perhaps quite the opposite. Physiocracy was more "science parading as mysticism". For this reason, the Physiocrats still exerted a considerable amount of influence on the development of economics...
September 06, 2005
Banning Junk Food From Schools
California says 'no' to junk-food sales in schools, by Daniel B. Wood, The Christian Science Monitor: California is poised to ban sales of soda and fast foods on public school campuses - including high schools... In a bill that public health authorities call "the most impressive gains in school nutrition since school lunch was introduced after World War II," the state Assembly and Senate have approved legislation ... eliminating access to certain drinks and snacks sold in vending machines and school stores. The legislative action, which has the support of Gov. Arnold Schwarzenegger, has been characterized by supporters as an appropriate regulation to curb an obesity crisis and derided by critics as misguided government intervention...
I don’t think anyone’s freedom is severely curtailed by this ban. If you want a coke, candy bar, and bag of chips, bring it in your lunch bag. I don’t like intrusion of government into the marketplace, and I have mixed feelings about this ban. But in the end, I don’t think the schools ought to be a marketplace. And even if we do want to allow our schools to become marketplaces, for the free marketeers, it’s already a heavily regulated market that grants monopolies to particular vendors, monopoly power that schools often exploit as a fundraising mechanism. For example, Taco Bell cannot set up a stand on school grounds without permission it's unlikely or difficult to get and schools generally choose either Coke or Pepsi, etc., both are not allowed. So it's not a free market in any case.
We Didn't Know This Would Happen
"I know! This is that rainy day I've heard about. We can use deficit spending to help, then pay it off over time as we recover. What? Don't tell me the deficit is ... I see. Really great time to have such a large deficit. So any deficit spending used to help with the recovery will have to be limited?"
Frist Delays Estate Tax Legislation
GOP Agenda Shifts as Political Trials Grow, by Shailagh Murray and Charles Babington, Washington Post: …The Senate was supposed to vote this week on whether to permanently repeal the estate tax, but Frist said yesterday that the bill will be temporarily shelved. The announcement came two hours after Senate Minority Leader Harry M. Reid (D-Nev.) called for Republicans to back off tax cuts in the wake of the Katrina tragedy. "Not now, for heaven's sake," Reid said. ... Frist … said the Senate would focus on several Katrina-related matters, including aid to victims, rebuilding and economic development assistance, and examining the many ways that government fell short in dealing with the crisis. "We're going to take a hard, hard look at our disaster response," Frist said…
Politics aside, I'm glad the focus has shifted to helping and to figuring out how to do better the next time something so terrible occurs. All of us need to ensure the focus stays on the victims, on rebuilding, on all the many things needed to recover. In the end we are the ones who control the reigns of power through the voting box, in the end we are responsible for those who lead us. When they fail us, we have failed ourselves.
The Fed’s Ears Are Burning!
Fed May See Katrina Inflation Risks Outweighing Slowdown Fears, Bloomberg: The Federal Reserve is likely to conclude that Hurricane Katrina poses more risk of inflation than of an economic slowdown, and probably will raise rates on Sept. 20 while signaling it may pause later if there are lingering effects on growth and hiring. … Current and former Fed officials also are stressing odds that any slowdown will be temporary, and emphasizing their reputations for keeping inflation at bay. Together, the comments suggest policy makers aren't convinced they need to stop raising rates, even if their Sept. 20 statement is reworded to give them more room to pause later if data warrants.
''From 1994 and on, we have managed to convince markets we are capable and willing to do what it takes to prevent inflation from getting out of control,'' Richmond Fed Bank President Jeffrey Lacker ... Anthony Santomero, a voting member and Lacker's counterpart at the Fed Bank of Philadelphia, said in a speech after the storm that he expects the Fed to keep raising rates at a so-called measured pace. Fed Bank of Chicago President Michael Moskow of Chicago will comment on the economy in a speech scheduled for tomorrow in Chicago at noon local time. San Francisco Fed President Janet Yellen of San Francisco will speak on the economy the next day…
…''The Fed does need to have rates higher. The question is: At what pace do you do it?''… ''We need to remember the Fed's job is not only to manage growth in the economy,'' Lehman Chief Economist Ethan Harris said in an interview. ''They also have to keep an eye on the inflation picture. They can't just step aside if they see a major inflation shock coming out of this episode.''… ''We think the cost of a pause would be a larger bulge in inflation,'' John Ryding, chief economist at Bear Stearns in New York, said … With so much in flux, there will be greater scrutiny of Fed officials' statements, such as those of Moskow and Yellen, between now and Sept. 20. ... ''There is a lot more uncertainty in forecasting both the economy and the Fed right now,'' economist Harris said. ''The economy should be in reasonable shape and the Fed, which was in a very hawkish mood going into this period, probably just continues hiking rates.''
Next, here's the commentary from John M. Berry. He also believes the Fed is likely to raise rates, though he isn’t positive about that prediction:
Fed May Raise Rates Even After Hurricane Katrina, John M. Berry, Bloomberg: …the outcome of the next Federal Reserve policy-making session, two weeks from today, isn't a foregone conclusion. The devastation caused by Hurricane Katrina …[is] going to slow economic growth. The issue for Fed officials is by how much and for how long. The odds at this point probably slightly favor another quarter-percentage point increase in the target for the overnight lending rate, which would raise it to 3.75 percent. One reason for that assessment is the rapid restoration of power in the area and progress in re-establishing interrupted oil and natural gas production and the flow of refined products through pipelines… Macroeconomic Advisers in St. Louis told its clients … ''… the severity of the hit to the domestic energy sector were probably overblown,'' …
Finally, Caroline Baum believes the Fed may give into political pressure to pause even if it is unsure if a pause is the proper policy. She sees signs of weakness in the economy that existed prior to the hurricane and believes this is the correct policy in any case, though she also hedges her bet. Thus, of the three Bloomberg articles, she is the strongest advocate of the view that the Fed will pause, and that assessment is due mainly to weakness she observed in the economy prior to Katrina:
Fed May Pause for Political, Not Policy, Reasons, Caroline Baum , Bloomberg: Before Hurricane Katrina … financial markets were expecting the Federal Reserve to boost its benchmark rate to 4.25 percent by early next year. No longer. And the Sept. 20 meeting is up for grabs… Will the Fed's response mirror the market's expectation, which has turned on a dime in the wake of Katrina's devastation? The answer isn't just a question of policy. Politics may be involved as well. …
Hurricane Katrina qualifies as a supply shock, which reduces output and raises prices. ... If Fed officials thought monetary policy was accommodative before Katrina, and we know from the minutes of the Aug. 20 meeting they did, by all rights they should not depart from their chosen course of removing that accommodation. A portion of the nation's productive capacity has just been damaged, disabled or destroyed, so pumping up demand for reduced supply is not exactly the correct policy prescription. But this isn't just about policy. It has a lot to do with appearances. How would the average citizen react to news on Sept. 20 that the Fed had just tightened credit again when television screens are showing thousands of people who have no homes, no means of support and inadequate food, water and medical care? … Besides, inflation expectations, the Fed notes often, are well contained. Long-term rates have fallen in conjunction with fed funds rate expectations, suggesting confidence in the Fed's inflation-fighting credentials. There's no harm in taking a pass at the Sept. 20 meeting. It would be in keeping with Mr. Risk Management's approach to address what he sees as the greater threat, weaker growth rather than higher inflation. … I still think …[t]he LEI was telegraphing a marked slowing in economic activity before Katrina was even a blot on the radar screen. The Fed, with the blessing of the bond market, may hold off on another rate increase in September because of the uncertainty surrounding the effects of Hurricane Katrina. What the Fed does for political reasons now may turn out to be the right policy prescription down the road.
September 05, 2005
Fed Watch: Too Contrarian on Monetary Policy?
As the horrific devastation (to people and property) from Katrina deepened, it became apparent that I took a remarkably contrarian position (thank you David) in my last post. Luckily, I don’t work for the Bush Administration, so I can admit to errors. Of course, I was not alone in my contrarianism. Regarding the minutes, former Fed Governor Lyle Gramley was quoted in Bloomberg the day after the hurricane saying:
''This points pretty firmly to continued increases at every meeting this year,'' reaching 4.25 percent by year-end, said former Fed governor Lyle Gramley, now a senior economic adviser at Stanford Washington Research Group in Washington.
Add, even given the bond market’s decisive turn, some analysts still expect the Fed to stick with the current plan and continue raising rates. From The Wall Street Journal:
The payroll details show decent gains in most services, though retail (+12K) was soft. Construction was up a hefty 25,000, while manufacturing was down 14,000. Overall, report shows the pre-Katrina labor market continuing to tighten, which is why the Fed will keep raising rates. Next month, payrolls will plunge; our guess is -500,000. -- Ian Shepherdson, High Frequency Economics
In contrast to these views, conventional wisdom now has it that Katrina represents a massive negative shock that could plunge the economy into recession. Consequently, markets are quickly pricing out additional Fed rate hikes, and the 10 year Treasury rate has slid down to around 4%. The collective wisdom of the markets has spoken. Still, some Fed watchers expect a continuation in rate hikes, others see a pause in September, and then a resumption later in the year, and others think the Fed is done, period. Given the bond market’s reaction, why would anyone still believe the Fed will continue to tighten?
Part of the answer, I believe, is a hesitation among many Fed watchers, myself included, to shift positions without complementary Fedspeak. Note that we have little information on Fed thought at the moment. Outside of the Santomero comments, and a few thoughts on inflation from Fed staffers, there has been essentially no Fedspeak. All we have to work with is where the Fed left off before Katrina. Greg Ip of the WSJ sums this position up with:
Fed officials have set a relatively high bar to pausing. Although short-term interest rates are higher, overall financial conditions are still stimulating growth, particularly because of a decline in long-term rates set in the bond market and a weaker U.S. dollar. Were the Fed to pause and later determine it was unneeded, it might find that it has added to the housing market's froth and to inflation pressures.
Another part of the answer regards uncertainty surrounding the nature and impact of the economic shock delivered by Katrina. What is the hit to demand from the cessation of business activity along the Gulf coast? How many billions of dollars will be spent on reconstruction? Are rising gas prices a supply or demand side event, strictly speaking? Etc, etc.
Regarding the demand side of the equation, I tend to see the negative impact as relatively short lived (and don’t forget that automatic stabilizers will come into play), while the stimulative impact of reconstruction to be substantial and long lived. To get an idea of the numbers, note that FEMA is currently spending $500 million dollars a day; this spending annualizes up to a rate of $182 billion dollars a year. Congress’ authorization of $10.5 billion dollars will only last 3 weeks and is clearly only a drop in the bucket that is to come.
Katrina exposed vividly and graphically the sharp class divisions within the United States. Politically, I don’t see how the Administration can let that wound fester for long, especially as refugees migrate to Congressional districts across the country. (I don’t see how from a humanitarian or moral perspective as well; I am just am not convinced the Administration cares. Indeed, the Senate leadership apparently is more worried about tax cuts for the wealthy than anything else). Money – big money – will be coming from Washington. And we know that big money for one state never comes without big money for others. I am betting on substantially higher deficits ahead.
On the supply side on the equation, I agree with Caroline Baum. Before Katrina, demand was the driving force behind higher energy prices. Hence I never expected higher oil costs to be recessionary. Katrina, in my view (and likely the Fed’s as well), represents a significant supply side hit. And the restrictions on productive capacity extend beyond just energy. From the New York Times (thank you anne):
...But with gasoline and diesel prices being sharply affected by the loss of refining capacity caused by the storm, shifting to other ports will create costly logistical complications that will probably be passed to consumers in the form of higher prices, shipping firms said.David Feider, a spokesman for Cargill, said it was "not feasible" to divert grain shipments to trucks or trains because of the high cost and the loading infrastructure required. Imports are not faring any better. Shippers were scrambling to arrange alternative ports for incoming shipments of oil, chemicals and steel additives. Millions of pounds of coffee remained in storage in New Orleans. "Everything is at a standstill right now," Mr. Feider said…
The upshot is a blow to the economy’s ability to produce goods and services, as noted by Caroline Baum, who muses:
If productive capacity and, hence, the economy's potential growth rate, have just been reduced, why stimulate demand for the limited supply?
To be sure, a supply side shock can cause a recession, with its toll on output and employment. But supply shocks cause inflation as well, and that is what I argue will be a problem for the Fed. Does the Fed really want to accommodate a supply side price increase? From The Wall Street Journal editorial page:
Which brings us to Katrina's impact and the Federal Reserve. The airwaves yesterday were full of suggestions -- pleas, really -- that Katrina's damage should cause the Fed to stop its slow and steady path of monetary tightening. Philadelphia Fed President Anthony Santomero even encouraged this wishful thinking by hinting to CNBC that this wasn't out of the question.
Now, one of the Fed's duties is to provide financial liquidity in a crisis. But while Katrina is a human calamity with economic consequences, it is not so far a financial crisis. Oil prices have spiked above $70 a barrel in anticipation of reduced supplies. But the Fed policy would only cause prices to rise further if it printed more money that would end up chasing scarcer supplies. This is precisely the trap the Fed fell into in the 1970s, easing money to help the economy offset rising oil prices, only to cause oil prices to spike again. The cycle kept repeating itself and the result was stagflation.
Chairman Alan Greenspan's Fed has already contributed to higher oil and commodity prices by keeping monetary policy too loose for too long in 2003 and 2004. This is beginning to show itself in rising consumer prices this year and is likely to continue to do so in the coming months. The last thing the Fed should do now is give the world's investors the idea that it can be bumped from its anti-inflation resolve by an act of nature, even one as destructive as Katrina.
Unlike September 2001, the economy has considerable underlying strength. Katrina will no doubt reduce its growth in the third quarter but that might also lead to a rebound in the fourth. Any sign that the Fed has gone soft today will only mean that interest rates will have to go that much higher in 2006 to head off any inflationary expectations.
Can we attempt to continue to allow Americans to consume the same amount of goods and services as they did prior to Katrina, while at the same time caring for refugees and rebuilding New Orleans, without generating inflationary pressures? Possibly – as long as we can rely on the rest of the world to continue to provide us the additional goods. Enter tankers of gasoline on their way from Europe. The trade deficit will continue to swell, and existing imbalances will only be exacerbated. This will work as long as foreign investors are willing to hold dollar denominated assets and not demand goods and services…this certainly could be the Fed’s plan, but I would think an increasingly risky one.
But when all is said and done, the financial markets, however, have rejected an ultra-hawkish view and have instead embraced the position that the Fed will pause in their campaign, perhaps as early as the next meeting. To be sure, a break to assess the situation doesn’t appear to be that much of a concession – they can always come back to the table later this year, although they will have to manage expectations accordingly. And after all, the Greenspan Fed has never met a crisis that can’t be cured with a quick rate cut.
But I can’t shake the feeling that the Fed will be thinking that if we are about to slide into another recession, stagflation will be the name of the game. And they won’t want to risk ratcheting up inflationary expectations if such an outcome is on the way. While I would agree that the probability of a policy shift has risen, before I change my call for more rate hikes, I really want to hear the Fed tell me I’m wrong. And this week Chicago Fed President Moskow and San Francisco Fed President Yellen will have that opportunity. We will all be listening closely.
McCain Will Now Support Estate Tax Reform
McCain and Taxes, by Robert Novak, Chicago Sun-Times (alternate link): Sen. John McCain will take a small step this week toward making peace with the Republican Party on the tax issue. He plans to vote for cloture to block a filibuster on the House-passed bill repealing the estate tax. ... McCain is not merely voting for cloture to enable an up-or-down vote on the estate tax. He is ready to support a significant scaling down of what Republican regulars call the "death tax" that is being crafted by his conservative colleague from Arizona, Sen. Jon Kyl. While McCain's rhetoric against the very rich passing on their wealth still sounds Democratic, his vote this week will be Republican.
The McCain problem is a major one for his party ... He is the most broadly popular possible Republican candidate, whom Democrats despair of opposing ... Yet, his ability to win closed Republican primaries is questionable because of his apostasy on several issues -- especially tax reduction. When I asked McCain last week about his views on the estate tax, he made clear how opposed he is to repeal: "I follow the course of a great Republican, Teddy Roosevelt, who talked about the malefactors of great wealth and gave us the estate tax. I oppose the rich passing on fortunes." … I then asked what he will do when the bill comes to the Senate floor after Labor Day. McCain told me he will vote for cloture... McCain also told me he looks to Kyl for a compromise short of total repeal. He added he could support Kyl's plan to keep the estate tax rate at the capital gains rate (currently 15 percent) with an exclusion from taxation of an estate's first $5 million -- compared with 55 percent and $1 million in the basic law. … McCain has been bombarded all summer with attacks on him for opposing repeal. In mid-July, Birmingham, Ala., lawyer Harold Apolinsky, a longtime crusader against the estate tax, sent 23,600 letters to contributors who gave at least $2,000 to 15 senators opposed to repeal. McCain contributors were told: "Sen. McCain has shockingly failed to act on an issue of extreme importance to you." … it asked backers to "contact" McCain and lobby him for his vote. In August, the American Family Business Institute sent letters to all of McCain's supporters recorded as giving him $1,000 or more, requesting their help in changing his vote to support repeal. On Aug. 29, the Club for Growth revealed TV ads personalized for targeted senators -- four Democrats and McCain: "Sen. John McCain wants to keep the death tax. Isn't a lifetime of taxes enough?" The McCain ads are running in New Hampshire, the first presidential primary state.
...he may get away with diverging from the Republican consensus on campaign finance reform, global warming and the highway and energy bills, but tax policy is another matter. ... McCain's willingness to support cloture and a compromise bill signals he recognizes that political reality.
Thorstein Veblen Explains Why Labor Always Gets Exploited
Thorstein Veblen (1857-1929) believed government existed to protect the existing social relationships and, in a capitalist system, that meant protection of property and the privileges of ownership. In a capitalist system, power ultimately resides in the hands of the ownership class because this class controls government. According to Veblen:
...modern politics is business politics... This is true both of foreign and domestic policy. Legislation, police surveillance, the administration of justice, the military and diplomatic service, all are chiefly concerned with business relations, pecuniary interests, and they have little more than an incidental bearing on other human interests.
Though Veblen believes that government exists to protect business interests, he did realize there were different political parties, and people could vote for the party of their choice. However, each party represents competing business interests, not the interests of workers:
The business interests ... within the scope of a given government fall into a loose organization in the form of ... a tacit ring or syndicate, proceeding on a general understanding that they will stand together as against outside business interests. The nearest approach to an explicit plan and organization of such a business ring is the modern political party, with its platform, tacit and avowed. Parties differ in their detail aims, but those parties ... stand for different lines of business policy, agreeing all the while in so far that they all aim to further what they each claim to be the best, largest, most enduring business interests of the community. The ring of business interests which secures the broadest approval from popular sentiment is, under constitutional methods, put in charge of the government establishment.
But why, if there are two parties, are only business interests represented? His explanation is that the working class believes in a “harmony of interests,” what’s good for business is good for society generally, and therefore this best serves the interest of the working class as well:
Representative government means, chiefly, representation of business interests ....for there is a naive, unquestioning persuasion ... among the ... people to the effect that, in some occult way, the material interests of the populace coincide with the pecuniary interests of those business men who live within the scope of the same set of governmental contrivances. This persuasion is an article of popular metaphysics, in that it rests on an uncritically assumed solidarity of interests, rather than on an insight into the relation of business enterprise to the material welfare of those classes who are not primarily business men. This persuasion is particularly secure among the more conservative portion of the community, the business men, superior and subordinate, together with the professional classes, as contrasted with those ... portions of the community who are tainted with socialistic or anarchistic notions. But since the conservative element comprises the citizens of substance and weight, and indeed the effective majority of law-abiding citizens, it follows that, with the sanction of the great body of the people, even including those who have no pecuniary interests to serve in the matter, constitutional government has, in the main, become a department of the business organization and is guided by the advice of the business men. The government has, of course, much else to do besides administering the general affairs of the business community; but in most of its work, even in what is not ostensibly directed to business ends, it is under the surveillance of the business interests.
Veblen believes control of government by business pervades every important branch of government. All important officials are drawn from the business community and the people selected are people with business like characteristics. There is nothing unnatural about this since those are the characteristics required for these administrative positions within government:
[The] intervention of government agencies in these negotiations between the owners and the workmen rebounds to the benefit of the former. Such is necessarily the case in the nature of things. ... As things go in any democratic community, these government agencies are administered by business like personnel, imbued with the habitual bias of business principles-the principles of ownership; that is to say, under current conditions, the rights, powers, and immunities of absentee ownership. In the nature of the case, the official personnel is drawn from the business community,-lawyers, bankers, merchants, contractors, etc.; ... “practical men,” whose preconceptions and convictions are such as will necessarily emerge from continues and successful experience in the conduct of business of that character.
Because business controls every important facet of government, any conflict between business and labor will, in the end, always be decided in favor of business. Anything the working class does that might threaten business interests is repressed by the coercive powers of government, and labor has no chance of prevailing in any protracted power struggle with business interests.
Note: This draws upon E.K. Hunt’s History of Economic Thought, pgs. 314-317. The Veblen quotes are from Theory of Business Enterprise and Absentee Ownership.
John Bates Clark Explains Why Labor Never Gets Exploited
J.B. Clark (1847-1938), Preface to The Distribution of Wealth: It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates. However wages may be adjusted by bargains freely made between individual men, the rates of pay that result from such transactions tend, it is here claimed, to equal that part of the product of industry which is traceable to the labor itself; and however interest may be adjusted by similarly free bargaining, it naturally tends to equal the fractional product that is separately traceable to capital. At the point in the economic system where titles to property originate,—where labor and capital come into possession of the amounts that the state afterwards treats as their own,—the social procedure is true to the principle on which the right of property rests. So far as it is not obstructed, it assigns to every one what he has specifically produced.
Because there is no class that exploits another class in the neoclassical model, an important distinction between classes disappears. Clark, with this book, completes a line of thought from Say and Senior before him by showing the payments to capitalists and laborers under capitalism are based upon natural law, a law that rewards each factor according to its contribution to production. In doing so, he provides capitalism with an important intellectual defense against the competing ideas at the time from the socialists and institutionalists that one group, the owners, exploited another, the workers, through the social and economic relationships inherent in the capitalist structure.
September 04, 2005
Graphs Gathered from Blogs (August 2005)
There is also a directory of links to graphs from other months.
The Illusion of Motion
Posted by Mark Thoma on Sunday, September 4, 2005 at 11:07 AM in Science
Will Katrina Deter the GOP Tax and Social Security Reform Agenda?
GOP Agenda in Congress May Be at Risk, by Jonathan Weisman, Washington Post: Republican leaders intended to return to work with a dream agenda for small-government conservatives: permanent repeal of the estate tax, an extension of deep cuts to capital gains and dividend taxes, the first entitlement spending cuts in nearly a decade, and the advent of private investment accounts for Social Security. But Congress and the White House are on the spot to respond to Hurricane Katrina's historic Gulf Coast destruction and skyrocketing gasoline prices, and the leadership is feeling pressure to set aside or jettison parts of that well-laid agenda. The federal budget already is stretched by spending on the war in Iraq and a nearly $11 billion emergency hurricane relief package ... GOP leaders will have to justify additional tax relief for upper-income people at a time of civil and economic crisis.
"How do you do tax cuts when your budget is straining to save lives?" asked Rep. Mark Foley (R-Fla). The Ways and Means Committee on which Foley serves had been set to pass a package of tax cuts and spending cuts by the end of September, followed by broad, controversial Social Security legislation. Katrina "is going to have a tremendous impact," he added. House Majority Whip Roy Blunt (Mo.) said he has every intention of pushing forward with the tax and spending cuts and Social Security legislation. Hurricane-related legislation will not be controversial and "may mean we work on a Friday or two," he said. Asked at a news conference whether tax cuts are wise when the government is pouring billions of dollars into emergency aid, Blunt replied: "I think we need to look at what we need to do to be sure that the economy isn't affected more than it needs to ... We'll be thinking about that." ... Marshall Wittmann, a former Republican political strategist now with the centrist Democratic Leadership Council, said the GOP agenda looks like "political suicide." "The entire fiscal landscape has been transformed in the last week," Wittmann said. "The entire Republican agenda of tax cuts, Social Security reform and big spending on pet Republican projects is over...
Amy Call, a spokeswoman for Senate Majority Leader Bill Frist (Tenn.) said the plan is still to move to legislation repealing the estate tax this week. "However, we remain willing and able to return to Katrina business at any time," she said... Rep. E. Clay Shaw Jr. (R-Fla.), a Ways and Means member, said some tax cut plans will have to change. Bush's push to add private investment accounts to Social Security is also all but lost...
...Lawmakers and aides say relief spending could easily double the $10.5 billion that Congress hastily approved as part of a relief package. And it will not be for the immediate hurricane victims only. Rep. Ray LaHood (R-Ill.) said he will push for assistance to Midwestern farmers, hurt by drought and now by grain prices that have plunged on word that grain harvests cannot be shipped down the Mississippi ... Republican Sens. Olympia J. Snowe and Susan Collins of Maine requested $900 million in emergency heating assistance to defray surging heating oil costs. Another priority is likely to be surging gasoline prices ... Rep. Joe Barton (Tex.), chairman of the House Energy and Commerce Committee … push legislation to address the glaring inadequacies of the energy infrastructure, especially pipelines and refineries that were shuttered in the wake of Katrina. Finally, he said, "if there is a silver lining in this," it will be renewed political impetus to expand oil exploration beyond the Gulf region, especially in Alaska's Arctic National Wildlife Refuge.
None of that will necessarily mean the abandonment of tax cutting and cuts to Medicaid, student loans, farm price supports and other popular programs. Conservative activists hotly denied that there had been any slackening of will. "I don't think Republicans will be fooled into taking this necessary spending and using it to oppose pro-growth tax cuts," said Grover G. Norquist of Americans for Tax Reform...
The senate realizes something Katrina related might come up. Frist’s office says they are ready to deal with anything that does, and Blunt believes it might take as much as a Friday or two. But it does not sound like there are any plans to investigate the federal, state, or local preparedness or response, or to set aside time to address needs arising in Katrina’s wake. If it were up to me, I’d set aside time now, and a single week shortened by a holiday does not seem excessive to deal with the aftermath of this tragedy. In my opinion, and you are welcome to express yours, estate tax and other reform can wait until we are absolutely sure the needs of all of those affected by Katrina are fully addressed. First things first.
Help Is Still Needed
Please donate to help the victims of Hurricane Katrina.
Extensive Set of Help Links in the Continuation Frame
• The Salvation Army -- (800) SAL-ARMY (725-2769)• Feed the Children -- (800) 525-7575• America's Second Harvest -- (877) 817-2307• Habitat for Humanity -- (866) 292-7892• MercyCorps -- (800) 852-2100• National Next of Kin Registry -- (800) 944-4084• Army National Guard -- (800) 833-6622 -- For Service Members and Families• ASPCA -- (866) 275-3923
• Feed the Children -- (800) 525-7575• Salvation Army -- (800) SAL-ARMY• America's Second Harvest -- (877) 817-2307• Catholic Charities USA -- (800) 919-9338• B'nai B'rith International -- (888) 388-4224• Church World Service -- (800) 297-1516 ext 222• MercyCorps -- (800) 852-2100• Noah’s Wish -- (530) 622-9313• North Shore Animal League -- (877) 4savepet• Operation Blessing -- (800) 730-2537• Episcopal Relief and Development -- (800) 334-7626• Habitat for Humanity -- (866) 720-2800• The United Way -- (800) 272-4630• Humane Society of America -- (888) 259-5431• ASPCA -- (866) 275-3923• Lutheran Disaster Response -- (800) 638-3522• Mennonite Disaster Service -- (800) 348-7468• Water Missions International -- (843) 769-7395• United Methodist Committee on Relief -- (800) 554-8583• The Baton Rouge Area Foundation -- (877) 387-6126• Samaritan’s Purse -- (800) 665-2843• Christian Reformed World Relief Committee -- (800) 55-CRWRC• Food for the Hungry -- (877) 780-4261 ext 2506• Northwest Medical Teams -- (800) 959-4325• World Relief -- (800) 535-5433• Adventist Development Relief Agency -- (800) 424-2372• Southern Baptist Convention -- (888) 571-5895• Save the Children -- (800) 728-3843• American Friends Service Committee -- (888) 588-2378• AmeriCares -- (800) 486-4357• International Aid -- (800) 251-2502• International Orthodox Christian Charities -- (877) 803 4622• International Relief and Development, Inc. -- (703) 248-0161• International Relief Teams -- (619) 284-7979• International Rescue Committee -- (877) 733-8433• Life for Relief and Development -- (800) 827-3543• MAP International -- (866) 627-4483• Mercy (M-USA) -- (800) 55-MERCY• Operation USA -- (800) 678-7255• Relief International -- (800) 573-3332• Relief International -- (800) 573-3332• USA Freedom Corps -- (212) 348-8882• World Concern -- (800) 755-5022 ext. 0
• National Next of Kin Registry -- (800) 944-4084
Posted by Mark Thoma on Sunday, September 4, 2005 at 03:06 AM in Miscellaneous
Inflation Targeting in Canada
Seventy Years of Central Banking: The Bank of Canada in International Context, 1935-2005, NBER WP 11586, August 2005: Abstract ...we evaluate the Bank's contribution to monetary policy in an international context. We focus on: the reasons for the establishment of the central bank in 1935, its unique record of floating in a sea of fixed currencies under Bretton Woods; its experience with the Great Inflation and monetarism; its pioneering adoption of inflation targeting; and recent innovations in the payments and the phasing out of reserve requirements.
One part that is particularly relevant for recent discussions of monetary policy in the U.S. and the debate between advocates of strict inflation targeting and advocates of flexibility is this section on the experience of the Bank of Canada since it adopted inflation targeting in 1991:
Inflation Targets In February 1991, the Minister of Finance and the Bank of Canada jointly announced that the Bank would target the CPI inflation rate. At the time the inflation rate was close to 6% and a target of 3% inflation (to be gradually reduced) was announced. Inflation targeting has been broadly successful. Whereas in past decades monetary policy has been controversial and has generated heated debate in the literature, today, there is broad acceptance – possibly disinterest – amongst Canadians about the conduct of monetary policy. ... But it is important to remember what inflation targeting isn’t. Inflation targets are not necessary to cause disinflation, or even to stabilize inflation; ... the US has a similar inflation history without explicit inflation targets. Inflation targets were not involved either in the end of the Great Inflation of the 70s, a much more critical anti-inflation step. Nor is there much evidence that they made the decline in inflation less expensive in terms of unemployment. It should also be emphasized – as the Bank has on many occasions –that inflation targeting is not inconsistent with a concern for employment (as required by the Bank Act).
What is inflation targeting? As conducted in Canada it is an explicit commitment by the Bank of Canada to orient policy to attain a particular rate of growth of the CPI, currently 2%. The tools that the Bank uses to attempt to attain that goal include (a) using a projection model to determine what over-night interest rate would be consistent with a 2% inflation rate within 8 quarters, and setting the target for the overnight rate at that level, and (b) a communications strategy. There has been a dramatic change in the transparency of monetary policy between 1995 and 2000. This is probably most starkly put by noting that in 1994, individuals in the economy had to guess that the Bank had changed its monetary policy stance – there was no announcement... there was no Monetary Policy Report...
September 03, 2005
How the World Sees the U.S. after Katrina
From the UK, the view reveals the obvious poverty of so many. Here's The Times Online:
From the murky water of doubt emerges an uncomfortable truth, by David Aaronovitch, Times Online: Day 4 and the BBC News 24 anchorwoman turned from the expert on the screen explaining how the city was in an inverted pudding bowl, from which the water could not now escape, to the correspondent in the studio. “So Nick,” she busked it, “what we have here is a pudding-basin-full-of-water situation.” Nick agreed. We are certainly in some kind of situation, and Nick and the rest of us need badly to know what it is... The truth is that the New Orleans disaster is far worse than 9/11, and dwarfs anything seen in the West in modern times save for the Etna eruption and the San Francisco earthquake. In that sense it only tells us how vulnerable we are. Well, not all of us equally. When disasters or fires or bombings happen, you discover just who was travelling on your trains, who was crammed into your hostels or who was living in the low-lying areas. It isn’t the failure to act in New Orleans that is the story here, it’s the sheer, uninsured, uncared for, self-disenfranchised scale of the poverty that lies revealed. It looks like a scene from the Third World because that’s the truth. It’s a quiet disaster that ’s been going on for years — a pudding-basin-full-of-poverty situation.
From The Jordan Times, the lesson is that if the U.S. is so unprepared, what about the rest of the world? There is also a jab at the Christian fundamentalists, and a veiled suggestion it might have been global warming that caused it, i.e. a suggestion that you reap what you sow:
Unprepared, again, The Jordan Times: It is natural that in times of great crisis people turn to religion for consolation, even guidance. What is unnatural, in fact provincial and pathetic, is to use religion and disasters of cataclysmic proportion to gain political capital off the tragedy of others. The “righteousness” of Christian fundamentalists in the US saying Hurricane Katrina was a sign of “divine wrath” is nothing but blasphemous in the face of the grave adversity threatening their fellow citizens. The intensity of Katrina and the devastation it has wrought on the people of the US states of Louisiana and Mississippi has proved to be a mighty natural disaster that could have been tamed if not prevented. Katrina, if nothing else, is a wake-up call about just how unprepared the world is for natural disasters of such magnitude and, more importantly, how neglect of warnings made over the years by emergency managers allowed for the human and material loss that will debilitate this southern US region for years to come. Who would have conceived that the US would find itself faced with such an emergency as suffered by other countries in Africa, Asia and Latin America, and in need of international support? Natural disasters make no distinction between poor or rich countries. And when they strike, usually with little or no warning, the affected country is ill- prepared to face the ensuing dangers and consequences. The lessons to be learned are many, but the most important one is that scientists, environmentalists, and emergency managers must never be dismissed as doomsayers. Although science has yet to determine with precision impending natural disasters, experts have long warned of the negative impacts of global warming and the destruction of the world's ecosystem as contributing to the rise in the rate of natural catastrophes…
From India in Asian Age, surprise at our ineffectual initial response and a lecture about what the U.S. can learn from Asia:
A Disaster, Asian Age: The merciless Hurricane Katrina left a trail of death and destruction along the US Gulf Coast. … while the world joins the Americans in condoling the deaths, there is also widespread surprise over the inability of the US administration to provide prompt relief. Reports of anarchy have in fact overwhelmed the horror stories of the destruction caused by the hurricane, as Americans are getting used to pictures that they usually see from other parts of the world. "This is America, this should not be happening," was a telling comment from a CNN correspondent. But it has happened, and anger appears to be mounting within the entire country confronted with images of bodies floating in the water, people trapped in their homes, and patients dying without being attended to in hospitals. Allegations of racism are being hurled from both sides, with one section of society blaming the other for the looting that has hit New Orleans hard, and the other adamant that the administration’s indifference could be attributed to colour considerations.
It does seem, however, that the US, always ready to comment on disaster management by countries across the globe, has failed to deal effectively with its own disaster. President George W. Bush was on vacation when Hurricane Katrina struck, and by the time Washington responded, the affected areas were plunged in total chaos and anarchy. Comparisons, of course, are odious, but the response of the people in the countries hit by the tsunami was model. There was no looting, just concern as volunteers poured into the disaster areas with relief. In fact at the time a BBC correspondent in Tamil Nadu to cover the tsunami-hit, was so surprised by what she saw that the story shifted from the victims to those who had come in from all over the country to help the victims.
Shoot at sight orders were issued in New Orleans following reports of gun battles and rapes as gangs of looters and carjackers took over the streets. The administration disappeared from view with bodies lying on the streets long after the hurricane had passed, again a far cry from the quiet manner in which the governments and volunteers had worked not just in India but also tsunami-hit Sri Lanka and Indonesia. There is a lesson for the Americans to learn from Asia.
Finally, from Australia, The Age expresses sympathy for our humiliation, our class divisions, and our poverty problem:
Katrina sweeps away an American dream, The Age: How could it happen? Six days after hurricane Katrina swept in from the Gulf of Mexico, America is waking up to a reality as frightening in its force as the storm and flooding themselves. It is that America has been humiliated by its inability to prevent, or then deal effectively with, a natural disaster in its own backyard; and, worse and more important in the long term, that the world's richest nation has been exposed, in a most brutal way, as a society still divided by race and possessing an underclass. … Of course, the infrastructure can be repaired, dam walls renewed and new homes and businesses constructed; and the French Quarter, which attracts millions each year from around the world, can be restored. What may prove more difficult for Bush and his successors — for this will surely be a project of many years' duration — is the rebuilding of trust and credibility in the nation's leaders and administrators and the healing of wounds so savagely and swiftly inflicted by hurricane Katrina. …
It is now clear that most of those left behind did not stay by choice: they were (and remain) economic refugees without the financial wherewithal to flee their homes. They are almost entirely black. Some two-thirds of the city's residents are black (the black population nationwide is about 12 per cent). It is believed that about 80 per cent of the city was evacuated before Katrina hit. And those left behind? The people with no cars, no means and no way out. New Orleans mayor Ray Nagin said 21 per cent of Orleans Parish households earned less than $A13,139 a year, and nearly 27,000 families are below the poverty line. Most are black.
That any American city could descend so quickly into anarchy will surely have stunned many. That it exposed a social underclass so desperate just to survive that looting became necessary must surely shame them. … Typical of the reaction are the words of this 29-year-old New Orleans office worker. "We in Louisiana have always known we were near the bottom of the totem pole," said Deborah Taylor. "Now we can say we truly are at the very, very bottom." And, in the words of Nagin: "You know, God is looking down on all this, and if they are not doing everything in their power to save people, they are going to pay the price." The victims of hurricane Katrina are angry and they feel betrayed. Belatedly, President Bush has admitted that not enough is being done to rescue them. In the coming days, this must be corrected. The challenge in the coming months and years is just as momentous. It is said there was one America before September 11, 2001, and a different one after it. Perhaps now there will be talk of America before and after Katrina.
Let us hope that it will be a nation that can instill hope among its poorest people, rebuild trust in its leaders and achieve equality among its races.
Fair or unfair, I don’t like what the rest of the world is seeing as it critically examines our society and our response to this tragedy. We can do so much better than this.
Reducing Economic Insecurity
An Economy Raised on Pork, by Robert B. Reich, NY Times: The old work-force compact is in shreds. Paychecks that rose with productivity gains through the middle decades of the 20th century no longer do so. Since the early 1970's, national product per person has grown more than 75 percent, but the median wage of male workers has risen barely two cents, adjusted for inflation, from $15.24 in 1973 to just $15.26 last year. Family incomes are up only because wives have gone into paid work and everyone's putting in more hours. Job loss often means loss of health insurance and a tax-advantaged pension. ...
Forty years ago, free-trade agreements passed Congress with broad backing because legislators recognized that they helped American consumers and promoted global stability. But as job and wage insecurity have grown, public support for free trade has declined. ... The increasing insecurity of ordinary workers also imperils our national defense by handcuffing the Pentagon. It can't shift the defense budget to fighting terrorism because of local fears that well-paying jobs will be lost. ... Its recent base-closing recommendations ignited a political firestorm ... Consider, finally, the pork that's been larded into the federal budget. Republicans may collectively oppose wasteful spending, but as individual legislators they've created more pork than any Congress in history. ... The president reassured the nation that it would, at the least, "give hundreds of thousands of Americans good-paying jobs." The new … energy bill cost twice what the White House sought because it's laden with what Senator Pete Domenici, the New Mexico Republican who ushered it through Congress, defends as measures to create "hundreds of thousands of jobs." ... Don't blame the politicians, though. Whatever the policy at stake - trade, defense, transportation, energy - it's likely to morph into a jobs issue because that's what's most on people's minds…
And don't blame corporate chief executives for causing the insecurity in the first place. Their predecessors reigned over a stable mass-production system where a few major companies in each industry grew through economies of scale and didn't have to compete very hard. Wage and benefit increases could be easily absorbed or passed on to their consumers, and jobs preserved. But today's profits depend on innovation and low costs. As a result, corporations are doing everything they can to cut hourly payrolls and benefits.
But if the insecurity keeps growing, and government keeps responding to it by trying to preserve jobs and spend pork, the economy will sink of its own dead weight. Future free-trade agreements will be impossible to pull off. The Pentagon and other agencies will be hamstrung. And our fiscal imbalances will swell to more grotesque levels. Yet what's the alternative? There's no returning to the stable jobs and steady wages of the mid-20th century.
The answer is a new compact that gives Americans enough security to accept economic change. Suppose, for example, lower and moderate-income workers got a larger share of today's productivity gains through a much bigger Earned Income Tax Credit starting at, say, $6,000 for those who earned the least and gradually tapering off well into the middle class. This would go a long way toward easing the pocketbook concerns of Americans who are working harder but getting nowhere. To cushion the pain of job loss, unemployment insurance should be turned into re-employment insurance, helping people to get new jobs instead of keeping them waiting for old ones to return. Community colleges would do the retraining, in league with area businesses that identified skill shortages. Wage insurance would cover part of the difference between their old salary and their new starting wage. The new compact would also decouple health and pension benefits from unemployment, further reducing the negative impact of job loss. Employer-provided health insurance would be replaced with no-frills universal health under an expanded Medicare program, which could use its huge bargaining leverage to extract lower costs from providers and drug companies. Lower-income workers would be encouraged to save for their retirement (over and above Social Security) by receiving several dollars from the government for every dollar they put away.
The price tag for the new compact won't be cheap. My back-of-the-envelope calculation is several hundred billion dollars a year. But given the high cost of our current doomed effort to turn back the global economic tides, it would more than pay for itself. By reducing the job insecurity felt by so many, a new compact would allow Americans to focus on embracing change instead of worrying about forever falling behind.
This is the kind of progressive change I would like to see Democrats embrace. Democrats should not fear free markets, we should embrace them when they work, and we won’t stop markets from doing their best to work in any case. But we can do a much better job of insulating workers affected by the constant change that comes with free markets. Change that diverts resources to their most efficent use helps us all in the long-run, but workers are hurt through no fault of their own in the process. We can, and in my opinion we should, do much better at providing those workers and their families with economic security.
September 02, 2005
Radio Economics Interview
Posted by Mark Thoma on Friday, September 2, 2005 at 08:01 PM in Economics
The Price of Economic Growth in China
Workers pay price for China's economy, by Li Qiang Guest Columnist, Seattle PI: With Chinese President Hu Jintao's first stop of his U.S. visit here in Seattle, it is appropriate to greet him with some observations that will probably not be made in his tour of corporate facilities or in meetings with government officials....China's roaring economy is being built on the back of millions of Chinese workers denied their most fundamental rights. And it is being built within a political system subject to greater and greater stress from this same economic growth that it does everything to promote. ...China's rapid economic growth is ... without parallel. But China's current economic system could not exist in a democratic nation. ... [D]ecisions ... in China do not require democratic discussion, and the government of China has put aside all other considerations in order to develop the economy. Only under such authoritarian rule is it possible for the market to be so tightly controlled and for there to be this kind of trade surplus.
The Chinese elites as well as the multinational corporations are the real winners of U.S.-China trade relations. For example, a typical article of clothing produced for one of the big multinational brands in a Chinese factory at a cost of $5 will be sold to the U.S. consumer for as much as $40. And the total compensation for the labor of the Chinese worker who made it will be less than 80 cents. For these reasons, it's easy to understand why the multinationals are so eager to move orders and production lines to China.
Last year, total U.S. trade … reached … $196.7 billion … of imports from China. The reality of these imports is that they arrive on the backs of millions of Chinese workers. These workers labor six days per week (seven during peak season), 13 hours per day, for as little as 35 cents per hour. They do not have pensions or Social Security; they do not have unemployment or medical insurance. By the time they reach age 40, they start having difficulty keeping up with the heavy workload. Soon, they are left with nothing.
Factories that pollute the environment are given investment opportunities in order to develop the local economy but no measures are taken to deal with the pollution. ... Rapid economic development has greatly increased demand for the consumption of energy, which has led to overexploitation in small coal mines and oil fields. To reduce the production cost, such exploitation often takes place with cheap labor and without safety measures. This condition has caused frequent safety incidents. Many lives of mining workers were lost. The cheap energies produced in this way are consumed in industrial production, particularly in export-oriented manufacture industry, which is another reason why products made in China are so cheap in the international market.
…We see that there are increasing numbers of strikes and displays of rebellion by workers. Social instability is becoming increasingly visible. In 2003, there were more than 58,000 industrial conflicts. In 2004, that number reached 74,000. The gap between rich and poor is increasing; state-owned factories are closing and going bankrupt; workers are being laid off and losing jobs; peasants are leaving the countryside and entering factories where they have no long-term guarantees. … According to a recent survey … China's richest 10 percent enjoyed 45 percent of the nation's wealth, while the poorest 10 percent owned just 1.4 percent. Because tax revenue is not used by the government as a way of evening out disparities between unequal income earners, the gap between rich and poor is increasingly conspicuous. More than 20 years after the beginning of the era of reforms, it is easy to see that the ideal of "collective prosperity" is still very far away.
More and more U.S. companies are developing close relationships with China and, of course, there is a great deal of discussion and concern about the huge U.S. trade deficit with China. Chinese economic and political stability is therefore a matter of major concern for U.S. companies and policy-makers. The most effective and fairest way to address this concern is for China to develop policies that will enable Chinese workers to exercise their rights and enjoy the fruits of their labor. Perhaps somebody will be bold enough to suggest this to President Hu Jintao during his visit.
The Newest Deal Does Not Help
Bush policies have crippled disaster response, by Edward Alden, FT: For a world watching astonished as one of the US’s oldest and proudest cities descended into anarchy this week after Hurricane Katrina, the enduring image will be the crowds of ... Americans pleading to the cameras with a single message: “We want help.” For the past quarter century in Washington, since the Republican Ronald Reagan rode a conservative backlash all the way to the presidency, US politics has been dominated by the conviction that what was wrong with America would be solved by getting government off the people’s backs. … Advocates of limited government have much on their side: the US has enjoyed higher growth rates, lower unemployment and greater economic flexibility than its more heavily taxed European rivals. … But that is little comfort to the tens of thousands stranded in primitive conditions in New Orleans who are begging for government help, and will face months and years of rebuilding their lives even after it comes.
There are at least three reasons why the hurricane may mark a turning point in the US debate over the role of government. First, the deep tax cuts enacted in 2001 … left no room for government initiatives that might have prevented the catastrophe and increased capacity to respond. The Louisiana Army Corps of Engineers had identified some $18bn (£9.8bn) in projects to shore up the levees and improve flood control in New Orleans after last year’s vicious hurricane season. Despite warnings … that New Orleans would face disastrous flooding even with a category 3 hurricane … none of those projects was funded. Instead, Army Corps funds in the region have fallen by nearly half since 2001, and the Bush administration has proposed a further 20 per cent cut next year. …
Second, despite huge increases in spending to fight the war in Iraq, the hurricane revealed how thinly the US military has been stretched. National Guard units, under the control of state governments, are supposed to be the front line for rescuing people and maintaining law and order in natural disasters. But 3,000 of Louisiana’s guard troops are in Iraq, as are 4,000 from Mississippi, and many of those back home have recently finished gruelling tours in Baghdad. The hurricane forced local authorities to seek help from guard troops in nearby states, but aid has been far too slow in coming for many of those stranded.
Most striking, however, has been how the storm has ruthlessly exposed the poverty that still afflicts a substantial minority of Americans, and has grown worse since Mr Bush pushed through tax cuts that overwhelmingly benefited the well-to-do. … The images of those left behind told the story. While nearly 1m people evacuated the region before the hurricane, New Orleans’ poor – most of them black – were left behind. ... Those who remained were probably not any braver than their wealthier white counterparts. Instead, many did not own cars or otherwise lacked the resources to leave the city. They waited behind and hoped. Many are still waiting.
Pico, a network of faith-based community organisations, says: “We are watching catastrophic failure by public officials to respond to those who are most vulnerable.” The criticism is ironic – as Washington has scaled down taxpayer-funded public services, it has encouraged such faith-based charities to step into the breach. The Salvation Army was the first group to get aid into the ravaged Mississippi Gulf coast, well before any government help arrived. With the New Deal in the 1930s, helping those who could not help themselves became a mission that spawned a vast expansion of government’s role. After a generation of determined effort the conservative movement has succeeded in squelching that mission. In the aftermath of Katrina, its success appears to have come at high cost.
Interview With Frustrated Mayor of New Orleans
Posted by Mark Thoma on Friday, September 2, 2005 at 09:18 AM in Economics
Social Insurance Guaranteed
The Social Security program grew out of a time when there was a large aggregate shock, a shock that resulted in the Great Depression. The Great Depression affected people collectively, it wasn’t just a few unlucky individuals balanced somewhere else by winners. It’s been hard for me to see how private accounts would help when stock market values fall, as they did after the crash of 1929, to one sixth their pre-crash values. Without some sort of social support from the government, such as it is, people would be much worse off after such events. How will personal accounts and individual accountability rebuild schools or bridges in New Orleans? How will private accounts or even the private sector rescue the elderly from rooftops or provide security against looters? They won’t. For large collective shocks the government, not the private sector induced purely by profit, must stand ready to act as the "insurer of last resort."
To have a social security system that falls apart when you most need it, when there are large disasters affecting entire regions or economies, is not optimal. Personal accounts would not have withstood the stock market crash associated with the Great Depression. Why do we want to implement a social support system that fails when it is needed the most? I don’t think any of us believes we should leave it to individuals to bear the full cost of the disaster caused by Hurricane Katrina, i.e. that government should not be involved at all. We all know that government has a role to play in this disaster, the cry from all sides is that the government is doing too little, not that it is doing too much. Things may not be perfect with government involved, and there is certainly room for improvement, but things would be even worse if government did not get involved at all. And just as the government has an essential role to play in this disaster, it will also have an essential role to play when the next big shock, whether it’s financial, natural, or human induced, hits us in the future. Social Security systems aren’t just for the next few years, they must survive as long as the country does. Social Security must survive the big shocks, and for that to happen the government must, in the end, provide social insurance. If you think such large shocks cannot happen again, that big shocks such as a Great Depression will never, ever happen again to anyone ever, think about the events in any one hundred year time period. Things happen.
Guest Posts at New Economist
- Abstract and link to “UK Monetary Policy Reaction Functions” by Christopher Scott Adam, David Cobham, and Eric Girardin, Oxford Bulletin of Economics & Statistics, Vol. 67, No. 4, pp. 497-516, August 2005. [Link to Post]
- Pulling the Curtain on Fed Wizardry. Brief post on the Fed's limitations. [Link to Post]
September 01, 2005
Bernanke Says Again That Economic Effects of Katrina Expected To Be Temporary
Bush Aide Bernanke Sees $3 Gallon Gas for 6-8 Weeks, Bloomberg: President George W. Bush's chief economic adviser said U.S. consumers are likely to pay $3 or more per gallon for gasoline for at least ``the next six to eight weeks'' as a result of damage caused by Hurricane Katrina. … Bernanke … also said jobs lost and disruption caused by Katrina will lower the third-quarter U.S. gross domestic product growth rate. He didn't say by how much. Bernanke, who briefed Bush on the hurricane's effect on the economy, noted that the oil futures market projects that gasoline prices will average $3.25 per gallon in September, with similar figures for October. ''Obviously, it is not a good thing to have gasoline prices that high; it will be a burden on consumers and businesses,'' Bernanke said in an interview. ''My view is that so long as the underlying infrastructure has not been permanently damaged, and the preliminary indications is that the refineries will come back online, the effects will be temporary.'' The president, after a lunch with Fed Chairman Alan Greenspan, was briefed by Bernanke and his economic team on a preliminary assessment of the economic impact of the hurricane. … Bernanke said the major topic of discussion in the economic advisers' hour-long briefing with Bush was the effect of the hurricane on gasoline prices. … ''The bottleneck we have is in refining capacity,'' Bernanke said. ''As refineries come back online, we will see prices fall, probably by November, to pre-hurricane levels.'' … Bernanke said that once cleanup and rebuilding efforts are under way, the Gulf Coast region should see job growth in building and trades industries that will help offset other jobs lost as a consequence of the hurricane. He did not predict how many jobs would be gained.
Posted by Mark Thoma on Thursday, September 1, 2005 at 05:49 PM in Economics
How Should the Fed Interpret Expectations That Rate Increases Will Stop?
The Fed faces a difficult decision in coming months. How should the Fed respond to a supply shock? Theoretically, a negative supply shock should lower the natural rate of output which, for any given level of output, would decrease the output gap. The reduction in the output gap places increased upward pressure on prices and the Fed would respond, assuming inflation targeting, by increasing rates to choke off the inflationary pressure. Caroline Baum, in her column in Bloomberg, stated it succinctly asking, essentially, “Why would the Fed want to increase demand (lower rates) in response to a decreased supply of goods?” That’s a good question. For example, imagine AS=AD=1000. Let AS fall to 900 so that AD>AS. How should the Fed respond if the fall in supply represents a permanent fall in the natural rate? Is there any reason to believe the Fed should pause or even decrease rates to increase demand? Let’s turn to recent remarks by ECB president Trichet from the Symposium at Jackson Hole to begin searching for an answer:
...Why should expectations be a problem within a credible policy environment? Because the economy is never at rest. Agents have to catch up with the continuous change in their environment by an ongoing process of learning. When shocks are moderate … imperfect information and learning do not excessively complicate our interactions with the private sector. But there are times in which … a perpetual process of learning ... can have implications for the overall stability of the economic system – to some extent, independently of the monetary policy regime that is in place. If agents do not possess rational expectations, but have to re-estimate continuously the coefficients of an unknown model of the economy … it can well happen that a shock of sufficiently serious magnitude can unsettle expectations, even under credible monetary institutions. The reason for this is simple. It might become impossible for private forecasters quickly to form a reasoned guess about the scale of the shock, its duration and persistence, and the likelihood that it might not be easily washed away, so that it would become, in their eyes, embedded in the fundamental relations regulating the functioning of the economy for some time to come. Long-term expectations thus may over-react to the shock. They may drift endogenously ... These are times in which, typically, there is a disconnection between private views about the macroeconomic outlook and the central bank’s own internal forecasts. … The difficulty lies in devising a prudent way to factor such situations into policy. And here is where the fundamental tension … comes in. On the one hand we want to keep our eyes on the fundamentals and avoid being misled … by what could well be noise and unfounded overreactions. On the other hand, excess endogenous volatility in private expectations could indeed provide advance warning of pending risks that the central bank should take into account. ... This might entail serious risks of instability. Recent work done at the Federal Reserve Board … shows that, … An aggressive policy adjustment in reaction to detected signs of expectation instability can help head off the risks that one might see associated with the manifestation of such phenomenon. … However, any unexpected and possibly unprecedented action that the central bank takes in response to these risks might disorient the market. … This would suggest that action may not always be advisable. Sometimes, more optimal behaviour consists in appropriately communicating the central bank’s assessment of the fundamental state of the economy and its prospects in order to regain control of inflation expectations. In the long term, the advantages of having systematically avoided hasty reactions outweigh the benefits that might be apparent in the short term. By maintaining a steadier posture, the central bank embracing this policy views its role as that of a lighthouse or, more accurately, a lightship, in a storm. In this respect, building a reputation for a calm and firm management of the events can pay off…
That "It might become impossible for private forecasters quickly to form a reasoned guess about the scale of the shock, its duration and persistence, and the likelihood that it might not be easily washed away..." seems to describe the present situation well. From a learning perspective, an interpretation of this is that private markets have not learned the lessons the Fed has learned from the 1970s and expect a repeat of that episode, i.e. a repeat of the policy of stimulating AD in response to AS shocks. The Fed has made it clear recently that it does not want to see the inflation of the 1970s repeated. The message Trichet is conveying is that with markets widely anticipating a pause in the rate increasing campaign by the Fed, to continue increasing rates would disorient the markets and potentially lead to even more instability. Should the Fed do what it thinks is correct according to the fundamentals, or does it behave according to market expectations it disagrees with? The answer Trichet gives is that you do not do anything rash that might upset the markets (particularly if the Fed itself is unsure of long-term consequences), it’s better to explain, explain, and then explain some more to re-anchor inflationary and other expectations (hence these kinds of comments from the Fed today). Unless FedSpeak can convince markets otherwise (and assuming FedSpeak would want to), it may be prudent from a risk management perspective to pause and wait for expectations of the Fed and the private sector to converge before considering further rate hikes.
Federal Reserve Economists Warn Katrina Could Push Up Inflation
Katrina seen pumping up US inflation in short run, by Alister Bull, Reuters: Hurricane Katrina's impact on prices for gasoline and other commodities could boost U.S. inflation for several months, Federal Reserve economists said on Thursday, but the fallout will likely prove temporary. … "In the immediate future, this will show up as a big blip in CPI … But that is not relevant for long-term price stability in this county," said Robert Rasche, director of research at the St. Louis Federal Reserve. … The Fed … must weigh the impact on inflation, as well as what higher energy costs mean for consumption and growth, as it sets rates. … "Any time there is a disruption in the supply chain it is going to affect prices. But whether it is short-term or long-term is very hard to gauge," said Mike Chriszt, a senior economist at the Federal Reserve Bank of Atlanta, the regional Fed with primary oversight of the storm-struck region. "It depends on the ability of producers to pass on costs, and we're just not sure ...
In interpreting these remarks, note that Rasche does not see this event as fundamentally altering the long-term inflationary outlook. Chriszt is more cautious and allows for the possibility that the long-term inflation rate could increase. If so, we will find out how committed the Fed is to inflation targeting, particularly with markets widely anticipating a pause in the Fed's measured rate increases.
Bush Meets With Greenspan on Effects of Katrina
President Bush, back from his shortened vacation in Texas, met with Federal Reserve Chairman Alan Greenspan and his top economic advisers on Thursday to assess the damage, particularly to the energy infrastructure. "We view this storm as a temporary disruption that's being addressed by the government and the private sector," Bush said. "Don't buy gas if you don't need it,"...
That's good advice, but not exactly what I hoped to hear from the president. I will update this post if more details of the meeting between Bush and Greenspan become available. [Update: MarketWatch has a bit more here in an update. This report has an the expanded quote from Bush. Reuters report here.]
WSJ : Rebuilding After Natural Disasters
Will New Orleans Rebound?, By Michael M. Phillips and Cynthia Crossen, The Wall Street Journal: At the close of World War II, American bombers incinerated the cities of Hiroshima and Nagasaki with atomic weapons. Within two decades, both cities had been rebuilt, and their populations had surpassed prewar levels. The lesson, according to economists who have studied the question, is that, while it may take years, cities are resilient and usually bounce back from the worst natural or man-made devastation. "Even nuclear bombs and fire bombing of cities was not enough to change the level and nature of economic activity," says Columbia University economist Donald R. Davis, who studied Japanese reconstruction. "People don't abandon their cities, and indeed industries don't abandon the cities they're in." … disasters are rare … but a look back at four of them in the U.S. … reinforces that conclusion...
1871 Chicago Fire …The fire killed perhaps 300 people, destroyed 18,000 buildings, left 100,000 Chicagoans without homes and caused some $3.2 billion in damages, at today's prices. Half of the city had insurance, but only half of those actually got paid from their policies. … Yet almost as soon as the embers had cooled, Chicago business leaders deployed to New York to persuade investors that this was the time to put more of their money into Chicago, not less. … The stockyards had been spared the flames, as had much of the city's heavy industry. ... Chicago, …was a crucial crossroads of agriculture and industry, too valuable to give up. By the end of the decade Chicago was bigger and better than before. The city had a population of roughly 300,000 before the fire. In 1880 it was home to half a million…
1906 San Francisco Earthquake When the last fire was extinguished after the San Francisco earthquake of April 1906, survivors emerged from their makeshift shelters to find three-quarters of their city in ruins. All telephone and telegraph communications had ceased. There was little water for drinking. The railroads had been destroyed; the port was completely blocked by debris. Few, if any, hotels, restaurants or cafés survived, and 300,000 people were homeless. Banks were closed, and would remain so for a month. Despite martial law, looters roamed the streets, and the mayor ordered them to be shot on sight. "As regards industrial and commercial losses, the conditions are appalling," wrote Victor H. Metcalf, secretary of labor and commerce, in a report to President Roosevelt. "Not only have the business and industrial houses and establishments of one-half million people disappeared, leaving them destitute financially and their means of livelihood temporarily gone, but the complicated system of transportation indispensable to them has been almost totally destroyed."
…In the first days and weeks after the disaster, that meant trying to feed, clothe and shelter survivors while raising money to repair the city's infrastructure. ... Engineers, contractors and draftsmen were recruited from other parts of the country, and the city began trying to buy all the lumber, cement and glass it could find. Temporary structures were erected in several centrally located squares for use by architects, transportation and insurance officials and lawyers. Labor unions quickly … set rules for the coming boom. The painters' union, for example, suspended many of its trade rules: "No overtime will be allowed; straight time for night or Sunday work. The brothers are requested to be satisfied with eight hours' work and give unemployed brothers a chance." … three months later, in July 1906, the St. Francis Hotel Annex re-opened, and hundreds of buildings were under construction…
1889 Johnstown Flood It could be argued that the Johnstown flood of 1889 wasn't a natural disaster at all, but the inevitable consequence of humans thinking they could control nature. Whatever the cause, the day after a dam burst, unleashing 20 million tons of water on the residents of Johnstown, Pa. … Pennsylvania's governor, James Beaver, created the Pennsylvania Relief Committee to coordinate cleanup and restoration, while the state militia kept order. With thousands of men working, the Pennsylvania Railroad rebuilt 20 miles of track in two weeks. One gang of workers … did nothing but sprinkle disinfectants over the entire area. Hundreds of cellars, flooded with "every kind of filth," had to be dug out by hand. But there was no hope the area would survive unless its biggest employer, the Cambria Iron Works, re-opened. On June 9, company officials announced that it would…
1900 Galveston Hurricane During the afternoon of Saturday, Sept. 8, 1900, the town of Galveston, Texas, became part of the ocean floor. … a hurricane … hit Galveston, and ... "Every part of the island was covered in water," says Christy Carl, director of the Galveston County Historical Museum. The row of wooden houses nearest the shore crumpled with the impact of the waves, and the debris slammed into the next block. And the next. And the next, until the detritus itself formed a wall to stop the advancing waters. All told, some 3,600 buildings were destroyed. …Galveston, a prosperous island of cotton merchants, bankers and shippers, boasted a population of 37,500 on Saturday morning. By day's end, as many as 8,000 residents were dead, along with 2,000 or so more on the mainland, making the Galveston hurricane the deadliest natural disaster in the history of the U.S. … town leaders and Army engineers launched an extraordinary effort to insulate the exposed barrier island from the fury of nature. Between 1902 and 1904, the Army Corps of Engineers built a seawall that now stretches more than 10 miles and stands 17 feet high. And in case the seawall didn't deflect the cresting waters, the engineers raised the city. They put each home on the Gulf side of the island up on stilts and pumped wet sand underneath to elevate it. Brick homes couldn't be raised, so the owners had to fill in their basements instead. The island's terrain was graded to slope gradually down toward Galveston Bay. The project took eight years to complete. Another hurricane -- thought to be as strong or stronger than the big storm -- hit the island in 1915, killing about 275 people. It was a disaster, but the seawall and the elevated ground level apparently kept the toll from approaching the grim tally from 1900.
Posted by Mark Thoma on Thursday, September 1, 2005 at 10:44 AM in Economics
Guest Post - Charles Bean to Robert Hall: There is an Output Gap!
Philadelphia Fed’s Santomero: Rates are Still Likely to Go Up
Economy Can Withstand Hurricane, Fed's Santomero, Bloomberg: The U.S. economy will withstand the effects of Hurricane Katrina, rising fuel costs and a slowdown in the housing market, allowing the Federal Reserve to keep raising interest rates at a ''measured'' pace, said Anthony Santomero, president of the Federal Reserve Bank of Philadelphia. ''If the economy evolves as I expect, it is likely that we can continue to move the federal funds rate toward neutrality at what we have described as a measured pace,'' … Santomero said U.S. economic growth may slow ''for a time'' because of the effects of higher oil prices, the housing market and the hurricane ... Even so, ''the expansion is strong enough to withstand them''…
Santomero's remarks were the first by a Fed official since the hurricane struck two days ago. Asked in an interview after his speech if the hurricane's effects might prompt the Fed to pause with its rate increases, Santomero said ''we still have to figure out'' the storm's economic effects. ''It's clearly something we have to look at, we have to be mindful of,'' Santomero ... ''We have to if necessary adapt to changing circumstances, but we don't know to what extent this is a serious disruption or a relatively short-term one,''…
Other Fed officials later offered similar views. Fed Governor Mark Olson said that ''it's too early to even make a comment'' on how Hurricane Katrina will affect the U.S. economy. Asked how long it will take the Fed to assess the storm's effect, Olson said, ''It's still in the early stages. We'll watch the information as it becomes available.'' When asked about the storm's effect on the economy, Janet Yellen, president of the Federal Reserve Bank of San Francisco, said, ''We have to watch things and see what happens.''…
And, in closing, Santomero reminds us that the Fed takes monetary policy one meeting at a time and uses the very latest information available to guide their decisions, then tells us what he expects the data to say:
…''The Fed's best strategy is to keep careful watch on economic developments, approach each policy decision with an open mind, and communicate the rationale for its decisions as clearly as possible,'' Santomero said. … Santomero said the economy will expand by 3.5 percent to 4 percent this year. Payroll growth will continue to average 150,000 to 200,000 jobs a month, though ''with the unemployment rate at 5 percent, we must also begin to ask how much slack remains in the labor market,'' he said.
If he’s right, rates are going up.