November 30, 2005
Have Skills, Will Travel
Give Us Your Skilled Masses, by Gary S. Becker, Commentary, WSJ: With border security and proposals for a guest-worker program back on the front page, it is vital that the U.S. ... does not overlook legal immigration. The number of people allowed in is far too small... Only 140,000 green cards are issued annually, with the result that scientists, engineers and other highly skilled workers often must wait years before receiving the ticket allowing them to stay permanently in the U.S. An alternate route for highly skilled professionals ... has been temporary H-1B visas... But Congress foolishly cut the annual quota of H-1B visas in 2003 ... to well under 100,000. The small quota of 65,000 for the current fiscal year that began on Oct. 1 is already exhausted!
This is mistaken policy. ... Skilled immigrants such as engineers and scientists are in fields not attracting many Americans, and they work in IT industries ... which have become the backbone of the economy. ... These immigrants create jobs and opportunities for native-born Americans of all types and levels of skills. ... The annual quota should be multiplied many times beyond present limits, and there should be no upper bound on the numbers from any single country. Such upper bounds place large countries like India and China ... at a considerable and unfair disadvantage -- at no gain to the U.S.
To be sure, the annual admission of a million or more highly skilled workers ... would lower the earnings of the American workers they compete against. The opposition from competing American workers is probably the main reason for the sharp restrictions on the number of immigrant workers admitted today. That opposition is understandable, but does not make it good for the country as a whole. Doesn't the U.S. clearly benefit if ... India's government spends a lot on the highly esteemed Indian Institutes of Technology to train scientists and engineers who leave to work in America? ...
Experience also shows that if America does not accept greatly increased numbers of highly skilled professionals, they might go elsewhere ... [where] they may compete against us through outsourcing and similar forms of international trade in services. The U.S. would be much better off by having such skilled workers become residents and citizens -- thus contributing to our productivity, culture, tax revenues and education rather than to the productivity and tax revenues of other countries. I do ... advocate that we be careful about admitting students and skilled workers from countries that have produced many terrorists... But the legitimate concern about admitting terrorists should not be allowed, as it is now doing, to deny or discourage the admission of skilled immigrants who pose little terrorist threat.
Nothing in my discussion should be interpreted as arguing against the admission of unskilled immigrants. ... But if the number to be admitted is subject to ... limits, there is a strong case for giving preference to skilled immigrants... Other countries, too, should liberalize their policies toward the immigration of skilled workers. I particularly think of Japan and Germany... America still has a major advantage in attracting skilled workers, because this is the preferred destination of the vast majority of them. So why not take advantage of their preference to come here, rather than force them to look elsewhere?
Robert Samuelson: Ghosts That Still Haunt GM
Ghosts That Still Haunt GM, by Robert J. Samuelson, Washington Post: ...General Motors ... recently announced it would close 12 facilities and cut 30,000 jobs by 2008. Granted, GM is burdened with costly labor contracts and huge numbers of retirees... But GM also inherits a self-defeating management style formed during its glory days. It presumed that superior managers could always anticipate and control change. By contrast, many top managers in younger companies accept that they will face disruptive surprises that could, unless successfully countered, destroy them. The difference has consistently disadvantaged GM. Its latest downsizing is the company's third since the early 1980s. With each, GM has struggled to catch up with changes that it badly misjudged -- the demand for smaller cars in the late 1970s; the superior quality and production techniques of Japanese manufacturers in the 1980s; and now the demand for snazzier cars and ... better fuel efficiency. ...
Alfred P. Sloan Jr.... was GM's chief executive from 1923 to 1946 ... In 1921 Ford had 60 percent of U.S. car sales. GM overtook Ford because "the old master [Henry Ford] had failed to master change," Sloan wrote. Ford stuck too long with the Model T ... even as the car market shifted. ... Aside from fighting Ford, Sloan had to fashion a huge industrial enterprise that would not collapse under the weight of its own complexity. ... Sloan solved this problem by decentralizing operations ... among separate divisions while centralizing policy matters ... at the top. ... Unfortunately at GM, it ... fostered overconfidence and inertia. "Management" became an exercise in ensuring stability. GM's market power made it less sensitive to cost increases, especially labor costs, because these could usually be recovered in higher prices. ... But that is only half the problem. The other half is that GM does not have the vehicles that command good prices. To move in volume, they require steep discounts. This is a management failing that can't be blamed on unions or retirees, and it's now compounded by the impact of high gasoline prices on SUV sales. Within GM, there are pockets of vitality. ... But too often, GM's deliberate management style has produced mediocre vehicles that fare poorly in today's hyper-competitive market. Since its peak, GM's market share has fallen by half. ...
Sloan shrewdly foresaw that too much success could be fatal. It might dull "the urge for competitive survival," which is "the strongest of all economic incentives." Companies might fail "to recognize advancing technology or altered consumer needs." Avoiding these traps, he said, was GM's challenge. There is now talk that GM could go bankrupt. Although that isn't inevitable, even the talk measures how poorly GM met the challenge.
Posted by Mark Thoma on Wednesday, November 30, 2005 at 12:24 AM in Economics
Reducing Deforestation Using Economic Incentives
A solution to climate change in the world’s rainforests, by Geoffrey Heal and Kevin Conrad, Financial Times: A novel economic model for reducing deforestation is being proposed by the Coalition for Rainforest Nations at the current United Nations climate change conference in Montreal. ... [T]he coalition is proposing economic incentives for conserving tropical forests while contributing to climate stability. Deforestation is a big source of carbon dioxide emissions ... In what could be crucial to current climate negotiations, coalition countries may accept binding caps on their emissions levels in exchange for tradable emission reduction credits. In fact, these countries are being drawn toward pledging “voluntary reductions” by the prospect of access to now viable emissions reductions markets. This is the first time for any developing countries to consider mechanisms to cap carbon emissions, and the first real global move to address the growing and critical issue of deforestation.
Deforestation contributes almost as much to climate change as does US fossil fuel use. ... Curbing deforestation reduces CO2 emissions just as surely as replacing coal by nuclear or renewable energy. Emission reductions from deforestation are not yet eligible for financial compensation under the Kyoto protocol, while replacing coal with renewable energy sources is. This gaping hole in the Kyoto protocol defies logic, is scientifically unsound and throws doubt on the efficacy of the entire framework. To help level the playing field, the rules must be revised to make carbon credits from reduced deforestation tradable in carbon markets on a par with other offsets. This would value them at present in the range of $25 (€21) per ton of CO2. Such a price is high enough to transform the economic incentives to conserve forests and is quite competitive with the lumber prices currently received by local communities from logging companies. Recognising carbon credits from avoiding deforestation makes standing timber an income-earning asset worthy of conservation. ...
The coalition’s proposal seeks to create new markets while reforming outmoded market and regulatory mechanisms. From the perspective of tropical countries, this change would make conservation a financially viable policy, with real economic returns. ... Instead of pitting the traditional conservation groups against industrial countries and business, this model appeals to all constituencies. ...
[Dual posted at Environmental Economics.]
An Enterprising Business Strategy
Sporting Goods and Its Own Business Model, by Kate Murphy, NY Times: Since it opened in June 2005, it's been hard to find a parking space at the Cabela's in this tiny town, halfway between Austin and San Antonio. A shuttle like those that ferry travelers between gates at airports zips around Cabela's stadium-size parking lot taking people from their cars to the outdoor equipment retailer's rough-hewn entrance. In their sensible shoes and fanny packs, looking like tourists instead of shoppers, many reach for their cameras to take pictures ... But there would be no bustle in Buda, which has a municipal budget of $4.5 million, if the town had not secured a $40 million bond to make the infrastructure improvements Cabela's demanded. As it has done in other communities, the company then bought the debt in exchange for a sales tax exemption. The state of Texas also awarded Cabela's a $600,000 enterprise grant and made $19.5 million in Interstate and overpass improvements. ... Locating in small towns like Buda and Lehi, where locals are more likely to offer such sweetheart deals, is part of Cabela's strategy. The company's senior vice president for retail operations, Mike Callahan, said, "They are more eager to work with us because we are a huge driver for economic growth," ...
November 29, 2005
Liberals, Government Intervention, and Competitive Capitalism
Labor's Lost Story, by E. J. Dionne Jr., Washington Post: ...General Motors' layoffs of 30,000 workers... [has] become a new litmus test in American politics. Almost everybody right of center sees the job losses as inevitable, the result of the American auto industry's failure to meet foreign competition and the "excessively" generous wages, health benefits and, especially, retirement programs... The believers in inevitability inevitably cite the economist Joseph Schumpeter to the effect that ... It is capitalism's gift for "creative destruction," ... that guaranteed new consumer goods, new methods of production and new forms of organization.
A different story is told left of center, though ... progressives can't quite agree on a single narrative. The left is united in talking about rising health care costs and the fact that most of our foreign competitors have government-run health insurance systems that take the burden of health care off employers. ... Critics of globalization tell an additional story of how free trade is sending many of our best-paying blue-collar jobs offshore. ... The contrast between these two accounts explains why economic conservatives currently hold the upper hand in America's political debate. The conservatives have a single, coherent story and stick to it: Economic change is good for everyone...
The left's narrative is less compelling not only because there is no single story but also because few on the left attack the current system with the same gusto the right brings to defending it. ... Much of the left accepts a certain amount of creative destruction because, in Margaret Thatcher's famous phrase, there is no alternative. But this muddle reflects a default on parts of the left ... [S]o many Democrats fear that they might sound like -- God forbid! -- socialists, they are unwilling to challenge the right's core story. Capitalism, all by itself, would never have achieved the rising living standards that were the pride of the United States in [the] 1950s and still are today. ... As medical costs rise, more Americans will need government help. ... Yes, that's "socialized medicine," just like Medicare. But don't tell anyone. The phrase plays terribly in focus groups.
For 60 years New Dealers and social democrats, liberals and progressives, turned Schumpeter on his head. They insisted that few would embrace capitalism's innovations if the system's tendency toward creative destruction was not balanced by public innovations to spread the bounty and protect millions from being injured by change. It's a compelling story. ... Too bad it isn't told very often anymore.
Here are the rules I try and play by. I advocate government intervention only when I can justify it through economics, otherwise I believe in the market's ability to do what we expect it to do, deliver goods as cheap as possible in the correct quantities. My default is a laissez faire approach. I don't advocate government sponsored healthcare and social insurance because I like bloated government, I do it because I believe these are instances where the private market cannot, without regulation or intervention, provide the proper quantities of goods and services at the lowest possible price. I don't think the government should be more active in preventing monopoly power because I dislike big business, I say that because I want a competitive marketplace. I don't want to hug trees of infinite utility, I want market based solutions to environmental problems whenever possible. Simple market principles can do wonders for recycling and conservation programs. I want efficient taxes that minimize distortions. I believe in equal marginal sacrifice to fund government, but that is a normative choice, not something derived from economics. Government should not be any larger than necessary. I don't advocate redistribution of income for the sake of "equity," but I do believe the government should ensure that everyone has an equal chance in life, not an equal outcome but an equal start, and that may involve redistributive policies.
It's quite possible to be a liberal and not abandon economics and not abandon capitalism in particular. We can argue over whether there truly is market failure in this instance or that, I will admit to seeing market failure more often than those on the right. We can debate contestable markets and whether it applies to a particular market, we can debate price cap versus rate of return regulation (no contest, price caps win, but what type of price cap is best?) and how best to make markets competitive (how do you get public utility regulators to understand you have to allow profit to attract entry?), we can debate the economics until the Gateway cows come home. But don't accuse me of being a socialist just because I believe the government is, in its heart of hearts, made up of good people who want to help, because I believe there are times when government is the solution rather than the problem. I don't want to "sound like -- God forbid! -- socialists," the economics of capitalism is the proper battleground for me.
Guns, Butter, and Retired Boomers
Big Issues - Guns, Butter and Retired Boomers: How Do We Pay for It All?, WSJ (free): This is the first of three online debates ... The federal budget deficit is the topic ... Joining the debate are Robert B. Reich, who was secretary of labor in the Clinton administration, and R. Glenn Hubbard, who served as chairman of the Council of Economic Advisers for two years under President Bush. ...
MR. WESSEL begins the debate: Has the federal government bitten off more than it can chew by reducing tax rates ... and subsequently -- despite the costs of responding to 9-11, fighting the war in Iraq, rescuing and repairing New Orleans and environs and expanding Medicare to cover prescription drugs? Is current fiscal policy sustainable ...?
MR. HUBBARD: The U.S. economy... is in excellent shape, and it can absorb the tax changes, military and homeland security changes, and disaster relief. Two points are in order, though: More restraint is needed to ensure that domestic spending growth does not continue, and tax reform is needed to codify pro-growth policy that can raise the revenue required to fund the federal government. The problem is not the next three or even five years; the problem is the long-run fiscal picture. ... [T]he Medicare expansion without substantial reform of the system was unwise fiscal policy. The current Social Security and Medicare systems are on an unsustainable path. In both cases, sound fiscal reform should involve slower benefit growth for high-income households. ... accompanied by reform of health-care markets. The bottom line issue is less guns v. butter today (the next three to five years) than whether the butter will crowd out guns tomorrow ... or indeed whether the butter itself will be affordable on the same terms tomorrow.
MR. REICH: Undoubtedly yes. But we should distinguish between deficits that occur when the economy has lots of unused capacity ... and deficits that become part of the long-term structure of the federal budget. If the tax cuts and spending increases ... at the start of the administration were temporary and stayed temporary, there'd be little to complain about. In fact, they might have helped get the American economy moving. But the administration wants to make the tax cuts permanent. And much of its new spending ... will go on for years. ... This isn't sustainable over the long haul and I don't think it's sustainable even over the next five years.
MR. HUBBARD: I agree wholeheartedly with Bob that dividing the timeline of fiscal worries into two parts -- short-run and long-run is important. I also agree that we must distinguish between running deficits when the economy is not at full employment versus when it is (read now). Tax cuts that add to the nation's productive capacity include reductions in the tax burden on saving and investment and reductions in marginal tax rates on entrepreneurial activity. ... The near-term tax debate should be about tax reform so that we can maximize ... pro-growth policy. On the spending side, a strong case can be made for continued basic research support and support for individualized training programs. What often goes under the heading of investment -- highways, for example -- is a tougher case to make from an economic perspective.
Where Bob and I disagree regards his characterization of "tax cuts that mostly benefit the wealthy." Reductions in the taxation of saving and investment show up in current tax distribution analysis as benefiting savers -- generally well-to-do savers. Yet, over the long run, those tax changes raise capital accumulation, productivity, and wages. ... It is hard to imagine what tax changes ... would add more to the nation's productive capacity.
MR. REICH: I'm not adverse to tax cuts on savings and investment, but in my view the growth we get from such tax cuts is far less than the growth we get from well-targeted public investments in education at all levels, on health care .., infrastructure, and basic research and development. ... Over the long term, capital flows to places around the world where it can get the highest return -- either because production is very inexpensive there, or because of natural resources located there, or ... because people there are enormously productive. And they're productive because they have high skills, good health, good infrastructure linking them together, and an excellent scientific base from which to draw.
Obviously, we can't do it all. We can't extend the tax cuts and at the same time carry out all the public investments that are necessary -- while at the same time we fight wars in Iraq and Afghanistan, build up homeland security, give the middle class some relief from the Alternative Minimum Tax, and dole out Medicare drug benefits (not to mention the rest of Medicare) to early boomers. Deficits do matter, and choices do have to be made. I'm skeptical of claims that continued tax cuts on capital gains and dividends have such a hugely positive effect on the economy ... This recovery ... is weaker than the average post-World War II recovery.... So I see no reason to extend them. ...
MR. WESSEL, Moderator, asks: On taxes, do either of you believe that a significant tax increase is either wise or inevitable either in President Bush's term or in the first term of his predecessor? If so, what tax and on whom? And on spending, what one or two things would you have the government spend more ... on? And what one or two things would have the government spend less ... on?
MR. REICH: ...I don't anticipate any concerted move by this administration to tame the deficit ... unless bond markets get so rattled by the size of pending deficits that the White House is forced to come up with something. .... That will ... leave a fiscal mess for the president's successor... What would I have the government spend more on, notwithstanding the above? Early-childhood education. The evidence is clear and compelling that these expenditures provide very large social returns... I'd also have the government spend more on K through 12 in poor communities .... I'd even be in favor of a progressive voucher system, ... What spending to cut? Start with subsidies and tax breaks directed to specific companies and industries ... "corporate welfare." ... Also, get rid of all earmarked spending on specific projects. It's pork. ... We need a capital budget that establishes clear priorities for infrastructure spending. Medicare savings are possible ... I'd also amend the new Medicare drug benefit to allow the government to use its huge bargaining power with pharmaceutical companies to push down costs.
MR. HUBBARD: Let me echo Bob's call for a reduction in corporate subsidies and earmarked spending projects. ... I think the administration is missing an important opportunity to talk ... about the enormous looming entitlement liabilities and the large implicit flow deficits ... that go with them. If we cannot bring these deficits ... under control, we will have to raise taxes, with significant adverse consequences for economic growth. I do not believe that a significant tax increase is wise or inevitable. ... I say this because I believe we should and will scale back the growth in the entitlement programs that are the clear and present fiscal danger. I would like to see the government spend more on basic research and on training (because our employment policies are outdated) -- but these $$$ are not large in the context of the overall federal budget. ... [T]he real area for spending restraint is the entitlement programs.
Re: Bob's second reply: Blanket spending increases on health care, infrastructure, and education strike me as unwise. Our goal for health care should be to improve value ... The evidence on the effectiveness of infrastructure spending is, to put it mildly, mixed, ... Even with education, ... structural reform is a bigger deal here than a cry for more money. ...
MR. REICH: I'm not suggesting "blanket spending increases" ... To the contrary, I'm urging more and better-targeted spending in these vital areas. ... As to health care, I'd recommend that the federal employee's health insurance system be made broadly accessible and affordable to all small businesses wishing to enroll their employees -- thereby giving the federal system far more bargaining leverage with providers and drug manufacturers, while at the same time enrolling a large portion of Americans currently without health care. This would be a first step toward a single-payer system.
As to entitlement spending, and contrary to what we've heard from the White House, Social Security isn't the biggest entitlement problem. It's Medicare. ... The reason Medicare spending is rising so quickly -- apart from the aging of the population -- is double-digit increases in annual health-care expenditures across the economy. So the key to containing Medicare is streamlining our whole health-care system. That's a big enough topic for a discussion all its own.
MR. HUBBARD: I couldn't agree with you more on Medicare being the more significant problem and that reform of health care markets is central. ...
The Natural Vacancy Rate for Housing
The vacancy rate in housing is similar to the unemployment rate in labor markets. Why isn't 0% unemployment for labor optimal? Some unemployment is optimal because it allows people to change jobs and allows new entrants to enter the labor market without a "double coincidence of wants." Without vacancies, to change jobs you would need to find someone who has the job you want and wants the job you have, and then trade. Those entering the labor market would have to find someone who is leaving the labor market and has an acceptable job, and they in turn must be acceptable to the employer. The matching costs are high with such an arrangement. With some unemployment, costs fall since finding an offsetting match is unnecessary.
Housing is no different. Without vacancies, to move from New York to Los Angeles would require finding someone moving in the other direction who has a house you are willing to buy and is also willing to buy your house, a difficult task (rentals would be similar). But with vacancies, the task is much easier.
But what should the optimal vacancy rate be and what causes it to change? If the actual vacancy rate is below the natural rate, prices should rise. If the vacancy rate is above the natural rate, prices should fall, so knowledge of the natural vacancy rate is helpful in understanding markets. The natural rate of vacancy is not a constant. It varies over time and there is no reason to think that one natural rate exists for all areas, for all housing types, and so on, so what causes the natural vacancy rate to change? One approach is to break it down much like unemployment. There are cyclical factors from the macroeconomy and local economy that make the vacancy rate rise and fall over time, but these aren't changes in the natural rate, these are variations around the natural rate. There are structural factors that cause increased job turnover that would presumably change the optimal vacancy rate, i.e. the more dynamic the labor market, particularly if labor is coming from outside or moving away from the local area, the higher the natural rate. And there are frictional factors as people change houses and move up or down depending upon their stage in the life-cycle, and as with unemployment, some of this is driven by demographics. I just started thinking about this, so I have surely overlooked important reasons for variation in natural vacancy rates. What other factors are important?
Will the data identify a natural rate? These graphs (Census data here) show housing and rental vacancy rates since 1956. The rates vary considerably through time:
A few observations. The turnover rate is higher for rentals and this is clearly reflected in the difference in mean vacancy rates. The vacancy rate averages 7.0% for rentals which is quite a bit higher than the 1.4% rate for owner-occupied housing. Second, there are both high frequency and low frequency cycles in the data and the low frequency cycles are, to me, surprisingly long. Third, for both series there has been an upward trend in vacancies over the last 25 years with the most pronounced increases occurring from around 1980-1990 and after 2000. This is most evident in rentals, but owner-occupied shows similar, but less discernable trends (the top graph appears noisier because it is on a smaller scale). This is not what I expected. I anticipated that that factors such as better search technology and more creative financial instruments would have lowered average vacancy rates. Anyone have ideas why the natural vacancy rate appears to be drifting upward over the last 25 years? Were their tax changes, demographic changes, changes in second homes purchases and speculation, or is it just weak demand in some time periods? There is a caution in the footnote about comparing pre and post 1986 rates, and the data do change at this point, but the upward trend exists both before and after this breakpoint. Finally, this leads me to wonder how much variation there is in the natural rate of unemployment over subgroups in labor markets. For example, is the unemployment rate for temporary workers (corresponding to rentals) substantially different from full time employees (corresponding to owner-occupied)? Are we missing anything important by focusing on a single national rate in policy applications such as the Taylor rule, or does that capture the national trend adequately?
November 28, 2005
Cold War Clues - Atomic Tests Allow Carbon Dating of Baby Boomers, by Christine Soares , Scientific American: Frustration was the mother of invention for Jonas Frisén of the Medical Nobel Institute in Stockholm.... As a neuroscientist working toward regenerating brain tissue, he would have found it handy to know whether some or all of the human brain ever regenerates naturally and, if so, how often. ... [T]he question was unanswerable for humans: the techniques used to tag cells and watch their life cycles in animals employ toxic chemicals... Then Frisén learned of a natural tag unique to people born after 1955, when aboveground testing of nuclear weapons increased substantially. The explosions, which stopped after the 1963 Limited Test Ban Treaty, threw enormous amounts of carbon 14 isotope into the atmosphere ... Plants incorporated the carbon 14 into their cells, animals ate the plants, and people ate both, absorbing the isotope into their own cells and creating a trail Frisén could follow. ...
As ... the team reported in the journal Cell..., many parts of our bodies are much younger than the whole. Jejunum cells from the gut tissue of subjects in their mid-30s were less than 16 years old. Skeletal muscle from two subjects in their late 30s was just over 15 years old. But the big surprises were in the brain.... Neurons ... dated to a period at or near the subjects' birth, indicating that those parts of the brain are formed at the beginning of life and do not normally turn over. Frisén thinks it is too soon to know whether his finding means less hope for therapeutic approaches to regenerating damaged brain tissue. ...
There goes any hope of getting that regenerated brain I wanted for Christmas. I guess my days of doing things like stopping in the middle of a sentence during lectures and asking "What was I just talking about?" aren't going to end anytime soon. At least I can still find my way home.
Sales of Existing Homes Fall
Existing Home Sales Dip, Prices Climb, by Martin Crutsinger, AP: ...The National Association of Realtors reported Monday that sales of existing homes and condominiums declined by 2.7 percent last month ... The decline would have been an even larger ... without a spurt in sales in areas where people displaced by the Gulf Coast hurricanes have moved. ... Even with the decline in sales, the median price of an existing home sold last month rose by 16.6 percent to $218,000 compared to the median ... price in October 2004. ...
Those price increases have contributed to a rise in mortgage rates[I misread this - the article meant the rise in energy costs induced a rise in interest rates.]
One part is puzzling. An increase in prices is not consistent with an increase in long-term interest rates and a decline in demand. Help me out - why are prices going up if the market is weak and long-term rates are inching upward? Is it just price inertia? [See also Bloomberg, NY Times, CNN/Money, Financial Times, and the WSJ (AP report)] [NAR Report]
Update: See Calculate Risk who, of course, has this covered.
Paul Krugman: Age of Anxiety
Age of Anxiety and Job Insecurity, by Paul Krugman, NY Times: Many eulogies were published following the recent death of Peter Drucker, ... however, ... few ... mentioned his book "The Age of Discontinuity," a prophetic work that speaks directly to today's ... economic anxieties. Mr. Drucker wrote "The Age of Discontinuity" in the late 1960's, a time when most people assumed that the big corporations ... like General Motors and U.S. Steel would dominate the economy for the foreseeable future. He argued that this assumption was all wrong.
It was true, he acknowledged, that the dominant industries ... of 1968 were pretty much the same as the dominant industries ... of 1945, and for that matter of decades earlier. ... But all of that, said Mr. Drucker, was about to change. New technologies would usher in an era of "turbulence" ... and the dominance of the major industries ... of 1968 would soon come to an end. He was right. ... Many of the corporate giants of the 1960's ... have fallen on hard times, their places in the business hierarchy taken by new players. General Motors is only the most famous example. So what? ...: why does it matter if the list of leading corporations turns over every couple of decades, as long as the total number of jobs continues to grow?
The answer is the reason Mr. Drucker's old book is so relevant...: corporations can't provide their workers with economic security if the companies' own future is highly insecure. American workers at big companies used to think they had made a deal. They would be loyal to their employers, and the companies in turn would be loyal to them, guaranteeing job security, health care and a dignified retirement. Such deals were, in a real sense, the basis of America's postwar social order. We like to think of ourselves as rugged individualists, not like those coddled Europeans with their oversized welfare states. But as Jacob Hacker of Yale points out in his book "The Divided Welfare State," if you add in corporate spending on health care and pensions ... we actually have a welfare state that's about as large relative to our economy as those of other advanced countries. ...
[T]hose who don't work for companies with good benefits are, in effect, second-class citizens. Still, the system more or less worked for several decades after World War II. Now, however, deals are being broken ... What went wrong? An important part of the answer is that America's semi-privatized welfare state worked in the first place only because we had a stable corporate order. And that stability - along with any semblance of economic security for many workers - is now gone.
Regular readers ... know what I think we should do: instead of trying to provide economic security through the back door, via tax breaks designed to encourage corporations to provide health care and pensions, we should provide it through the front door, starting with national health insurance. You may disagree. But one thing is clear: Mr. Drucker's age of discontinuity is also an age of anxiety, in which workers can no longer count on loyalty from their employers.
Positively Normative Economic Analysis
Positive economics, value-free economics ... is the part of economics that focuses on facts and cause-and-effect relationships. It includes descriptions, development and testing of economics theories. Positive economics avoids value judgments. It tries to establish scientific statements about economic behavior and deals with what the economy is actually like. For example, a positive economic theory might describe how interest rate affects inflation but it does not provide any guidance on whether what policy should be followed. ...
Normative economics is the branch of economics that incorporates value judgments about what the economy should be like or what particular policy actions should be recommended to achieve a desirable goal. Normative economics looks at the desirability of certain aspects of the economy. It underlies expressions of support for particular economic policies.
And this is how Wikipedia describes a positive science:
Positive science: ...The term positive lies at the heart of one of the major epistemological debates in the humanities and social sciences. Positivists ... advocate a 'value-free' approach to the study of humanity that shares much in common with methods employed in the natural sciences. Positivists seek only to make objective descriptions of humanity and society without making normative judgments. In contrast non-positivists reject the notion that the methods of the natural sciences are adequate in explaining and describing humanity and society - this is primarily because of the 'meanings' that humans attach to their actions. They believe that it is not possible to be completely value-free in their study, as a person cannot stand totally removed from their place within space and history.
In the classroom, I am as careful as I can be to do positive economics and avoid normative. It's not entirely possible to avoid normative analysis though, and one could "positively" ask questions such as "What are the negative impacts of the Bush tax increase," "What are the negative effects of budget deficits," "How much additional inequality is there in the income distribution in recent years," "Is there any evidence that tax cuts actually pay for themselves," and so on. Each question is analyzed factually, but the totality leaves a clear normative impression. The questions you ask are dictated to some extent by value judgments, the topics one chooses to cover in class are a judgment call as well - normative elements are always present. I feel a strong professional obligation in the classroom (and in research) to avoid politics and one-sided presentations when there is any question over the theory or empirical results. I know it's only an ideal, but it seems one worth striving for even if it cannot be perfectly achieved. Other disciplines do not seem to have this boundary. I wonder though, is my opinion more valuable than someone else's on economic matters? What about outside my area, do I have special insight? If I am a professor of English or biology, does my opinion on the war matter? As an economist, what do I add to the abortion debate beyond the economics?
If a policy makes everyone better off and nobody worse off (perhaps after transfers between people), then I can be an advocate for the policy. But if the policy makes some people better off and others worse off, even if it's a single individual, then all I can do is document the effects. I cannot judge whether the losses of one group are larger or smaller than the gains of another. That is what the political process is designed to do, make decisions when there are winners and losers. An economist's job is to advise what the gains and losses are, not decide if they are just.
But it's frustrating to never be able to state one's own views, let alone with the passion they are held. And this goes beyond the classroom or research. I cannot, in my capacity as a state employee, even take a position on an initiative or a candidate for political office. In Oregon I can talk politically from 12-1 during lunch hour and wear a lapel pin not to exceed a size governed by law, but not outside of that - e.g. I cannot write a letter to the local paper and say a particular initiative or proposed economic policy makes no economic sense and sign it as a member of the Economics Department at the UO (though I could sign just my name without the Department and University affiliation and that would be okay).
So I have a blog, and the word "View" in the blog's title was chosen very deliberately. But I find it hard to be overly political. I manage, I have my moments, most of you know how I lean, but I often find myself slipping into a passive voice that simply presents material without judging it, "Here's an article on x, y, and z for you to read" and I've tried to stick, mostly but not exclusively to economics (You have no idea how many times I've wanted to post on some stupid politician, etc.). I think about this distinction a lot and even thought about creating positive and normative tags for posts, but I would debate myself endlessly trying to figure out if I could actually tag something as positive analysis, and if I did, someone would object.
I'm not sure what the purpose of this post is other than to talk about an issue that's bothered me since I started doing this. I want to give my opinion, just go off when things bug me, but when I do it feels unprofessional so it's been fairly tempered (not always). I think the purpose is twofold. First, to acknowledge this is not an attempt to do purely positive analysis as I would in my research, this is also normative, and I am not going to be particularly careful day to day to try and separate the two. Somehow saying that makes it easier to do. But, economics will always trump politics. Second, to raise the issue of whether the positive/normative distinction remains as important to the profession as it once was, or have these lines become blurred both in academics and in government positions such as economists working for the Council of Economic advisors? Is it a mistake for economists to engage in normative debates? Does it undermine our ability to make positive analyses and arguments to the public and to policymakers? I worry that it does.
Finally, in the value free tradition, I do not mean to judge any other econ blogger, not in the least. In fact, I would be pretty disappointed if you didn't give your opinions. That's the best part.
Update: The liberal bias police are active:
Teacher accused of giving 'liberal' quiz, CNN: A high school teacher is facing questions from administrators after giving a vocabulary quiz that included digs at President Bush and the extreme right. ... One example: "I wish Bush would be (coherent, eschewed) for once during a speech, but there are theories that his everyday diction charms the below-average mind, hence insuring him Republican votes." "Coherent" is the right answer. ... School Superintendent Wesley Knapp said he was taking the situation seriously. "It's absolutely unacceptable," Knapp said. "They (teachers) don't have a license to hold forth on a particular standpoint." Chenkin, 36, a teacher for seven years, said he isn't shy about sharing his liberal views with students as a way of prompting debate, but said the quizzes are being taken out of context. "The kids know it's hyperbolic, so-to-speak," he said. "They know it's tongue in cheek." But he said he would change his teaching methods if some are concerned. "I'll put in both sides," he said. "Especially if it's going to cause a lot of grief." ...
If he also includes digs at the left, does that make it okay?
November 27, 2005
French Fried Socialist Centralized Liberal Communist Progressive Health Care
The monsters who eat escargot, by Jonathan Chait, LA Times: One of the iron laws of U.S. history is that there always has to be a foreign boogeyman that conservatives can hold up to demonstrate the dangers of domestic liberalism. When progressive Californians tried to implement a sweeping healthcare reform in 1917, a conservative group attacked it as "a dangerous device invented in Germany announced by the German emperor from the throne the same year he started plotting and preparing to conquer the world." First you're offering universal health insurance, and next thing you know you're invading France.
For many decades thereafter, the Soviet Union served admirably as foreign boogeyman, serving to warn us of the dangers of anything from Social Security to progressive taxation. Since the Cold War ended, this role has fallen upon Western Europe in general and France in particular. For a few years now, conservatives have been throwing Europe's slow economic growth in the face of American liberals. The recent riots in Paris have naturally offered them an irresistible opportunity. The Cato Institute's Michael Tanner recently articulated this taunt in the conservative Washington Times. "There are important lessons for U.S. policymakers" from the riots, he wrote. "American liberals often look fondly to the European welfare state as a model for U.S. social policy." First you're opposing President Bush's plan to privatize Social Security, and next thing you know you're invading Fran … er, I meant to say, you are France.
The funny thing is that when Europe is doing well, conservatives tend to uphold it as a vindication of their own policies. Fifteen years ago, Germany was an economic powerhouse, and righties routinely claimed this was because of its low capital gains taxes. (After the 1990 upper-bracket tax hike, a National Review editorial sulked: "The dollar has sunk to new lows against the German mark…. It seems that capital is flowing out of the United States to nations where 'from each according to his ability, to each according to his need' has lost its allure.") And when Russia imposed a flat tax, conservatives responded in the rapturous tones of a 1930s fellow traveler recounting Stalin's worker's paradise. Heritage Foundation scholar and flat-tax buff Daniel Mitchell wrote, "Russia's flat tax already beats America's punitive redistribution- oriented tax code hands down." Conservative columnist Deroy Murdock noted how "ex-Communist states confidently reject progressive taxation" and lamented, "Too bad this isn't Russia." Need I point out that Russia is a bleak hellhole of corruption, decay and political repression, and a far less pleasant place to live than France?
Instead of just ridiculing the conservative argument, let's take it seriously for a moment. Near as I can tell, they seem to be saying this: Liberals want bigger government. Europe has bigger government. Bad things are happening to Europe. Q.E.D.
Do conservatives have even a germ of a point here? No. It's true that liberals admire some things that Europe does, and it's also true that Europe has some highly destructive policies. But there's almost no overlap between the two. By almost all accounts, the single most damaging aspect of European and French policy is the absurdly restrictive rules on firing employees, which discourage businesses from hiring anybody and result in high unemployment. I've never, ever heard an American liberal call for emulating French labor regulations. You do, on the other hand, hear liberals praising France's effective public transportation and, above all, its healthcare system. Tanner's column doesn't try to cite France's advanced rapid transit as a cause of social decay, but it does mention its "universal national healthcare system."
This is particularly laughable. France's healthcare system does cover everybody, has far more doctors per capita than the U.S. and produces better health outcomes. Is this lavish socialist system bankrupting the country? Far from it. France spends about 10% of its national income on healthcare, as opposed to 15% in the U.S. In fact, we're the country being bankrupted by its healthcare system, which is by far the most market-intensive in the advanced world. Skyrocketing healthcare costs are discouraging job growth and strangling the automobile industry, among others.
Maybe we should address that problem, and maybe we shouldn't. (I subscribe to the former view.) Either way, we shouldn't be held back by the fear that reform will lead to marauding Islamic youth taking over our streets.
Help Wanted: Academic Economists, Pro-Bush
Who Ya Gonna Call?
Discover Dialogue: Geophysicist Didier Sornette, The Dauphin of Disasters, by Jocelyn Selim, Discover: Didier Sornette is a professor of geophysics at UCLA ... He uses complexity theory to study the myriad causes and effects of catastrophic events, ranging from earthquakes to stock market crashes.
Is there a simple way to explain complexity theory? S: It's an attempt to understand the organization of all the stuff of interest around us, from galaxies down to bacteria, by understanding the interplay between the positive and negative feedbacks of the various interacting elements. Negative feedback is often obvious—if there are too many rabbits, they eat all the grass, and the population goes down. Positive feedback is much less well appreciated and understood. For example, the more fax machines there are, the more attractive they become because you have more people sharing and extending information. ... We use empirical observation. ... [to develop] a complex system ... reflecting the interplay of positive and negative feedbacks ...
How can you extend that thinking to human behavior? S: Systems influenced by behavior, like the stock market, are surprisingly simpler to predict because we have an extraordinarily large base of ... very good quality data. We now know, for example, that if people believe in incorrect things, they can influence events. If everybody believes that the stock market is going to go up, the stock market will go up ..., even if this is completely wrong on the basis of fundamental analysis ...
Is that how bubbles happen? S: When prices skyrocket above a reasonable bracket, they become unstable because eventually they must return to a reasonable level. So ... a crash ... is not due to a specific event; it's the result of an instability that has matured over months or years. Think of putting a pen on your finger vertically. You may be able to hold it for a while, but it is a very unstable situation. ... [T]he fundamental explanation is that the pen was put in an unstable situation.
Should we use government intervention to stabilize the market? S: I'll quote Alan Greenspan. In the aftermath of the burst of the new economy bubble in 2000 he said, "We probably should have not done anything because the result of our action would probably have been worse than the result of the bubble and the crash itself." Investors watch Greenspan a lot, right, and if he's calling for a correction, confidence can be lost. ... [T]hat's the big problem that any policymaker has to take into account—to discount how people will act.
So it's better to just let things be? S: From a scientific point of view, it's an extremely interesting problem. It illustrates the interplay effect of positive and negative feedbacks. Southern California and Baja California in Mexico have nearly identical terrains and climate. In Southern California you have no small fires because the policy is to extinguish them immediately. But once in a while you have a huge, devastating, unstoppable fire. That doesn't happen in Mexico because little fires are allowed to burn corridors of biomass and thus develop the negative feedback of natural barriers. ...
Is it too late to put my money into real estate? S: Stocks and real estate often operate on the "greater fool" theory. Suppose I buy a house that is very expensive, even though real estate prices are way up. I still buy it because I think I will be able to sell it later to a greater fool. It is based on this positive feedback of the appreciation of the price attracting speculators. ... A crash is dependent on the health of the economy as a whole and in the confidence of spenders.
Are we in a real estate bubble right now? S: Yes. Sometime in the first semester of 2006 (and already in the second semester of 2005 in some states), we expect the bubble to transition to another regime. It might be a crash; it might be a plateau. But according to our analysis, the bubble will not continue beyond that.
How do I know you're right? S: Well, in 2003, ... in the United Kingdom, ... we correctly predicted the end of the bubble there, around the summer of 2004. But this is only one success, which . . . could be luck. In science, ... one success doesn't prove anything. But as scientists we need to stick our necks out a bit; otherwise we lose accountability. ...
What do you think of gloom-and-doom predictions for the U.S. economy? S: These statements are really based ... on overinterpreting a very complex system using unscientific methods. ...[T]he United States ... is a very special player, eh? It has the dollar, which is the world's currency. It has the army of the world; ... So it has a lot of things that are a positive leverage to its clear overspending. Is it sustainable? I don't believe it is. But the correction won't necessarily be a crash.
What else can you analyze with complexity theory? S: We looked at the thousands of books and all the sales figures and the rankings on Amazon, and we were able to discover that book sales can take off for two reasons. A good review, like one on Oprah, can trigger an avalanche of sales. Or you can have a slow, steady word-of-mouth effect, like the one for Divine Secrets of the Ya-Ya Sisterhood ... We made a model taking into account both phenomena. We have been able to discover a ... universal law ... It appears to be universal with respect to describing social interactions. It's really a description of the peaks and the decay of fame. ...
"It might be a crash, it might be a plateau." There's a heck of a prediction. What specificity. And it might happen, oh, I don't know, "Sometime in the first semester of 2006." Turning points are a lot easier to forecast if you can put them in a large interval of time. He almost has network externalities nailed (the thing he says is not well understood - by him - at the beginning), hints at an understanding of a vehicle currency, seems to have some notion of self-fulfilling expectations, and if you read closely, you can see him trying to discover the Lucas critique. If he does, then he can build a theoretical model as opposed to a model that only predicts transitions to new states (telling us little about structural relationships) and maybe he can start catching up to, say, the mid 1970s. At that point, he might be able to say more about why bubbles happen than "the pen was put in an unstable situation." Economists know all about complexity theory. There's a reason (many actually) we don't use it.
When Discover magazine has questions about geophysics, perhaps about the difficult problem of decomposing fluctuations in land elevation over time near coastal subduction zones into trend, seasonal, and cycle components to measure trend plate stresses for use in assessing earthquake probabilities, will they call a time-series econometrician? Perhaps they should.
November 26, 2005
Education, Income, and Good Job Growth
California's going to get a shocking education, by Patrick M. Callan, Commentary, LA Times: ...If current education policies continue unchanged, the California workforce of 2020 is going to be less educated than today's, according to a recent report ... and the state's per-capita income will drop more substantially than elsewhere in the country. The transformation will occur as baby boomers, the most highly educated generation in U.S. history, retire. Across the country they will be replaced by a growing population of young workers from the nation's least-educated minority groups. The share of the workforce that is college educated will shrink accordingly, losing the U.S. much of its advantage in the global marketplace. The problem is national, but in California it will be particularly severe. ... The Latino population, by far the least educated of any of the state's large minority groups, is expanding dramatically. By 2020, Latinos will make up as large a share of the state's working-age population ... as whites... This is a seismic shift; in 1990, only 22% of working-age adults were Latino and 61% were white. ... [T]he state is making only limited progress with its current students. ... the gaps between young Latinos ... and young whites, blacks and Asian Americans remain large. To some extent, the problem may be one of inadequate preparation in California's schools. ... But preparation is not the whole story. The expense of higher education can also be prohibitive. California provides more low-cost college options than most states and has recently increased ... need-based financial aid. But for the poorest 40% of California families, the cost each year of sending a child to community college still amounts to more than a third of the average family income. The cost of sending a child to a public four-year college, even after figuring in financial aid, amounts to nearly half of such a family's income. If California does nothing more to raise the education level of its residents, and particularly of its largest, fastest-growing and least-educated minority group, it can expect to lose economic ground against the world and other states. ...
Next, here's more from the St. Louis Fed:
Employment Growth in America What Determines Good Jobs?
Employment growth is one of the most fundamental aspects of a strong economy. Yet not all jobs are created equal. Some pay generously and offer desirable working conditions, while others do not. A study by Federal Reserve Bank of St. Louis economist Christopher H. Wheeler examined the growth of high-paying (“good”) and low-paying (“bad”) jobs across a sample of 206 metropolitan areas in the United States. This study suggests that ... [c]ities that experience rapid growth in high-wage employment also tend to see increasing incomes throughout the entire labor market, not just among those who happen to hold high-paying jobs...
Does Education Matter? One of the fundamental sources of good job growth is an educated labor force. Within the past three decades, the demand for highly educated workers has grown dramatically in the United States. In 1980, the average proportion of workers across 200 industries with some education at the college level was 32 percent. By 2000, it had risen to 51 percent. In fact, no industry saw its proportion of college-educated workers decrease over this period. At the same time, high-paying jobs also tend to have a particularly strong demand for college-educated workers. Among the top 25 percent of jobs in the sample, the average proportion of workers with a bachelor’s degree rose from 18 percent in 1980 to 36 percent in 2000. There is also a strong positive association between an industry’s average hourly rate of pay and the fraction of its workers with a bachelor’s degree. ... Why is the general level of education so important? ... Not only is education associated with higher earnings for individuals, but as the general level of education within a city rises, the average labor earnings of all workers tend to rise. An additional benefit of a more-educated work force concerns the potential for future job growth. The level of education among a city’s population is strongly associated with subsequent rates of growth among high-paying sectors. ... [C]ities with more-educated populations tend to see the ratio of good to bad jobs increase over time...
Here are the top 5 and bottom 5 industries identified in the article:
Jobs in the U.S.: Average Hourly Pay and Total Employment
Average Hourly Wage ($)
|2||Security, Commodity Brokerage and Investment Companies||36.26||991,548|
|3||Business Management and Consulting Services||32.83||825,480|
|5||Computer and Data Processing Services||29.70||1,385,009|
|194||Gasoline Service Stations||12.52||392,666|
|195||Eating and Drinking Places||12.06||5,151,237|
|196||Bowling Alleys, Billiard and Pool Parlors||12.02||49,759|
This article was adapted from “Employment Growth in America” ... by Christopher H. Wheeler ... published ... in July 2005.
Here's a link to the July 2005 paper. It has quite a bit more information on the topic of growth in good/bad jobs for those who want to follow up.
Revived Bretton Woods System: A New Paradigm for Asian Development?
At the center of this symposium was a presentation by Michael Dooley (UC Santa Cruz and Deutschebank) and Peter Garber (Deutschebank) based on their papers with David Folkerts-Landau (2003a, b, 2004). ... on the current international exchange rate system, the sustainability of global trade imbalances, and the implications for development by emerging markets, such as China. Other participants presented papers that questioned ... the extent to which those arguments account for current developments. [The papers listed at the end are available here].
A revival of Bretton Woods?
Dooley, Folkerts-Landau, and Garber (DFG 2003b) argue that the current international exchange rate system operates much like the Bretton Woods system of fixed exchange rates that prevailed for nearly a quarter of a century, from the end of World War II until the early 1970s. Under Bretton Woods, foreign currencies were pegged to the dollar at fixed parities, and the dollar was pegged to gold at $35 an ounce. The system was abandoned when foreign governments perceived that guarantees of currency conversion at fixed rates were no longer credible.
Although the current international exchange rate regime carries no guarantees of fixed parities in terms of gold or the dollar, DFG argue that many countries, particularly those in Asia, do limit exchange rate fluctuations against the dollar to varying degrees. For example, Japan often has conducted foreign exchange intervention—selling yen for dollars, which pushes the yen down against the dollar—in order to maintain its export competitiveness. As a result, Japan has been a net accumulator of dollar-denominated assets; indeed, it ranks first among official reserve holders of U.S. Treasury securities.
China's policy of keeping exchange rates low relative to the dollar is also related to a desire to boost exports. In addition, according to DFG, China has also been motivated by a desire to attract foreign direct investment by multinational firms as well as the technical expertise that usually comes with it. As a result, China also has been a net accumulator of dollar-denominated assets and is second only to Japan among official reserve holders of U.S. Treasury securities.
This result is surprising, however. Given that China is a rapidly growing developing country, one might expect it to be a net international borrower, as capital presumably enjoys a higher rate of return there than in the U.S. Naturally, this question also arises with other developing economies that may peg their exchange rates to varying degrees to the dollar. Whether this issue is a valid point or not, DFG (2004) have an answer. They argue that developing nations like China need to accumulate U.S. Treasury securities, because they provide a form of "collateral" against concerns about possible future expropriation of the assets of U.S. foreign direct investors.
This argument has implications for the U.S. trade deficit. The exchange rate policies discussed have been accompanied by large trade surpluses in most Asian countries vis—vis the U.S., as well as by a corresponding need by the U.S. to borrow to finance its purchases of net imports. This implies that, insofar as developing countries like China continue to accumulate these U.S. assets, the U.S. will see ongoing trade deficits.
Perhaps the biggest question facing DFG's world view is whether the current system is sustainable as the U.S. current account deficit continues to grow. DFG (2003a) argue that the system is sustainable in the near term (though their estimates of what the "near term" is varies from three to ten years or more) as long as Asian countries are willing to finance the growing U.S. current account deficit by purchasing additional U.S. securities.
Does China fit the story?
Several symposium participants questioned the merits and viability of a strategy of deliberate currency undervaluation by developing countries, particularly in the case of China.
For example, Nicholas Lardy (Institute of International Economics), in his paper with Morris Goldstein, pointed out that more than half of China's exports go to markets other than the U.S. or to countries with currencies not pegged to the dollar. Thus, a strategy of undervaluation by China to boost its exports should depend not just on the renminbi's exchange rate against the dollar but also on its effective rate against the currencies of all of its trading partners. In fact, between 1994 and 2001 the renminbi's real trade-weighted exchange rate (adjusted for inflation differences across countries) appreciated by 30% before falling by 13% since 2001. Lardy also disagreed with DFG's argument that the undervaluation contributed significantly to increasing foreign direct investment in China and the growth of China's capital stock. In his view, this argument ignores the fact that foreign direct investment in China has financed less than 5% of fixed asset investment over the past few years.
Barry Eichengreen (University of California at Berkeley) dismissed the purported role of U.S. assets as collateral that justify U.S. multinational firms' decisions to invest in China. For one thing, he argues that the timing is wrong: rising U.S. foreign direct investment in China began around 1992, whereas China's massive reserve accumulation came a decade later. In addition, he doubts that political conditions would support U.S. expropriation of Chinese claims, invalidating the collateral role these claims are purported to play. Finally, he points out that in recent years the U.S. has accounted for less than 10% of China's inward foreign direct investment.
Steven Kamin (Board of Governors) agreed with DFG that the authorities in developing economies other than China have been acting to maintain the competitiveness of their exports by limiting currency appreciation. However, he argues that the recent large current account surpluses in the region mainly reflect the special, ongoing effects of a decline in investment and domestic demand following the Asian financial crisis of 1997-1998. He attributes this fall in investment to factors such as the presence of considerable excess capacity after the crisis and the near collapse of domestic banking systems in the region. To be sure, immediately after the Asian financial crisis, the desire to rebuild foreign exchange reserves was another reason that authorities in the region intervened in foreign exchange markets to acquire dollar assets, but this motive has diminished in importance as reserves have grown. He believes that, over time, Asian investment spending will revive, that the authorities will be more comfortable in allowing their currencies to strengthen, and that their trade surpluses will narrow.
Will the system last?
Barry Eichengreen and Ted Truman (Institute of International Economics) argue that DFG make a false analogy between the current international foreign exchange system and Bretton Woods. In particular, they argue that the U.S. is now no longer a net saver with current account surpluses, as it was in the years immediately after World War II. In addition, domestic financial systems are more liberalized, capital accounts are more open, and exchange rates are more flexible, for both industrial and emerging market economies. These differences make it harder to sustain undervalued exchange rates indefinitely.
Nouriel Roubini (New York University) and Brad Setser (Roubini Global International) also questioned the sustainability of efforts to limit dollar appreciation, arguing that the scale of the financing required is increasing faster than the willingness of the world's central banks to build up their dollar reserves. In addition, the enormous reserve growth in these countries has become increasingly harder to sterilize fully, particularly in China, where the resulting increase in the money supply is fueling a lending boom and an asset-price bubble. Lardy and Roubini both suggest an earlier rather than a later end of China's peg to the dollar. Eichengreen argues that China has good reason to abandon its peg soon, while confidence is strong, capital is still flowing in, and reserves are still being accumulated.
DFG suggest that because the euro area has borne a large and disproportionate share of the adjustment of the U.S. trade imbalance, the European Central Bank will be compelled to engage in large-scale currency intervention to resist further euro appreciation. However, Roubini and Setser and Truman all argue that the European Central Bank is unlikely to do so, in part because of its conviction that the recent massive Japanese intervention had limited effectiveness. The implication is that there will be continuing downward pressure on the dollar against floating currencies until the overall adjustment is consistent with a lower U.S. current account deficit.
Might global imbalances spark a sharp decline in the dollar? Maurice Obstfeld (University of California at Berkeley) discusses the likelihood that the U.S. might face an emerging markets-style "sudden stop" crisis. In his work with Kenneth Rogoff, he questions the sustainability of U.S. current account imbalances, and suggests that a large depreciation of the dollar is indeed very likely.
Ron McKinnon (Stanford University) agrees with DFG that it is in China's interest to maintain a dollar peg, but his argument is different. He argues that a stable exchange rate is an important way for China to anchor low inflation expectations. Accordingly, he provides three arguments for why it is not a good idea for China to allow the renminbi to appreciate. First, an appreciation of the renminbi would not necessarily improve the U.S. trade balance; for example, it could lead to reduced world demand for China's exports, thus slowing China's economic growth, which, in turn, could lead to significant declines in Chinese demand for U.S. products. Second, it may create deflationary pressure in China. Third, it would encourage more speculative capital inflows.
One way to assess the arguments of DFG and their critics may be to examine the implications of the revaluation of the Chinese renminbi in July 2005, five months after the symposium took place. On one hand, it is clear that the Chinese have adjusted their currency by revaluing against the dollar and announced that they would move towards more flexibility in the future. These developments would seem to portend changes that conflict with the DFG vision of Asian countries' ongoing willingness to finance ever-increasing U.S. deficits in the interest of maintaining their trade balance surpluses.
On the other hand, it must be acknowledged that DFG's first works on this subject were published in 2003, and the imminent sharp adjustment in the dollar that was predicted by many has yet to take place. Indeed, so far, the renminbi has adjusted by less than 3%. As such, the DFG framework has already lasted for a notably long duration in today's volatile international financial markets.
- Eichengreen, Barry. "Global Imbalances and the Lessons of Bretton Woods"
- Goldstein, Morris, and Nicholas R. Lardy. "China's Role in the Revived Bretton Woods System: A Case of Mistaken Identity."
- Kamin, Steven. "The Revived Bretton Woods System: Does It Explain Developments in Non-China Developing Asia?"
- McKinnon, Ronald. "Exchange Rates, Wages, and International Adjustment: Japan and China versus the United States."
- Obstfeld, Maurice, and Kenneth Rogoff. "The Unsustainable U.S. Current Account Position Revisited."
- Roubini, Nouriel, and Brad Setser. "Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006."
- Truman, Edwin. "The U.S. Current Account Deficit and the Euro Area."
November 25, 2005
The Old Deal is Broken
Costs can be reduced by enhancing labor's productivity through training, better equipment and tools, and so on. Costs can also be reduced by replacing people with machines. Yet another way to reduce costs is to pay labor less. All of these strategies have been pursued by businesses in recent years, both through adjustment of existing businesses and through location decisions, but I want to focus on the pay labor less option.
Labor compensation can be reduced by limiting or eliminating benefits. Firms often put forth a stark choice in this regard: Either agree to give up benefits or we will go bankrupt and you won't have a job at all. Other countries don't face these costs and if we are to compete we must shed them as well. What's a worker to do?
The problem is that the old deal is broken. Firms no longer feel, due to the pressures of international competition, a long-run obligation to their workers. And even if they do, competition makes such obligations difficult to fulfill. They need flexibility, the ability to expand and contract quickly and efficiently, to relocate, to retool, to change prices, and so on, to meet the competitive challenges they face.
In this world of increasing flexibility, workers as opposed to jobs need protection. If workers are expected to flexibly change employment, they need health care that travels with them from job to job. If they are expected to show flexibility and relocate as necessary, workers need institutions that support and ease such transitions. We can be flexible and still be decent to those who are affected.
Flexibility is a safe increase in volatility. An employee who comes to work every day and works hard to support a family, a model employee perhaps, can suddenly be left jobless as a company pursues the flexibility to adapt to changing conditions. The worker has done nothing wrong but choose the wrong job or the wrong major in college.
That worker, not the worker's job, needs protection from the risk brought about by enhanced flexibility and there are questions as to whether the private sector can provide efficient levels of insurance to workers against these risks. In addition to the efficiency question, there may not be a private insurance carrier large enough to assume the sheer magnitude of risk that would be required. The Great Depression was like a hurricane hitting the entire economy and the ability of private insurance carriers to withstand such a large shock is questionable.
The efficiency question has been widely discussed and adverse selection and moral hazard problems, as usual in insurance markets, are the barriers to efficient provision of insurance against economic risk. Government regulation and intervention into the markets is a solution to this problem. In addition, the federal government is perhaps the only carrier capable of assuming such a large magnitude of risk.
Workers need unemployment compensation, they need health care that follows them from job to job, they need support for moving to find new jobs, they need support for retraining, they need to know their children are safe if both parents work, that their children can still attend college if their parents are unemployed, this type of support will also make workers more flexible and aid in the ability of the economy to respond quickly and efficiently to changing economic conditions.
As the long-term mutual obligations between workers and firms break down under the pressures of globalization, it's time to think about protecting workers and their families in a different and better way than we have in the past. Capitalism is a societal choice to organize ourselves in a way that efficiently provides goods and services. Because of that, the economic risks associated with the economic system we choose are a societal obligation as well. For capitalism to work well, it needs as much flexibility as possible from all sides, but workers need protection from the risks that capitalism thrusts upon them.
We can start down this path by rethinking how we provide health care. The current system is not functioning for either side. Workers are not receiving the care they need, I don't think there is much doubt about that, and we have to also acknowledge that firms are increasingly burdened and disadvantaged in the international marketplace by health insurance costs.
For those worried about flexibility, it is not obvious that such steps make workers or the economy less flexible. Worker's job choices can be distorted by health care considerations both in the jobs they choose and in how long they stay. Have you ever heard people talk about working for the government or a large business because of health coverage considerations, or hold onto a job they hate just to keep health care? That's not efficient.
We can do better, but we must be willing to admit that the existing system isn't working, and be willing to consider the full range of solutions, including a national health care system. The old deal is broken and its time for a new and better deal to take its place.
Paul Krugman: Bad for the Country
Bad for the Country, by Paul Krugman, NY Times: "What was good for our country," a former president of General Motors once declared, "was good for General Motors, and vice versa." G.M. ... has announced that it will eliminate 30,000 jobs. Is what's bad for General Motors bad for America? In this case, yes. ... I won't defend the many bad decisions of G.M.'s management, or every demand made by the United Automobile Workers. But job losses at General Motors are part of the broader weakness of U.S. manufacturing, especially ... manufacturing that offers workers decent wages and benefits. And some of that weakness reflects two big distortions in our economy: a dysfunctional health care system and an unsustainable trade deficit. ...
[L]ast year General Motors spent $1,500 per vehicle on health care. By contrast, Toyota spent only $201 per vehicle in North America, and $97 in Japan. If the United States had national health insurance, G.M. would be in much better shape ... Wouldn't taxpayer-financed health insurance amount to a subsidy to the auto industry? Not really. ...[T]ying health insurance to employment distorts the economy: it systematically discourages the creation of good jobs, the type of jobs that come with good benefits. And somebody ends up paying for health care anyway. ... either ... taxpayers or ...those with insurance. Moreover, G.M.'s health care costs are so high in part because of the inefficiency of America's fragmented health care system. We spend far more per person on medical care than countries with national health insurance, while getting worse results.
About the trade deficit: ... The flip side of the trade deficit is a reorientation of our economy away from ... manufacturing, to industries that are insulated from foreign competition, such as housing. ... The trade deficit isn't sustainable. ... [O]ne of these days the easy credit will come to an end, and the United States will have to start paying its way in the world economy. To do that, we'll have to reorient our economy back toward producing things we can export or use to replace imports. And that will mean pulling a lot of workers back into manufacturing. So the rapid downsizing of manufacturing since 2000 ... amounts to dismantling a sector we'll just have to rebuild a few years from now.
I don't want to attribute all of G.M.'s problems to our distorted economy. One of the plants G.M. plans to close is in Canada, which has national health insurance and ran a trade surplus last year. But the distortions in our economy clearly make G.M.'s problems worse. ... G.M.'s woes are yet another reminder of the urgent need to fix our health care system. It's long past time to move to a national system that would reduce cost, diminish the burden on employers who try to do the right thing and relieve working American families from the fear of lost coverage. Fixing health care would be good for General Motors, and good for the country.
Fed Watch: Changing the Course?
Nothing like the Fed minutes to liven up the debate! The minutes generated a buzz among bloggers as well as the financial community, with stocks and bonds gaining on news that the Fed may be looking at a pause in the near future. Is this the correct interpretation? Is this one of the little shifts in sentiment that I am looking for? Very possibly the first salvo in the inevitable move toward changing the statement and policy – but I think the Fed still sees plenty of reason to keep raising rates into next year.
The market moving section of the minutes was:
In that context, all members believed it important to continue removing monetary policy accommodation in order to check upside risks to inflation and keep inflation expectations contained, but noted that policy setting would need to be increasingly sensitive to incoming economic data. Some members cautioned that risks of going too far with the tightening process could also eventually emerge…
…Several aspects of the statement language would have to be changed before long, particularly those related to the characterization of and outlook for policy…Participants noted that any forward-looking elements of the statement should clearly be conditioned on the outlook for inflation and economic growth.
The Fed believes in fostering a healthy relationship with markets, which in practice translates into providing clear signals about the path of policy. At the same time, policymakers do not like to be roped into a policy path. And I believe the latter is the current concern on Constitution Ave. When the Fed Funds rate was 1%, there was little question about the path of policy. As long as inflation remained tame, the Fed could remove policy in 25bp increments and rest easy with the markets convinced that they would follow that path. But now that rates have been mostly “normalized” in the neutral range, the fact of the matter is that policy is no longer so straightforward.
Instead, policy is increasingly data dependent. Recognizing this, a growing number of Fed officials believe they need more flexibility – ability to shift without surprising financial markets – to react to incoming data.
The problem is trying to achieve that flexibility. Leaving the language as it is implies the path is set for the next meeting. But changing the message apparently means that the path is set as well – to a pause in the cycle. Market participants might take that to mean not just pause, but done raising rates entirely. Consequently, the attempt to increase flexibility could trigger reduced flexibility in the opposite direction. Something of a conundrum and one that I believe has been a persistent problem with the statement over time.
A problem that is not without a solution, of course. Policymakers could clarify their intentions with Fedspeak. And indeed they have – Mark Thoma reports that Fedspeak remains convincingly hawkish. This suggests that policymakers want to regain flexibility, not necessarily signal a pause in rates is imminent.
Moreover, the staff’s expectation is that the impact of higher energy prices on core inflation fades, this does not necessarily argue for a pause. Why? Because the outlook for growth holds strong. Notably, look at the staff’s forecast (italics mine):
Output growth was expected to pick up in 2006, as the boost from hurricane-related rebuilding activity more than offset the effects of somewhat tighter financial conditions, and then slow in 2007, as the impetus from rebuilding waned.
Growth is expected to accelerate – but Chicago Fed President Michael Moskow claims growth is already above potential and excess slack in the economy has been largely eliminated. Slowing in 2007 is not much comfort to someone worrying about inflationary pressures now. So I don’t sense that he is going to be arguing for a pause in the near future.
Also notice that despite 300bp of tightening, financial conditions are only “somewhat tighter.” This reflects the fact that Fed tightening to date appears to have had minimal impact on the long end of the yield curve. This lack of pass through is likely the reason for the staff’s optimistic outlook despite a long series of rates hikes. If markets take a pause to mean that hikes are over and start looking for a rate cut, financial conditions could loosen back up in a period of what staff expects to be accelerating activity. This appears to be counterproductive given the Fed’s inflation worries.
In short, I think you can focus on the expected “pickup in growth side” or the “risk of going too far” side of the minutes. I will stick to the midpoint of these interpretations: The Fed is increasingly worried that policy is being taken for granted. They want more flexibility in policy, more recognition that incoming data is increasingly important, they need to communicate the possibility of change while sticking to the current path, and convey that a pause does not necessarily mean the tightening cycle is over. Looks like a big communication challenge ahead.
Overall, I am not surprised that officials are ready to revisit their message – but we are still looking for the data and Fedspeak to tell us that more flexibility means a pause. [All Fed Watch posts.]
November 24, 2005
Thanksgiving Day - Nov. 24, 2005
What many regard as the nation’s first Thanksgiving took place in December 1621 as the religious separatist Pilgrims held a three-day feast to celebrate a bountiful harvest. The day did not become a national holiday until 1863 when President Abraham Lincoln proclaimed the last Thursday of November as a national day of thanksgiving. Later, President Franklin Roosevelt clarified that Thanksgiving should always be celebrated on the fourth Thursday of the month to encourage earlier holiday shopping, never on the occasional fifth Thursday.
256 million The preliminary estimate of the number of turkeys raised in the United States in 2005. That’s down 3 percent from 2004. The turkeys produced in 2004 weighed 7.3 billion pounds altogether and were valued at $3.1 billion.
Weighing in With a Menu of Culinary Delight
44.5 million The preliminary estimate of the number of turkeys Minnesota expects to raise in 2005. The Gopher State is tops in turkey production. It is followed by North Carolina (36.0 million), Arkansas (29.0 million), Virginia (21.0 million), Missouri (20.5 million) and California (15.1 million). These six states together will probably account for about 65 percent of U. S. turkeys produced in 2005. 649 million pounds The forecast for U.S. cranberry production in 2005, up 5 percent from 2004. Wisconsin is expected to lead all states in the production of cranberries, with 367 million pounds, followed by Massachusetts (170 million). Oregon, New Jersey and Washington are also expected to have substantial production, ranging from 18 million to 52 million pounds.
1.6 billion pounds The total weight of sweet potatoes — another popular Thanksgiving side dish — produced in the United States in 2004. North Carolina (688 million pounds) produced more sweet potatoes than any other state. It was followed by California (339 million pounds). Mississippi and Louisiana also produced large amounts: at least 200 million pounds each.
998 million pounds Total pumpkin production of major pumpkin-producing states in 2004. Illinois, with a production of 457 million pounds, led the country. Pumpkin patches in California, Ohio, Michigan, Pennsylvania and New York also produced a lot of pumpkins: each state produced at least 70 million pounds worth. The value of all the pumpkins produced by these states was about $100 million.
2.1 billion bushels The total volume of wheat — the essential ingredient of bread, rolls and pies — produced in the United States in 2005. Kansas and North Dakota — combined — accounted for about 33 percent of the nation’s wheat production.
$5.2 million The value of U.S. imports of live turkeys during the first half of 2005 — all from Canada. Our northern neighbors also accounted for all of the cranberries the United States imported ($2.2 million). When it comes to sweet potatoes, however, the Dominican Republic was the source of most ($2.3 million) of total imports ($2.6 million). The United States ran a $1.7 million trade deficit in live turkeys over the period, but surpluses of $3.5 million in cranberries and $10.6 million in sweet potatoes.
13.7 pounds The quantity of turkey consumed by the typical American in 2003 and, if tradition be true, a hearty helping of it was devoured at Thanksgiving time. On the other hand, per capita sweet potato consumption was 4.7 pounds.
The Turkey Industry
$3.6 billion The value of turkeys shipped by the nation’s poultry processors in 2002. Those located in Arkansas led the way with $581.5 million in shipments, followed by processors in Virginia ($544.2 million) and North Carolina ($453.0 million). Businesses that primarily processed turkeys operated out of 35 establishments, employing about 17,000 people.
The Price is Right
$1.00 Cost per pound of a frozen whole turkey in December 2004.
Where to Feast
3 Number of places in the United States named after the holiday’s traditional main course. Turkey, Texas, was the most populous in 2004, with 496 residents; followed by Turkey Creek, La. (357); and Turkey, N.C. (267). There also are 16 townships around the country named “Turkey,” three in Kansas.
8 Number of places and townships in the United States that are named “Cranberry” or some spelling variation of the name we call the red, acidic berry (e.g., Cranbury, N.J.), a popular side dish at Thanksgiving.
20 Number of places in the United States named Plymouth, as in “Plymouth Rock,” legendary location of the first Thanksgiving. Plymouth, Minn., is the most populous, with 69,797 residents in 2004; Plymouth, Mass., had 54,604. Speaking of Plymouth Rock, there is just one township in the United States named “Pilgrim.” Located in Dade County, Mo., its population was 135.
107 million Number of occupied housing units across the nation — all potential gathering places for people to celebrate the holiday.
Finally, thanks to everyone who visits this site. I started writing one day around nine months ago not expecting much. This has exceeded, by a substantial margin, even my wildest expectations and I'm very, very grateful for that (and astounded to be honest). I owe a big thanks to all who visit and to all of the other bloggers who have helped people find Economist's View as they agree or take issue with the things I post. I plan to continue and to do my best to improve the site over time. So whether you comment regularly, occasionally, or not at all, whether you agree with what I say or straighten me out when you don't:
Modes of Producing the First Thanksgiving
They Held Their Noses, and Ate, by James E. McWilliams, Commentary, NY Times: No contemporary American holiday is as deeply steeped in culinary tradition as Thanksgiving. ... [It's] a feast with a narrowly proscribed list of foods - usually some combination of turkey, corn, cranberries, squash and pumpkin pie. Decorated with these dishes, the Thanksgiving table has become a secular altar upon which we worship America's pioneering character, a place to show reverence for the rugged Pilgrims who came to Plymouth in peace, sat with the Indians as equals and indulged in the New World's cornucopia with gusto. But you might call this comfort food for a comfort myth.
The native American food that the Pilgrims supposedly enjoyed would have offended the palate of any self-respecting English colonist ... Our comfort food ... was the bane of the settlers' culinary existence. Understanding this paradox requires acknowledging that there's no evidence to support the holiday's early association with food - much less foods native to North America. ... It wasn't until the mid-19th century that domestic writers began to play down Thanksgiving's religious emphasis and invest the holiday with familiar culinary values. Sarah Josepha Hale and her fellow Martha Stewarts of the day implored families to "sit down together at the feast of fat things" and raise a toast to the Thanksgiving holiday. When Abraham Lincoln declared Thanksgiving a national holiday in 1863, the cornucopia-inspired myth was, as a result of these literary efforts, in full bloom. ... [H]owever, the earthy victuals that Thanksgiving revisionists arranged on the Pilgrims' fictional table were foods that Pilgrims and their descendants would have rather avoided.
The reason is fairly simple. Hale and her fellow writers seem to have forgotten ... their Puritan forebears ... strict notions about food production and preparation. Proper notions of English husbandry generally demanded that flesh be domesticated, grain neatly planted and fruit and vegetables cultivated in gardens and orchards. Given these expectations, English migrants recoiled upon discovering that the native inhabitants hunted their game, grew their grain haphazardly and foraged for fruit and vegetables. ... [T]he English deemed the native manner of acquiring these goods nothing short of barbaric. ... They typically prepared fields by setting fire to the underbrush and girdling surrounding trees. Afterward, they planted corn, gourds and beans willy-nilly across charred ground, possibly throwing in fish as fertilizer. To the Indian women who tended the plants with clamshell hoes, the ecological brilliance of this arrangement was abundantly clear: the cornstalks stretched into sturdy poles for the beans to climb upon, the corn leaves fanned out to provide squash with shade, and the beans enriched the soil with extra nitrogen. But the English, blinded by tradition, never got it - they just looked on in horror. Where were the fences? The neat rows of cross-sectioned grain? The plows? ... The team of oxen? ... Why were perfectly good trees left to rot? ... And those fish! Why not salt them down and export them to Europe for a tidy profit? What was wrong with these people? The collective English answer - "everything" - honed the colonists' distaste for foods, especially corn and squash, that they quickly judged best for farm animals.
A similar culinary misunderstanding developed over meat. To be sure, the English frequently hunted for their meals. But hunting was preferably a sport. When the English farmer chased game to feed his family, he did so with pangs of shame. To resort to the hunt was, after all, indicative of agricultural failure... Thus the colonists reacted with extreme disapproval when they saw Indian men ... disappearing into the woods for weeks at a time to track down protein. Making the scene even more primitive was that the women who stayed behind ... toiling away at odd jobs that the English valiantly considered men's work. The elk, bear, raccoon, possum and indeed the wild turkeys that the men hauled back to the village were, for all these reasons, tainted goods reflective of multiple agricultural perversions.
They were also ... unavoidable. The methods that colonists condemned as agriculturally backwards ... became necessary to their survival. No matter how hard they tried, no matter how carefully they tended their crops and repaired their fences ... and furrowed their fields, colonial Americans failed to replicate European husbandry practices. Geography alone wouldn't allow it. The adaptation of Indian agricultural techniques ... provoked severe cultural insecurity. This insecurity turned to conspicuous dread when the colonists were mocked by their metropolitan cousins as living, in the words of one haughty Englishman, "in a state of ignorance and barbarism, not much superior to those of the native Indians." This hurt. And under the circumstances no status-minded English colonist would have possibly highlighted his adherence to native American victuals ... Indeed, it wasn't until after the Revolution, when the new nation was seeking ways to differentiate itself from the Old World, that these foods became celebrated as a reflection of emerging ideals like simplicity, manifest destiny and rugged individualism. ...
Caroline Baum at Bloomberg also talks about early Thanksgivings:
Give Thanks for Incentives Along With the Feast, by Caroline Baum, Bloomberg: It is the tradition of this column every year at this time to relate the story of Thanksgiving. For source material, I relied on the accounts of William Bradford, governor of the Plymouth Bay Colony beginning in 1621 (Bradford's History ''Of Plimoth Plantation'').
Most Americans think of Thanksgiving as a day off from school or work, a time to gather with friends and family and celebrate with a huge feast. If children know anything about the origins of this national holiday, ... it's that the Pilgrims, grateful for a good harvest in their new land, set aside this day to give thanks. What they and many adults don't know is that conditions weren't always good for the Pilgrims... Their first winters after they landed at Plymouth Rock in 1620 and established the Plymouth Bay Colony were harsh. The weather and crop yields were poor. Half the Pilgrims died or returned to England in the first year. Those who remained went hungry. Despite their deep religious convictions, the Pilgrims took to stealing from one another. ...
One of the traditions the Pilgrims had brought with them from England was a practice known as ''farming in common.'' Everything they produced was put into a common pool; the harvest was rationed among them according to need. They had thought ''that the taking away of property, and bringing in community into a common wealth, would make them happy and flourishing,'' Bradford recounts. They were wrong. ''For this community (so far as it was) was found to breed much confusion and discontent, and retard much imployment that would have been to their benefite and comforte,'' Bradford writes. Young, able-bodied men resented working for others without compensation. They thought it an ''injuestice'' to receive the same allotment of food and clothing as those who didn't pull their weight. What they lacked were proper incentives.
After the Pilgrims had endured near-starvation for three winters, Bradford decided to experiment when it came time to plant in the spring of 1623. He set aside a plot of land for each family, that ''they should set corne every man for his owne perticuler, and in that regard trust to themselves.'' The results were nothing short of miraculous. Bradford writes: ''This had very good success; for it made all hands very industrious, so as much more corne was planted than other waise would have bene by any means the Govr or any other could use, and saved him a great deall of trouble, and gave far better content.'' The women now went willingly into the field, carrying their young children on their backs. Those who previously claimed they were too old or ill to work embraced the idea of private property and enjoyed the fruits of their labor, eventually producing enough to trade their excess corn for furs and other desired commodities.
Given appropriate incentives, the Pilgrims produced and enjoyed a bountiful harvest in the fall of 1623 and set aside ''a day of thanksgiving'' to thank God for their good fortune. ''Any generall wante or famine hath not been amongst them since to this day,'' Bradford writes in an entry from 1647, the last year covered by his History. With the benefit of hindsight, we know that the Pilgrims' good fortune was not a matter of luck. In 1623, they were responding to the same incentives that, almost four centuries later, have come to be regarded as necessary for a free and prosperous society.
Interesting contrast in views.
Posted by Mark Thoma on Thursday, November 24, 2005 at 02:22 AM in Economics
Have Recent Tax Cuts Made the Wealthy Worse Off?
November 24, 2005 Economic Scene Sometimes, a Tax Cut for the Wealthy Can Hurt the Wealthy, by Robert H. Frank, NY Times: ...A careful reading of the evidence suggests that even the wealthy have been made worse off, on balance, by recent tax cuts. The private benefits ... have been much smaller, and their indirect costs much larger, than many recipients appear to have anticipated. On the benefit side, tax cuts have led the wealthy to buy larger houses in the ... expectation that doing so would make them happier. ...[H]owever, ... for the wealthy in particular, when everyone's house grows larger, the primary effect is merely to redefine what qualifies as an acceptable dwelling. So, ... these purchases appear to have had little impact. As the economist Richard Layard has written, "In a poor country, a man proves to his wife that he loves her by giving her a rose, but in a rich country, he must give a dozen roses."
On the cost side of the ledger, the federal budget deficits ... will exceed $300 billion for each of the next six years... [S]ince the wealthy are well represented in our political system, their favored programs may seem safe from the budget ax. Wealthy families have further insulated themselves by living in gated communities and sending their children to private schools. Yet such steps go only so far. For example, deficits have led to cuts in federal financing for basic scientific research... Such cuts threaten the very basis of our long-term economic prosperity. As Senator Pete Domenici, Republican of New Mexico, said: "We thought we'd keep the high-end jobs, and others would take the low-end jobs. We're now on track to a second-rate economy and a second-rate country." Large deficits also threaten our public health. Thus, despite the increasing threat from micro-organisms like E. coli ..., the government inspects beef processing plants at only a quarter the rate it did in the early 1980's. Poor people have died from eating contaminated beef but so have rich people. Citing revenue shortfalls, the nation postpones maintenance of its streets and highways, even though doing so means having to spend two to five times as much on repairs in the long run. In the short run, bad roads cause thousands of accidents each year... Poor people die in these accidents but so do rich people. When a pothole destroys a tire and wheel, replacements cost only $63 for a Ford Escort but $1,569 for a Porsche 911.
Deficits have also compromised the nation's security. In 2004, for example, the Bush administration reduced financing ... to secure loosely guarded nuclear stockpiles in the former Soviet Union by 8 percent. ... And despite the rational fear that terrorists may try to detonate a nuclear bomb in an American city, most cargo containers continue to enter the nation's ports without inspection. Large federal budget deficits and low household savings rates have also forced our government to borrow more than $650 billion each year, primarily from China, Japan and South Korea. These loans must be repaid in full, with interest. The resulting financial burden, plus the risks associated with increased international monetary instability, fall disproportionately on the rich.
At the president's behest, Congress has already enacted tax cuts that will result in some $2 trillion in revenue losses by 2010. ... Republicans in Congress are now calling for an additional $69 billion in tax cuts aimed largely at high-income families. With the economy already at full employment, no one pretends these cuts are needed to stimulate spending. ... Moralists often urge the wealthy to imagine how easily their lives could have turned out differently, to adopt a more forgiving posture toward those less prosperous. But top earners might also wish to consider evidence that their own families would have been better off, in purely practical terms, had it not been for the tax cuts of recent years.
[Update: See Kash at Angry Bear who disagrees with Frank's conclusion. I don't know for sure how the numbers would net out, but for me, the net effect isn't as important as the idea that costs must be fully accounted for when asking how benefits from tax cuts are distributed, and that includes any costs that accrue to other income classes as well. The exact quantification will always be controversial.]
Paul Krugman in Money Talks: Denial and Deception
Denial and Deception, Revisited, by Paul Krugman, NY Times: I’m trying not to write too much about the Iraq war these days. It’s an issue I’m passionate about, and there was a long time when I felt I had to speak out, even though I have no special expertise in national security, because it seemed that so few people in major news organizations were willing to say the obvious. But now there are many voices talking about how we got into this disastrous war and how we might get out, so by and large it makes sense for me to focus more on the economic issues The Times originally hired me to cover.
There is one question about Iraq, however, on which I think I can shed some light: Why now? Why has the question of whether we were misled into war sprung into the forefront of our political debate, more than two years after it became clear that there were no W.M.D.? Part of the answer is that some new information has emerged about how the White House misrepresented the intelligence it had. But the truth is that by the summer of 2003 there was ample evidence that the administration had deliberately misled the public to promote a war it wanted.
So why didn’t the public read and hear more about this evidence until very recently? The answer, I’m afraid, is that the polls led the discussion, rather than following it. With some honorable exceptions, politicians and the news media weren’t willing to take the issue on until President Bush had already been politically wounded by the failure of his Social Security plans and his hapless response to Hurricane Katrina – and a majority of the public had already come to the conclusion that we were misled into war.
And I’m sorry to say that I saw it coming. What follows is a column I published in The Times on June 24, 2003, under the headline “Denial and Deception.” I think the piece speaks for itself.
DENIAL AND DECEPTION (June 24, 2003): Politics is full of ironies. On the White House Web site, George W. Bush's speech from Oct. 7, 2002 — in which he made the case for war with Iraq – bears the headline ''Denial and Deception.'' Indeed.
There is no longer any serious doubt that Bush administration officials deceived us into war. The key question now is why so many influential people are in denial, unwilling to admit the obvious.
About the deception: Leaks from professional intelligence analysts, who are furious over the way their work was abused, have given us a far more complete picture of how America went to war. Thanks to reporting by my colleague Nicholas Kristof, other reports in The New York Times and The Washington Post, and a magisterial article by John Judis and Spencer Ackerman in The New Republic, we now know that top officials, including Mr. Bush, sought to convey an impression about the Iraqi threat that was not supported by actual intelligence reports.
In particular, there was never any evidence linking Saddam Hussein to Al Qaeda; yet administration officials repeatedly suggested the existence of a link. Supposed evidence of an active Iraqi nuclear program was thoroughly debunked by the administration's own experts; yet administration officials continued to cite that evidence and warn of Iraq's nuclear threat.
And yet the political and media establishment is in denial, finding excuses for the administration's efforts to mislead both Congress and the public.
For example, some commentators have suggested that Mr. Bush should be let off the hook as long as there is some interpretation of his prewar statements that is technically true. Really? We're not talking about a business dispute that hinges on the fine print of the contract; we're talking about the most solemn decision a nation can make. If Mr. Bush's speeches gave the nation a misleading impression about the case for war, close textual analysis showing that he didn't literally say what he seemed to be saying is no excuse. On the contrary, it suggests that he knew that his case couldn't stand close scrutiny.
Consider, for example, what Mr. Bush said in his ''denial and deception'' speech about the supposed Saddam-Osama link: that there were ''high-level contacts that go back a decade.'' In fact, intelligence agencies knew of tentative contacts between Saddam and an infant Al Qaeda in the early 1990's, but found no good evidence of a continuing relationship. So Mr. Bush made what sounded like an assertion of an ongoing relationship between Iraq and Al Qaeda, but phrased it cagily – suggesting that he or his speechwriter knew full well that his case was shaky.
Other commentators suggest that Mr. Bush may have sincerely believed, despite the lack of evidence, that Saddam was working with Osama and developing nuclear weapons. Actually, that's unlikely: why did he use such evasive wording if he didn't know that he was improving on the truth? In any case, however, somebody was at fault. If top administration officials somehow failed to apprise Mr. Bush of intelligence reports refuting key pieces of his case against Iraq, they weren't doing their jobs. And Mr. Bush should be the first person to demand their resignations.
So why are so many people making excuses for Mr. Bush and his officials?
Part of the answer, of course, is raw partisanship. One important difference between our current scandal and the Watergate affair is that it's almost impossible now to imagine a Republican senator asking, ''What did the president know, and when did he know it?''
But even people who aren't partisan Republicans shy away from confronting the administration's dishonest case for war, because they don't want to face the implications.
After all, suppose that a politician – or a journalist – admits to himself that Mr. Bush bamboozled the nation into war. Well, launching a war on false pretenses is, to say the least, a breach of trust. So if you admit to yourself that such a thing happened, you have a moral obligation to demand accountability – and to do so not only in the face of a powerful, ruthless political machine but in the face of a country not yet ready to believe that its leaders have exploited 9/11 for political gain. It's a scary prospect.
Yet if we can't find people willing to take the risk – to face the truth and act on it – what will happen to our democracy?
NBER Papers on Declining GDP Volatility and the Bias in the CPI
What Caused the Decline in U.S. Business Cycle Volatility?, by Robert J. Gordon , NBER WP 11777, November 2005: Abstract This paper investigates the sources of the widely noticed reduction in the volatility of American business cycles since the mid 1980s. Our analysis of reduced volatility emphasizes the sharp decline in the standard deviation of changes in real GDP, of the output gap, and of the inflation rate. The primary results of the paper are based on a small three-equation macro model that includes equations for the inflation rate, the nominal Federal Funds rate, and the change in the output gap. The development and analysis of the model goes beyond the previous literature in two directions. First, instead of quantifying the role of shocks-in-general, it decomposes the effect of shocks between a specific set of supply shock variables in the model’s inflation equation, and the error term in the output gap equation that is interpreted as representing “IS” shifts or “demand shocks”. It concludes that the reduced variance of shocks was the dominant source of reduced business-cycle volatility. Supply shocks accounted for 80 percent of the volatility of inflation before 1984 and demand shocks the remainder. The high level of output volatility before 1984 is accounted for roughly two-thirds by the output errors (demand shocks) and the remainder by supply shocks. The output errors are tied to the paper’s initial decomposition of the demand side of the economy, which concludes that three sectors - residential and inventory investment and Federal government spending, account for 50 percent in the reduction in the average standard deviation of real GDP when the 1950-83 and 1984-2004 intervals are compared. The second innovation in this paper is to reinterpret the role of changes in Fed monetary policy. Previous research on Taylor rule reaction functions identifies a shift after 1979 in the Volcker era toward inflation fighting with no concern about output, and then a shift in the Greenspan era to a combination of inflation fighting along with strong countercyclical responses to positive or negative output gaps. Our results accept this characterization of the Volcker era but find that previous estimates of Greenspan-era reaction functions are plagued by positive serial correlation. Once a correction for serial correlation is applied, the Greenspan-era reaction function looks almost identical to the pre-1979 “Burns” reaction function! [Open link to conference version of paper.]
Robert Gordon and Todd vanGoethem ask if there is a downward bias in the CPI:
A Century of Housing Shelter Prices: Is There a Downward Bias in the CPI?, by Robert J. Gordon, Todd vanGoethem, NBER WP 11776, November 2005: Abstract Tenant rental shelter is by far the most important component of the CPI, because it is used as a proxy for owner-occupied housing. This paper develops a wide variety of current and historical evidence dating back to 1914 to demonstrate that the CPI rent index is biased downward for all of the last century. The CPI rises roughly 2 percent per year slower than quality-unadjusted indexes of gross rent, setting a challenge for this research of measuring the rate of quality change in rental apartments. If quality increased at a rate of 2 percent per year, the CPI was not biased downward at all, but if quality increased at a slower rate of 1 percent per year, then the CPI was biased downward at a rate of 1 percent. Our analysis of a rich set of data sources goes backward chronologically, starting with a hedonic regression analysis on a large set of panel data from the American Housing Survey (AHS) covering 1975-2003. Prior to 1975, we have large micro data files from the U. S. Census of Housing extending back to 1930. In addition to the hedonic regression data, we stitch together data on the diffusion of important quality attributes of rental units, including plumbing, heating, and electrification, over the period 1918-73. Our final piece of evidence is based on a study of quality-adjusted rents in a single local community, Evanston IL, covering the period 1925-99. Our overall conclusions are surprisingly consistent across sources and eras, that the CPI bias was roughly -1.0 percent prior to the methodological improvements in the CPI that date from the mid-1980s. Our reliance on a wide variety of methodologies and evidence on types of quality change and their importance, while leaving the outcome still uncertain, at least in our view substantially narrows the range of possibilities regarding the history of CPI bias for rental shelter over the twentieth century. [Open link to earlier version.]
November 23, 2005
The Medicare Drug Benefit Disaster
Drug Benefit Disaster, by Robert J. Samuelson, Washington Post: Good policy can make for good politics, and bad policy can make for bad politics. Republicans may be about to discover this truism with their Medicare drug benefit... scheduled to take effect in January. As policy, the drug benefit is a calamity. It worsens one of the nation's major problems (paying baby boomers' retirement costs) while addressing a nonexistent "crisis" (allegedly oppressive drug costs for retirees). Its purpose was mostly political: to bribe the elderly or soon-to-be-elderly to vote for Republicans in 2004. Now it may backfire on Republicans. ... Here, Republicans created grief for themselves. They rejected a simple add-on of drug coverage to Medicare. Instead, they preferred a "market-based" system that has private insurance companies offer plans that are, in turn, subsidized by Medicare. Congress set a minimum benefit ... and invited insurers to provide that plan or something "actuarially equivalent." The result: many plans -- and much confusion. In 46 states, Medicare beneficiaries can choose from at least 40 plans, reports the Kaiser Family Foundation. People feel overwhelmed. It's hard to compare plans... One monthly premium is $1.87, another $99.90. ...
For Republicans, there's a second political problem -- outrage among conservatives over the new spending and the biggest expansion of Medicare since its creation in 1965. From 2005 to 2015, the drug benefit will cost $858 billion, estimates the Congressional Budget Office. Similarly, many conservatives ridicule the role of private insurance companies. "This is not a market-based system. It's central planning," says Robert Moffit of the Heritage Foundation. ... Republicans deserve the backlash, because their motives were so blatantly political. ... [T]he drug plan's features confirm its political nature. First, Republicans declined to pay for it; most costs (literally trillions of dollars) must be covered by borrowing or future tax increases. Second, there's the "doughnut hole" -- the standard benefit provides coverage up to $2,250 of drug costs and then no coverage for the next $2,850. Of course, this makes no sense as health or social policy. The purpose was political: to provide benefits for lots of people while limiting total costs. ...
This administration reminds me of the comic-strip husband turned plumber who invariably, while trying to fix a leak, ends up flooding the basement and making things worse. Even when there are problems that everyone wants fixed, you are reluctant to turn this group loose with the pipe wrench.
Bill Clinton: American Engagement
American Engagement, by Bill Clinton, Wall Street Journal Commentary: Ten years ago, at the Wright-Patterson Air Force Base outside Dayton, Ohio, the leaders who had waged a brutal four-year war in Bosnia ... finally agreed to peace... after intense international military and diplomatic pressure led by the United States. At the time, almost everyone predicted that the Dayton Peace Agreement would fail. To enforce the agreement, I sent 20,000 U.S. soldiers to Bosnia as part of a 60,000-troop NATO peacekeeping force... After the genocide of 1995, when more than 7,000 men were murdered in Srebrenica, it was clear that only NATO under America's leadership could ensure peace. Still, a large majority of the American public opposed my decision. Some expected heavy casualties; some feared another round of war, with Bosnia split in two and the need for our troops never-ending. On the day before the Dayton Agreement was to take effect, the House of Representatives voted three-to-one against an American troop deployment to Bosnia. Despite this opposition, I felt the United States had to act in order to stop the atrocities and try to bring peace and stability to the region. ...
Dayton ended the war. It will not resume. The region is now stable and peaceful... Bosnia is one country. It does have two distinct entities, one Serb and one a Croat-Muslim Federation, but movement is unimpeded across the boundary line... The country has a single currency and a single economy. ... Almost no one dared to predict these successes a decade ago. To be sure, Dayton was not a perfect peace. ... But it achieved vital national security interests. It ended the worst war in Europe in half a century, which threatened the peaceful integration of Europe after the Cold War. It, and subsequent events in Kosovo, laid the basis for a multiethnic state, which has lived in peace for a decade with its neighbors. It triggered the events that led to the dictator Slobodan Milosevic's removal and trial at The Hague for war crimes. Additionally, at the time of Dayton we estimated that there were more than 1,000 Islamic extremist fighters in Bosnia, and Iran had forged close ties to some in Bosnia's government. Special provisions that we wrote into the military annex of the Dayton Agreement gave us the opportunity to use NATO troops to clean out those cells, even as al Qaeda was building its organization in the heart of Europe.
We were well aware of Dayton's shortcomings. ... Regrettably, one major Dayton task remains to be met. While this year the authorities in the Serb republic of Bosnia and Herzegovina have assisted in the transferal of some 12 indicted war criminals to the International War Crimes Tribunal, ... Without the arrest and transfer of all indicted war criminals, especially Radovan Karadzic and Ratko Mladic, justice will not have been done and the Balkans will be unable to leave the past behind them.
Bosnia's 10-year path since Dayton reminds all of us privileged to lead U.S. foreign policy of a simple truth: Every one of us who starts a large initiative will be out of office before America's job is done. Progress takes time... Therefore, we cannot undertake an initiative without preparing to hand it off -- by building support across the aisle at home, and by finding international partners who will pick up the job when America is occupied by new challenges. To this end, my administration built our policy around gaining allied support and adding international help over time. ... Today Bosnia and its neighbors are on their way to becoming part of a Europe whole and free -- something every American president since Harry Truman has wanted. This could not have happened had America not sustained our partnership with Europe during the difficult process of making peace. ...
Today, the United States is again showing leadership in the region. ... After this week's focus on Bosnia, I look forward to the far more daunting task that lies ahead for ... resolving the final status of Kosovo. The long delay and rising tensions will make negotiations harder, but they must proceed with strong American involvement. Looking back, it is clear that the United States and our European allies should have acted in Bosnia earlier. But when America did act, with bombings followed by the diplomatic initiative that culminated in Dayton, we made a decisive difference. ... Was it worth it? Absolutely. While there is still work to be done, ... the dream of a Europe united, free and at peace, is still alive.
Posted by Mark Thoma on Wednesday, November 23, 2005 at 01:41 AM in Politics
Gali, Gertler, and Lopez-Salido: There is Too a Hybrid New Keynesian Phillips Curve
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.
Gali, Gertler, and Lopez-Salido respond with:
Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve, by Jordi Gali, Mark Gertler, David Lopez-Salido, NBER WP 11788, November 2005: Abstract Galí and Gertler (1999) developed a hybrid variant of the New Keynesian Phillips curve that relates inflation to real marginal cost, expected future inflation and lagged inflation. GMM estimates of the model suggest that forward looking behavior is dominant: The coefficient on expected future inflation substantially exceeds the coefficient on lagged inflation. While the latter differs significantly from zero, it is quantitatively modest. Several authors have suggested that our results are the product of specification bias or suspect estimation methods. Here we show that these claims are incorrect, and that our results are robust to a variety of estimation procedures, including GMM estimation of the closed form, and nonlinear instrumental variables. Also, as we discuss, many others have obtained very similar results to ours using a systems approach, including FIML techniques. Hence, the conclusions of GG and others regarding the importance of forward looking behavior remain robust. Introduction In this paper we show that the estimates of the hybrid New Keynesian Phillips curve presented in Gali and Gertler (1999; henceforth GG) and refined in Gali, Gertler and Lopez- Salido (2001; 2003; henceforth, GGLS) are completely robust to recent criticisms by Rudd and Whelan (2005) and Linde (2005). It follows that the main conclusions in GG and GGLS remain intact. In this section, we first summarize the results in GG and GGLS and then provide a brief summary of the response to our critics. In the sections that follow we offer a more detailed response and also present some new results based on alternative estimation approaches. [Free author web site and Bank of Spain versions. Linde paper here.]
Will Santa Pause Visit the Fed?
Minutes of the Federal Open Market Committee, November 1, 2005: ...In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 4 percent at this meeting. The economy seemed to be growing at a fairly strong pace, despite the temporary disruptions associated with the hurricanes, and underlying economic slack was likely quite limited. In that context, all members believed it important to continue removing monetary policy accommodation in order to check upside risks to inflation and keep inflation expectations contained, but noted that policy setting would need to be increasingly sensitive to incoming economic data. Some members cautioned that risks of going too far with the tightening process could also eventually emerge. Nonetheless, all members agreed to indicate at the conclusion of this meeting that a continued measured pace of policy firming remained likely.
In their ongoing discussion of the Committee's communication strategy, participants expressed a variety of perspectives about how the policy statement issued at the end of FOMC meetings might evolve over time. Several aspects of the statement language would have to be changed before long, particularly those related to the characterization of and outlook for policy. Possible future changes in the sentence on the balance of risks to the Committee's objectives were also discussed. Participants noted that any forward-looking elements of the statement should clearly be conditioned on the outlook for inflation and economic growth. For this meeting, members concurred that the current statement structure could be retained, as it accurately conveyed their near-term economic and policy outlook.
I am not reading as much into this as some. We knew rates would stop increasing at some point and this, to me, is just the Fed doing its best to be ready when the day comes.
As noted above, David Altig at macroblog also comments.
November 22, 2005
Does the U.S. Have a 'Skills Gap'?
US manufacturing ‘undermined by skills gap’, Financial Times: America’s ability to compete in the global economy is being undermined by a “serious shortage”, of skilled workers in manufacturing industries, according to a survey released on Tuesday. More than 80 per cent of US manufacturers are now experiencing a shortage of qualified workers, which is taking an increasingly negative toll on their ability to compete with global rivals, says the report by the National Association of Manufacturers, the Manufacturing Institute and Deloitte Consulting LLP. “The pain is most acute on the front line, where 90 per cent report a moderate to severe shortage of qualified skilled production employees including machinists, operators, craft workers, distributors and technicians... Engineers and scientists were also in short supply, with 65 per cent of respondents reporting current deficiencies.
The survey exposes “a widening gap between the dwindling supply of skilled workers in America and the growing technical demands of the modern manufacturing workplace,” said John Engler, NAM president. “It is essential that America close this skills gap if we are to maintain our edge in the global marketplace and remain the world’s leader in innovation.” Mr Engler said both the public and private sectors had to take “urgent action“ to improve skills and competitiveness. ... If manufacturers are to remain competitive, the issues of education and training reform must be given at least as much attention as other top business concerns like trade, taxes, energy and regulatory reform.”
Manufacturers face the additional challenge of poor skill levels among current employees, according to the report. The skills gap threatens America’s ability to compete “in today’s fast-paced and increasingly demanding” global economy. “It is emerging as our nation’s most pressing business issue,” stated Manufacturing Institute President Jerry Jasinowski. “Nearly three out of four manufacturers surveyed believe that a high performance workforce is the most important driver of future business success. “
I'll say it again. Education is a key factor in our ability to compete in the emerging global marketplace.
Help for the Poor from Venezuela
Chavez Pushes Petro-Diplomacy High Oil Profit Leads to Venezuela's Plan to Subsidize Heating in United States, by Justin Blum, Washington Post: ...Citgo Petroleum Corp., a company controlled by the Venezuelan government of President Hugo Chavez, a nettlesome adversary of the United States who has accused the Bush administration of plotting to assassinate him and invade his oil-rich country... is planning to announce today that it will provide discounted heating oil this winter to many low-income residents of Massachusetts... The company also plans to offer similar aid in New York. ... The populist South American president would relish being able to show that Venezuela, far less wealthy than the United States, had come to the rescue of low-income people here. ... This is the second time in recent months that Chavez has used oil to tweak the United States... In September, Venezuela made a very public announcement about diverting shipments of gasoline to the United States to help prevent shortages after hurricanes Katrina and Rita... The assistance might be viewed as altruistic by the United States, if not for the history of tension between the Bush administration and Chavez. In a September appearance at the United Nations, Chavez attacked the Bush administration for not doing more for the poor residents of New Orleans... He also said the United States was abetting "international terrorism" because it failed to arrest the Rev. Pat Robertson for saying that the United States should consider assassinating Chavez. ... Chavez ... concerns U.S. officials because he has repeatedly threatened to cut off oil shipments. Venezuela is one of the largest suppliers to the United States, providing about 1.5 million barrels a day of oil and oil products. Chavez has been seeking new markets for his oil, including energy-hungry China. ... The Venezuelan government said the oil-related initiatives ... are for humanitarian purposes and regional unity. ... Fadi Kabboul, minister-counselor for petroleum affairs ... [said] "Venezuela never used oil as a political weapon. Venezuela is not going to use oil against the U.S. as a political weapon for anything."
The Trade Deficit
Trade Gap, by Paul Blustein, Washington Post: Newark, Del.: A $700 billion $ per year current account deficit sounds incredibly huge. How is this going to end? Paul Blustein: This is a good question ... Some think it will be a "hard landing"--a financial crisis in which foreign investors dump U.S. securities en masse. Some think it will be a "softer" landing, in which foreigners just gradually insist on higher rates on their U.S. investments. And some people think the landing will be softer still, with the dollar just gradually easing down and trade flows reversing over time. ... I have to admit I find myself nodding my head when I hear economists say that the risks of a bad outcome are unacceptably high.
Virginia: ...[O]ne could make the argument that there are states in the U.S. that run trade deficits with other states or that there are U.S. cities that have trade deficits with other U.S. cities, and yet nobody worries or cares. So, why should one worry? Paul Blustein: You're right to say that just because a country is running a trade deficit, or a budget deficit, or almost any other kind of deficit, that's not necessarily a reason to worry. ... Just like a company that borrows to finance the building of a profitable factory, there is no reason why governments and countries shouldn't borrow. However, ... when it comes to the U.S. trade deficit... the U.S. has a very high consumption rate and rather low investment rate at the moment. That means that instead of investing the foreign inflows in ways that will give us higher living standards in the future ... we're consuming most of the money. The second reason is the sheer size of the deficits, and the accumulated debt. ... That could certainly start to worry foreign creditors at some point if they see little chance that it will be turned around.
Washington, D.C.: Not a question--just a comment. These two pieces were terrific! Easily the best description and explanation of the inter-relation of the trade and saving questions that I have seen anywhere! Congratulations! Alice M. Rivlin Paul Blustein: Well, I can't resist posting this--for those of you who don't know, Ms. Rivlin is a former vice chairman of the Federal Reserve. Thanks very much... [Here are the links: U.S. Trade Deficit Hangs In a Delicate Imbalance, As U.S. Trade Gap Grows, So Do Asian Banks' Foreign Reserves, Mark]
Northville, Mich.: Why is it the U.S.A. deficit has gone so long uncheck that we now owe every country around the world boat loads of money. Is it that this administration is so corrupt and greedy it does not care? Paul Blustein: Actually, I think some people in the administration care quite a bit about the problem. Not all--some think the problem is overblown, and some of their rhetoric has certainly reflected that. But in talking to people like Tim Adams, the undersecretary of the treasury for international affairs, I'm quite struck by the fact that he seems determined to take measures that will ameliorate the global imbalances. ...
Monroe Township, N.J.: Why is China willing to hold a large part of US debt? Can they use the debt aggressively against us? Paul Blustein: ...The Chinese are "willing" to hold our Treasury securities for one important reason--for the past decade or so, they have rigidly linked their currency, the yuan, to the U.S. dollar, ... As for the second part of your question, if you read Saturday's story, ... I quoted from a Foreign Affairs article by Nouriel Roubini and Brad Setser. They pointed out that the Chinese COULD use their vast holdings of Treasury securities against us, by threatening to dump them, in some sort of foreign policy confrontation. Of course, that would hurt the Chinese a lot--perhaps more than it would hurt us; it's hard to say. But one way of thinking about this is that it's a sort of "balance of mutual terror"--a term used by former Treasury Secretary Larry Summers. It's not a very healthy situation, in other words.
Burke, Va.: In his recent book recent book "Three Billion New Capitalists" Clyde Prestowitz's argues that the trade deficit in combination with budget deficits and a debt-dependent economy will result in an "economic 9/11" where the dollar collapses and interest rates sky-rocket. What ... changes in policy would be necessary to avert these sequences of events? Paul Blustein: ...I think there's pretty broad agreement among economists on both the right and left about what ought to be done. First of all, the U.S. needs to increase its savings... Second, Asian countries need to raise the value of their currencies. ... Third, Europe needs to take steps to increase its growth, so that Europeans would import more too. But Europe is a far smaller part of the global imbalance problem than is Asia. ... Not all economists agree, of course, but the consensus is pretty broad. ...
Should Bernanke Focus on Asset Price Bubbles Instead of Explicit Inflation Targets?
Bernanke should rethink his monetary ‘Maginot Line’, by Peter Hartcher, Financial Times: Ben Bernanke... earnestly pledged to continue the policies of Alan Greenspan... But ... [i]n his Senate confirmation hearing ..., Mr Bernanke began a campaign to give the Fed an explicit, public target for its inflation rate... He appeared to be committing his honeymoon period, and all the goodwill and latitude that come with it, to imposing this one reform. Is this a good idea? ... For the US to introduce one today ... would be like creating a monetary Maginot Line. An inflation target for the US, like the famous line of French defences in the second world war, would do no real harm. But, like the fixed defensive artillery that was supposed to keep the Germans out of France, it would not be very useful either. ... At first glance, it is hard to see why the incoming Fed governor feels the need to install an inflation-targeting regime. The Fed already has one, although it is undeclared, or “covert”. ... Now Mr Bernanke has arrived proposing the Fed publicly disclose its inflation target and ... “From his earlier speeches he wants an inflation target of 1 to 2 per cent,” said Bill Dudley, chief US economist for Goldman Sachs. ...
It is hard to see why Mr Bernanke is devoting all his initial political capital to this issue. Perhaps, like the Maginot Line, it is all about the last war. ... The clue to what is driving Mr Bernanke may be found in a speech he gave in March 2003: “Credibility is not a permanent characteristic of a central bank; it must be continuously earned.” In effect, an untested Fed chairman is seeking to establish through a formal arrangement the credibility that his two towering predecessors won through action. But in the meantime, ... there are other defensive works left undone. The experience of Japan in the 1980s, and the US in the 1990s until today, is that easy money no longer flows into traditional inflation, but into asset price inflation. ... [O]ther central banks around the world – including those of Britain, Australia, Canada, New Zealand and Norway – started publicly addressing the question of how to deal appropriately with bubbles. The US central bank, under Mr Greenspan and, shortly, Mr Bernanke, avoids focusing on it. ... What will happen when, as there inevitably will be, there is another bubble in asset prices but no clear threat of inflation? Under current Fed doctrine, the Fed would do what it did during dotcom mania – wait for the burst and the recession that follows. Is there a better way? This is the big new agenda item for central banks, but Mr Bernanke is preoccupied with the old agenda. An inflation target does not hold any answer. ...
The choice to move to explicit inflation targets depends, of course, on the costs and benefits of doing so. Rather than debate the benefits of explicit targets, I want to focus on the cost. In this commentary, the main criticism of Bernanke pushing explicit inflation targets is that the opportunity cost, a potential loss of focus on asset bubbles, is large. First, plenty of academic research is underway on the question of how best to respond to asset price bubbles, research Bernanke knows well, and this large body of research is relatively unaffected by what Bernanke does or does not push within the narrow confines of the Board of Governors and the FOMC. But in addition, there is no necessary inconsistency between an explicit inflation target and combating asset price bubbles. The commentary talks about an explicit consumer price index target, but there are many potential price indexes to use as a target and this too is an active area of research. If you do use an explicit target, what index should be used? Core inflation? In measuring core inflation, what prices are thrown out? Where is the line between including and excluding a price? Should the index include (or be limited to) wage inflation? Should asset prices be included in the index? If asset prices are included, then bubbles are addressed within the explicit target and the concerns in the commentary are alleviated.
There are lots of misperceptions about why the Fed focuses on core inflation and what core inflation represents. Here's one line of thinking in this area. When there are wage and price rigidities, inflation distorts relative prices. This causes both resource losses and resource misallocations both of which lower welfare. The goal of policy is to remove these welfare reducing distortions and one way to do that is to stabilize prices. What this means is that the prices to focus on in stabilization policy are the prices that are the most sluggish because these are the prices most likely to be distorted by inflation. In general these are not oil prices, stock prices, housing prices, food prices, and so on, all of which are very flexible. This explains why a policy maker may want to focus on core inflation rather than total inflation (and also suggests how core inflation might be defined), and why asset and other flexible prices may not be included in the core measure. But there are other points of view and, as I noted, this is an active research area, one I have no doubt whatsoever Bernanke will keep up with.
Creative Careers: The Life Cycles of Nobel Laureates in Economics
Creative Careers: The Life Cycles of Nobel Laureates in Economics, by Bruce A. Weinberg and David W. Galenson, NBER WP 11799, November 2005: Abstract This paper studies life cycle creativity among Nobel laureate economists using citation data. We identify two distinct life cycles of scholarly creativity. Experimental innovators work inductively, accumulating knowledge from experience. Conceptual innovators work deductively, applying abstract principles. We find that conceptual innovators do their most important work earlier in their careers than experimental laureates. For instance, 75% of the most extreme conceptual laureates published their single best work in the first 10 years of their career, while none of the experimental laureates did. Thus while experience benefits experimental innovators, newness to a field benefits conceptual innovators. [Free version on author web page.]
Chicago Fed's Moskow on the Strength of Labor Markets and the Need to Continue Removing Accommodative Policy
- GDP growth is above potential growth
- Much of the slack in the economy has been eliminated
- There are two risks to growth, a slowing of the housing market and high energy prices
- He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
- He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
- Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward
There were also new parts in today's speech on the strength of the labor market, why it is sometimes necessary in the short-run to increase the interest rate beyond the long-run neutral rate, and longer term economic challenges of maintaining human and physical capital at optimal levels. Here's the part on the strength of the labor market where he spends quite a bit of time trying to convince us that slack in labor markets has been mostly eliminated and that statistics such as labor force participation rates do not alter this view:
U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: ... The unemployment rate deserves a bit of elaboration. Some analysts question whether that rate accurately reflects the "true" degree of labor market slack. Their concern is that an unusual number of those who want to work may have become so discouraged about their prospects of finding a job that they have given up looking for work. ... Indeed, the labor force participation rate, which is the fraction of the population either working or actively looking for work, is well below where it was prior to the 2001 recession. In contrast, 4 years after the 1990-91 recession, the labor force participation rate had returned to its prerecession level. So the question is, do we think the participation rate will return to its prerecession level? At the Chicago Fed, ... our best judgment is that we will not see a big rebound in participation. This suggests that the current low levels of labor force participation are not indicative of a slack labor market.
First, much of the unusual behavior of labor force participation during this cycle has been caused by a sharp decline in the percentage of teenagers in the labor force. This has occurred at the same time that there have been notable increases in summer school enrollments—a development that is unlikely to be reversed any time soon... Therefore, we don't expect to see teenagers flood back into the labor force. Trends in adult labor force participation are also important. While we have seen large secular increases in women's labor force participation for several decades, this was mostly due to differences in behavior between women born before and after 1960. ... So the increase in women's labor force participation appears to have largely run its course. Men's labor force participation, in contrast, has been declining since the 1950s, and we do not see any reason to expect a strong reversal. Finally, and perhaps most importantly, the aging of the baby boomers is putting downward pressure on labor force participation, because it increases the share of the population that is retired. Putting all these pieces together, I do not expect a large increase in labor force participation. Accordingly, the current unemployment rate is probably close to the level associated with a healthy economy and little labor market slack.
The next new part relative to the previous speech begins with the third sentence where he explains why, in the short-run, it can be necessary to increase the federal funds rate beyond what is required for long-run neutrality:
Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations contained. For me, at this time such policy likely entails further removal of policy accommodation. [start of new part] ... Conceptually, it's easiest to think about the neutral—or equilibrium—rate as being the rate consistent with an economy growing steadily along its potential growth path over a long period of time. ... we're currently near the bottom of this range. Of course, ... we have to recognize that many factors can cause differences between the longer-run concept of neutral policy and what may be neutral policy over the short or medium term. For example, ... [e]ven if the funds rate were at neutral, further changes in policy may be appropriate. ... With inflation at the upper end of my comfort zone, an unexpected increase in inflation would be a serious concern, while a decline in inflation would be beneficial. My views about policy will depend importantly on how these cost factors play out and affect the outlook for inflation. ... or inflation expectations ... What I've just described is the conditionality of monetary policy. As we've said many times, the FOMC will react to changes in economic prospects. Future policy will not be a mechanical reaction to the next number on inflation and employment. ...
This last substantive change is the addition of a section on the longer term challenges of how to maintain sufficient investment in both physical and human capital in with economic issues such as low savings rates and growing budget deficits making this task more difficult:
The risks I've talked about so far primarily relate to the near-term economic outlook. But in the long term, we face a different set of challenges. In order to support productivity growth and maintain a solid trend in economic growth, we need to continue to invest in physical and human capital at sufficiently high rates. In the case of physical investment in plant and equipment, the long-term challenge will be financing. Spending on physical capital must be financed by our national savings... [O]verall national saving has fallen in recent years. Fortunately, the rest of the world has viewed the United States as a good place to invest. ... Unfortunately, such deficits are not sustainable indefinitely. ... This means that if we are to maintain our current rates of capital investment, national saving will have to rise ... This will be happening at the same time that the aging of our population will put increasing pressure on our Social Security and Medicare spending. ... Medicare outlays will account for a rapidly expanding share of the national budget. Without changes in spending or taxes or both, this increased demand for social insurance will further increase government deficits and decrease net national saving.
Finally, another factor that will affect our future economic growth is our ability to improve the quality of our workforce. This requires us to do a better job educating our school age population and providing further opportunities for training and retraining of those already in the workforce. Education has historically been a strength of the United States, but some current trends are worrisome. ...
Given that the economy currently looks healthy, now is a good time to attack some of our longer-term challenges. How we generate increases in national savings and improve education are important issues for our nation. ...
November 21, 2005
As the World Churns
GM Chief Wagoner to Announce Plant Closings Today, People Say, Bloomberg: General Motors Corp. Chief Executive Rick Wagoner... today will announce ... efforts to reduce costs... The world's largest automaker will idle or reduce operations at about nine manufacturing sites and close other non-manufacturing facilities such as parts depots... GM will likely eliminate at least 32,000 jobs ... by 2007, said Rod Lache, an analyst at Deutsche Bank Securities Inc. in New York. That's a bigger and faster cut than the 25,000 jobs Wagoner promised to cut five months ago... Coupled with the idling of GM factories [elsewhere] this year, it would ... lower ... North American assembly capacity to 4.4 million vehicles by 2007, compared with 5.8 million at the beginning of 2005. ... ''Over the long term, if GM keeps losing market share, everything is up in the air,'' Hargrove said. The CAW agreed to more than 1,000 GM jobs cuts last month. ''The October numbers were just horrible.''...
Posted by Mark Thoma on Monday, November 21, 2005 at 12:42 AM in Economics
Paul Krugman: Time to Leave
Time to Leave, by Paul Krugman, NY Times: ...Representative John Murtha's speech calling for a quick departure from Iraq was full of passion, but it was also serious and specific in a way rarely seen on the other side of the debate. President Bush and his apologists speak in vague generalities about staying the course... But Mr. Murtha spoke of mounting casualties and lagging recruiting, the rising frequency of insurgent attacks, stagnant oil production and lack of clean water. Mr. Murtha - a much-decorated veteran who cares deeply about America's fighting men and women - argued that our presence in Iraq is making things worse, not better. Meanwhile, the war is destroying the military he loves. ... I'd add that the war is also destroying America's moral authority. When Mr. Bush speaks of human rights, the world thinks of Abu Ghraib. ... When administration officials talk of spreading freedom, the world thinks about ... much of Iraq ... ruled by theocrats and their militias. Some administration officials accused Mr. Murtha of undermining the troops and giving comfort to the enemy. But that sort of thing no longer works, now that the administration has lost the public's trust.
Instead, defenders of our current policy have had to make a substantive argument: we can't leave Iraq now, because a civil war will break out... But the real question is ... When, exactly, would be a good time to leave Iraq? ...[W]e're not going to stay in Iraq until we achieve victory, ... At most, we'll stay until the American military can take no more. Mr. Bush never asked the nation for the sacrifices - higher taxes, a bigger military and, possibly, a revived draft - that might have made a long-term commitment ... possible. Instead, the war has been fought on borrowed money and borrowed time. And time is running out. With some military units on their third tour of duty..., the superb volunteer army that Mr. Bush inherited is in increasing danger of ... collapse in quality and morale similar to the collapse of the officer corps in the early 1970's. So the question isn't whether things will be ugly after American forces leave Iraq. They probably will. The question... is whether it makes sense to keep the war going for another year or two, which is all the time we realistically have. ... And there's a good case to be made that our departure will actually improve matters. As Mr. Murtha pointed out..., the insurgency derives much of its support from the perception that it's resisting a foreign occupier. Once we're gone, the odds are that Iraqis, who don't have a tradition of religious extremism, will turn on fanatical foreigners like Zarqawi.
The only way to justify staying in Iraq is to make the case that stretching the U.S. army to its breaking point will buy time for something good to happen. I don't think you can make that case convincingly. So Mr. Murtha is right: it's time to leave.
Scooping the Froth Off of Housing
Real-Estate Speculators, Pulling Back, Help Fed Remove 'Froth', Bloomberg: ...Investors who helped fuel the U.S. housing boom by bidding up prices are now so desperate for buyers that some are offering cash bonuses in such markets as Washington. That's a sign the Federal Reserve is succeeding in removing some of what Chairman Alan Greenspan called ''froth'' from the market. Inventories of unsold single-family homes are near a 17-year high as demand from speculators wanes and mortgage rates have risen more than a percentage point from a four-decade low reached in 2003. ''We're at the turning point,'' says Susan Wachter, professor of real estate at the University of Pennsylvania in Philadelphia. ''We're all hoping for a flat market, and not a plummeting market.'' That would be welcomed by Fed policy makers as a sign that they are succeeding in slowing the economy to a sustainable pace of growth...
Applications for loans to purchase real estate are down 12 percent from the record set in June, the Mortgage Bankers Association reports. ... The falloff in demand is already being felt in regions such as Las Vegas, the fastest-growing housing market in the U.S. a year earlier. ''The mom-and-pop investors are unloading their properties,'' says Greg Sullivan, 42, a partner in Cash Now Vegas LLC, a Las Vegas company that buys homes from investors and resells them. ''When home values were going up $10,000 a month, everyone wanted in. Now, all those properties are sitting empty.'' ... Investment buying accounted for almost a quarter of U.S. home transactions last year, according to the Realtors group. ... ''This is the sign of a soft landing in the marketplace,'' Nicolas Retsinas, director of housing studies at Harvard University in Cambridge, Massachusetts, said in an interview. ''I do believe the levels of price appreciation in some of the markets, particularly the two coasts, were unsustainable. At some point they had to moderate.''
Still, demand for less expensive housing remains strong. ... The Fed is ''getting exactly what they wanted, and that is a little bit of the froth taken away, but still the economic growth, and growth that supports housing,'' Bob Walters, chief economist at Quicken Loans Inc. in Livonia, Michigan, said in an interview. Lyle Gramley, a former Fed governor ... says market forces played a larger role than speculation in pushing up home prices. Prices rose because of economic growth, low interest rates and a shortage of building lots in some markets, he says. ''When fundamental factors drive prices up, it certainly does encourage speculation and more buying by investors,'' ... ''And when the froth begins to come out of the market, those are the first people who run for the hills.'' ... Gramley foresees ''declines in home prices of maybe 10, 15 or 20 percent on both coasts on a year-over-year basis.'' ''The economy can take that,'' he says. ''It won't cause a major problem, but we don't know if it will stop there.''
Facts About Gasoline
There is quite a bit more in the report.
November 20, 2005
The Consumption Boom
"I just got my home equity loan so I needed a bigger cart. You must live in an apartment. Sorry about that lady!"
Why is Public Interest in the Fed Falling?
Are the Fed Fights Over? By Aan S. Blinder, Commentary, NY Times: Something rare and important happened in Washington on Tuesday. ... The Senate held a hearing on the nomination of Ben Bernanke to be the new chairman of the Federal Reserve Board. The last time that happened was in July 1987, when Alan Greenspan was first confirmed. Before that, it was Paul Volcker in July 1979. This newspaper's own coverage offers a revealing historical progression. On the morning after Mr. Volcker's hearing, the paper ran a Page 1 article ... Eight years later, the article on Mr. Greenspan's confirmation hearing appeared on the first business page. And... the account of Mr. Bernanke's hearing was on Page 4 of the business section...
The Federal Reserve chairman is widely agreed to have more influence on the national economy than does the president of the United States. Yet the national news media - as opposed to the specialized financial news media, which dote on the Fed - seem to find monetary policy less engaging than they did in 1979 or 1987. Why? One reason is clearly Mr. Bernanke's ability and qualifications, which make him a stellar choice in the eyes of Republicans and Democrats alike. ... But that cannot be the whole story, for Mr. Volcker and Mr. Greenspan were also widely acclaimed at the times of their confirmations. A second reason is that these are pretty placid times for the nation's central bank. The United States has not had an inflation scare for 15 years. While the Fed is now raising interest rates, it is merely bringing them up from their previous abnormally low levels ... at a pace it calls "measured," with clear warnings at each step. No fuss, no muss, no bother - and limited public interest.
The situation was different when Paul Volcker went up for confirmation in July 1979. High inflation had plagued the country for years and was about to get worse. Taming it ranked high on the national agenda, maybe at the top. So the Federal Reserve's monetary policy claimed the public's and the news media's attention. By the time Alan Greenspan was confirmed in 1987, inflation had been under control for several years, and the Fed's policy interest rate had barely changed over the previous 15 months. Both inflation and the Fed therefore commanded much less of the limelight. If you read the hearing transcript, you will find that as much attention was paid to the federal budget deficit and the trade deficit as to inflation and the Fed's interest rate policy. (Sound familiar?) ... But there is a third, and very important, reason that Mr. Bernanke's nomination and confirmation have received so little press attention. The happy truth is that monetary policy is not very controversial - and is certainly not very political - these days.
Instead, there is a strong intellectual and political consensus that the central bank should be free of political interference, should keep inflation low and should promote high employment. Furthermore, while central banking remains part art, part science, the science has clearly been gaining on the art in recent decades. Central bankers around the world are increasingly thought of as technocrats, not as philosopher-kings or sorcerers. It was not always thus. In the early days of the republic, Hamilton and Jefferson battled over whether the young country should have a central bank at all. No one was thinking about "monetary policy" back then, but they were thinking about "sound money." While Hamilton won that debate, the first Bank of the United States lasted only 20 years before falling prey to populist politics. A similar fate befell the second Bank of the United States under Andrew Jackson. These were intense political struggles. .. In fact, ... [Bernanke's] hearing illustrated a new reality: that debates over monetary policy are now apt to be boring and technical - and far removed from politics.
These are salutary developments. John Maynard Keynes once longed for the day when economists would be "humble, competent people, on a level with dentists." At least as far as central bankers are concerned, we are not quite there yet. Mr. Bush's choice of Mr. Bernanke remains far more important than his choice of a dentist. But not important enough to make Page 1.
The underlying theoretical support for inflation targeting in the conduct of monetary policy and the more technocratic approach that comes out of it may owe part of its success to the fact that such an automated rule-like transparent process helps to remove politics from the process. Commitment to a particular course of action that is known in advance and enjoys theoretical support makes it easier to resist political pressure to change course and, as noted in the article, helps to confine the debate to the technical merits of the approach.
Delicate Rebalancing Act
As the McMansions Go, So Goes Job Growth, Commentary, Daniel Gross, NY Times: ...But there's some good news. Ms. Bangalore notes that while housing's contribution to job growth has declined in recent months, "other sectors are picking up the slack."
For four stories on housing and employment, including more on this one, see Calculated Risk.
Work and Leisure in the U.S. and Europe: Why So Different?
Work and leisure in the U.S. and Europe: Why so different?, Alberto Alesina, Edward Glaeser, and Bruce Sacerdote NBER Macroeconomics Annual vol. 20, Revised: June 2005: Abstract Americans average 25.1 working hours per person in working age per week, but the Germans average 18.6 hours. The average American works 46.2 weeks per year, while the French average 40 weeks per year. Why do western Europeans work so much less than Americans? Recent work argues that these differences result from higher European tax rates, but the vast empirical labor supply literature suggests that tax rates can explain only a small amount of the differences in hours between the U.S. and Europe. Another popular view is that these differences are explained by long-standing European "culture," but Europeans worked more than Americans as late as the 1960s. In this paper, we argue that European labor market regulations, advocated by unions in declining European industries who argued "work less, work all" explain the bulk of the difference between the U.S. and Europe. These policies do not seem to have increased employment, but they may have had a more society-wide influence on leisure patterns because of a social multiplier where the returns to leisure increase as more people are taking longer vacations. [Free earlier version on author web site.]
Central Bank Independence and Inflation
This has changed with the adoption of inflation targeting by central banks. Note also that Adam Posen casts doubt on whether causality runs from central bank independence to improved macroeconomic performance in Central Bank Independence and Disinflationary Credibility: A Missing Link?, NY Fed Staff Report, May 1995.
November 19, 2005
November 2005: Helicopter churn: The macro view on job loss and growth, by Terry Fitzgerald, Mark Holland: ...This fedgazette looks through a ... window of time ... to see what might be learned about the sources and effects of employment shocks during this period. ... From a longer-run perspective, it is clear that employment shocks are not rare. In any given year, even with a hot national economy, some counties will experience a major decline in employment. The reason for this is an often overlooked feature of market economies called “churn.” Simply, market economies tend to create and destroy a lot of jobs simultaneously, as employers collectively allocate scarce resources for additional labor in some sectors and occupations while cutting back in others. Even in strong job markets, some jobs are being lost, just as some jobs are gained in the midst of a recession. ...
Data on all district counties from 1969 to 2002 show that major job loss happens ... often... In three-plus decades, there were more than 900 instances where one of the district's 303 counties experienced an employment decline of 3 percent or more—roughly, one every decade for each county in the district. ... Are the same counties getting endlessly sucker-punched? In general, no. During the 1969-2002 period, every district county except one experienced a net employment decline in at least one year, and better than 80 percent of district counties endured a 3 percent employment loss in at least one year. ... But some counties certainly experience more than their share of shocks. Though all counties have some probability of employment shock, small counties are more prone. Counties with fewer than 4,000 workers make up 44 percent of district counties ... But these counties experienced 66 percent of the 905 employment shocks... At the other end, 7 percent of district counties have more than 32,000 workers, but they experienced just 1 percent of all shocks.
Flip side: The boom Before getting too gloomy about the employment picture in the district, remember that counties also experience employment booms more frequently than you might imagine. From 1969 to 2002, 86 percent of district counties experienced at least one year of 5 percent employment growth. Furthermore, a majority of counties saw at least one year of 7 percent employment growth, and all but one county had at least one year of 3 percent growth. ... The moral of the story? A central feature of U.S., state and county labor markets is job churn. Each year millions of people nationally lose their jobs. But in most years, an even larger number of people find new jobs. The same is true on a smaller scale at the county level. Jobs are gained and lost within a county, and oftentimes other counties offer an employment counterbalance. Again, however, counties with fewer than 4,000 workers experienced proportionately more shocks than booms from 1969 to 2002... Job churn can often be messy, unpleasant—even gut-wrenching—particularly at the household and community level. But over time, it is this very churn that helps struggling economies transfer resources to better uses, while keeping healthy economies robust in an ever changing world.
The positive correlation between "booms" and "shocks" that emerges around 1995 in the graph is interesting. Prior to 1995 the correlation appears to be negative - when more counties are booming, fewer are experiencing shocks. After 1995 it is reversed - when more counties are booming, more are also experiencing shocks.
Calculated Seasonal Risk
"A sharp drop in U.S. housing starts and permits for new building in October pointed to some cooling in the red-hot real estate market...".
And the Indianopolis Star headline screamed:
"Housing starts plunge in October"
But did starts really "plunge"?
Click on graphs for larger image.
This graph shows the NSA housing starts for the last four years. Every year housing starts decline in the fall, yet the October housing starts are still near the peak summer pace for 2004. That is hardly a plunge.
The second graph shows October housing starts since 1980. Total starts in Oct, 2005 showed a small decline from Oct, 2004. But for one unit structures (SFR), 2005 was an all time record for October starts.
Hardly a plunge.
With rising inventories and rising interest rates, it is understandable that analysts are looking for confirmation that the housing market has slowed substantially. This isn't it.
Besides, permits and housing starts are historically lagging indicators for a housing slowdown. In addition to rising inventories, I believe the more timely indicators are falling mortgage applications and declining sales.
Limits to Central Bank Independence
Editorial/ Bank of Japan, The Asahi Shimbun, Nov. 19: All of a sudden, senior government and ruling Liberal Democratic Party officials are speaking out against the Bank of Japan's monetary policy. Hidenao Nakagawa, chairman of the LDP Policy Research Council, noted: "The central bank needs to constantly coordinate its policy target with that of the administration. If the bank doesn't understand that, we ought to consider revising the Bank of Japan Law." On doing away with the policy of quantitative monetary easing, Prime Minister Junichiro Koizumi said: "It's premature. The price rise index ought to be above zero. We are still in a period of deflation." It is rare for Koizumi to comment on central bank policy. ... The ... government and LDP officials should not be blatantly meddling in the central bank's policy. Those officials ought to recall why the Bank of Japan Law was revised in 1998 to give it independence. The law had to be revised because the government and ruling party admitted they had put undue pressure on the central bank with the result it could not implement appropriate policy. The BOJ jeopardized its hard-won independence with its 2000 blunder. ...
In the United States, ... It is practically unheard of for any ranking public official to complain about Fed policy in public. ... The Bank of Japan's independence is a matter that could affect the nation's economic activity in real terms. The government is now trying to wield its influence over the central bank because it is afraid that higher long-term interest rates will bloat its bond payments, which in turn would set back fiscal rehabilitation plans. But basically, long-tern interest rates are tied to long-term economic and inflation forecasts. If the Bank of Japan is viewed as unable to resist government pressure and control inflation, that could cause long-term interest rates to rise. Politicians be warned: You may be inviting misfortunes if you continue to loudly proclaim what the Bank of Japan should be doing.
Politicians, economists, lots of people complain about Fed policy. The hope is that none of them believe it has any influence whatsoever on the Fed, even if, or perhaps particularly if, politicians threaten to take away or limit the Fed's independence. Is this relevant for the U.S.? Some recent examples include a call from Senators Dorgan and Reid in 1996 for the non-monetary activities of the Fed to be subject to budget oversight giving them the power of the purse string. In addition, in 1975 congress required the Fed to announce its money growth targets. This was followed by the Full Employment and Balanced Growth Act in 1978 requiring the Fed to explain how its monetary plans are consistent with the plans of the president. In effect, though, this has had little effect on Fed behavior.
November 18, 2005
Why Hasn't the Jump in Oil Prices Led to a Recession?
FRBSF Economic Letter, Why Hasn't the Jump in Oil Prices Led to a Recession?, by John Fernald and Bharat Trehan: Oil prices have increased substantially over the last several years. When oil price increases of this magnitude occurred during the 1970s, they were associated with severe recessions. Why hasn't that happened this time around? This Letter explores some answers to that question.
Why should oil affect the economy?
When the price of oil rises, U.S. households and businesses who purchase fuel oil, gasoline, and other petroleum-based products have less disposable income to spend on other goods and services. However, for domestically produced oil, oil producers receive the extra income from the products they sell, so total U.S. income is not directly affected. Therefore, for domestic oil, a price increase represents a transfer from one group of U.S. residents (oil users) to another group of U.S. residents (oil producers).
The story is different for imported oil. An intuitive way to think about the initial effects of an increase in the price of imported oil on the economy is to consider it as a tax on domestic users. In 2004, the U.S. imported almost 5 billion barrels of energy-related petroleum products, amounting to about two-thirds of domestic petroleum use. Of these imports, 3.8 billion barrels were crude petroleum, or an average of 10.4 million barrels per day. For each $10/barrel increase in oil prices, the United States pays an effective "tax" of about $50 billion (5 billion barrels times $10), or 0.4% of GDP.
This is not the same thing as saying that GDP will fall by 0.4%. For instance, this estimate does not take into account what the foreign oil producers do with the additional income. It is likely that they would use at least part of this income to purchase goods from other countries. To the extent that these purchases consist of goods made in the U.S., they will help support U.S. GDP. Indeed, it is possible—in theory—to conceive of a situation where foreign oil producers purchase enough from the U.S. that U.S. GDP does not decline much, even though consumers are paying a higher price for oil and therefore can afford fewer goods and services themselves.
How big is the effect in practice?
As mentioned earlier, the experience of the 1970s suggests that oil shocks have a substantial effect on output. Indeed, Figure 1, which plots the real, inflation-adjusted price of imported petroleum, shows that high oil prices have frequently coincided with recessions. In a series of papers, Hamilton (1983, 1996, 2003) has argued forcefully that the oil shocks were responsible for these recessions. However, he argues that not all changes in the price of oil have the same effect on the economy. For instance, a fall in oil prices is unlikely to boost the economy in the same way that an increase can drag it down. In addition, he argues that oil price increases that simply reverse previous price decreases are unlikely to have a significant effect. One approach he recommends to isolate the kinds of price changes that can affect the economy is to record an oil shock only if the prevailing price of oil is higher than it has been over the past three years.
Figure 2 plots oil price shocks according to this recommendation. The spikes line up closely with recessions. From the figure, it is easy to find a clear statistical relationship between this oil-shock variable and output. Indeed, the magnitude of the predicted effect is much larger than the simple tax analogy suggests. This could reflect some sort of multiplier, as the loss in income in the first round would lead to a reduction in spending, which would imply a further loss in income, and so on. However, a simple statistical analysis does not provide insight into why the magnitude is so much larger than the direct income loss.
Moreover, the statistical evidence is not necessarily as strong as Figure 2 might suggest. Because an oil price shock is recorded if and only if oil reaches a three-year high, a temporary increase in the price of oil is treated as having the same impact as a permanent increase. But if the spike is temporary, then the effects on income are fleeting, and one would expect that many consumers will reduce their saving in order to avoid a big hit to consumption.
To see the point, compare the 1990 experience in Figures 1 and 2. Figure 1 shows that the price of oil spiked only briefly. But in Figure 2, which uses the Hamilton price-increase transformation, the 1990 spike was one of the largest. In Figure 2, this spike is followed by a long series of zeros. In Figure 1, however, more than 95% of the oil price increase is reversed next quarter and oil prices over the next year or two appear no different from the period preceding the spike. Indeed, more formal statistical analysis shows that over the post-1982 period the Hamilton oil shock variable has a significant negative impact on output only because of the spike in 1990. If the 1990 spike is set to zero, there is no evidence of a statistically important relationship.
Note also that the timing is suspect in several cases. The 1973-1975 recession began in November 1973; but oil prices surged in January 1974. The 1990-1991 recession began in July 1990; but oil prices surged in August.
Another way to get a sense of how large the effect of oil shocks may be is to consider the implications of more fully specified models, which incorporate the direct expenditure effects but then allow for additional, second round effects. These tend to suggest that the ultimate effects are roughly in line with the direct expenditure shares. In a recent paper, Guerrieri (2005) finds that a 50% increase in the price of oil starting in the first quarter of 2004 causes output to fall about 0.4% below what it would otherwise be in the long run (assuming that the Fed conducts policy using the well-known Taylor rule). The effects are likely to have been larger in the 1970s, when the economy was more energy-intensive; however, even if we assume that the economy's energy-intensity is unchanged since the 1970s, the effect is not likely to be huge.
Other explanations for the 1970s
Considerations like these have led a number of economists to suggest that the recessions of the 1970s reflected other kinds of shocks. For instance, Barsky and Killian (2001) argue that the great stagflation of the 1970s was the result of monetary policy alternating between periods of stimulation and restraint and not oil price shocks. Similarly, Burbidge and Harrison (1984) examine developments in five major industrial economies including the U.S. and conclude that even though the oil shocks in the early 1970s did have a significant effect, recessions were already on the way even before the jump in oil prices. They also find that the 1979-1980 oil shocks had a minimal effect on all these countries except Japan.
Others have argued that the recessions may have been caused by the Fed's reaction to the oil shocks. Bernanke, Gertler, and Watson (1997) show that postwar recessions have been preceded not only by rising oil prices but also by a tightening of monetary policy, which makes it difficult to distinguish between the effects of the two. According to them, the confusion between oil shocks and the response of monetary policy explains why oil shocks appear to have an effect that far exceeds what is expected based on a comparison of energy costs to total production costs. Their own analysis leads them to conclude that oil shocks have not played a major role in recessions and that endogenous monetary policy can account for a major portion (and sometimes all) of the effects attributed to oil shocks.
Is the current episode different?
It has also been suggested that the latest jump in oil prices has not had the usual effect on the economy because the price of oil has jumped for different reasons. For example, in the 1970s, the OPEC oil embargo and the fall of the Shah of Iran led to substantial reductions in the world supply of oil; similarly, the world supply fell in 1990 after Iraq's invasion of Kuwait. These seem like exogenous shocks to the world supply.
But much of the run-up in oil prices in the past few years seems to reflect the endogenous response of prices to the strength of global demand. The source of this higher demand turns out to be important. If the higher prices were the result of higher U.S. demand, then there would be little reason to fear a recession. It is hard to believe that the "tax" imposed by the oil price increase would exceed the increase in income that was the cause of the higher oil demand. But if the increase in demand originates abroad, things get more complicated. For instance, high oil prices which reflected rapid growth in China would have the same direct impact on the U.S. as a price increase engineered by OPEC, basically because higher oil consumption in China coupled with a relatively inelastic supply means that less oil is available to the U.S. There is a potential offset to this effect, as more rapid growth in China is likely to be accompanied by higher imports. Thus, countries that export significant amounts to China relative to their size will benefit from the rapid Chinese growth. The U.S. is not one of these countries, however, so that for the U.S. an increase in the price of oil due to higher demand from China is probably similar to an increase due to a reduction in supply.
Our discussion suggests that the answer to the question posed in the title has two parts. First, looking only at the correlation between some measure of the price of oil and output tends to exaggerate the role that oil price shocks played in the recessions of the 1970s, at least partly because one ends up ignoring the other things that were going on at that time. Second, an increase in the price of oil that reflects higher demand will not have the same effect as a decrease in supply. Here, though, it is useful to keep in mind that price increases that reflect higher growth in other countries will have the same effect on the U.S. as price increases that reflect a reduction in the worldwide supply of oil—unless U.S. exports to these fast growing countries account for a significant share of U.S. output.
Nonpartisan Monetary and Fiscal Policy Brokers
Straight With the Numbers, Editorial, Washington Post: When Douglas Holtz-Eakin was named to head the Congressional Budget Office almost three years ago, we were ... a bit jittery. Mr. Holtz-Eakin was going to the nonpartisan budget office from a stint as the White House chief economist, ... Now Mr. Holtz-Eakin is leaving ... and we're sorry to see him go. He has been an honest and clear-thinking director who has resisted political pressures to skew or sugarcoat the difficult policy choices confronting Congress; he's maintained the office's credibility and independence. ... Mr. Holtz-Eakin ... insisted that the president's proposed personal Social Security accounts had a cost that had to be reflected on the books; he disputed administration claims that limiting medical malpractice lawsuits would curb health care costs. When the administration started to crow about falling deficits, Mr. Holtz-Eakin urged that the improvement be taken "with a grain of salt," noting the continuing grimness of the long-term outlook. Mr. Holtz-Eakin's record underlined the value of maintaining at least one nonpartisan broker of budget information in an increasingly partisan town.
I haven't yet figured out exactly how many years Ben Bernanke will have as Fed chair, but when he does retire I hope similar things are written. With regard to the length of his term, does Bernanke's previous time on the Board count against his new term, or will he have a full fourteen years? How does it work legally given that he resigned and Board members cannot be reappointed (unless, like Olson, you are filling an unexpired term for someone else, see here)? Does Bernanke have to resume his previous term? Can a Board member resign after 13 years and 364 days and then be reappointed to a new fourteen year term? Can you take a time-out by resigning and then go back and finish your term later? It's probably all very simple - does anyone know how this will work? Will he have a full fourteen years?
Paul Krugman: A Private Obsession
Brad DeLong: Paul Krugman Keeps on Writing About Health Insurance: Here is today's installment:
A Private Obsession - New York Times: By PAUL KRUGMAN: "Lots of things in life are complicated." So declared Michael Leavitt, the secretary of health and human services, in response to the mass confusion as registration for the new Medicare drug benefit began. But the complexity of the program - which has reduced some retirees to tears as they try to make what may be life-or-death decisions - is far greater than necessary.
One reason the drug benefit is so confusing is that older Americans can't simply sign up with Medicare, as they can for other benefits. They must, instead, choose from a baffling array of plans offered by private middlemen. Why?
Here's a parallel. Earlier this year Senator Rick Santorum introduced a bill that would have forced the National Weather Service to limit the weather information directly available to the public. Although he didn't say so explicitly, he wanted the service to funnel that information through private forecasters instead.
Mr. Santorum's bill didn't go anywhere. But it was a classic attempt to force gratuitous privatization: involving private corporations in the delivery of public services even when those corporations have no useful role to play.
The Medicare drug benefit is an example of gratuitous privatization on a grand scale.
Here's some background: the elderly have long been offered a choice between standard Medicare, in which the government pays medical bills directly, and plans in which the government pays a middleman, like an H.M.O., to deliver health care. The theory was that the private sector would find innovative ways to lower costs while providing better care.
The theory was wrong. A number of studies have found that managed-care plans, which have much higher administrative costs than government-managed Medicare, end up costing the system money, not saving it.
But privatization, once promoted as a way to save money, has become a goal in itself. The 2003 bill that established the prescription drug benefit also locked in large subsidies for managed care.
And on drug coverage, the 2003 bill went even further: rather than merely subsidizing private plans, it made them mandatory. To receive the drug benefit, one must sign up with a plan offered by a private company. As people are discovering, the result is a deeply confusing system because the competing private plans differ in ways that are very hard to assess.
The peculiar structure of the drug benefit, with its huge gap in coverage - the famous "doughnut hole" I wrote about last week - adds to the confusion. Many better-off retirees have relied on Medigap policies to cover gaps in traditional Medicare, including prescription drugs. But that straightforward approach, which would make it relatively easy to compare drug plans, can't be used to fill the doughnut hole because Medigap policies are no longer allowed to cover drugs.
The only way to get some coverage in the gap is as part of a package in which you pay extra - a lot extra - to one of the private drug plans delivering the basic benefit. And because this coverage is bundled with other aspects of the plans, it's very difficult to figure out which plans offer the best deal.
But confusion isn't the only, or even the main, reason why the privatization of drug benefits is bad for America. The real problem is that we'll end up spending too much and getting too little.
Everything we know about health economics indicates that private drug plans will have much higher administrative costs than would have been incurred if Medicare had administered the benefit directly.
It's also clear that the private plans will spend large sums on marketing rather than on medicine. I have nothing against Don Shula, the former head coach of the Miami Dolphins, who is promoting a drug plan offered by Humana. But do we really want people choosing drug plans based on which one hires the most persuasive celebrity?
Last but not least, competing private drug plans will have less clout in negotiating lower drug prices than Medicare as a whole would have. And the law explicitly forbids Medicare from intervening to help the private plans negotiate better deals.
Last week I explained that the Medicare drug bill was devised by people who don't believe in a positive role for government. An insistence on gratuitous privatization is a byproduct of the same ideology. And the result of that ideology is a piece of legislation so bad it's almost surreal.
Another Look at Euro Area Labor Markets
Seeing Europe the right way up, The Economist: ...Europe's performance has been better than the conventional wisdom says. Although America has outpaced Europe this year, over the past five years GDP per head, the best single measure of economic performance, grew at an average rate of 1.4% in the euro area, just behind America's 1.5%. Ah, but America is better at creating jobs, isn't it? Actually, no. Employment has grown a tad faster in the euro area than in America whether one looks at the past five years or the past ten-a striking improvement on the decade to the mid-1990s (see chart).
Since 1996 the proportion of the population of working age with jobs has fallen from 73% to 71% in America; in the euro area it has risen from 59% to 65%. The fact that the euro area has achieved its growth without enormous increases in its current-account and budget deficits might also indicate that its record is more sustainable than America's. This is not to say that everything is rosy in euroland. Far from it. Europe has to cope with a shrinking workforce and an ageing population, as well as fiercer global competition. Europe's markets will have to become more flexible... and its productivity growth must improve. ...
St. Louis Fed President Poole on Tracking Inflation
Tracking Inflation, by William Poole, St. Louis Fed President: ...I have said previously that I favor a goal of zero inflation, properly measured. In practice, because of various statistical problems in measuring prices, that goal translates, approximately, to price changes of something like a 1 percent annual rate of increase in the chain-price index for Personal Consumption Expenditures—the PCE ... for short. In its day-to-day policymaking, the Fed focuses on the core PCE price index, which excludes volatile food and energy prices... On average over time, the total and core indexes change at almost identical rates. Even putting volatile food and energy prices aside, it is not possible to achieve an inflation target precisely year by year; thus, my goal might be stated as a change in the core PCE index of 0.5 to 1.5 percent per year. That range itself needs to be a bit elastic to allow for special circumstances that might be important in a particular year. ... I believe that all of us have in mind inflation goals that are so close one to the other that differences in the goal are not really an issue. However, there is an important issue that I struggle with every time I go to an FOMC meeting: What policy will yield an outcome close to the inflation goal? ...
How does the Fed control inflation as successfully as it does? The Fed extracts as much information as it can from all the data and anecdotal reports available. An important aspect of this work is to track the inflation process—the internal dynamics of the inflation rate. That is my main topic today. ... In a 2005 paper, James Stock and Mark Watson, using data through the end of 2004, conclude:
- that inflation has become “easier” to forecast, in the sense that models have low forecast errors because inflation rates have been low and stable. And
- that inflation has become “more difficult” to forecast in the sense that the contribution to the forecast of variables other than lags of inflation has largely vanished.
On balance, Stock and Watson’s results tell us that “tracking inflation” has become easier than it was a decade ago—because the rate is lower and varies less—but also is more difficult because future inflation is far less sensitive to measures of real economic activity. ... Forecasts presented to the FOMC by its staff combine model-based information with judgment. ... judgment is critically important. Policymakers often have to act “observation by observation,” evaluating incoming data and responding to events. ... Inflation-tracking involves tracking market expectations of inflation and a careful analysis of wage trends, productivity and profit margins. ...
Current Inflation Developments ...I’ll close with a brief discussion of the current inflation environment. Energy prices are the big story. ... To date, it appears that little of the energy price increase has bled over into core inflation. .... My prediction that little of the energy price inflation will bleed into core inflation is based on my belief that inflation expectations are well-anchored and ... that the FOMC has tightened its policy stance considerably. Moreover, the FOMC has a clear commitment to price stability, and that leads me to believe that the Committee will adjust its policy stance in the future as required by incoming information. If new information calls for further tightening—and I emphasize the “if” because I do not have a crystal ball that permits me to predict incoming information—then that is what the FOMC will do. ...[H]igher energy prices are a change in relative prices that will inevitably lead to changes in other relative prices... Energy price increases will affect other prices, at least for the medium-term, but should have little impact on longer-run inflation expectations. ... What are these data saying? ...[T]he ... figures suggest the market has considerable faith in the FOMC’s commitment to price stability. The Survey of Professional Forecasters and the University of Michigan’s Survey of Consumer CPI inflation expectations yield similar results. ...
Putting all these indicators together, core inflation and inflation expectations have been contained, but underlying determinants of inflation suggest caution. Depending on what measure is used, wage change has been about steady or has risen. The profit share of GDP has risen, suggesting that firms have increased pricing power. Fortunately, productivity growth remains robust. ...
[Bloomberg also discusses the speech.]
November 17, 2005
Hal Varian: The Mortgage Interest Deduction Causes Large Distortions in Housing Markets
An Opportunity to Consider if Homeowners Get Too Many Breaks, Economic Scene, by Hal R. Varian: The President's Advisory Panel on Federal Tax Reform struggled long and hard to come up with some economically sensible and politically feasible ways to reform the tax code. ... Some, like simplifying the crazy quilt of tax-deferred savings plans, are relatively noncontroversial. But proposals like eliminating the federal deduction for state and local taxes are much more contentious. ... Certainly the panel's least popular suggestion is to limit the mortgage interest deduction. ... A change of this sort would probably have a significant impact on housing values, particularly at the high end, and therefore would be unpopular with homeowners. Neither party wants to alienate solid middle-class voters, so this suggestion has not been greeted with enthusiasm in Washington.
But many economists would argue ... [i]t would make a lot of sense to eliminate the housing mortgage deduction entirely. ...[H]ousing is highly subsidized in this country and we would probably be better off if the tax treatment of housing were brought more into line with that of other assets. How is housing subsidized? ... First, there is the mortgage interest deduction. Second, the deduction for property taxes. Third, the capital gains exclusion... Fourth, the deduction for points on mortgage loans. Fifth, the deduction ... on home equity loans. And there are many more tax breaks, among them home office deductions. There are also more subtle ways that housing investment is favored by the tax system. The most fundamental subsidy is that homeowners are not taxed on the implicit rent they receive from their housing investment. Think of it this way. Suppose you buy a house outright... If you rent the house out to someone else, you owe tax on the rental payments you receive. If you live in the house, you are effectively renting it to yourself, but no taxes are due on the transaction. ... True, you have to pay a local property tax on your house's value. But property taxes are used to support local services like schools, roads and fire departments, which also enhance the value of a house...
Even if one thinks that homeownership deserves some subsidy, does it really deserve as much as it gets? An excessive subsidy on one asset means that less will be invested in other assets. The money put into building those huge villas on the hillside could have been put into factories, office buildings and schools. Investment in physical capital and human capital makes the economy as a whole more productive, unlike investment in housing.
Given the huge subsidies to housing, it is likely that we as a country have overinvested in this area. Cutting back some of those subsidies would be good economic policy. That being said, I hasten to add that this is unlikely to happen anytime soon. ... The housing tax subsidy has been built into housing prices ... and cutting back could lead to painful capital losses on home values. If you give a lollipop to a baby, it may make him smile, but you will pay dearly for that smile if you try to take the candy away. The best thing to do is to distract the baby with other sweets, while you gradually extricate the lollipop from that sticky hand. That is pretty much what the tax panel has proposed: it offers reduced tax rates on other forms of investment, along with the mortgage interest credit, to make cutting housing subsidies less painful. Carefully tuned policies of this sort may be a politically palatable way to reduce housing subsidies. But I'm not holding my breath.
Sharing the Costs and Benefits of Economic Growth
Transcript from Washington Post: Laurel, Md.: One thing that's always bothered me about "pro-growth" economics as usually considered (i.e. from the right-wing) is that they seem to think that measuring the GDP captures every aspect of our well-being; so that any money diverted out of the private economy and spent for the public good reduces our standard of living. Lots of things government does admittedly reduces economic growth. But economic libertarians don't seem to understand that the benefits of building bridges, operating parks and libraries, regulating pollution or vaccinating children benefit us in ways that aren't measured by GDP. ... Does your book address ways we can get people to see the things that aren't counted in the GDP? Gene Sperling: My book does not go into trying to come up with a new definition of GDP that might include more quality of life issues, but it does do related things. One, ... the book is based on the notion that the type of growth we aspire for ... is shared growth .... This is particularly relevant right now, because GPD and productivity has been solid in the recent years, and yet .... [w]eekly wages for example have fallen ... Another premise of the book is that ... it will hurt our nation if we get stuck in the outdated, ideological view that less government is always better for growth. ... One of the important points is that many of the things you mention in your question are clearly good for growth - it is just that they pay-off over a longer period of time, and a wise nation would be smart to invest in them.
Saint Louis, Missouri: How is it possible for a nation that created such a strong infrastructure of "looking out for each other" as a way of life lost that perspective? We ... are currently in the process of destroying the middle class and returning to the extremes of the landed and servant class. Gene Sperling: ...[W]hen it comes to economic change and globalization we have a real cost-sharing crisis. The benefits -- lower prices, innovation, more choices -- are shared broadly, but the costs are concentrated sometimes very harshly on random communities and workers. Despite this our system for helping families during severe dislocations is pretty pathetic. You could go to any city in the US and know how to instantly find the movies, a pizza, or a one-stop mega store - but at the moment a breadwinner loses a job that threatens ... economic security -- hardly anyone knows where to go and what to do. ...
Arlington, Va.: How would you characterize the economic policies you advocate in your book? Do you consider yourself "new-Keynesian"? Gene Sperling: I have never put that type of label on myself ... What I want to make clear is the following: some people have misunderstood the Clinton economic team as rejecting basic Keynesian economics. Not the case. ...
Philadelphia, Penn.: How will we be able to implement effective job training? ... Gene Sperling: This is an important question. Right now some just want to say that retraining have not been effective enough and wash their hands of it. That would be a very counter-productive and defeatist attitude. One thing I do think is that we have to get more serious about ongoing education -- not just after you have lost a job...
Washington, D.C.: What do you think the most pressing economic issue is right now and why? Gene Sperling: ...Let me answer this way: I think the paramount economic challenge of this era will be to ensure that the process of globalization leads to a strengthened middle class... If you are super-educated you are okay: if your job has to be done here you are okay: but how we keep creating new strong middle class jobs when so many that are now in the middle are contestable by global labor markets ...
Cincinnati, Ohio: Is the good "lunch pail" job a thing of the past? ... jobs with great benefits and head of household incomes that permitted a middle class existence to the skilled but non-degreed worker. What's the outlook for the generation coming out of high school now? Gene Sperling: The fact of the matter is many manufacturing jobs are under fire right now. ... But that doesn't mean that manufacturing can't be viable or that people working in manufacturing now, who lack a degree cannot succeed. It is true that there are some trade issues - like China currency undervaluation that should be dealt with -- but in the long run the key is moving both the manufacturing sector and its workers to the cutting edge. ...
George Will on Rent-Seeking in Politics
Grand Old Spenders, by George F. Will, Washington Post: The storm-tossed and rudderless Republican Party should particularly ponder the vote last week in Dover, Pa., where all eight members of the school board seeking reelection were defeated. This expressed the community's wholesome exasperation with the board's campaign to insinuate religion, in the guise of "intelligent design" theory, into high school biology classes, beginning with a required proclamation that evolution "is not a fact." But it is. And President Bush's straddle on that subject -- "both sides" should be taught -- although intended to be anodyne, probably was inflammatory, emboldening social conservatives. Dover's insurrection occurred as Kansas's Board of Education, which is controlled by the kind of conservatives who make conservatism repulsive to temperate people, voted 6 to 4 to redefine science. ... "It does me no injury," said Thomas Jefferson, "for my neighbor to say there are twenty gods, or no God. It neither picks my pocket nor breaks my leg." But it is injurious, and unneighborly, when zealots try to compel public education to infuse theism into scientific education. The conservative coalition, which is coming unglued for many reasons, will rapidly disintegrate if limited-government conservatives become convinced that social conservatives are unwilling to concentrate ... on the private institutions that mediate between individuals and government, and instead try to conscript government into sectarian crusades.
But, then, the limited-government impulse is a spent force ... most Republicans are moderates as that term is used by persons for whom it is an encomium: Moderates are people amiably untroubled by Washington's single-minded devotion to rent-seeking -- to bending government for the advantage of private factions. ... Gerard Alexander of the University of Virginia ... says: "Perhaps conservatives were naive to expect any party, ever, to resist rent-seeking temptations when in power. ..." Perhaps. But if so, limited-government conservatives will dissociate from a Republican Party more congenial to overreaching social conservatives. Then those Republican congressional caucuses will be smaller, and Republican control of the executive branch will be rarer.
I'm not sure I would ascribe the main problem to "Moderates ... untroubled by Washington's single-minded devotion to rent-seeking." I think politicians would change in an instant to protect their power if they felt this behavior would hurt them at the ballot box, so I think voters bear some responsibility. But others don't always agree that is a big factor in explaining the burgeoning deficit and other government behavior. The bridge to nowhere, now eliminated is perhaps one example, though it is noted that Alaska still gets the money and is fully free to build a bridge to nowhere else.
An Echo of Black Holes, Scientific American (sub.): When Albert Einstein proposed his special theory of relativity in 1905, he rejected the 19th-century idea that light arises from vibrations of a hypothetical medium, the “ether.” Instead, he argued, light waves can travel in vacuo without being supported by any material—unlike sound waves, which are vibrations of the medium in which they propagate. This feature of special relativity is untouched in the two other pillars of modern physics, general relativity and quantum mechanics. Right up to the present day, all experimental data, on scales ranging from subnuclear to galactic, are successfully explained by these three theories. Nevertheless, physicists face a deep conceptual problem. As currently understood, general relativity and quantum mechanics are incompatible. Gravity, which general relativity attributes to the curvature of the spacetime continuum, stubbornly resists being incorporated into a quantum framework. Theorists have made only incremental progress toward understanding the highly curved structure of spacetime that quantum mechanics leads them to expect at extremely short distances. Frustrated, some have turned to an unexpected source for guidance: condensed- matter physics, the study of common substances such as crystals and fluids. Like spacetime, condensed matter looks like a continuum when viewed at large scales, but unlike spacetime it has a well understood microscopic structure governed by quantum mechanics. Moreover, the propagation of sound in an uneven fluid flow is closely analogous to the propagation of light in a curved spacetime. By studying a model of a black hole using sound waves, we and our colleagues are attempting to exploit this analogy to gain insight into the possible microscopic workings of spacetime. The work suggests that space time may, like a material fluid, be granular and possess a preferred frame of reference that manifests itself on fine scales— contrary to Einstein’s assumptions. ... If so, ... [t]he unification of general relativity and quantum mechanics may lead us to abandon the idealization of continuous space and time and to discover the “atoms” of spacetime. Einstein may have had similar thoughts when he wrote to his close friend Michele Besso in 1954, the year before his death: “I consider it quite possible that physics cannot be based on the field concept, that is, on continuous structures.” But this would knock out the very foundation from under physics, and at present scientists have no clear candidate for a substitute. Indeed, Einstein went on to say in his next sentence, “Then nothing remains of my entire castle in the air, including the theory of gravitation, but also nothing of the rest of modern physics.” Fifty years later the castle remains intact, although its future is unclear. Black holes and their acoustic analogues have perhaps begun to light the path and sound out the way.
November 16, 2005
The CPI Report
If you can only read one of the three, that is unfortunate, but if so, read the first one on the list. For news reports (I'd still recommend reading the post at macroblog first) go to The Washington Post, NY Times, CNN/Money, and Bloomberg.
Senate Panel Approves Bernanke's Nomination
Senate Panel Approves Bernanke for Fed, by William Branigin, Washington Post: The Senate Banking Committee today approved the nomination of top White House economic adviser Ben S. Bernanke to be the next chairman of the Federal Reserve, recommending his confirmation to the full Senate. ... The 20-member committee approved the nomination by a voice vote in executive session, with only one dissenting "nay." The lone opponent was Sen Jim Bunning (R-Ky.), a Greenspan critic who complained that Bernanke has not demonstrated independence from the outgoing Fed chairman. ...[E]ight Republicans and six Democrats ... were present for the vote ... The nomination now goes to the full Senate for a vote that has not yet been scheduled. Bernanke ... is expected to win easy confirmation.
Effective Marginal Tax Rates on Labor Income
- Provisions of tax law, such as the different tax rate brackets and the phasing in and out of various credits and deductions, interact with taxpayers’ individual characteristics to create a wide range of effective marginal tax rates on labor income. Moreover, marginal rates can vary substantially for taxpayers with comparable incomes...
- In terms of federal individual income taxes, most taxpayers face effective marginal rates of 15 percent or less. Less than one-fifth face rates of more than 25 percent, and about 7 percent of taxpayers face rates in excess of 30 percent. Taxpayers who are subject to higher rates tend to be disproportionately high earners: the one-15th of taxpayers with marginal rates above 30 percent account for one-fifth of total earnings, whereas the two-thirds with marginal rates of 15 percent or less account for just one-third of earnings.
- Payroll taxes and state income taxes significantly raise effective marginal rates. For example, the median marginal federal income tax rate is 15 percent, but the median rate including payroll and state income taxes is more than twice as high: 31.6 percent. (Payroll taxes account for most of the difference.)
- If tax provisions enacted in 2001, 2003, and 2004 expire as scheduled over the next five years, marginal rates will increase across most of the income distribution. Compared with a fully phased-in version of existing law, expiration would raise effective marginal tax rates by an average of almost 3 percentage points. Roughly half of taxpayers would face higher marginal rates; most other taxpayers would see no change in their marginal rates.
Here's a graph of marginal and average effective tax rates broken down by income:
Here's another graph showing how the 3% average increase in taxes mentioned in the summary would be distributed if the 2001, 2003, and 2004 tax provisions are not extended:
Interesting. The graphs pretty much speak for themselves so I think I'll leave it at that.
Explicit Inflation Targets and Flexibility
Inflation Targets and Inflation Targeting, by Fed Governor Laurence Meyer: Retaining Flexibility with the Dual Mandate The key issue for me is whether setting an explicit inflation target would reduce the flexibility of policymakers to pursue a dual mandate and select the preferred point along the tradeoff between output and inflation variability. ... Specifically, would implementing an explicit inflation target inevitably also raise the response parameter on the inflation gap relative to that on the output gap? In my view, the answer is that this need not be the case, but I agree that there is some risk of this outcome. It seems to me, however, that it is less likely if the move to an explicit inflation target is taken in the context of a reaffirmation of the dual mandate.
Quoting Bernanke in his opening statement today on implementing explicit inflation targets:
I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment.
Chicago Fed's Moskow: U.S. Economic Outlook
- GDP is somewhat above potential growth
- Much of the slack in the economy has been eliminated
- There are two risks to growth, a slowing of the housing market and high energy prices
- He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
- He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
- Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward
The bottom line for policy: It will likely entail further removal of accommodation (code for rates are going up), and if expectations of inflation show signs of increasing, a stronger response may be needed. But like other recent speeches, there does seem to be the sense that an end is in sight even if the timing is not yet clear. Note also the key phrase "As we move into 2006 and try to determine whether we have removed enough accommodation..." implies a rate increase in December is fairly certain in his mind:
U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: Over the last two years real Gross Domestic Product has been growing an average of 3.7 percent each year. This is somewhat faster than potential, or the rate of GDP growth that can be sustained without creating inflation pressures. ... [M]uch of the slack has been eliminated. The unemployment rate has fallen to 5 percent; ... a level ... roughly consistent with an economy operating at potential. In addition, the capacity utilization rate in manufacturing is only slightly below its historical average. This indicates that there may be some slack remaining in manufacturing, but probably not much. Finally, core inflation has changed little in recent months. Currently we're not seeing the kinds of disinflationary forces that would be associated with a substantial degree of resource slack ... As we move into 2006 and try to determine whether we have removed enough accommodation, the FOMC will have to answer two critical questions: One, will the economy continue growing near its potential? And, two, will there be persistent pressures on core inflation? ... Abstracting from the effects of the storms, current economic growth appears to be self-sustaining because the underlying economic fundamentals continue to be sound. ... According to the Blue Chip consensus, GDP is expected to grow by 3.5 percent in 2005 and by 3.3 percent in 2006—numbers on the high side of recent estimates for potential. ... While this forecast is good, there certainly are risks. One relates to home prices. ...[M]any analysts warn that housing is overvalued. ... I am starting to hear more anecdotes ... and seeing more reports that home prices are increasing at a slower rate. If housing does prove to be overvalued and home prices fall, residential construction would be adversely affected. But history suggests that the impact on overall consumer spending would be more modest. Moreover, the changes in wealth ... likely would be gradual. ...[I]t seems likely that these gradual aggregate changes would allow time for any appropriate recalibration of policy... But, it's far from certain what will happen to home prices. ... Another risk to the outlook relates to energy prices. ... Higher energy prices have had some effect on growth in the U.S., but to date, it's been relatively modest. ... [because] solid productivity growth and accommodative monetary policy have offset some of the negative effect of rising oil prices. ..., the increase in crude prices, after adjusting for inflation, is smaller than during the 1970s, and the level remains well below the peak reached in 1980 ..., [a]nd ..., the U.S. economy is less dependent on oil today. ...
In addition to the risk to growth, rising energy prices are a risk to the outlook for inflation. ... The latest reading of the core price index for personal consumer expenditures, the Fed's preferred measure of inflation, shows an increase of 2 percent over the last 12 months. This is at the upper end of the range that I feel is consistent with price stability. One question about inflation is whether businesses will pass through the recent increases in energy costs to the prices ... [U]nless energy costs continue to rise, such pass-through would just result in a one-time increase in prices and a temporary spike in the core inflation rate, not a sustained higher rate of core inflation. ... Furthermore, although energy prices are still high, they have been falling recently... There is another worry however. If we indeed start to see a string of higher inflation numbers, then people may begin to expect permanently higher inflation. Such expectations could become self-fulfilling ... And this would have adverse effects on longer term economic performance. Fortunately, current financial market data and consumer surveys suggest that long-run inflation expectations remain contained. Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations well contained. For me, at this time such policy likely entails further removal of policy accommodation. And if inflation expectations did become unhinged, this might require a stronger response. ...
Asset Prices and The Great Moderation
Asset Price Levels and Volatility: Causes and Implications, by Fed Vice Chairman Roger W. Ferguson: The variability of real activity and inflation in the United States has declined substantially since the mid-1980s--a development often termed the Great Moderation. ... [T]he decline does not appear to be the result of a long-term downward trend but appears to conform more to a structural break around the mid-1980s. The moderation is substantial: The standard deviation of the quarterly growth rate of real gross domestic product from 1985 to 2004 ... is only about one-half its standard deviation from 1960 to 1984. ... A variety of explanations for this Great Moderation have been put forth, ... First, the U.S. economy might have been lucky, ... Another explanation is that firms may have adopted information technologies that allow them to more efficiently manage their inventories ... Better conduct of monetary policy could also lead to lower inflation and economic volatility ... Finally, financial innovations, such as risk-based loan pricing and expanded securitization, may have enhanced the ability of households to borrow, which would make them less sensitive to fluctuations in income... Importantly, equity valuation ... has been higher in the past two decades than in the two decades before that. ... The rise in equity valuations at the same time that macroeconomic volatility fell is circumstantial evidence of a link between the two. ...
Does volatility of real activity affect the level of asset prices? ... [A]lthough the data are suggestive, tests based on asset pricing models have not firmly established an empirical link between reduced macroeconomic volatility and higher asset prices. ... A more concrete finding is that the decline in macroeconomic volatility has not led to a decline in asset price volatility. ... Rather, existing research suggests that asset price volatility remains largely a reflection of variation in investors' discount rates rather than of changes in forecasts of fundamentals. On a micro level, financial innovations and new types of market participants appear to have led to greater market efficiency and liquidity. ...
The second speech is by Governor Olson and discusses the development and unification of the payments system within the U.S. and where it is headed in the future. If you are interested in this topic, there is a lot of useful information and detail in the linked speech:
Perspectives on the Development of a Unified National Payments System in the United States, by Fed Governor Mark W. Olson: ...This morning, I would like to discuss the development of a unified national payments system, or single payments area, in the United States. I will sketch the foundations of the contemporary U.S. payments system and remark on the history of U.S. banking. ... I will then discuss some of the challenges in the U.S. experience, as well as some thoughts on the future of the U.S. payments system. The overarching theme of my remarks is that the United States has evolved toward an increasingly unified national payments system, through both market-driven development and some specific public-sector actions. ...
References from Ferguson Speech:
- Ahmed, S., A. Levin, and B. Wilson, 2004, "Recent U.S. Macroeconomic Stability: Good Policies, Good Practices, or Good Luck?" Review of Economics and Statistics 86 (3), 824-832.
- Bansal, R., and A. Yaron, 2004, "Risks for the Long-Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, 59(4), 1481-1509.
- Bekaert, G., E. Engstrom, and Y. Xing, 2005, "Risk, Uncertainty, and Asset Prices," FEDS Working Paper 2005-40, Board of Governors of the Federal Reserve System.
- Blanchard, O. J., 1993, "Movements in the Equity Premium," Brookings Papers on Economic Activity, 2, 75-138.
- Campbell, J., and J. Cochrane, 1999, "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, 107, 205-251.
- Campbell, S., 2005, "Stock Market Volatility and the Great Moderation," FEDS Working Paper 2005-47, Board of Governors of the Federal Reserve System.
- Clarida, R., J. Gali, and M. Gertler, 2000, "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," Quarterly Journal of Economics, 115(1), 147-180.
- Dynan, K., D. Elmendorf, and D. Sichel, 2005, "Can Financial Innovation Help to Explain the Reduced Volatility of Economic Activity?" Journal of Monetary Economics, forthcoming.
- Kahn, J. A., M. M. McConnell, and G. Perez-Quiros, 2002, "On the Causes of the Increased Stability of the U.S. Economy," Federal Reserve Bank of New York, Economic Policy Review, 8 (1), 183-202.
- Kim, C., and C. Nelson (1999), "Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle," Review of Economics and Statistics, 81(4), 608-616.
- Kim, D. H., and J. H. Wright (2005), "An Arbitrage-Free Three-Factor Term Structure Model and the Recent Behavior of Long-Term Yields and Distant-Horizon Forward Rates," FEDS Working Paper 2005-33, Board of Governors of the Federal Reserve System.
- Lettau, M., S. Ludvigson, and J. Wachter, 2005, "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?" paper presented at the Federal Reserve Board conference on Financial Market Risk Premiums: Time Variation and Macroeconomic Links, July 21.
- McConnell, M. M., and G. Perez-Quiros, 2000, "Output Fluctuations in the United States: What Has Changed Since the Early 1980s?" American Economic Review, 90 (5), 1464-1476.
- Pritsker, M., 2005, "Large Investors: Implications for Equilibrium Asset Returns, Shock Absorption, and Liquidity," FEDS Working Paper 2005-36, Board of Governors of the Federal Reserve System.
- Romer, C., and D. Romer, 2002, "The Evolution of Economic Understanding and Postwar Stabilization Policy," (439 KB PDF) in Rethinking Stabilization Policy. Kansas City: Federal Reserve Bank of Kansas City, 11-78.
- Stock, J., and M. Watson, 2002, "Has the Business Cycle Changed and Why?" in M. Gertler and K. Rogoff, eds., NBER Macroeconomics Annual. Cambridge, Mass: National Bureau of Economic Research.
November 15, 2005
Ben Bernanke's Opening Statement
- Continuity from Greenspan
- Maintaining independence and non-partisanship
- Long-term price stability as an important goal
- Flexibility as reflected, e.g., in the risk management approach
- Explicit inflation targets, but he won't move in that direction immediately or without a broad consensus
- Maintaining stability and equity in financial markets
Statement of Ben S. Bernanke before the Committee on Banking, Housing, and Urban Affairs United States Senate November 15, 2005:... I recently testified before this Committee in my capacity as Chairman of the President’s Council of Economic Advisers. Today, however, I appear before this Committee in a different capacity, as the President’s nominee to lead the Federal Reserve System. In this prospective new role, I would bear the critical responsibility of preserving the independent and nonpartisan status of the Federal Reserve--a status that, in my view, is essential to that institution’s ability to function effectively and achieve its mandated objectives. I assure this Committee that, if I am confirmed, I will be strictly independent of all political influences and will be guided solely by the Federal Reserve’s mandate from Congress and by the public interest.
With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority. ... First, central bankers in the United States and around the world have come to understand that ensuring long-run price stability is essential for achieving maximum employment and overall economic stability. In recent decades, the variability of output and employment has decreased markedly, and recessions have been less frequent and less severe. ... If I am confirmed, I am confident that my colleagues on the Federal Open Market Committee (FOMC) and I will maintain the focus on long-term price stability ...
Second, monetary policy at the Fed has been executed with both careful judgment and flexibility. ... Chairman Greenspan’s risk-management policy approach ... approach requires sophisticated judgments about possible risks to the economy as well as the flexibility to respond quickly to new information or unexpected developments. Risk analysis of this type is a necessary component of successful monetary policymaking. ... Monetary policy is most effective when it is as coherent, consistent, and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.
Finally, under Chairman Greenspan, monetary policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support. ... One possible step toward greater transparency would be for the FOMC to state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long-term price stability ... I have supported this idea in my academic writings and in speeches as a Board member. Providing quantitative guidance about the meaning of “long-term price stability” could have several advantages, including further reducing public uncertainty about monetary policy and anchoring long-term inflation expectations even more effectively. ... I assure this Committee that, if I am confirmed, I will take no precipitate steps in the direction of quantifying the definition of long-run price stability. This matter requires further study at the Federal Reserve as well as extensive discussion and consultation. I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment.
My comments so far today have focused on monetary policy. Of course, the Federal Reserve’s responsibilities extend well beyond this area. Since its founding, the Federal Reserve has been given substantial responsibility for protecting the stability of the nation’s financial system, which is a precondition for stability of the broader economy. ... If I am confirmed, I will work to enhance the stability of the financial system and to ensure that the resources, procedures, and expertise are in place as needed to respond to any threats to stability that may emerge. The Federal Reserve, along with other regulators, is also engaged in trying to ensure that consumers are treated fairly in their financial dealings: that their privacy is protected, that they receive clear and understandable information about the terms of financial agreements, and that they are not subject to discriminatory or abusive lending practices. ... These are important responsibilities and, if I am confirmed, I will give them my close attention and active support. ...
Let me conclude by offering special thanks to Chairman Greenspan for his collegiality and support ... One may aspire to succeed Chairman Greenspan but it will not be possible to replace him...
King Kong vs. Godzilla
SciAm Observations: King Kong vs. Godzilla: First came a new report on Gigantopithecus, a huge prehistoric ape that inevitably invites comparisons to King Kong because of the imminent release of the film remake by the same name. And now comes the discovery of Dakosaurus andiniensis, a monstrous species of 135-million-year-old aquatic crocodile that has been nicknamed "Godzilla." The synchronicity of these reports can mean only one thing:
People of Tokyo, run for your lives.
Gigantopithecus, the largest known primate that ever lived, has always been the beast that cryptozoologists have claimed as the prototype for Bigfoot, the Yeti and similar humanoid giants of folklore. The recent work by Jack Rink of McMaster University doesn't lend any additional credibility to the existence of those creatures, but it does seem to confirm that humans and Gigantopithecus coexisted in Southeast Asia as recently as 100,000 years ago.
Dakosaurus was truly a sea monster, measuring 13 feet long. Of course, some modern crocodiles exceed that length, and this size pales beside the 40-foot crocodilian called Sarcosuchus imperator. What makes Dakosaurus remarkable is that, unlike its known cousins, it has a short, blunt muzzle full of serrated teeth rather than a thin snout of sharp but unspecialized teeth. Think of it, loosely speaking, as a Tyrannosaurus head stuck onto a crocodile body. As this article from National Geographic notes:
The animal's unusual features suggest that it had completely different feeding habits from its relatives. While other marine crocs fed on small fish, Dakosaurus hunted for marine reptiles and other large sea creatures, using its jagged teeth to bite and cut its prey.
"The most perplexing thing about the animal is that its head shape does not appear to be well suited to a fast swimming crocodilian, because rather than being streamlined, it is somewhat high and flattened from side to side," said Clark, who was not involved with the research.
"Presumably it moved its head mainly up and down rather than sweeping it from side to side, like fish-eating crocodilians."
So, a thoroughly nasty beast.
In the laughable Japanese monster flick King Kong vs. Godzilla, when those two rubber-suit gargantuas clashed, the ape was the hero who saved the day from the villainous reptile. (It figures; a mammal directed that picture.) But if, through the miracle of time travel and reality TV, Dakosaurus were ever to fight Gigantopithecus--vicious sea carnivore against oversized herbivore--then in my opinion, it's no contest. Godzilla takes it in the second round.
Posted by Mark Thoma on Tuesday, November 15, 2005 at 02:06 AM in Science
Taking Better Aim at Overshooting?
New Economist: Dornbusch's overshooting hypothesis revisited: ...Rudiger Dornbusch’s (1976) well known exchange rate overshooting states that the nominal exchange rate immediately appreciates with the increase in nominal interest rates, in line with uncovered interest parity (UIP). The problem is, many recent studies suggest otherwise. As Hilde C. Bjørnland of the University of Oslo writes:
Instead they have found that following a contractionary monetary policy shock, the real exchange rate either depreciates, or, if it appreciates, it does so for a prolonged period of up to three years, thereby giving a hump-shaped response that violates UIP. These results have been so persuasive that the puzzles themselves are now about to be considered consensus, of which many recently developed DSGE models seek to replicate.
In Norges Bank working paper 2005/11, Monetary policy and the illusionary exchange rate puzzle, she argues there is a major problem with ...[the] models used. They ignore the immediate effects of a monetary shock on the exchange rate... [T]he Dornbusch hypothesis can be reconciled with the empirical data if one "...leaves the contemporaneous relationship between the interest rate and the exchange rate unaltered". ...
Allowing for full simultaneity between monetary policy and the exchange rate, I find striking results; Contrary to the recent “consensus”, a contractionary monetary policy shock has a strong effect ... consistent with the Dornbusch overshooting hypothesis. Furthermore, the ensuing movement of the exchange rate is with few exceptions consistent with UIP. Hence, I have found no evidence of the typical hump-shaped response found in the empirical literature...
The Grass is Always Greener at Home ... But I'm Biased
Stability and Economic Growth: The Role of the Central Bank, by Fed Chair Alan Greenspan: International finance presents us with a number of intriguing anomalies, but the one that seems to bedevil monetary policy makers the most as they seek stability and growth ... is the seemingly endless ability of the United States to finance its current account deficit. To date, despite a current account deficit exceeding 6 percent of our gross domestic product (GDP), we ... are experiencing few difficulties in attracting the foreign saving required to finance it... Of course, deficits that cumulate to ever-increasing net external debt ... cannot persist indefinitely. At some point investors will balk at further financing. ...
In all instances, a current account balance is essentially the product of a wide-ranging interactive process ... To the extent that an economy harbors elements of inflexibility, so that prices and quantities are slow to respond to new developments, the deficit-adjustment process is likely to adversely affect the levels of output and employment. ... The rise of our deficit and our ability to finance it appears to coincide with ... a major acceleration in U.S. productivity growth and the decline in what economists call home bias, the parochial tendency to invest domestic savings in one's home country. ...[S]tarting in the 1990s home bias began to decline discernibly. ... The decline in home bias reflects a number of recent factors that ... lessen restraints on cross-border financial flows as well as on trade in goods and services. ... [T]he advance of information and communication technologies has effectively shrunk the time and distance that separate markets around the world. ... Technological innovation and ongoing deregulation and tariff reductions have driven the globalization process by ... lowering the cost of transacting across borders. The effect of these developments has been to markedly increase the willingness and ability of financial market participants to reach beyond their national borders to invest in foreign countries...
The decline in home bias has clearly enlarged sources of finance for the United States. ... How much further home bias can decline is obviously conjectural, ... Federal Reserve staff studies indicate that ... U.S. and foreign portfolios still exhibit marked home bias. ... Presumably, well before the practical lower limits of home bias are reached, effective constraints on deficit funding, and hence on the deficit itself, are likely to come from foreign investors' fear of portfolio concentrations of claims on the residents and government of the United States. Concentration and other risks in holding dollar balances seem to have become a consideration at least for some investors. ... What could be the potential consequences should the dollar's status as the world's reserve currency significantly diminish...? Most analysts would contend that U.S. interest rates were lowered by the world's accumulation of dollars. Accordingly, in the event of a significant diminishing of the dollar's reserve currency status, U.S. interest rates would presumably rise. ...
[T]here are ... lessons to be learned from the experience of sterling as it faded as the world's dominant currency. ... Many wartime controls were maintained ... immediately after World War II. ... The experience of Britain's then extensively regulated economy provides testimony to the costs of structural rigidity in times of crisis. Any diminution of the reserve status of the dollar ... is likely to be readily absorbed by a far more flexible U.S. economy than existed in Britain immediately following World War II. ... Governments today ... are rediscovering the benefits of competition and ... beginning to recognize an international version of Smith's invisible hand in the globalization of economic forces. ... We appear to be revisiting Adam Smith's notion that the more flexible an economy, the greater its ability to self-correct after inevitable, often unanticipated disturbances. ... Being able to rely on markets to do the heavy lifting of adjustment is an exceptionally valuable policy asset. The impressive performance of the U.S. economy over the past couple of decades ... offers the clearest evidence of the benefits of increased market flexibility. ...
Flexibility is most readily achieved by fostering an environment of maximum competition. A key element in creating this environment is flexible labor markets. Many working people equate labor market flexibility with job insecurity. Despite that perception, flexible labor policies appear to promote job creation. An increased capacity of management to discharge workers without excessive cost, for example, apparently increases companies' willingness to hire without fear of unremediable mistakes. ... Protectionism in all its guises ... does not contribute to the welfare of workers. At best, it is a short-term fix for a few workers at a cost of lower standards of living for a nation as a whole. Increased education and training for those displaced by creative destruction is the answer, not a stifling of competition. ...
See Kash at Angry Bear for more comments. I would also add that sometimes government intervention is required to make markets work. Does anyone doubt that the protection of property rights by the government is necessary for markets to flourish? It's hard to bring goods to market if they are stolen along the way. Monopolies are easy to create if the most powerful can block the gates to the market. Governments and other institutions make markets work in both obvious and subtle ways, a lesson learned most recently by formerly socialist countries attempting to transform to market economies. As we go down the path to less government regulation, a path justified in most cases, we should be careful not to undermine rather than promote competition.
Is High European Unemployment Due to Labor Market Rigidities?
Unemployment, Inequality and the Policy of Europe: 1984-2000, by James K. Galbraith and Enrique Garcilazo, UTIP WP 25: Abstract: This paper reconsiders the problem of unemployment in Europe ... We employ a panel structure that permits us to separate regional, national and continental influences on European unemployment. Important local effects include the economic growth rate, relative wealth or poverty, and the proportion of young people in the labor force. ... [W]e find that higher pay inequality in Europe is associated with more, not less, unemployment, and the effect is stronger for women and young workers. ... [D]istinctive effects at the national level are few, perhaps indicating that national labor market institutions are not the decisive factor in the determination of European unemployment. Changes in the European macro-environment are picked up by time fixed effects, and these show a striking pan-European rise in unemployment immediately following the introduction of the Maastricht Treaty, though with some encouraging recovery late in the decade.
I. Introduction ...[T]he literature on unemployment in Europe tends to concentrate on national characteristics and national unemployment rates. The predisposition is to blame unemployment on labor market “rigidities” -- and then to search for particular culprits, generally in the fields of national unemployment insurance, job protections, and wage compression. Periodic movements to reform national labor markets sweep aside the careful qualifications found in empirical work such as Nickell (1997) and Blanchard and Wolfers (1999), and presuppose that greater wage flexibility is the established cure for European unemployment. ... In a recent paper, Baker, Glyn, Howell and Schmitt (2002) provide a comprehensive review of the national-institutions approach to explaining European unemployment. They find only one robust result, namely that coordinated collective bargaining and (perhaps) union density are associated with less unemployment in Europe. Of course, this interesting finding is inconsistent with the rigidities framework. ...
In this paper, we try a different approach. Instead of the nation, our smallest unit of analysis is the region. ... We specify just four regional “labor market” variables that, we find, account significantly for the variation in regional unemployment rates. ... We identify two regional factors that influence the demand for labor. First is the strength of economic growth at any given time – an obvious determinant of construction and investment jobs, and a consequence of the local effects of macroeconomic policies and regional fiscal assistance. The second is a measure ... of the average wage rate of the region relative to the average for Europe as a whole. Our thinking is that regions with higher average wages should tend to have stronger tax bases, more public employment, and also more open (and therefore taxed) employment in services. On the supply side, we also identify two factors. The first is the relative size of the population of very young workers – an obvious measure of the difficult-to-employ. The second is a measure of the inequality of the wage structure. To acquire this measure, we construct, for the first time, a panel of European inequalities at the regional level, comparable both across countries and through time.
Our hypothesis that regional pay inequalities should be placed on the supply side of the labor market is an innovation. ... [I]n this analysis we take the regional wage structure as a datum facing individual workers. We consider that this datum affects how long they choose to search for employment. The greater the differential between high and low-paid jobs in the local setting, the longer a rational person will hold out for one of the better jobs, accepting unemployment if necessary. This theoretical position is well-known in neoclassical development economics, ... The general concept, that inequality creates an incentive to search, has not been applied to Europe or to any developed-country setting so far as we know. But there is no compelling reason why it should not be. In practice, we find that pay inequality is a strong determinant especially of cross-sectional variation in European unemployment, ...
The time effects are striking for all population groups. They show a sharp rise in unemployment common to all regions beginning in 1993. This is an interesting break-point in view of the introduction of the Maastricht Treaty on European Union at the start of that year. The effect continues through the 1990s, and suggests that a substantial part of European excess unemployment – generally between two and three percentage points–reflects policy conducted at the European level since the Union. In this regard, the monetary policy of the European Central Bank and the convergence criteria for the Euro come to mind as leading suspects.
November 14, 2005
Not So Transparent Reasons for Discontinuing M3
Discontinuance of M3: On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.
Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).
The Big Picture has been tracking this story closely and it was through a post at that site that I first became aware of this notice (he was kind enough to quote me in his latest). My assumption is that the Fed believes this is no longer an informative aggregate and has decided that its potential to confuse by sending misleading signals outweighs its value.
Unfortunately, the Fed has been silent about its reasons for the discontinuance and that is my biggest complaint. This is not how transparency works. There are all sorts of conspiracy stories about (e.g. the Fed wants to hide the rapid growth of liquid assets so it's burying the information) and all the confusion could have been easily avoided by a simple explanation for the discontinuance posted on the Fed's web site. If it's there, I couldn't find it.
I am waiting to hear more on this decision from our newly transparent Fed, and as I find out more about the Fed's reasons I will update this post. William Polley has indicated he will post on this later as well. [Update: Institutional Economics also comments. Prudent Investor has lots to say as well. Graphs of M1, M2, and M3.]
[Update: David Altig at macroblog comments and is unconcerned.]
Fed Watch: Headed for More of the Same
I believe this is something of a dangerous time for a Fed watcher. At the moment, the data and Fedspeak can be described as “monotonous” – it consistently points to higher rates, as dutifully reported by David Altig. The danger here is twofold. One is that the Fedwatcher gets complacent and fails to recognize shifts in sentiment at the Fed or in the economy. Two, that in the need to feel like they are doing something new, he/she begins predicting the inevitable pause. I have committed the first sin in the past, and came, in my opinion, close to committing the second in my last post.
Little has come to my attention in the past couple of weeks to change my underlying outlook – the Fed will continue to raise rates until they see a clear shift in real activity. In this case, “clear” means “evident in the data,” not anecdotal evidence (I will comment on housing later in this piece).
We are not seeing such clear data. The 3rd quarter GDP report was strong enough to keep the Fed on path, not withstanding the likely push and pull from revisions due to the September inventory and trade reports. And while commentators such as Kash at Angry Bear have highlighted some weaknesses in the employment repots, the Fed will respond to the payroll weakness as hurricane distorted data, while the wage gains will be interpreted as signs of incipient inflation pressures. That is the interpretation that Fedspeak leads us to.
To be sure, inflation expectations appear to be dropping off. And some might see this as supporting a pause in rates. But the Fed is worried not so much about the rise in headline inflation (actual and expected), they are worried about pass through to core. As Mark Thoma reports, the pass through will only happen with a lag. Along these lines, note the story in Saturday’s WSJ reporting on growing signs of rising pricing power among firms.
I see that Fed St. Louis President William Poole declared that a hard landing, at least on the basis of internal imbalances, is highly unlikely. Truly a dangerous statement. I vividly remember a Fed official (sorry, I don’t kiss and tell) assuring me in 2000 that “there is no way the US economy can have a hard landing.” The basic idea was that the equity bubble was fundamentally confined to a small segment of the economy, and consequently the impact of its bursting would be confined as well. But whether or not you agree that the downturn was “hard” or “soft,” the Fed’s frantic rate cutting in 2001 suggests that they were caught off guard by the drop in activity.
Incidentally, that little insight into policymaker psychology allowed me to call the Fed’s hardline approach through 2000 as I recognized the Fed was considerably less concerned than the bond market. But I also became complacent, not to mention stubborn, and subsequently failed to look for the January 2001 intermeeting easing.
The lesson here is that the Fed can be heavily influence by prior beliefs; but also that those beliefs can change rapidly when the data hits some critical mass.
What prior beliefs might be at play? Indirectly, housing is a significant factor here. I noticed some comments on William Polley’s site regarding our Econoblog discussion on the Wall Street Journal online. Some were surprised that we did not comment more on the housing “bubble.” Bill and I appear to share the same opinion on this: The “bubble” itself is not driving policy. It is the incipient inflationary pressures that are the Fed’s concern, a position that stands in contrast to many commentators (thank you, David).
Greenspan & Co., however, recognize that tightening will likely work via a housing slowdown. Does this mean a slowdown in housing will be enough to shift the Fed’s stance? Maybe – if the slowdown is sharp enough. The anecdotal evidence so far, while interesting and though provoking, is too thin to hang policy on. Likewise with the data religiously monitored by Calculated Risk. While these could be the precursors to a significant slowdown, I tend to believe that we will have to see an impact on consumers in the data for the Fed to be confident that overall activity is slowing to trend. This is likely on the mind of Cleveland Fed President Susan Pianalto:
"As we start to see an increase in interest rates will that cause the consumer problems?" she asked rhetorically in response to a question. "I think it depends on whether that's gradual and how consumers adjust to that."
"In the past several years consumers ... have been very diligent in managing some of their debt in terms of refinancing to lower rates, but we'll have to ... keep our eye on this situation as the conditions change," Pianalto said.
My interpretation of Pianalto’s statement is that she expects consumer spending to weaken, but not rapidly or catastrophically. Consequently the first signals of a slowdown will be events that match her expectations. If I am reading all this correctly, the Fed will not react until it sees significant stress on the consumer (assuming that is the correct channel of transmission) – again, in the data, not anecdotally. Note that such a point could still be months away: A housing slowdown will need to become evident, then spread into consumption, and then show up in the data.
Of course, consumption is just an example – an example that the Fed appears to be watching – of bearish signals. Another signal could be a swing in investment. Considering the conventional wisdom that recessions are investment driven events, I think that a slowdown in investment would be grounds to think about actual easing, whereas a consumer slowdown would be reason to pause. In any event, the hawkish rhetoric will ease only slowly, I suspect, until some critical mass of data is reached.
Overall, I come to the point where I find myself repeating the party line: The Fed will continue to raise interest rates to keep inflation expectations in line. Monotonous. But while I repeat the line, I take care to watch the data (and rhetoric) to find that shift in policy sentiment. After all, as I noted last week, the tightening will have an impact at some point.
For public consumption, I offer this outlook for next year that I presented on October 18, prior to the latest GDP report (I underestimated Q3 growth). You will notice that I play close to the razor edge of Okun’s law – I tend to be neither excessively optimistic nor pessimistic. I based my high estimate of aid relief for Katrina on news reports (numbers that ranged from $500 million to $2 billion per day). I am sympathetic to the prediction that housing market will curtail consumer spending next year. You may also notice that I expect the Fed to stop raising interest rate in early 2006, with the possibility of a cut at the end of next year. I had March for the last rate hike in the back of mind when I wrote this.
Overall, I believe it is a reasonable baseline…but time and data will tell how much I adjust my outlook in the months ahead. I wrote this in September (the publishing department needs some lead time); currently, data suggests to me that the rate peak may be farther out than I anticipated. I am not wedded to this outlook; it simply represents the baseline in my mind. Consistent with my anticipation of how the Fed will behave, I will adjust this forecast to any notable change in data or any perception of a change in the Fed’s outlook. Complacency is dangerous, and arrogance and stubbornness can lead you stick to a story long after its time has past. Humbleness is a virtue in Fed watching – you are only as good as your last call.
Paul Krugman: Health Economics 101
Health Economics 101, by Paul Krugman, NY Times: ...[W]e rely on free markets to deliver most goods and services, so why shouldn't we do the same thing for health care? .... It comes down to three things: risk, selection and social justice. First, about risk: ... In 2002 a mere 5 percent of Americans incurred almost half of U.S. medical costs. If you find yourself one of the unlucky 5 percent, your medical expenses will be crushing, unless you're very wealthy - or you have good insurance. But good insurance is hard to come by, because private markets for health insurance suffer from ... the economic problem known as "adverse selection," in which bad risks drive out good. To understand adverse selection, imagine what would happen if ... everyone was required to buy the same insurance policy. In that case, the insurance company could charge a price reflecting the medical costs of the average American, plus a small extra charge for administrative expenses. But in the real insurance market, a company that offered such a policy ... would lose money hand over fist. Healthy people, who don't expect ... high medical bills, would go elsewhere, or go without insurance. ... [T]hose who bought the policy would be a self-selected group of people likely to have high medical costs. And if the company responded to this selection bias by charging a higher price for insurance, it would drive away even more healthy people.
That's why insurance companies ... devote a lot of effort and money to screening applicants... This screening process is the main reason private health insurers spend a much higher share of their revenue on administrative costs than do government insurance programs like Medicare, which doesn't try to screen anyone out. ... [P]rivate insurance companies spend large sums not on providing medical care, but on denying insurance to those who need it most. What happens to those denied coverage? Citizens of advanced countries ... don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action... Some ... are covered by Medicaid. Others receive "uncompensated" treatment, ... paid for either by the government or by higher medical bills for the insured. ...
At this point some readers may object that I'm painting too dark a picture. After all, most Americans ... have private health insurance. So does the free market work better than I've suggested? No: to the extent that we do have a working system of private health insurance, it's the result of huge though hidden subsidies. ... [C]ompensation in the form of health benefits... isn't taxed. One recent study suggests that this tax subsidy may be as large as $190 billion per year. And even with this subsidy, employment-based coverage is in rapid decline.
I'm not an opponent of markets. ... I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semiprivate system supported by large government subsidies. That system is now failing. And a rigid belief that markets are always superior to government programs - a belief that ignores basic economics as well as experience - stands in the way of rational thinking about what should replace it.
For similar comments on Social Security insurance, see Social Security is about insurance, not savings, The Need for Social Insurance, and Optimizing Social Security through Poverty Insurance and Retirement Saving. And from Paul Krugman, see Passing the Buck.
Update: Tyler Cowen at Marginal Revolution notes:
Marginal Revolution: Paul Krugman, circa India: Here is yesterday's column on health care; I am not sure if the The Hindu will be carrying them all on-line. Arnold Kling offers excellent commentary. Thanks to Eswaran for the pointer.
Are Programs to Help Dislocated Workers Effective?
Just how effective is our expanding public system for helping dislocated workers?, by Ronald A. Wirtz, Minneapolis Fed: Take two aspirin, and find a new job in the morning. Historically, that's been the advice to workers facing layoffs. Grab your bootstraps. Pound the pavement. Good luck. ... But as globalization continues apace, so has society's anxiety over the job dislocation commonly associated with it. ... Layoffs are “very traumatic” for workers ... and many are having trouble adjusting to new realities of employment. After being laid off, some workers will “sit on unemployment waiting for the world to snap back to normal.” It rarely does, and many workers find themselves ill-equipped to compete for new jobs that come close to replacing their old salaries. ... Is this gut-punch a fatal blow ... While the immediate effect of layoffs on individual households is surely great, most economists argue that such job dislocations are actually a backdoor wellspring of economic growth. Layoffs allow the economy to reallocate resources (including labor) from mature, declining firms and industries to growing, healthy ones. This job churn—the many jobs lost, and new ones found—ultimately makes the U.S. economy more competitive and, in turn, prosperous. But that claim rests on a matter that doesn't get a lot of attention: our ability to rechannel dislocated workers ... to new job opportunities that are advantageous for both new employer and dislocated worker. Traditionally, dislocated workers have had to find their own way to the next job opportunity. But as the economy's job churn has increased over the last decade, ... What's evolving slowly ... is a public system of job-matching services for those workers not able to do it on their own. Government programs for these workers appear to be improving ... But they've also been hit with stinging and evidently well-founded criticisms about their tepid performance and questionable long-term effects. Equally important, ... redundancy becomes an issue: Public programs are offering services already available from a rapidly growing and sophisticated job-matching industry in the private sector.
Typically, dislocated workers need or seek help in three basic areas: wage insurance, which acts as a temporary fill-in for lost job income; job search, which includes hands-on activities like resume writing, interview coaching and career counseling; and skill training, which improves job-matching prospects. Each of these areas draws public and private responses of varying degree and sophistication. Wage insurance ... has been handled almost exclusively by the public system since Congress created Unemployment Insurance in 1935 as part of the Social Security Act. ... The only wage insurance offered by the private market comes in the form of severance pay, which typically goes to a small minority of laid off workers. Workers in need of other job services—specifically, search and training—will find a variety of private and public options at their disposal. For example, job Web sites like Monster.com have exploded with the advent of the Internet, complementing traditional job-search standbys ... Private staffing agencies (otherwise known as temp firms) also help unemployed workers find their way to the next job... On the public side, myriad government programs help workers search for and obtain new jobs. This safety net is truly a bureaucratic morass of programs, resource streams and guidelines. Funding is modest at best and, it turns out, so are results—likely one reason that the majority of workers bypass such programs. The largest program geared specifically toward permanently laid off workers is the Workforce Investment Act (WIA), ... The program got its start when Congress passed the Manpower Development and Training Act of 1962 at the behest of President Kennedy, who sought redress for thousands of workers laid off as a result of growing automation. (That same year, the Trade Expansion Act began the tradition of helping workers displaced by foreign competition, offering cash assistance and training through the Trade Adjustment Assistance program. TAA remains in force today and is the next-largest program for dislocated workers, but eligibility is narrow, limited to those who can prove dislocation by foreign competition. The program has received particularly poor evaluations from a number of government agencies and academic studies.) ... Even with these caveats, the WIA deserves praise for the simple reason that before its creation, no comprehensive effort was made to help dislocated workers of all stripes get back on their feet. Still, it's difficult to say how well the WIA is performing. Virtually no evaluation is given to core and intensive services. Maybe more important, the utility of publicly subsidized worker training—still the programmatic heart of the WIA—is not quite the slam-dunk it might seem. Most evaluations lean toward positive, but just barely (see “Does job training pay off?”). ... [T]he WIA has often met or exceeded its performance benchmarks, ... But ... [t]hese results were not much better than those achieved by workers receiving only core and intensive job-search services. Job training apparently had little independent effect. ...
Other important program aspects remain largely overlooked in terms of evaluation. Two industry experts ... pointed out that programs are often heavy in infrastructure (like staffing and office space), leaving little money for training. The state source pointed out that retraining costs per job placement can reach into the thousands (averaging $4,500 in the source's state), despite the fact that many clients typically received just three to four weeks worth of training. “You know those people aren't getting that [full monetary] amount of training. ... It's ridiculously expensive.”...
Some argue that large pieces of public programming for dislocated workers are redundant, given the wide job-matching services offered in the private market. ... For now, private and public systems each have a different client focus, revealing something of a tiered service market. Staffing agencies ultimately work for employers... Lower-skill and other “not readily marketable” workers end up in public programs. ... Still, there are enough similarities between one-stops and staffing agencies to suggest the possibility of greater overlap in the future. ...
The WIA is currently up for reauthorization, ... One of the main proposals is to simplify the funding labyrinth for programs serving dislocated workers, a maze not uncommon to programs that develop over the course of decades. ... Once you add up the various funding sources from this confusing labyrinth, “there's a good pot of money out there” for dislocated workers, according to Golembeski. ... The problem, he says, is that his office spends “an awful lot of time” coordinating these many funding streams because each comes with its own eligibility requirements and program rules. The WIA reauthorization is proposing ... to fuse funding streams and eliminate idiosyncratic guidelines ...
Whatever changes are made in coming years to the WIA, anyone expecting a perfectly designed public safety net for dislocated workers doesn't have a good sense of the countless moving parts and circumstances that public agencies have to deal with but have little control over. For example, layoffs in rural areas are particularly challenging for any government program, given stagnant job growth and generally lower wages. If they're unwilling to move, workers have to wait—for a long—time, in some cases-for new job opportunities. Numerous program officials also acknowledged a certain amount of stubbornness and a sense of entitlement among workers when it comes to program services. Still, despite all the flaws and caveats, most people with experience in or knowledge of previous job training regimes consider the WIA a step forward. ...
I'm not ready to give up on helping displaced workers. As explained here, I beleive we owe it to those who are hurt, through no fault of their own, by the economic system we have chosen as it continues its never ending march toward greater efficiency. However, a fair reading of the evidence suggests that existing retraining programs have not had a large positive impact, certainly not as large as hoped. However, rather than conclude that these programs will not work, we can build upon the parts that do work, avoid repeating mistakes, and continue to try to find how best to help those who are negatively affected by the dispassionate and inevitable forces of globalization.
November 13, 2005
What Lurks in Its Soul?, by David A. Vise, Washington Post: The soul of the Google machine is a passion for disruptive innovation. Powered by brilliant engineers, mathematicians and technological visionaries, Google ferociously pushes the limits of everything it undertakes. The ... goal: to organize all of the world's information and make it universally accessible, whatever the consequences. Google's colorful childlike logo, its whimsical appeal and its lightning-fast search results have made it the darling of information-hungry Internet users. ... But these friendly features belie Google's ... voracious appetite for aggressively pursuing initiatives to bring about radical change. ... Consider the wide-ranging implications of the activities now underway at the Googleplex, the company's campuslike headquarters in California's Silicon Valley. Google is ... scanning millions of books without traditional regard for copyright laws; tracing online searches to individual Internet users and storing them indefinitely; demanding cell phone numbers in exchange for free e-mail accounts (known as Gmail) as it begins to build the first global cell phone directory; saving Gmails forever on its own servers, making them a tempting target for law enforcement abuse; inserting ads for the first time in e-mails; ...
Google has also created a new kind of work environment. It serves three free meals a day to its employees (known as Googlers) so that they can remain on-site and spend more time working. It provides them with free on-site medical and dental care and haircuts, as well as washers and dryers. It charters buses with wireless Web access between San Francisco and Silicon Valley so that employees can toil en route to the office. To encourage innovation, it gives employees one day a week -- known as 20 percent time -- to work on anything that interests them. To eliminate the distinction between work and play -- and keep the Googlers happily at the Googleplex -- they have volleyball, foosball, puzzles, games, rollerblading, colorful kitchens stocked with free drinks and snacks, bowls of M&Ms, lava lamps, vibrating massage chairs and a culture encouraging Googlers to bring their dogs to work. (No cats allowed.) The perks also include an on-site masseuse, and extravagant touch-pad-controlled toilets with six levels of heat for the seat and automated washing, drying and flushing without the need for toilet paper.
Meanwhile, the Googlers spend countless hours tweaking Google's hardware and software to reliably deliver search results in a fraction of a second. Few Google users realize, however, that every search ends up as a part of Google's huge database, where the company collects data on you, based on the searches you conduct and the Web sites you visit through Google. The company maintains that it does this to serve you better, and deliver ads and search results more closely targeted to your interests. But the fact remains: Google knows a lot more about you than you know about Google. ...
Google ... has grander plans. The company is quietly working with maverick biologist Craig Venter and others on groundbreaking genetic and biological research. ... Venter and others say that the search engine has the ability to deal with so many variables at once that its use could lead to the discovery of new medicines or cures for diseases. Sergey Brin says searching all of the world's information includes examining the genetic makeup of our own bodies, and he foresees a day when each of us will be able to learn more about our own predisposition for various illnesses, allergies and other important biological predictors by comparing our personal genetic code with the human genome, a process known as "Googling Your Genes." ...
From Madison Avenue to Microsoft, Google's rapid-fire innovation and growing power pose a threat of one kind or another. Its ad-driven financial success has propelled its stock market value to $110 billion, ... Its simplified method of having advertisers sign up online, through a self-service option, threatens ad agencies and media buyers who traditionally have played that role. Its penchant for continuously releasing new products and services in ... test form... has sent Microsoft reeling. ... Microsoft also worries that Google is raiding the ranks of its best employees. ... [I]t grew worse when Google opened an outpost in the suburbs of Seattle, just down the road from Microsoft headquarters, and aggressively started poaching. Microsoft finally sued Google for its hiring of Kai-Fu Lee, a senior technologist who once headed Microsoft's Chinese operations. Lee is now recruiting in Asia for Google, despite a court order upholding aspects of a non-compete clause that Lee signed while at Microsoft. ...
Google's distinctive DNA makes it an employer of choice for the world's smartest technologists because they feel empowered to change the world. And despite its growing head count of more than 4,000 employees worldwide, Google maintains the pace of innovation in ways contrary to other corporations by continuing to work in small teams of three to five, no matter how big the undertaking. Once Google went public and could no longer lure new engineers with the promise of lucrative stock options, Brin invented large multi-million-dollar stock awards for the small teams that come up with the most innovative ideas. ...
Despite all that has been achieved, Google remains in its infancy. Brin likes to compare the firm to a child who has completed first grade. ... Quietly, they have been buying up the dark fiber necessary to build GoogleNet, and provide wireless Web access for free to millions or billions of computer users ... potentially disruptive to phone and cable companies that now dominate the high-speed Internet field. Their reasoning is straightforward: If more people globally have Internet access, then more people will use Google. ... Supremely confident, the biggest risk that Brin, Page and Google face is that they will be unable to avoid the arrogance that typically accompanies extraordinary success...
[Update: Brad DeLong has more on Google.]
Are Innovations in Inventiveness Slowing for U.S. Innovators?
Are U.S. Innovators Losing Their Competitive Edge?, by Timothy L. O'Brien, NY Times: ...Inventors have always held a special place in American history and business lore, embodying innovation and economic progress in a country that has long prized individual creativity and the power of great ideas. In recent decades, tinkerers and researchers have given society microchips, personal computers, the Internet, balloon catheters, bar codes, fiber optics, e-mail systems, hearing aids, air bags and automated teller machines, among a bevy of other devices. Mr. West [an award-winning research professor at Johns Hopkins University. ... who has secured 50 domestic and more than 200 foreign patents on inventions] stands firmly in this tradition - a tradition that he said may soon be upended. He fears that corporate and public nurturing of inventors and scientific research is faltering and that America will pay a serious economic and intellectual penalty for this lapse.
A larger pool of Mr. West's colleagues echoes his concerns. "The scientific and technical building blocks of our economic leadership are eroding at a time when many other nations are gathering strength," the National Academy of Sciences observed in a report ... "Although many people assume that the United States will always be a world leader in science and technology, this may not continue to be the case inasmuch as great minds and ideas exist throughout the world. We fear the abruptness with which a lead in science and technology can be lost - and the difficulty of recovering a lead once lost, if indeed it can be regained at all." ...
To spur American innovation, [a committee of leading scientists, corporate executives and educators] recommends enhanced math and science education in grade school and high school, a more hospitable environment for scientific research and training at the college and graduate levels, an increase in federal funds for basic scientific research and a mix of tax incentives and other measures to foster high-paying jobs in groundbreaking industries. The report cites China and India among a number of economically promising countries that may be poised to usurp America's leadership in innovation and job growth. "For the first time in generations, the nation's children could face poorer prospects than their parents and grandparents did," the report said. "We owe our current prosperity, security and good health to the investments of past generations, and we are obliged to renew those commitments." ...
While tipping their hats to the scores of breakthroughs that have emerged from corporate labs, inventors also say they are concerned that bottom-line pressures at many companies may cause pure research to be eclipsed by innovation tied to rapid commercialization - leading to routine refinements of existing products rather than to breathtaking advances. ... Robert S. Langer, a research scientist at the Massachusetts Institute of Technology and a biotechnology pioneer, says that he shares the concerns raised in the National Academy of Sciences report but that he remains confident about the country's prospects. "While I think we can always do better, I am optimistic about the spirit of innovation in this country," he said. "I think we hold a lead, but no lead is unassailable."
That is closest to my view, cautiously optimistic. If we do the best we can do, and we can do better than we are doing now, then inventions elsewhere in the world help all of us. I want more people working hard to find solutions to difficult problems. As the rest of the world develops the gap will close in any case, I just don't want the gap to close faster because our rate of innovation slows unnecessarily. On that point, there is more pessimism in some quarters:
"The inventiveness of individuals depends on the context, including sociopolitical, economic, cultural and institutional factors," said Merton C. Flemings, a professor emeritus at M.I.T. who holds 28 patents and oversees the Lemelson-M.I.T. Program for inventors. "We remain one of the most inventive countries in the world. But all the signs suggest that we won't retain that pre-eminence much longer. The future is very bleak, I'm afraid." Mr. Flemings said that private and public capital was not being adequately funneled to the kinds of projects and people that foster invention. The study of science is not valued in enough homes, he observed, and science education in grade school and high school is sorely lacking. But quantitative goals, he said, are not enough. Singapore posts high national scores in mathematics, he said, but does not have a reputation for churning out new inventions. In fact, he added, researchers from Singapore have studied school systems in America to try to glean the source of something ineffable and not really quantifiable: creativity. "In addition to openness, tolerance is essential in an inventive modern society," a report sponsored by the Lemelson-M.I.T. Program said last year. "Creative people, whether artists or inventive engineers, are often nonconformists and rebels. Indeed, invention itself can be perceived as an act of rebellion against the status quo." ...
[Update: Michael Mandel at Economics Unbound comments.]
November 12, 2005
Criticism of Chinese Economists
Qualified Chinese economists no more than five?, by Hector Lee (mranti), China Daily: 2005 is an eventful year for Chinese's mainstream economists, who have been plunged into stern criticism both from the public and on the Internet. Reflection on the current status of China's economics may lead to a retrospect of China's reform and policy. Therefore China Business Times (CBT) had an interview on Oct 26 with Professor Ding Xueliang, a sociologist from the Hong Kong University of Science and Technology.
CBT: During the past two decades, it seems that only economists have been playing in the intellectual arena, compared with other disciplines. They seem to have an exclusive edge to affect our government's policy and become the limelight in the China's opening-up and reform process. What's your comment on this?
Ding: In the past quarter century, we implemented our reform and policy without considering sustainable development and a harmonious society. We always stick to one subject and ignore others at the same time; this easily causes us go astray. Some interest groups have emerged that are hard to ignore. The cost will be expensive if we want to make things up. During the past two decades, many people believed it was the economists' responsibility to develop the economy, and economists were the only ones who could speak out among the "silent majority." However, this is far from the truth. In a mature and sustainable society, developing the economy is a systematic project. Disciplines like law, sociology and political science all play their own part in the policy-making process. Their impact may not be overwhelming, but they cannot be replaced. Sociology focuses on social structure and fairness. Law emphasizes procedure and justice. Political science concerns the government's efficiency and cost. Each discipline has its own approach, so there should not be a dominant discipline that muffles the others. You've seen the English term "social studies?" The term is plural rather than singular. We need different voices; we need dialogue and argument based on a normal environment. Policy making should be a systematic project and should be made by comprehensively understanding the essence of various disciplines.
CBT: How do you judge China's contemporary economics?
Ding: In those western countries whose economics are advanced and developed, these disciplines are deeply professionalized, like physics and mathematics. Their topics are professional and profound. How could economics become such a communal discipline? China's economics are too popular. Too many people claim to be economists, and they dare to talk about everything. This means China's economics are still young and far from being a serious discipline, let alone a science. True science can't be so popular.
CBT: what do you think of the misleading policies made by economists, like those in education reform?
Ding: Over a long period, a couple of so-called economic problems were not real economics problems; they belonged to another area in international practice. But experts from other areas were silenced while economists become talkative. And since China's economics were still young, many un-economic solutions and arguments which pretend to be economic led to more leeway in policy-making.
CBT: During the past two years, more and more mainstream economists have been blamed in public and on the Internet. How do you explain that?
Ding: This is complicated. One important reason is those mainstream economists spend too much time on speaking for a certain interest group and too little time studying. You can find many interest group spokesmen among Chinese economists. Yes, it is true that there are also western economists who play such roles, but they are few. And the most distinctive western economists never do such things. They may be hired by banks and investment banks to study industrial economics. Most so-called Chinese economists act like economic analyzers in a western bank; they only speak for their employer's industry. But in terms of professional quality, they cannot even be compared with an economic analyzer. The best western economists are professors and researchers in top university economics departments.
CBT: Are there any qualified economists in China?
Ding: I think there are no more than five. Some of the most famous Chinese economists are not even qualified to be postgraduates in the world's top 50 economics departments. Some economists long for the Nobel Prize, but they contribute nothing. A real economist should make academic research the first priority, not personal wealth, fame and rank. In western society, some economists become officials in government and big banks, but only after they have made distinguished and independent research achievements. And one day, they expect to return to their original field and resume research. Wealth, fame and rank are not their goals.
Minneapolis Fed Interview with Robert Barro
Interview with Robert Barro, The Region, Minneapolis Fed: The staircase that leads to Robert Barro's second-floor office at Harvard spirals like a helix; on the wall above these steps hang large photos of renowned Harvard economists. ... Schumpeter, Hansen, Kuznets, Leontief... In the early 1970s, Barro followed this lineage faithfully, publishing several significant papers along Keynesian lines. But ... Barro broke with tradition in 1974 with a powerful critique of Keynesian thought. ... His articles are among the most often cited in economics...
Region: The Ricardian equivalence hypothesis, which you brought to prominence in 1974, might be taken to suggest that deficit spending isn't inherently harmful since rational people, expecting to pay higher taxes in the future to pay off government debt, will save more, so private savings will balance out the public deficit. Does that imply that concerns about “irresponsible” levels of debt are unfounded? ...
Barro: Let me say first that I think the Ricardian equivalence idea is basically right as a first-order proposition. However, people get confused as to exactly what it says. ... To illustrate the potential pitfalls in what Ricardian equivalence says and does not say, one can consider the famous quote attributed to Vice President Cheney to the effect that President Reagan proved that budget deficits don't matter. The Cheney quote is often interpreted to mean that the level of government expenditure does not matter, and that surely is not what Ricardian equivalence says. The Ricardian proposition is about the consequences of paying for a given amount of public expenditure in different ways. Specifically, does it matter ... whether the government pays for its spending with current taxes or with current borrowing, which entails higher future taxes?
So, a central part of the proposition is that the amount of public expenditure—today and tomorrow—is being held constant. ... As a first-order proposition, it is right that it matters little whether you pay for government spending with taxes today or taxes tomorrow, which is basically what a fiscal deficit is. ... The method of public finance is an important question, but it is less important than the question of how big the government is and what activities it should carry out. Taxing now versus taxing later is ... a public-finance topic. This view moves the analysis away from pure Ricardian equivalence to the optimal tax perspective, which brings in the principle of tax smoothing. The idea is that ... optimal public finance dictates having tax rates ... that are similar from one year to another. ... erratic movements in tax rates ... are highly distorting. From that standpoint, it is not desirable to have a very low tax rate today, financed by a fiscal deficit, followed by much higher tax rates in the future. ...
Region: I'd like to follow that with an empirical question, if I might. By some measures, U.S. personal savings rates are quite low. What does this say about people's anticipation of having to pay higher taxes in the future?
Barro: National savings rates are not constant over time in the United States, and they are not the same across countries. ... However, economists have not demonstrated empirically for the U.S. or across countries that there is a regular relation between fiscal deficits or the size of the public debt and the level of the national saving rate. The idea that fiscal deficits drive down national saving is often claimed, but it is mainly proof by repetition. No one has actually shown convincingly that the U.S. national saving rate relates in a systematic way to the size of the fiscal deficit or the stock of public debt, both measured in relation to GDP. ...
SOCIAL SECURITY AND MEDICARE/MEDICAID
Region: Social Security and Medicare/ Medicaid are two major government expenditures, of course. Are you concerned about future spending for those programs?
Barro: I should say, in general, that the Bush administration has been a real failure with respect to fiscal discipline, especially during its early years. I mean this with respect to the level of federal expenditure, not about fiscal deficits per se. Particularly in the first term, there was a tendency to increase spending across the board—a very different pattern from most of the Clinton period, although Clinton did become less disciplined at the end of the 1990s. ... The expansion of Medicare, in terms of coverage for prescription drugs, is one important aspect of the lack of discipline, and this “generosity” will have long-term adverse consequences for the federal budget. So, although I am not particularly concerned about the current fiscal deficit, I am worried about the growth of federal outlays under Bush. ...
Of course, the legacy of deficits and debt came from Reagan and the first President Bush; that is, they involved what economists now call “strategic budget deficits.” I think this Reagan-Bush strategy actually worked to promote discipline on the federal spending side in the 1990s. ... Unfortunately, the spending discipline coming from fiscal deficits did not seem to work during Bush's first term. ... Anyway, I agree that the longer-term expenditure problems related to Social Security and Medicare are significant. But there is also a broader, short-run problem with regard to federal spending across the board. President Bush really should try vetoing a spending bill sometime.
ECONOMICS OF RELIGION
Region: Most economists will not expound on religion... You're an exception to that rule. In your work with your wife [Harvard scholar] Rachel McCleary on the associations between religion and growth, you're trying to tease out not just correlations but causality. Can you tell us what you've found?
Barro: I'm excited about this research project. It's on the interplay between religion and political economy, so there's a two-sided interplay here. One is about religion having influence on beliefs, values, traits like honesty, work ethic, thrift and so on... In this context, we are studying the impact of religion on economic growth and productivity, and also on political institutions, including democracy. These effects represent one direction of causation. The other effect, a big part of the literature on the sociology of religion, is that economic development and government policies influence the levels of religiosity in society. For example, one idea is that as nations get richer and better educated, they tend to become less religious.
Region: The “secularization” of society?
Barro: That's the secularization hypothesis, exactly. And though that hypothesis has lost favor, I think the empirical evidence supports it. ... A related idea is that what governments do in terms of having official state religions or regulating the market—either subsidizing or suppressing religion—has an impact. Communist countries were particularly focused on antireligion policies ... that is, if we do not count communism as its own religion. ...
Region: Could you explain your concept of “religious capital”?
Barro: The general idea is analogous to investing in education to accumulate human capital. Or, alternatively, one can think of investing in networks and friendships to form social capital. Analogously, you can invest in spirituality and beliefs to form a kind of religion capital. Rachel and I think of this influence as working through beliefs, not so much through networking, or going to church and meeting lots of people. That would be more like social capital. ... These beliefs matter ... if they support certain traits and values, such as honesty, work ethic, thrift and hospitality to strangers. These traits then influence productivity and work effort, which ultimately affect economic growth. ... The other thing I might mention is that I find that whenever I give a seminar on this topic, I inevitably get a question about whether I'm personally religious. The attitude seems to be that if I'm studying this topic it must come from some individual set of beliefs or commitment to a particular religion. It's curious because people studying other aspects of social science do not tend to get analogous questions. [University of Chicago economist] Gary Becker studied the economics of crime, and (as far as I know) nobody ever asked him if he was a criminal ...
Region: If I'm not mistaken, Gary Becker got his idea about crime and economics when he was thinking about parking illegally. ...
INFLATION TARGETING Region: Your research on rules, discretion and reputation in central banking has been very influential on monetary policy theory and practice. What is your view of inflation targeting?...
Barro: The change in monetary policy over the last 20 years or so has been a tremendous success in the United States and other advanced countries. It's been a tremendous change compared to what we were going through in the 1970s and early 1980s. In a general sense, there has been a shift toward the idea that the monetary authority should be committed to something like price stability or inflation targeting. This general idea has been pretty well accepted. ... In the United States, the watershed period was when Paul Volcker was in charge. The inflation rate shot up like crazy at the end of the 1970s, into the early 1980s. Volcker's committed policy with very high interest rates brought down inflation—I think that was the key event.
Region: Was Volcker essentially creating reputation, in the sense of your 1983 paper with David Gordon?
Barro: There were a couple of things there. Volcker was establishing the credibility and commitment to bringing down inflation. Secondly, there was the more technical point that driving up nominal interest rates actually worked. ... I think over the last two decades the Fed has come close to an inflation targeting regime even though it's not explicit. ...
Region: Is the relationship you have in mind here similar to a Taylor rule?
Barro: Yes, it looks like that, but there are some differences. For example, it's clearly not GDP that the Fed reacts to. ... when GDP growth goes up because of higher productivity growth, there's no tendency to raise the federal funds rate. But if the economy is strong in terms of ... higher employment growth and a low unemployment rate, there seems very regularly to be an upward movement of interest rates. The reverse holds when the labor market is weak. On the inflation side, it's a broad inflation index that seems to influence the Fed—something like the GDP deflator or the deflator for personal consumption expenditures. ... A crucial feature is that monetary policy responds to the economy in a way that's particularly strong with respect to inflation. The idea is that when you bring the [federal] funds rate up, inflation is supposed to go down. This mechanism has worked much better than I would have predicted at the end of the 1970s and early 1980s—it's kind of amazing how well this has turned out, and not just in the United States. Many other countries have gone further in terms of formalizing this policy reaction into a rule. I think the more formal rule is a good idea. I'm not sure it's that important because the United States is pretty close to it anyway. However, if Ben Bernanke becomes head of the Fed, he will likely try to implement something that looks more like a formal rule.
Region: “Constrained discretion” is a term he's used.
Barro: Yes. ...
THE EQUITY PREMIUM PUZZLE
Region: I understand you've made some headway on the equity premium puzzle, the unexplained gap between average returns on stocks and bonds that Rajnish Mehra and Ed Prescott pointed out 20 years ago. Your explanation for the gap, I believe, involves rare events, a suggestion made by [University of Iowa economist] T. A. Rietz in 1988 that was immediately dismissed by Mehra and Prescott.
Barro: It is certainly fair to say that this insight was in the 1988 paper by Rietz, which I think came out of his Ph.D. thesis. 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, ... 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... 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. ...
EUROPE'S MONETARY UNION
Region: You've conducted research with [Harvard economist] Alberto Alesina on optimal currency areas. What's your viewpoint on the struggles that the Economic and Monetary Union is having with its Stability and Growth Pact?
Barro: I think the European monetary union or common currency is a good idea. The free trade area earlier was also a good idea. But I think it's a big mistake to be extending the integration to try to have more of a political union and a union that covers almost everything, including fiscal and social policies and regulations. That's why, from the standpoint of the United Kingdom, even though it would be attractive to be on the euro, I don't think it's worth it in terms of all the rest of the baggage that they would get from the Continent. ... But the monetary union itself is very positive in terms of promoting trade and financial flows. ...
Region: I'd like to ask you more broadly about the issue of economic growth. ... [I]t seems that economists ... have been engaged in empirical analysis, trying to figure out the relative levels of influence of technology, human capital, geography, institutions—“do institutions rule?” is the phrase often used here at Harvard—or even culture, on economic growth. ... Where do your sympathies lie? What seems most powerful?
Barro: ...Some interesting recent empirical research has been on the formation and influence of institutions. ... I think it's right that institutions, rule of law, corruption and so on are important factors for determining economic growth. Even the World Bank now thinks that these issues are central.
INEQUALITY AND GROWTH
Region: What have you discovered in your research on the relationship between inequality and economic growth?
Barro: I did not find an important, systematic effect of income inequality on economic growth. And theoretically it can go in either direction. ... The Kuznets curve refers to ... the idea that, as a country develops... initially, inequality goes up and later it goes down. There is a little evidence to support the existence of this Kuznets curve, but the evidence is not that powerful. You can see the Kuznets relation in China. Inequality went up a lot because certain urban areas have been doing especially well. Rural agriculture, although performing better than under the previous regime (which really was communist), has not done as well as the urban areas. So that means inequality increased in China at the same time that per capita GDP went way up and poverty went way down. You would anticipate that, as China continues to grow, it will also integrate more fully the poorer rural sections of society with the advanced urban ones. Enhanced mobility from rural to urban areas is part of this process. This dynamic should generate a classic Kuznets curve...
THE FUTURE OF MACRO
Region: In the early 1970s, I believe, you told Gary Becker that you thought macroeconomics was stagnating and you thought you might get into microeconomics. ... And then rational expectations swept the field, and you were one of the pioneers in that revolution. Bearing in mind your past forecast, what would you say about macroeconomics today? What do you think are promising areas for research in macro now? And are you still thinking of going micro?
Barro: I was clearly a very bad predictor in the early 1970s of how macroeconomics would evolve. ... Now it does seem that perhaps the last 10 years or so have been less exciting ... There has been progress, even on the Keynesian side. We now have more sophisticated approaches to sticky-price models. ...
Region: If things are stagnating, perhaps another revolution is in the offing.
Barro: Well, it's the essence of a revolution that it has to be unpredictable, right? If you could have predicted it in advance, it would have already happened. ...
Region: Are you going to go micro?
Barro: I've always had a great interest in applied micro, ... I'm not sure why I got into macroeconomics in the first place, except that I started there. In fact, my first economics course used Keynes' General Theory as a textbook. In some ways, I like the applied micro topics better. However, macroeconomics usually deals with larger, more important issues.
Region: The International Monetary Fund came under severe criticism in the 1990s, but in recent years it has undergone substantial reform. ... Some of your research indicates that countries that take IMF loans or are involved in IMF lending programs do more poorly in terms of economic growth, in terms of rule of law and democracy. Would you tell us about that work?
Barro: Recently there has been a lot of discussion about debt relief, foreign aid, the role of the World Bank, as well as IMF programs. I think these are all basically analogous in terms of their impacts. ... The problems are embedded in the nature of the institution. By design, the setup has to encourage moral hazard; it has to encourage poor behavior on the part of the potential and actual recipients. I once suggested that they change the name to IMH for Institute of Moral Hazard, instead of IMF [laughter]. I guess that suggestion wasn't taken too seriously.
I'm often asked by government policymakers what the IMF should do better or how it should be reformed, and I think there's no answer to that—other than going out of business. ...
I don't think money for nothing is the way to get economic development. That's why even though I like [Irish rock star] Bono—I think he's very smart, a well-meaning person, and he's amazingly influential—I think his whole project of debt relief is so woefully misguided. This well-meaning assistance will not be the way to get poor African countries to do better.
Region: So you and [Columbia University economist] Jeff Sachs don't see eye-to-eye?
Barro: We had a wonderful lunch back in 1999—Sachs, Bono and I. It was clear that they invited me not to get information or advice. Instead, Bono wanted to learn the conservative, free-market objections to his approach so that he could come up with better counterarguments. Then he could be more persuasive, as he turned out to be, even with Republican officials in Washington. ... It's amazing what kind of influence he's had. He really did manage to convince many people in Washington to carry out substantial debt relief. It's a shame that we could not harness his talents for persuasion in more productive directions.
Region: Thank you very much.
Joseph Stiglitz Questions Greenspan's Record and the Independence of the Fed
Is central bank independence all it’s cracked up to be?, by Joseph Stiglitz, Daily Times, Pakistan: Alan Greenspan attained an almost iconic status as Governor of the Federal Reserve Board. ... Few central bank governors have the kind of hagiography lavished upon them, especially in their lifetime... But what makes for a great central bank governor ... great institutions or great individuals? ...[T]here is little doubt that those “managing” the economy receive more credit than they deserve, if sometimes less blame. ... So ... while no central bank governor can ensure economic prosperity, mismanagement can cause enormous harm. Many of America’s post-World War II recessions were caused by the Fed hiking interest rates too fast and too far. There is little doubt that Greenspan had great moments... These successes ... reinforced Greenspan’s exalted status. But they also led many to forget less successful moments. ...
[T]he real problem for Greenspan’s legacy concerns what happened to the American economy in the last five years, for which he bears heavy responsibility. Greenspan supported the tax cuts of 2001 with the most specious of arguments – that unless something was done ... the national debt would be totally paid off within, say, ten to fifteen years. According to Greenspan, immediate action needed to be taken to avert this looming disaster, which would impede the Fed’s ability to conduct monetary policy! It says a great deal about the gullibility of financial markets that they took this argument seriously. More accurately, tax cuts were what Wall Street wanted, and financial professionals were willing to accept any argument that served that purpose... Greenspan’s irresponsible support of that tax cut was critical to its passage. ...
But soaring deficits did not return the economy to full employment, so the Fed did what it had to do – cut interest rates. Lower interest rates worked, but not so much because they boosted investment, but because they led households to refinance their mortgages, and fueled a bubble in housing... [A]s Greenspan departs, he leaves behind an American economy burdened with high household and government debt and fragile balance sheets – a legacy that is already contributing to global financial instability. It is still not clear what led Greenspan to support the tax cut. Was it a massive economic misjudgment, or was he currying favor with the Bush administration? The most likely explanation is a combination of the two, for he and Bush were pursuing the same “starve the beast” political strategy...
The traditional argument for an independent central bank is that politicians can’t be trusted to conduct monetary and macroeconomic policy. Neither, evidently, can central bank governors, at least when they opine in areas outside their immediate responsibility. Greenspan was as enthusiastic for a policy that led to soaring deficits as any politician ... engendering support from some who otherwise would have questioned its economic wisdom. This, then, is Greenspan’s second legacy: growing doubt about central bank independence. Macroeconomic policy can never be devoid of politics: it involves fundamental trade-offs ... Unemployment harms workers, while the lower interest rates needed to generate more jobs may lead to higher inflation, which especially harms those with nominal assets whose value is eroded. Such fundamental issues cannot be relegated to technocrats, particularly when those technocrats place the interests of one segment of society above others. Indeed, Greenspan’s political stances were so thinly disguised as professional wisdom that his tenure exposed the dubiousness of the very notion of an independent central bank and a non-partisan central banker. Unfortunately, many countries have committed themselves to precisely this illusion, and it may be a long time before they take heed of Greenspan’s most important lesson. Stressing the new Fed chief’s “professionalism” may only delay the moment when this lesson is learned again.
I share these views, but my own take is more tempered. The chair is designed to bring political influence to the FOMC, the four year appointment and the ability to be reappointed make political considerations important. But on the FOMC, the chair has become a dominant voice leading to questions about how well other interests are represented in the deliberations and outcome of monetary policy decisions. To me, that is where the problem begins. To the extent that FOMC decisions will be driven less by the wishes of a single person under Bernanke, that will be a welcome change.
November 11, 2005
Stock Returns and Expected Business Conditions
Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence, by Sean D. Campbell, Francis X. Diebold, NBER WP 11736, November 2005: Abstract ...[U]sing half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwise standard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R-squared. Expected business conditions retain predictive power even after controlling for ... the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion. [Free versions here and here.]
Paul Krugman: The Deadly Doughnut
The Deadly Doughnut, by Paul Krugman, NY Times: Registration for Medicare's new prescription drug benefit starts next week. Soon millions of Americans will learn that doughnuts are bad for your health. ... [L]et's look at how the Medicare drug benefit will work... At first, the benefit will look like a normal insurance plan, with a deductible and co-payments. But if your cumulative drug expenses reach $2,250, ... you'll suddenly be on your own. The Medicare benefit won't kick in again unless your costs reach $5,100. This gap in coverage ...[is] the "doughnut hole." (Did you think I was talking about Krispy Kremes?) ... [T]his will place many retirees on a financial "roller coaster." People with high drug costs will have relatively low out-of-pocket expenses for part of the year... Then, suddenly, they'll enter the doughnut hole, and their personal expenses will soar. ...
How will people respond when their out-of-pocket costs surge? ...[B]ased on experience from H.M.O. plans with caps on drug benefits, ... it's likely "some beneficiaries will cut back even essential medications while in the doughnut hole." ... [T]his doughnut will make some people sick, and for some people it will be deadly. The smart thing to do... would be to buy supplemental insurance that would cover the doughnut hole. But guess what: the bill ... specifically prohibits ... buying insurance to cover the gap...
[B]ear in mind that I've touched on only one of the bill's awful features. There are many others... Why is this bill so bad? The probable answer is that the Republican Congressional leaders who rammed the bill through ... weren't actually trying to protect retired Americans... In fact, they're fundamentally hostile to the idea of social insurance... Their purpose was purely political: to be able to say that President Bush had honored his 2000 campaign promise to provide prescription drug coverage... Once you recognize that the drug benefit is a purely political exercise..., the absurdities ... make sense. For example, the bill offers generous coverage to people with low drug costs, who have the least need for help, so lots of people will get small checks in the mail and think they're being treated well. Meanwhile, the people who are actually likely to need a lot of help ... were deliberately offered a very poor benefit. According to a report issued along with the final version of the bill, people are prohibited from buying supplemental insurance to cover the doughnut hole to keep beneficiaries from becoming "insensitive to costs" ... A more likely motive is that Congressional leaders didn't want a drug bill that really worked for middle-class retirees. Can the drug bill be fixed? Yes, but not by current management. ... We won't have a drug benefit that works until we have politicians who want it to work.
Next (11/14) column: Paul Krugman: Health Economics 101
Bernanke and Budget Deficits
Nominee for Fed Chief Wins Backing of Schumer, by Edmund L. Andrews, NY Times: A leading Senate Democrat ... endorsed President Bush's nomination of Ben S. Bernanke to become chairman of the Federal Reserve. "I think he's going to be an outstanding Fed chairman, and I think he's going to be in the mold of Alan Greenspan," said Senator Charles E. Schumer of New York, a member of the Senate Banking Committee, after a 45-minute meeting with Mr. Bernanke. ... Mr. Schumer's emphatic endorsement means that Democrats are likely to clear the path for an easy confirmation. "I think the only people who might not like him are on the far right or the far left," ... Mr. Schumer said he had received assurances from Mr. Bernanke that he would follow the lead of Mr. Greenspan and speak out about fiscal policy and about the need to reduce deficits. That is a shift for Mr. Bernanke, who ... initially told lawmakers and others that he would avoid commenting on fiscal policy if he became Fed chairman. But Democrats are hoping that Mr. Bernanke will echo the view of Mr. Greenspan that tax cuts should be paid for with savings in other areas. ...
G.O.P. Dissension Delays Vote on Budget-Cutting Bill, by Carl Hulse, NY Times: Facing defeat, House Republican leaders on Thursday abruptly called off a vote on a contentious budget-cutting bill in a striking display of the discord and political anxiety running through the party's ranks. Despite making major concessions to moderate Republicans, the House leadership failed to win enough converts to the budget plan and surrendered in mid-afternoon. Leading Republicans said they would try again next week to find a bare majority for more than $50 billion in spending cuts and policy changes. ... It was a stunning retreat for a Republican majority that has prided itself on iron party discipline and an ability to consistently win even the most difficult floor votes ... And the fiscal fight is not limited to the House. Also on Thursday, Senate Republicans on the Finance Committee had hoped to approve a bill .... But they were forced to postpone a vote after failing to win over a key dissident, Senator Olympia Snowe, Republican of Maine, despite two hours of closed door talks. ... In the House, .... top Republicans said a main impediment was the unity of the Democrats...
The Response of the CPI and Core CPI to Energy Shocks
The main thing to notice is the delay between the time the shock hits and the subsequent rise in core inflation. For the first month after the shock, the CPI rises, but core CPI rises very little. At the end of two months the effect on core inflation is much larger but the peak effect does not occur until three months after the shock. After the peak at three months, core inflation slowly declines through the end of the year. Remember, the shock to energy prices lasts only one month yet the effects are drawn out over a much longer period of time. The two lag model is similar, but shows a little less persistence and the response of core inflation occurs a bit earlier. But there is still a delay between the response of the CPI and the subsequent response of core inflation.
Okay, enough for now. I should caution that with more time I would want to build a much better model than this. Real variables such as consumption, investment, GDP, and wages might be included and an interest rate, perhaps the federal funds rate, is another candidate variable. There are trend and co-integration issues to worry about, whether to include levels or changes (or both, or gaps) of some variables, I would want to find a better energy index, check robustness to ordering and alternative structural assumptions, ...
November 10, 2005
"The Rabbit is Indeed in the Middle of the Python"
Why China stands to grow old before it gets rich, by David Willetts, Commentary, Financial Times: ...One reason for China’s stellar growth is that it is at a demographic sweet-spot. The massive reduction in infant mortality achieved by China’s barefoot doctors in the 1960s and 1970s is now yielding a surge of young workers – an extra 10m working-age adults per year. China’s challenge now is just to absorb them into the labour force. ... There are few pensioners and there are not many children either. The rabbit is indeed in the middle of the python. As early as 2015, China’s working age population will actually start falling. By 2040, today’s young workers will be pensioners – in fact the world’s second largest population, after India, will be Chinese pensioners. ... The desperate rush for economic growth is fuelled by fears that China could grow old before it grows rich. ... Imposing the one-child policy ... is having an extraordinary effect. If you can have only one child it becomes highly desirable to have a boy. The rule is not as strictly enforced as it was, but you can now see its effect on the second child, which in the eyes of many Chinese really is the last chance to have a boy. For every 100 female second children, there are 152 males. Overall, there are now about 120 boys for every 100 girls in China. ... China is going to have to attract large-scale female immigration or many of its young men will leave. ... So China is going to be full of old people and rather earnest, frustrated young men. It will be one of the most dramatic and unusual demographic changes the world will have seen for a very long time, and Chinese leaders now would do well to plan for such a future.
Next The Los Angeles Times discusses how economic insecurity, lack of an effective social security system, underdeveloped financial and mortgage markets, and high educational costs cause the high savings rate in China:
Anxiety Drives Chinese Fixation on Frugality, by Don Lee, LA Times: ...China's economic reforms have vastly improved living standards, but the last two decades also have seen a dismantling of the socialist "iron rice bowl" that provided basic health and welfare from cradle to grave. The result is that many Chinese today feel more insecure about their future than their parents' generation did. Chinese families are saving about half of their income. ... [M]ost experts expect China's savings rate to stay high for years to come because of the need to prepare for a large dependent elderly population. ... China, like other nations in East Asia, has a long tradition of thrift. Analysts say it may be linked to Confucian values that encourage thrift and production rather than consumption. China's propensity to save also reflects its agrarian society, where people face more risks of fluctuating incomes and their long work hours leave them with little leisure time to consume. ... pensions, for those who have them, tend to be modest. China's healthcare system is broken; insurance is inadequate for most everybody. Many employers in China don't provide insurance ... In the event of a serious ailment, ... "even an entire life savings may not be enough. So they dare not spend." Zhuo Yunbao recently had a scare when his father was hospitalized with a stroke. He says his father may need a pacemaker, but that's not covered by the state insurance for the elderly. The family is saving for more than a rainy day. They want to buy a car. A few years from now, Zhuo says, maybe they'll look at moving into a bigger home. ... More than anything else, though, the Zhuos are squirreling away for their son's education. ... Like many young Chinese parents, the Zhuos want to send their son abroad for college. They have their sights on England or the U.S., where four years of tuition could reach $125,000. The family has saved a little more than 10% of that. "We have a long way to go," Zhuo says.
William Poole: A Hard Landing is Unlikely
How Dangerous Is the U.S. Current Account Deficit?, by William Poole, St. Louis Fed President: The U.S. current account deficit has attracted considerable attention from academics, policymakers and market participants. So also has the U.S. international investment position—the difference between U.S.-owned assets abroad and foreign-owned assets in the United States. The net position has become increasingly negative as current account deficits have accumulated over time. ... [A] situation in which the U.S. net international investment position becomes ever more negative as a percentage of GDP is inconsistent with long-run equilibrium. So, the question is not whether the U.S. current account deficit will fall in the future but whether the inevitable adjustment is likely to be painful and disruptive of U.S. economic growth and stability—a hard landing. My answer is that a hard landing is very unlikely provided that U.S. monetary and fiscal authorities maintain sound policies. ...
It is sometimes said that the United States has become a “net debtor” nation, and that this situation increases the risk that currency depreciation might lead to financial crisis. Indeed, ... some have drawn comparisons with countries such as Argentina, Brazil, Mexico and other countries that at times have experienced severe balance-of-payments crises. I consider it highly unlikely that such a crisis will befall the United States. ... In fact, about 95 percent of international claims on the United States are denominated in dollars. A country with most of its debt denominated in its own currency is in a very different situation from one whose debt is denominated in other currencies. The familiar crises experienced by several Asian countries ..., by Mexico ..., and by numerous other countries have all involved situations in which the impacted countries have had large external debts denominated in foreign currencies. ... Consider what typically happens to a country suffering a balance-of-payments crisis. As the foreign exchange value of its currency depreciates, the value of its foreign liabilities ... increases, as does the burden of servicing its international debt. Recognizing this implication of a crisis, international investors respond by paring back their positions further, engendering even greater currency depreciation. Hence, the combination of foreign-denominated debt and a depreciating currency has proven to be something of a vicious circle—compounding and accelerating a crisis.
The U.S. situation is completely different. To the extent that the foreign exchange value of the dollar declines, ... Dollar-denominated U.S. liabilities remain unchanged in domestic value, which means that debt service in dollars and relative to the size of the U.S. economy does not change. Moreover, holdings of U.S. investors abroad, about two-thirds of which are denominated in foreign currencies, appreciate in dollar terms. The composition of the U.S. international investment account, therefore, contributes to stability rather than to instability. ... If the capital markets view is correct—and I obviously think it is—the ... transition to a sustainable long-run path [will not] necessarily require wrenching adjustments in domestic or international markets or in exchange rates. ... The United States has created for itself a comparative advantage in capital markets, and we should not be surprised that investors all over the world come to buy the product.
Finally, for those looking for a statement about the future course of interest rates, Bloomberg reports remarks made after the speech:
Federal Reserve Bank of St. Louis President William Poole said the risk of inflation is still ''skewed toward the high side'' after 12 consecutive interest- rate increases. ... ''I would put a higher probability on an upside surprise than on a downside surprise,'' he told reporters today following a speech... ''That in my mind calls for the Federal Reserve to make sure that policy is risk-averse with respect to that outcome.'' ...
The Federal Reserve does not have a set goal for how high it wants to push up short-term U.S. interest rates and will be guided by economic conditions... "There is no numerical target because where ... we adjust it to ... depends on economic conditions," ... Pianalto... noted the Fed has been taking stimulus away from the economy... "Our statement says we are continuing to remove that accommodation," she said... "Where we determine we are no longer accommodative again depends on economic conditions." ... Pianalto also ... acknowledged ... that households could face a harder time servicing debts as rates rise. "As we start to see an increase in interest rates will that cause the consumer problems?" she asked rhetorically in response to a question. "I think it depends on whether that's gradual and how consumers adjust to that." "...we'll have to ... keep our eye on this situation as the conditions change," ...
Explaining the Global Pattern of Current Account Imbalances
New Economist: The Fed's explanation of global current account imbalances: it's not all glut: A new Federal Reserve Board working paper, Explaining the Global Pattern of Current Account Imbalances, makes a thoughtful attempt to explain the global current account imbalances that have emerged in recent years... As Fed economists Joseph W. Gruber and Steven B. Kamin note, a variety of reasons for this imbalance have been put forward:
There is no consensus explanation for the current pattern of international capital flows, and many hypotheses have been put forward: U.S. fiscal deficits; declines in U.S. private saving; the surge in U.S. productivity growth; increases in global financial intermediation; a global savings glut; a rash of emerging market financial crises; and exchange rate pegs by our trading partners. However, many of these factors are quite amorphous, and it has been difficult to muster support for one explanation against another.
Though the authors don't quite manage to square the circle, their modelling gets some of the way there. Here's a summary:
Based on the approach developed by Chinn and Prasad (2003), we ... estimate panel regression models for the ratio of the current account balance to GDP. We find that a model that includes as its explanatory variables the standard determinants of current accounts proposed in the literature - per capita income, relative growth rates, the fiscal balance, demographic variables, and economic openness - can account for neither the large U.S. deficit nor large Asian surpluses of the 1997-2003 period. However, when we include a variable representing financial crises, ... the model explains much of developing Asia’s swing into surplus since 1997. Even so, the model cannot explain why the capital outflows associated with Asia’s current account surpluses were channeled primarily into the U.S. economy. Observers have pointed to strong growth performance and a favorable institutional environment as elements attracting foreign investment into the United States, and we found strong evidence that good performance in these areas significantly reduces the current account balance. ... [A] model incorporating these factors still fails to predict the large U.S. current account deficit...
Both advocates and critics of the 'global savings glut' hypothesis will be interested in their findings. On the Asian surplus side, they find support:
First, our work provides support for at least half of the global savings glut hypothesis: the half suggesting that the U.S. deficit owes partly to an autonomous rise in the quantity of saving made available to the United States... In particular, our estimation results indicate that financial crises systematically lead to higher current account imbalances, and ... especially in East Asia, contributed to their shift into current account surplus. This finding tends to undercut a related explanation for the East Asian surpluses, that they reflect the rational development strategy of East Asian governments and can be expected to persist for a long time ... In fact, our sense is that, with much of developing Asia’s surpluses explained by prior financial crises, these surpluses will likely dissipate as adjustments following those crises are completed. ... consistent with standard theory.
That conclusion is likely true of non-Chinese Asian current account surpluses. Kamin provided some plausible reasons why in another recent paper of his: The Revived Bretton Woods System: Does It Explain Developments in Non-China Developing Asia? But China's large and growing surplus is due to other factors, and cannot be expected to dissipate anytime soon.
As to the large US current account deficit, it is less easily explained by the savings glut hypothesis:
Second, for the global saving glut story to explain the large U.S. current account deficit, however, some explanation must be posited for why the increase in global savings availability was tapped primarily by the United States. Our research provides mixed support for the explanations that have been advanced (some of which, in principle, could operate even without an autonomous rise in foreign saving).
The expansion of the U.S. budget deficit ..does not appear to explain the U.S. current account deficit, at least for the 1997-2003 period; not only is the estimated pass-through of the fiscal balance to the current account quite small, at about 0.1, but the average budget balance during this period was relatively positive by international standards. The view that current account deficits can be caused both by strong economic performance ..and by a market-friendly institutional environment ..was well-supported by our research; we found that the pace of output growth generally exerted a significant negative effect on the current account.
Cleveland Fed's Pianalto: Education is a Key Factor for Economic Flexibility
The Role of Innovation in Economic Transformation, by Sandra Pianalto, Cleveland Fed President, November 9, 2005: At the Federal Reserve Bank of Cleveland, we spend a lot of time thinking about what factors drive economic growth and prosperity. We have found that innovation is one of the key factors in creating the kind of economic conditions that will benefit all of our citizens. Today, I would like to share my thoughts on the role of innovation in economic transformation. ...[I]n Northeast Ohio ... After a century of relying on the heaviest types of traditional industry — such as coal, steel, autos, and rubber — we have been deeply affected by global trends including rapidly changing technology and increased international trade. As I am sure you know, these trends have led to a decline in manufacturing jobs and a growing wage differential between high-school and college graduates. ... Economists call this process “creative destruction.” It is a natural part of our economic development... Economic change is as relentless as the tides, and this change will direct resources to wherever they are most productive. ... [O]ur region’s transition does not necessarily mean we have to live in a world with downsized dreams, or less productive industry, or less prosperous communities. ... Every sector of society — public and private; for-profit and non-profit; philanthropic and academic — can participate in fostering a growing regional economy in the future. The key to our shared success, I am convinced, will be our ability to foster and sustain innovation. ... I don’t think it is any exaggeration to say that innovation is the mainspring for economic renewal. ... The task now... is to educate a new generation of inventors and entrepreneurs, to encourage their creativity, to invest in their potential, and to promote their access to worldwide markets. ... To create a dynamic economy that promotes innovation in Northeast Ohio, we must find a way to do a few important things well (bullets added for emphasis):
- We must fund academic research...
- [W]e must support business startups to move innovations from the labs to production sites.
- We must build on our existing strengths — using the industrial knowledge and workplace skills from older industries and applying them to new tasks. ...
- But there is one more important thing that we need to do well, and that is educating our workforce for the future. In a global economy that grows more competitive every day, the words “education” and “opportunity” are becoming increasingly synonymous. Creating a civic culture that supports education is the most promising pathway to creating a base for innovation. ... Investments in education today ... can generate dramatic new productivity growth tomorrow. The fact is that Northeast Ohio lags behind many other regions of the country in levels of educational attainment, and nowhere is that more evident than in our large cities.
Making effective investments in our people must be among our foremost priorities. Investments, after all, come in many forms. ... As we look ahead, our prospects depend on our commitment to invest in intellectual capital: the knowledge base of our students, the technological skills of our workers, and the imaginative power of our inventors. ... Instead of resisting change, we must prepare for new opportunities by rethinking our approaches, retraining our workforce, and investing in new initiatives. ...
"Economic change is as relentless as the tides." As I've said before many times here, we will not stop globalization, the economic tide will move where it wants to move - but we can do a whole lot better helping those who, through no fault of their own, have the costs of globalization thrust upon them, and a key component of that effort is education.
November 09, 2005
Structural Change and Declining Output Volatility
Declining Output Volatility: What Role For Structural Change?, by Christopher Kent, Kylie Smith and James Holloway, RDP 2005-08 Abstract The decline in output volatility in a number of countries over the past few decades has been well-documented, though less agreement has been reached about the causes of this decline. In this paper, we use a panel of data from 20 OECD countries to ... suggest that reforms in product and labour markets can reduce volatility of aggregate output by encouraging productive resources to shift more readily in response to differential shocks across firms and sectors. In contrast to other studies, we include direct measures of product market regulations and monetary policy regimes as indicators of structural reform. We find that less product market regulation and stricter monetary policy regimes have played a role in reducing output volatility...
And from the conclusion, what is different about these results as compared to previous work, and why we should believe the decline in output volatility is permanent:
Studies that have used structural models to identify various demand and supply shocks find that most of the decline in output volatility is due to a decline in the magnitude of shocks, with a limited role for structural reforms and monetary policy. In comparison, our atheoretical approach accounts for the possibility that smaller shocks may themselves be the result of structural changes. The finding of a significant role for increased efficacy of monetary policy and less regulated markets ... has an important implication for future output volatility. Namely, while any decline in global shocks that has been driven solely by good fortune cannot (by definition) continue indefinitely, the benefit of significant structural reforms is likely to limit the extent of any future rise in output volatility.
Amber Tidal Waves of Grain
Mountains of Corn and a Sea of Farm Subsidies, by Alexei Barrionuevo, NY Times: ...[C]orn production by American farmers ... this year is estimated to reach a nationwide total of at least 10.9 billion bushels, second only to last year's 11.8 billion bushels. ... underscoring what critics call a paradox at the heart of the government farm subsidy program: America's efficient farmers may be encouraged to produce far more than the country can use, depressing prices and raising subsidy payments. ... [F]ederal spending on farm payments is closing in on the record of $22.9 billion set in 2000... If export sales stay weak, this year's subsidies could hit a new record. ...In response to pressure, the Bush administration said last month that the United States was prepared to cut its most trade-distorting farm subsidies by 60 percent over five years. The world's poor nations, which tend to be heavily dependent on agriculture, complain that American and European Union farm subsidies spur growers to produce gluts that depress crop prices throughout the world. ...
Farmers are hardly shy about exploiting the government safety net provided by guaranteed loan-deficiency payments. "Everybody leans on the L.D.P.'s as much as they can," said Ash Kading, a farmer in western Iowa... "It is like opening up the federal Treasury. There were quite a few people this year that wish corn prices would go to zero because they would have a bigger L.D.P." ... This year grain piles are everywhere across Iowa and parts of Illinois, the two biggest corn-producing states. In Iowa, the amount of grain being stored on the ground for lack of storage is averaging more than 19 percent, its highest level in at least 25 years... Lately the giant piles have become the butt of jokes in farm country. They were spoofed in a fake picture... that showed a skier airborne atop West Central's biggest pile, with the caption that said "one thing you can do with a 3-million-bushel pile of harvested corn: Ski Iowa."
Here's the Ski Iowa picture from Chicago Boyz. There seems to be general agreement that farm subsidies distort markets and should be eliminated. There also seems to be general agreement that to do so is political suicide. I do want to add one note. Maybe this will make farmers a little less ticked off at economists for calling for an end to the gravy train. Farming can lead to highly volatile incomes. Some years are great, others are awful. So as we cut subsidies, if we ever do, we should be careful to keep in place institutions that serve to smooth farm incomes over time. Though many believe market failures lead to an underprovision of this type of insurance and government intervention is needed to overcome them, it seems natural that farmers, politicians, and others in favor of privatization of Social Security would also favor this type of income insurance being provided by the private sector instead of the government, but I'm not sure that is generally the case.
The European Central Bank Pressures Nations to Reduce Fiscal Deficits
ECB targets its problem nations, by Ralph Atkins and Mark Schieritz, Financial Times: The European Central Bank will sharply step up pressure on Italy, Greece and other eurozone fiscal laggards by warning that it will refuse to accept their sovereign debt as collateral if their credit ratings slip. ...[T]he bank is to state that it will only accept bonds with at least a single A- rating from ... the main rating agencies as collateral in its financial market activities.... A refusal by the ECB to accept a government's bonds would amount to a humiliating swipe at that government's policies, and make its bonds harder to sell. ... The eurozone has been dogged by the failure of many countries to keep budget deficits under control... The ECB appears to hope that the market mechanism will help impose fiscal discipline where political pressure has failed. But the move will not put additional pressure on France and Germany which enjoy high credit ratings in spite of having broken EU rules on budget deficits. Jean-Claude Trichet, ECB president, last week described the outlook for the deficits of some eurozone countries as "a matter of great concern". ... The ECB's move is likely to divide finance ministries. Some are expected to regard it as a welcome embrace of market-based pricing mechanisms but others may worry about the increased importance given to ratings agencies. ... The convergence of bond spreads since the introduction of the euro in 1999 has meant that less fiscally disciplined governments have largely escaped punishment by the markets, although the ECB argues that investors have priced in different risks in recent months. ...
Senator Grassley: Social Security Reform Unlikely Before 2009
U.S. Social Security overhaul unlikely before 2009, by Donna Smith, Reuters: ... Charles Grassley, the chairman of the Senate Finance Committee, told a business group he is unable to win agreement for a Social Security overhaul even among his fellow Republicans on the tax writing panel. ... "I am very pessimistic about it in the future," Grassley told the U.S. Chamber of Commerce. "Probably the next bite at Social Security will come in 2009." ... Bush still mentions Social Security in speeches, but has not devoted any public appearances solely to the private account proposal in months. ... Backers of private accounts hope to keep the issue alive by pushing a bill sponsored by Sen. Jim DeMint, a South Carolina Republican, ...[and a] second bill sponsored by Sen. Rick Santorum, a Pennsylvania Republican ... Aides to the two senators said the lawmakers enjoyed support of Senate Republican leaders and they hope to see a floor vote on the proposals before the end of the year. Grassley said he would support any effort to revive Bush's plan, but told reporters he was unsure how the drive for a vote by the two lawmakers would play out...
So some will continue to push for a vote. And, as reported in CNN/Money:
Grassley: no Social Security reform now, CNN/Money: ...Grassley said he will try to get his fellow committee members to act sooner than 2009, but those efforts may be hampered by next year's Congressional elections. "I'm pessimistic that it could come up before 2009," Grassley said. "Doesn't mean that I won't try to bring it up before 2009."
Nevertheless, reform in the near term looks very unlikely.
November 08, 2005
Econoblog: Changing Times at the Fed
Econoblog: Changing Times at the Fed: Alan Greenspan will soon step down as chairman of the Federal Reserve and, if the Senate consents, hand the reins to former Fed governor and celebrated academic economist Ben Bernanke. But that's not the only change likely to be in store at the U.S. central bank.
To be sure, Mr. Bernanke has vowed that he'll follow closely on the policy path marked by the Greenspan Fed. But he could bring along some new tools -- such as inflation targets -- to help him navigate. Further, Mr. Bernanke will be stepping to the helm as the Fed appears to be nearing the end of a long tightening cycle. Will he continue to raise interest rates, or apply the brakes to the central bank's long campaign to lift borrowing costs to a "neutral" level?
The Wall Street Journal Online asked economist bloggers William Polley and Tim Duy to explore what the future might hold for the seat of U.S. monetary policy.
I encourage you to read the discussion as well as William Polley's comments at his blog. Thanks to both for doing this. Also, the subscription wall is down this week at the WSJ so all content is free. Finally, here are all of Tim Duy's Fed Watch posts.
The Relationship between R&D and Successful Innovation
For innovation success, do not follow the money, by Michael Schrage, Financial Times: The “Chicken Littles” of Eurocompetitiveness are clucking in despair. The latest research shows that yet again, American and Asian companies have boosted their rates of research and development spending even as Europe’s own innovation investment has gone flat. ... Worse yet, Europe ranked last in the key global benchmark of “R&D intensity” – R&D spending as a percentage of sales. ... You can almost hear the Eurocrats crying: “The innovation is falling! The innovation is falling!” Is it perhaps time for some European soul-searching into the short-sighted and risk-averse nature of the continent’s industrial elite? Hardly. These global R&D budget numbers are an exercise in accurate rubbish. They simultaneously deceive and mislead.
Any policymaker, chief executive or innovation champion who relies on R&D intensity and R&D budgets as a meaningful or usable metric to assess global competitiveness virtually guarantees shoddy analysis and distorted decisions. Few things reveal less about a company’s ability to innovate cost-effectively than its R&D budget. Just ask General Motors. ... “There is no correlation between the percentage of net revenue spent on R&D and the innovative capabilities of an organisation – none,” Bart Becht, chief executive of Reckitt Benckiser... said recently. The ... company reports an R&D intensity of 1 per cent. Nevertheless, Mr Becht’s company enjoys a reputation both for innovation and for relatively high margins... Similarly, Illinois Tool Works ... spends but 1 per cent of its revenues on R&D ... Yet the ... company is likewise regarded as a premier industry innovator that consistently ranks in the top 100 of US corporate patent recipients. Even Apple Computer defies the high-tech, high R&D intensity stereotype ... its ... R&D spending was a fraction of larger competitors such as Sony or Microsoft. Yet the iPod, iTunes and iBook enjoy breakthrough status as profitable innovations...
This anecdotal evidence is not atypical. Last month, Booz Allen ... published a report confirming ... there was “no discernible statistical relationship between R&D spending levels and nearly all measures of business success including sales growth, gross profit, operating profit, enterprise profit, market capitalisation or total shareholder return”. In other words, more is not better. Econometricians may quibble over the survey’s methodological details but ... The simple fact is that R&D spending ... is an input, not a measure of efficiency, effectiveness or productivity. Ingenuity, invention and innovation are rarely functions of budgetary investment. ... [C]ompanies get far more design value for far less money from their information technology spending now than a decade ago. ... [by] doing more R&D in developing markets such as China and India where quality research is much cheaper... Consequently, comparisons between the corporate R&D intensities of today with the intensities of yesteryear become even less meaningful.
R&D productivity – not R&D investment – is the real challenge for global innovation. Innovation is not what innovators innovate, it is what customers actually adopt. Productivity here is not measured in patents granted but in new customers won and existing customers profitably retained. ... Growing market competition, not growing R&D spending, is what drives innovation. A successful innovation policy is a competition policy where companies see innovation as a cost-effective investment to differentiate themselves profitably. ...
If I were to take back the floor, I would note the existence of market failures requiring remedies such as government enforced patents and how such factors are related to the role of government and university research within this "free market" framework. Global enforcement of property rights and how that may affect innovation might also be discussed. And while it may be part of the solution, there are a lot more complicated issues to think about in this area beyond calling for increased competition as a means of increasing global innovative investment.
Krugman Responds in Money Talks
On "Pride, Prejudice, Insurance," Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Lynne Koester, Yuba City, Calif.: Would it be feasible to convert Medicare into a national health insurance system? I realize that its present per-patient cost is high because of the age of those who qualify..., but if the pool were enlarged by including most all Americans, wouldn't the per-patient cost decrease? By eliminating the profits built into private health insurance companies, we could save even more money. Plus, when ill, many uninsured people presently use a hospital emergency room because they do not have medical insurance, but if they were covered by a national health insurance, they could be treated in a doctor's office, which is less costly than a hospital. Paul Krugman: Yes, indeed. One way to implement national health care would simply be to expand Medicare to everyone. Of course, doing that would require additional funds, probably in the form of an increase in the payroll tax. And that would elicit howls from the right. But the apparent rise in tax rates would be an illusion: it would simply substitute an explicit tax for the implicit tax that companies and workers pay in the form of insurance premiums. Given international experience, I have no doubt that overall spending on health care would actually fall, and that job creation would actually rise, after the supposed tax increase. It's a simple solution, building on a program that we already know works. It would make the vast majority of Americans better off. And it's considered a complete non-starter politically. Now why is that?
In another response, Krugman answers questions from readers about where to get further information on international health care comparisons:
Notes on International Comparisons of Health Care, Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Some readers may want to follow up on my Nov. 7 column on international comparisons of health care. Here are a few useful links.
- Trends in employer-based insurance: The underlying data come from the Census. Here is a shorter, useful summary of the data.
- International comparisons of health spending: The Factbook of the Organization for Economic Cooperation and Development, an international research organization supported by member governments, is available at www.sourceoecd.org. It provides comparative data on many economic, environmental, and social trends. Data on health care spending per capita are ... adjusted for international differences in the cost of living. Two things stand out. First, the United States is off the scale in terms of the amount we spend per person. Second, the U.S. system is unique in its reliance on private spending.
- Quality of Health Care: “Taking the Pulse of Health Care Systems: Experiences of Patients With Health Problems in Six Countries,” is a new study published in Health Affairs. Check out Exhibits 6 and 7, in particular.
- Taiwan: A very interesting study, also online, is “Does Universal Health Insurance Make Health Care Unaffordable? Lessons from Taiwan.” Since it’s predictable that ... the usual suspects will attack my column by citing newspaper articles about runaway costs in Taiwan, it’s particularly interesting to read the paper’s discussion of how “political theater” – overstating the quite mild financial difficulties of the Taiwanese system – was used to sell a modest increase in premiums.
Finally, here's a comment Krugman included about his column on the role of the press:
On "Ending the Fraudulence," Paul Krugman, Money Talks (link to original column, discussion of Krugman's column at this site): Bill Paoli, Oakland, Calif.: I liked your column but think it was too tepid. ... There are two factors that I think lead to our rotten press:
The first is laziness. Reporters seem to think that they have to have anonymous informants to get the news. They are unwilling to use their own eyes and ears and do the spade work necessary to get these stories. The obvious example of a muckraking journalist who avoided insiders and did not use anonymous sources was I.F. Stone. He never thought it was necessary to have drinks with the likes of a Karl Rove, for instance, something editor Bill Keller seems to favor. You mention the use of the interview as a favored device for reporting. Again, this is sheer laziness and it results in a journalistic product, not reporting.
Secondly, there is a complete lack of courage except for a few columnists here and there, including a few at your paper. There seems to be a status quo, common knowledge, everyone knows, undercurrent that blinds reporters to what would otherwise seem obvious. This is sometimes referred to as buying the party line... Of course this blindness also helps the old career along as well — no one is offended and everything is sweetness and light...
Tax Reform Thoughts from Marginal Utility's Perspective
Marginal Utility: The Tax "Reform" Panel's Report: Some Thoughts: While tax "reform" may be deader than a dead dodo, in the spirit of teaching Democratic strategists a lesson from the other side's not-necessarily-evil behavior, I will not refrain from kicking it when it's down. This is in no way a comprehensive list, as I only have so much leisure time to devote to poring over the report. 1. Having Democrats around does matter: Had the panel recommended a consumption tax or a progressive wage tax a la the "X Tax" — thereby offering political cover to the right's goal of exempting investment income from taxation — a host of tax policy analysts from the AEI, Cato, Heritage, etc. would have been walking around resembling "Nail's Tales." Tom DeLay, I'm sure, would be describing the reforms as gilding the deck chairs on the Queen Mary 2 rather than re-arranging same on the Titanic. Some credit for this not happening must go to John Breaux, otherwise hardly a progressive's progressive, and other representatives of the center on the panel, who at least were not going to let zero rates for personal investment income fly. 2. Lies, damn lies, statistics, and marketing: Max Sawicky is right that the report is not only a policy analysis document. It's full of non-functional illustrations like this one, meant to dramatize how much better it will be to fill out the proposed 1040-SIMPLE than the existing 1040 (non-EZ, I presume):
Preying on fear of math may be effective, though doing so on page 107 of a several hundred page report overestimates the mean level of wonkery in the target audience.
The reality is, the existing income tax is not complicated at all for wage and salaries income, which accounts for the vast majority of income for the vast majority of taxpayers. Features like graduated tax rates don't count since tax tables turn the calculation (not advanced math to begin with) into a simple lookup, and anyway there are these things called computers and e-filing initiatives have driven the price of tax software effectively to zero.
The Simplified Income Tax alternative, meanwhile, introduces new complexity — e.g., regionally variable limits on the mortgage interest credit — and retains other forms, such as preferential treatments of some investment income. This provision may look simple:
(p. 108) Exclude 100% of dividends of U.S. companies paid out of domestic earnings.
Quick, define U.S. companies and domestic earnings! Does the former include tax-avoiding expatriates? Can you figure the latter while decreasing (other things equal) the level of employment in the transfer pricing business? 3. Dept. of "Are you kidding me?": The report does, early on, express a touching bit of concern for the possibility that tax rates distort labor supply decisions. When I was a student, some conservative economics professors actually were concerned about such things, before the obsession with capital market distortions took over. This, however, has to be the worst example ever:
(p.6) Let’s say you are just offered a great job at $120,000 a year. You are married with one child and your current salary is $80,000. You take the job, right? Not necessarily. The increase in salary might cause you to lose some of the child credit – and subject you to other provisions that increase your total tax bill even more, such as the alternative minimum tax. In all, the pre-tax jump in your new salary may be $40,000, but it could end up costing you an extra $9,203 in tax – meaning that your salary would rise by 50 percent while your tax liability would increase by 140 percent. Not surprisingly, some workers figure this out quickly and avoid taking on work... simply because of how the tax code penalizes that extra effort.
Forget for a moment that $120,000 is in a sufficiently high percentile of the wages-and-salaries distribution that relatively few people will have the problem of making the decision. Those percentages are highly misleading. Yes, tax increases more than income since the marginal rate on the extra $40,000 is higher than the average rate on the previous $80,000. But let's rephrase the problem. Define "great job" how you will. Would you forego the after-tax $30,797? (If yes, really? Why?) More later...
November 07, 2005
FRB Survey on Bank Lending Practices
More seriously, I want to make you aware of a Fed survey on bank lending practices. These are just a few of the tables from the report, there's an accompanying analysis, but in all honesty given my current state of mind, I started to read it and dozed off almost immediately so I will set it aside for later or for others to report on (CR perhaps on the residential stuff?). There do appear to be some interesting tidbits here and there just from scanning it.
Here are the tables. A few very quick notes: (1) banks appear to be, surprisingly, easing credit standards in the residential loan market over the last three months. (2) demand appears to have weakened over the last three months, (3) the size of loans and length to maturity has increased moderately, and terms appear to have eased in general, (4) If I'm reading it right, a necessary qualifier right now, the last table says that banks did not change at all in response to the May 16, 2005, joint guidance on home-equity lines of credit issued by Federal regulators. This leads to speculation that recent talk of a stepped up regulatory response under Bernanke to events such as housing bubbles may not produce the desired decline in risky mortgages, at least not the type of regulatory response implemented in May:
Senior Loan Officer Opinion Survey on Bank Lending Practices, The Federal Reserve Board: ... Questions 9-12 ask about residential mortgage loans at your bank. ... If your bank's credit standards have not changed over the relevant period, please report them as unchanged even if the standards are either restrictive or accommodative relative to longer-term norms. If your bank's credit standards have tightened or eased over the relevant period, please so report them regardless of how they stand relative to longer-term norms. Also, please report changes in enforcement of existing standards as changes in standards.
9. Over the past three months, how have your bank's credit standards for approving applications from individuals for mortgage loans to purchase homes changed?
|All Respondents||Large Banks||Other Banks|
|Remained basically unchanged||46||85.2||25||78.1||21||95.5|
10. Apart from normal seasonal variation, how has demand for mortgages to purchase homes changed over the past three months? (Please consider only new originations as opposed to the refinancing of existing mortgages.)
|All Respondents||Large Banks||Other Banks|
|About the same||32||59.3||19||59.4||13||59.1|
11. Over the past two years , how have the following terms changed for mortgage loans to purchase homes originated by your bank? (Please assign each term a number between 1 and 5 using the following scale: 1=tightened considerably, 2=tightened somewhat, 3=remained basically unchanged, 4=eased somewhat, 5=eased considerably.)
|All Respondents||Large Banks||Other Banks|
|Maximum size of primary mortgage||3.40||3.41||3.40|
|Maximum size of second mortgage||3.31||3.35||3.24|
|Maximum loan-to-value ratio including all outstanding loans for that property||3.26||3.28||3.24|
|Loan origination fees (higher fees=tightened, lower fees=eased)||3.11||3.03||3.24|
|Spreads of mortgage rates over an appropriate market base rate (wider spreads=tightened, narrower spreads=eased)||3.28||3.34||3.19|
|Maximum length of extended interest-rate locks||3.08||3.00||3.19|
|Maximum debt-service ratio including all other debt payments||3.19||3.22||3.14|
|Minimum required credit score||3.09||3.16||3.00|
|Other (please specify)||3.00||3.00||3.00|
|Number of banks responding||53||32||21|
12. Because of rapid growth in home equity lending that has involved products with higher embedded risk, federal bank regulators released, on May 16, 2005, joint guidance on home-equity lines of credit (SR 05-11). In light of the concerns expressed in the supervisory letter, how has your bank changed its lending standards and terms for home equity lines of credit? (Please assign each term a number between 1 and 5 using the following scale: 1=tightened considerably, 2=tightened somewhat, 3=remained basically unchanged, 4=eased somewhat, 5=eased considerably.) Note: The text of the letter is available from the Board's public website:
|All Respondents||Large Banks||Other Banks|
|Price-related terms (higher fees and wider spreads=tightened; lower fees and narrower spreads=eased)||2.91||2.90||2.92|
|Number of banks responding||55||31||24|
A Drunk and Her Dog: An Illustration of Cointegration and Error Correction
Update: Open link to paper - Thanks Paul.
Paul Krugman: Fixing Health Care
Pride, Prejudice, Insurance, by Paul Krugman, NY Times: ...Employment-based health insurance is the only serious source of coverage for Americans too young to receive Medicare and insufficiently destitute to receive Medicaid, but it's an institution in decline. ... The funny thing is that the solution - national health insurance ... - is obvious. But to see the obvious we'll have to overcome pride - the unwarranted belief that America has nothing to learn from other countries - and prejudice - the equally unwarranted belief, driven by ideology, that private insurance is more efficient than public insurance. Let's start with the fact that America's health care system spends more, for worse results, than that of any other advanced country. In 2002 the United States spent $5,267 per person on health care. Canada spent $2,931; Germany spent $2,817; Britain spent only $2,160. Yet the United States has lower life expectancy and higher infant mortality than any of these countries.
But don't people in other countries sometimes find it hard to get medical treatment? Yes ..but so do Americans. ... The journal Health Affairs recently published ... a survey of the medical experience of "sicker adults" in six countries, including Canada, Britain, Germany and the United States. ... It's true that Americans generally have shorter waits for elective surgery ... although German waits are even shorter. But Americans ... find it harder ... to see a doctor when we need one, and our system is more, not less, rife with medical errors. Above all, Americans are far more likely than others to forgo treatment because they can't afford it. ...
Why does American medicine cost so much yet achieve so little? ...[W]e treat access to health care as a privilege rather than a right. And this attitude turns out to be inefficient as well as cruel. The U.S. system is much more bureaucratic, with much higher administrative costs, ... because private insurers and other players work hard at trying not to pay for medical care. And our fragmented system is unable to bargain with drug companies and other suppliers for lower prices. Taiwan... offers an object lesson in the economic advantages of universal coverage. In 1995 less than 60 percent of Taiwan's residents had health insurance; by 2001 the number was 97 percent. Yet ... this huge expansion in coverage came virtually free: it led to little if any increase in overall health care spending ... The economic and moral case for health care reform in America... is overwhelming. One of these days we'll realize that our semiprivatized system isn't just unfair, it's far less efficient than a straightforward system of guaranteed health insurance.
I agree. As discussed extensively at this site, there are important market failures in the provision of social insurance, moral hazard is one problem, adverse selection is another, the inefficiencies from fighting over who pays the bills identified by Krugman is yet another, that make the private sector provision of social insurance less efficient than public sector provision.
November 06, 2005
Blanchard: "European Unemployment: The Evolution of Facts and Ideas"
European Unemployment: The Evolution of Facts and Ideas, by Olivier Blanchard, NBER WP 11750, November 2005: Abstract In the 1970s, European unemployment started increasing. It increased further in the 1980s, to reach a plateau in the 1990s. It is still high today, although the average unemployment rate hides a high degree of heterogeneity across countries. The focus of researchers and policy makers was initially on the role of shocks. As unemployment remained high, the focus has progressively shifted to institutions. This paper reviews the interaction of facts and theories, and gives a tentative assessment of what we know and what we still do not know. [free September Version] [free October version] See also "Explaining European Unemployment."
The paper is worth reading for more than this particular point, but given the increasing job insecurity arising from globalization and other forces, I want to highlight an important distinction Blanchard makes between protecting jobs and protecting workers:
6 Do We Know Enough to Give Advice?At the end of this tour, one may ask whether we know enough to give advice to policy makers about how to reduce unemployment. I believe we do—with the proper degree of humility. ...
6.1 A General Story Line Going back over the last thirty years, there is little question that the initial increase in unemployment in Europe was primarily due to adverse and largely common shocks, from oil price increases to the slowdown in productivity growth. There is not much question that different institutions led to different initial outcomes. ... There is not much question, ... that the increase in unemployment led... most countries.. to changes in institutions... to limit the increase in unemployment through employment protection, and to reduce the pain of unemployment through more generous unemployment insurance. There is not much question that, since the early 1980s... most governments have partly reversed the initial change in institutions. But this reversal has been partial, and sometimes perverse. The different paths chosen may well explain the differences in unemployment rates across European countries today. ...
6.2 Which Institutions? It is one thing to say that labor market institutions matter, and another to know exactly which ones and how. Humility is needed here, and there is no better reminder than the comparison between Portugal and Spain. Both experienced revolutions and wage explosions in the 1970s ... both have, at least on the surface, rather similar institutions, including high employment protection. Yet, Spanish unemployment has been very high, exceeding 20% in the mid–1990s, whereas Portuguese unemployment has remained low, with a high of 8.6% in the mid–1980s, and a decrease thereafter. Many researchers, including myself, have tried to trace the differences to differences in shocks or institutions ... I am not sure that our explanations are much more than ex-post rationalizations. ... Nevertheless, even if one cannot pretend to have much confidence about the optimal overall architecture, much has been learned ... We know much more about the incentive aspects of unemployment insurance on search intensity and unemployment duration... We know more about the effects of decreasing social contributions on low wages ... We know more about the effects of employment protection, ... From both the macro evidence and this body of micro–economic work, a large consensus—right or wrong—has emerged:
- It holds that modern economies need to constantly reallocate resources, including labor, from old to new products, from bad to good firms.
- At the same time, workers value security and insurance against major adverse professional events, job loss in particular. While there is a trade-off between efficiency and insurance, the experience of the successful European countries suggests it need not be very steep.
- What is important in essence is to protect workers, not jobs.
- This means providing unemployment insurance, generous in level, but conditional on the willingness of the unemployed to train for and accept jobs if available.
- This means employment protection, but in the form of financial costs to firms to make them internalize the social costs of unemployment, including unemployment insurance, rather than through a complex administrative and judicial process.
- This means dealing with the need to decrease the cost of low skilled labor through lower social contributions paid by firms at the low wage end, and the need to make work attractive to low skill workers through a negative income tax rather than a minimum wage.
This consensus underlies most recent reforms or reform proposals ... These measures are probably all desirable. If they were to be implemented, would they be enough to eliminate the European problem? I see ... reasons to worry. ... these reforms deal only with a subset of the institutions that govern the labor market. ...
Keeping Up With the Experiential Joneses
Material riches fail the happy test, by Henry Tricks, Financial Times: Rich people are likely to find more happiness scuba-diving or going to a concert than buying that Ferrari, global investors were told on Friday. According to what many in financial circles will regard a heretical piece of research by Dresdner Kleinwort Wasserstein, materialistic goals may even cause dissatisfaction with life and mental disorders such as paranoia. The report by James Montier, DrKW global equity strategist, comes a year after he shocked clients with ... another jaw-dropping suggestion, that money and happiness shouldn't be equated. Building on the theme, he said on Friday that there was a mass of evidence to suggest that spending on experiences, such as walking the Machu Picchu trail in Peru, rather than possessions, such as “flash watches”, seemed to make people happier, provided their basic needs were satisfied. This notion applied to people once they were earning more than $25,000. “This doesn't mean you have to give your wordly possessions away, although there may be a lot to say for this,” he told clients. Explaining the benefits of experiences over possessions, he said they tended to be unique, whereas a house or car is likely to become the norm very quickly. He urged readers to avoid a keep-up-with-the-Joneses syndrome. However, other experts believe that is a pipe dream. “Human beings have to look over their shoulder before they decide how happy they feel,” said Andrew Oswald, professor of economics at Warwick University.
So, like he says, avoid those paranoia inducing materialistic goals. Instead, grab that new scuba gear made possible by the home equity loan, take advantage of those expensive diving lessons, and enjoy yourself! Just don't drive there in a Ferrari.
Posted by Mark Thoma on Sunday, November 6, 2005 at 12:48 AM in Economics
Charitable Tax Write-Offs and Social Insurance
Tax-Bill Provisions Would Limit Charity Write-Offs, by Jacqueline L. Salmon, Washington Post: ... This week, senators are expected to propose rules that would limit a number of charitable write-offs. ... Last year, Congress tightened rules for donations of vehicles and gifts of intellectual property. This week, Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) is expected to propose amendments to the tax-reconciliation bill ... that would ... would tighten rules on appraisals of non-cash charitable donations, such as art, land and closely held stock. Another would limit deductions for donations of easements that protect the outward appearance of historic buildings... And those who donate clothing and household goods to charities will no longer be able to guess at their value. Under a Grassley proposal, they would have to consult a guide, to be published by the Internal Revenue Service, to determine the value of the items. ... The news isn't all grim for charities and their contributors. Sen. Rick Santorum (R-Pa.) is expected to offer a proposal allowing taxpayers to withdraw money from their individual retirement accounts and donate it to charities, a provision long sought by nonprofit organizations. ... In the coming months, it is expected to consider proposals that would expand disclosure requirements for charities and modify the way they govern themselves.
How Much Will Google Enhance Competition?
Just Googling It Is Striking Fear Into Companies, by Steve Lohr, New York Times: Wal-Mart, the nation's largest retailer, often intimidates its competitors and suppliers. ... But there is one company that even Wal-Mart eyes warily these days: Google... In Google, Wal-Mart sees both a technology pioneer and the seed of a threat... The worry is that by making information available everywhere, Google might soon be able to tell Wal-Mart shoppers if better bargains are available nearby. Wal-Mart is scarcely alone in its concern. ... Businesses already feeling the Google effect include advertising, software and the news media. Apart from retailing, Google's disruptive presence may soon be felt in real estate and auto sales. ... And ever-smarter software... will cull and organize larger and larger digital storehouses of news, images, real estate listings and traffic reports, delivering results that are more like the advice of a trusted human expert. Such advances... would be an unsettling force for all sorts of industries and workers. But it would also reward consumers with lower prices and open up opportunities for new companies. ...
Among the many projects being developed and debated inside Google is a real estate service, according to a person who has attended meetings on the proposal. The concept... would be to improve the capabilities of its satellite imaging, maps and local search and combine them with property listings. The service... could make house hunting far more efficient... Search engines, combined with other technologies, have the potential to drive comparison shopping down to the shelf-by-shelf level. Cellphone makers, for example, are looking at the concept of a "shopping phone" with a camera that can read product bar codes. The phone could connect to databases and search services and, aided by satellite technology, reveal that the flat-screen TV model in front of you is $200 cheaper at a store five miles away. ... Such services could lead to lower prices for consumers, but also relentless competition that threatens to break up existing businesses. ...
Graphs Gathered from Blogs (October 2005)
There is also a directory of links to graphs from other months.
November 05, 2005
Monetary Institutions and Economic Development
Cato Institute 23rd Annual Monetary Conference, Monetary Institutions and Economic Development, Cosponsored with The Economist
Emerging Markets, Debt, and the Dollar Watch Panel in Real Video
William A. Niskanen - Moderator Chairman, Cato Institute Kenneth Rogoff Thomas D. Cabot Professor of Public Policy and Professor of Economics, Harvard University John H. Makin Principal, Caxton Associates, LLC, and Senior Fellow, American Enterprise Institute Nouriel Roubini Associate Professor of Economics and International Business, New York University Eugenio Andrea Bruno Attorney, Nicholson and Cano, Buenos Aires
Monetary Credibility and Sustainable Development Watch Panel in Real Video
Zanny Minton Beddoes - Moderator Washington Economics Editor, The Economist Roger W. Ferguson Jr. Vice Chairman, Federal Reserve Board Jonathan Anderson Chief Economist for Asia, UBS Mickey Levy Chief Economist, Bank of America Morris Goldstein Dennis Weatherstone Senior Fellow, Institute for International Economics
Financial Market Liberalization and Economic Development Watch Panel in Real Video
Ian Vásquez - Moderator Director, Cato Institute Project on Global Economic Liberty Raghuram G. Rajan Director of Research, International Monetary Fund Deepak Lal James S. Coleman Professor of International Development Studies, University of California, Los Angeles Yasheng Huang Associate Professor of International Management, MIT Sloan School of Management Reuven Brenner REPAP Chair in Economics, McGill University
Keynote Address Watch Keynote Address in Real Video:
Rodrigo Rato Managing Director, International Monetary Fund, Transcript of Director Rato's Address [PDF]
The Case Against a Dollar Policy
Samuel Brittan Economics Columnist, Financial Times, [Samuel Brittan was unable to deliver his scheduled speech (PDF) on dollar policy.]
Some in GOP Regretting Pork-Stuffed Highway Bill, by Shailagh Murray, Washington Post: The highway bill seemed like such a good idea when it sailed through Congress this summer. But now Republicans who assembled the record spending package are suffering buyer's remorse. The $286 billion legislation was stuffed with 6,000 pet projects for lawmakers' districts, including what critics denounce as a $223 million "Bridge to Nowhere" ... But with spiraling war and hurricane recovery costs, the pork-laden bill has become a political albatross for Republicans ... Conservative groups, government watchdogs and ordinary folks around the country are so offended by the size of the legislation ... that efforts are underway in the House and the Senate to rescind or reallocate a portion of its funds. ... Former House majority leader Tom DeLay..., who was instrumental in shaping the highway bill in the House, ... blamed the runaway spending of recent years on minority Democrats. When he took questions, the first came from a senior official at the American Conservative Union, who asked DeLay, "How large does the Republican majority in the House and Senate need to be before Republicans act like the fiscal conservative I thought we were?" ...
Globalization and Monetary Policy
Globalization and Monetary Policy, by Richard W. Fisher, Dallas Fed President: ...The literature on globalization is large. The literature on monetary policy is vast. But literature examining the combination of the two is surprisingly small. ...[I]n Michael Woodford’s influential book Interest and Prices: Foundations of a Theory of Monetary Policy, the word “globalization” does not appear in the index. Nor do the words “international trade” or “international finance.” What gives? Is the process of globalization disconnected from monetary policy? Is the business of the central bank totally divorced from globalization? I think not. I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold. ... Where does monetary policy come into play in this world? Well, consider the task of the central banker, seeking to conduct a monetary policy that will achieve maximum sustainable non-inflationary growth. ... Central bankers want GDP to run at no more than its theoretical limit, for exceeding that limit for long might stoke the fires of inflation. They do not wish to strain the economy’s capacity to produce. ... Until only recently, the econometric calculations of the various capacity constraints and gaps of the U.S. economy were based on assumptions of a world that exists no more. ... The destruction of communism and the creation of vast new sources of inputs and production have upset all the calculations and equations that the very best economics minds, including those of the Federal Reserve staff—and I consider them the best of all—have used as their guideposts. The old models simply do not apply to the new, real world. This is why I think so many economists have been so baffled by the length of the current business cycle and the non-inflationary prosperity we have enjoyed over the past almost two decades. ... From this, I personally conclude that we need to redraw the Phillips curve and rejig the equations that inform our understanding of the maximum sustainable levels of U.S. production and growth. ... [H]ow can we calculate an “output gap” without knowing the present capacity of, say, the Chinese and Indian economies? How can we fashion a Phillips curve without imputing the behavioral patterns of foreign labor pools? How can we formulate a regression analysis to capture what competition from all these new sources does to incentivize American management? Until we are able to do so, we can only surmise what globalization does to the gearing of the U.S. economy, and we must continue driving monetary policy by qualitative assessment as we work to perfect our quantitative tool kit. At least that is my view. ...
Natural and Government Induced Economies of Scale and the Consolidation of Credit Unions
Economies of Scale and Continuing Consolidation of Credit Unions, FRBSF Economic Letter, by James A. Wilcox Visiting Scholar, Professor, Haas School of Business, UC Berkeley: Whether depository institutions can achieve economies of scale ... by increasing their sizes has been a subject of great interest and importance to economists, regulators, and depository institutions themselves. Deregulation has allowed banks, thrifts, and credit unions to increase their size—and, thereby, to reap whatever economies of scale have long been available to larger depositories ... However, the overall evidence in favor of the practical importance of economies of scale in banking has, at best, been mixed. ... The evidence for credit unions is different. This Economic Letter shows that, in contrast to banks, larger credit unions, on average, have decidedly lower average costs and higher net incomes, as we might expect in the presence of important economies of scale. ...
One conventional measure of the cost efficiency of a depository is noninterest expense: Other things equal, lower expenses signal greater efficiency. ... These data show that costs for larger credit unions are substantially lower, suggesting very considerable economies of scale in credit unions' noninterest expenses. ...
Figure 2 depicts interest expense and ROA (return on assets, which is net income as a percent of assets) for the sample of credit unions. One repercussion of higher noninterest costs at smaller credit unions is that they cannot afford to pay the same high interest rates on deposits that larger credit unions can. Figure 2 shows that interest expense at the credit unions in the two largest size categories exceeded that paid by those in the two smallest size categories by about ... one-half percentage point... Figure 2 also shows that ROA rises steadily with the size of credit unions... Thus, larger credit unions tend to have lower noninterest expenses, which enable them both to pay their members higher interest rates on their deposits and to earn higher net income for their member-owners. One might expect this pattern of performance when economies of scale in the industry are both large on average and ... available to numerous credit unions over a wide range of sizes. ...
Perhaps not surprisingly, ... the numbers of larger credit unions and the share of total credit union industry assets in larger credit unions have grown from 1980 through 2004. For example, the number of credit unions that had over $1 billion in assets grew from 2 to nearly 100, and the share of total credit union assets in those credit unions grew from 2% to 33%. ... Government policies may also increase the economies of scale that depositories face. Recent legislation, such as the Gramm-Leach-Bliley Act, the USA Patriot Act, and the Bank Secrecy Act, may well provide some important benefits to the nation. But, quite apart from such benefits, these recent laws ... may have the effect of imposing various sizable costs that are borne disproportionately by the smaller depositories. ... Such disproportionate, law-induced costs would increase the returns to scale in the banking and credit union industries and thereby strengthen the motives for consolidation.
Chicago Fed President Moskow: The Future of Higher Education
Higher Education at a Crossroad, by Michael H. Moskow, Chicago Fed President: ...Let me begin by offering my perspective on the value of higher education to our economy. At various points in my life I have been a student, a university professor, a college trustee, and an employer who relies on highly educated workers to help run a complex organization. As both an employer and an economist, it is clear to me that the relationship between education, productivity, and economic growth has never been more closely linked. While states and regions once prospered based on an abundance of physical capital and natural resources, today the quality of a region's human capital is paramount. This feature is particularly true for regions such as the Midwest, where our economy continues to restructure from manufacturing to services and high technology industries. These growing industries increasingly require college graduates to successfully compete in a global economy. Even in today's manufacturing firms, higher level skills are required, which mandates that workers obtain an education beyond the high school level.
Despite this recognition, we are at an inflection point. Enrollment in college in the U.S. is at a record level and expected to climb, as students and their parents recognize the very high returns to education ... However, financial pressures on colleges have also mounted. For public institutions, state support has eroded. As state spending pressures continue to rise for elementary and secondary education, Medicaid, and prisons, less is available for higher education. In response, universities today are increasingly forced to rely on their own resources to make budgets balance. But this can restrict access, because schools must often dip into endowments and resort to aggressive tuition hikes to close the gap. It's a Hobson's choice. If the school is concerned with maintaining academic quality, large tuition increases are often the best option, but in doing so access for students may be limited. If on the other hand the university limits tuition increases, it is often forced to economize and offer reduced services, which can jeopardize quality through large classes and the use of part-time faculty. ...
How can universities navigate these challenges and flourish? ... [U]niversities have been unable to maintain the implicit "social compact" ... based on a belief that education was largely a public good and, as such, government support was warranted. This notion has eroded over time. Today, many argue that higher education is a private good whose benefits primarily accrue to the student who is able to ... achieve a more satisfying quality of life and often significantly higher wages. This more market-driven notion suggests that higher education is an investment in an individual's human capital that has limited public spillovers. Therefore, it should be primarily financed by the individual. I believe for universities to flourish, they need to revisit this "social compact" and make a clearer case for the public good content of education. In order to do this, universities will need to be more transparent in their operations so that the public can have a better sense of what the value of the institution is to society. ... Polls indicate that the public ... often does not understand the return to society generated from the use of public funds for university research. In sum, universities need to become better educators of the general public and marketers of their product if they hope to attract greater tax support. ... The historic and increasing importance of higher education to our economic well being makes this a policy area where we must succeed. ...
November 04, 2005
Credibility, Independence, Stable Inflation, and Economic Growth
Monetary Credibility, Inflation, and Economic Growth, by Federal Reserve Vice Chairman Roger W. Ferguson, Jr.: By now it must be universally agreed that low and stable inflation is a primary and essential goal for monetary policy, in large part because we believe it ... fosters sustainable economic growth over the longer run. ... To me, it is axiomatic that monetary credibility, by reducing the level and variability of inflation, lays the foundations for stronger and more-sustained economic growth. In my remarks today, I want to discuss anecdotal and academic evidence for the relationship between monetary policy credibility and economic growth and to do so in two segments: first, the link between monetary policy credibility and inflation performance and, second, the link between inflation performance and longer-run economic growth. ... [C]ommon intuition and numerous academic journal articles ... suggest that .... [w]hen the central bank is viewed to be both committed to and effective at keeping inflation contained, inflation expectations will tend to be anchored. And so long as the central bank pursues sensible policies, those expectations will tend to be self-fulfilling, as they should lead to movements in prices and wages that are consistent with inflation staying low and stable. ... One does not have to look far to see examples of the practical importance of monetary credibility. In the past two years, crude oil prices have about doubled. During the 1970s, similar run-ups set off sharp increases in global inflation. Today, by contrast, core inflation rates both in the United States and abroad, while they have moved up some, remain essentially contained. In large part, they remain so because central banks, including the Federal Reserve, have substantially bolstered their commitment to price stability since the 1970s and markets are now much more confident that monetary authorities will keep inflation from rebounding. ... Aside from such anecdotal evidence, much formal research supports the view that a strong commitment to price stability helps reduce and stabilize inflation. ... Finally, there is considerable literature on the effects of central bank independence on inflation ... [C]entral bank independence frees the monetary authority to pursue price stability more diligently, resulting in lower and less-variable inflation, is supported by many studies. ...
Assuming that monetary credibility does make it easier for central banks to pursue the objective of price stability, what can we say about how stable prices affect the bottom line--economic activity and growth? Empirical research attempting to establish solid links between low inflation and sustainable economic growth has met with mixed success... [R]esearchers seem to agree that extreme inflation rates, say above 40 percent per year, are associated with reduced economic growth. ... But what can we say about lower inflation rates? Is the pace of economic development slower when inflation is at 15 percent than when it is at 5 percent? Research by IMF staff economists ... has turned up a negative association between inflation and growth. ... To be completely fair regarding the academic literature, however, others have not found such a clear relationship. ... Of course, as a central banker, it makes sense to me that lower and more-stable inflation, by making the returns to saving and investment more predictable and by diminishing the likelihood of shocks to the financial system, should encourage economic growth. ... I am obviously not alone in this view, it is clear that central banks should strive to achieve low, stable inflation... In conclusion, let us not forget that the declines in inflation over the past two decades and the resulting boost to monetary credibility we currently enjoy were earned with some economic pain... If the academic evidence does not yet unequivocally support this conclusion, perhaps it is because we are only starting to see the return to sacrifices made in the past. ...
Those who would like to see the Fed pause in its campaign of raising the federal funds rate at a measured pace might wonder why the Fed is so concerned about inflation rather than a weak labor market if there is, as governor Ferguson suggests, only mixed evidence that moderate inflation is costly to the economy.
Update: I should have distinguished between the trend growth of GDP and stabilizing GDP growth around the trend. As I read the evidence, price stability reduces variation of GDP around the trend rate of growth but does not have much, if any, affect on the trend rate of growth itself.
Amazon and Google Race to Offer Digital Books
Want 'War and Peace' Online? How About 20 Pages at a Time?, by Edward Wyatt, NY Times: In a race to become the iTunes of the publishing world, Amazon.com and Google are both developing systems to allow consumers to purchase online access to any page, section or chapter of a book. ... Consumers could purchase a single recipe from a cookbook, for example, or a chapter on rebuilding a car engine from a repair manual. ... Random House ... proposed a micropayment model yesterday in which readers would be charged about 5 cents a page, with 4 cents of that going to the publisher to be shared with the author. The fact that Random House has already developed such a model indicates that it supports the concept, and that other publishers are likely to follow. The proposals could also become bargaining chips in current lawsuits against Google by trade groups... These groups have charged that Google is violating copyrights by making digital copies of books... But if those copies of older books ... that have long been absent from bookstores started to produce revenue ... the trade groups might drop some of their objections. ... Amazon said yesterday that it was developing two programs that would begin some time next year. The first, Amazon Pages, is intended to ... allow users to search its universe of books and then buy and read online whatever pages they need... The second program, Amazon Upgrade, will allow customers to add online access to their purchase of a physical copy of a book. ... Google is working to develop a similar system, said executives at three publishing companies who were briefed by Google on its efforts. Using the Google Print site, readers would be able to search Google's digitized library of books, then buy either an entire book or the relevant parts. ...
Posted by Mark Thoma on Friday, November 4, 2005 at 02:23 AM in Economics
Tom DeLay and Robert Reich on Tax Reform
A Swing and A Miss on Tax Reform, by Tom DeLay, Commentary, Washington Post: In case you were wondering what that giant "whoosh" emanating from Washington was, it was the sound of the people on the President's Advisory Panel on Federal Tax Reform swinging and missing at the easy underhand toss that George W. Bush sent their way. ... [R]ather than taking the president's broad mandate for fundamental, comprehensive reform, the panel recommended preserving the basic elements of the "archaic, incoherent" monstrosity already on the books. ... This was a chance to scrap the Internal Revenue Code -- the 5-million-word monstrosity that costs American businesses and families billions of dollars and billions of hours to comply with -- once and for all. ... Instead, it proposed an array of incremental policy tweaks of the kind that one might expect to be presented in the president's annual budget.
Meanwhile, even the most cursory look at the panel's recommendations reveals a minefield of serious political trouble. Recommendations such as the reduction of the mortgage interest deduction and elimination of the state and local tax deductions may have sound economic arguments on their side, but they're an awfully bitter pill for Americans to swallow if all they get in return is a few deck chairs moved around on the Titanic. Those of us who have long advocated fundamental tax reform, for decades in some cases, have reason to wonder -- especially given President Bush's well-deserved reputation for thinking big -- "Where's the vision? Where's the boldness?" ... The American people are ready for this debate. They are ready for a debate about a flat tax that would gut the Internal Revenue Service and allow almost every American to file his or her tax return on a simple form the size of a postcard. They are ready, I believe, to learn more about replacing the income-based tax system altogether with a national sales tax, as in the FairTax proposal I have co-sponsored in the House. This plan would allow Americans to choose, based on their spending decisions, how much tax they would pay every year. ...
Capping the mortgage deduction has another strike against it - support from someone connected to the Clinton administration, Robert Reich, on equity grounds:
Mortgage deductions could use a ceiling, by Robert B. Reich, LA Times: In these dark days for the Bush administration, I've been looking for some light, something on which to lavish unequivocal praise. And here it is. The president's advisory commission on tax reform on Monday recommended a limit on the home mortgage interest deduction. ... As it is designed right now, it mostly benefits the rich, is grossly unfair and costs the Treasury a bundle. Here's how it currently works. Homeowners can deduct from their income taxes all interest paid on mortgages written for up to $1.1 million. ... But most people who rent their homes don't get a dime from the government to subsidize their cost of housing — and they generally have far lower incomes than homeowners. Nor does the mortgage interest deduction help most homeowners with modest incomes — those in the $20,000 to $50,000 range. That's because, at tax time, they take the standard deduction. ... You couldn't design a more regressive housing policy if you tried. The home mortgage interest deduction cost the Treasury $63 billion in lost revenue last year, and the rich got most of it. ... Enter the president's tax reform commission. It wisely wants to lower the million-dollar ceiling on the mortgage interest deduction to the size of an average mortgage in any region of the country. In today's market, the ceiling would range from about $170,000 in many rural areas to a high of $412,000 in high-priced housing areas such as Southern California. This is just good common sense, and fair.
The commission also wants to turn the deduction into a tax credit. ... Remember that tax credits are subtracted directly from the income taxes otherwise due. So anyone with a $100,000 mortgage, for example, would be able to subtract the same amount from their taxes, regardless of their incomes. Also sensible and fair. Together, these proposals would extend the tax benefit for homeownership to most middle-class and lower-income Americans. ... So the Treasury saves billions of dollars, average Americans get more help with their housing and the government's hidden housing subsidy to the rich is finally ended. The only problem is that these sensible ideas are probably dead on arrival. Realtors, mortgage lenders and home builders are already screaming bloody murder. ...
The Creative Creation of Creativity in China
From Gunpowder to the Next Big Bang, by Thomas L. Friedman, NY Times: There is a techie adage that goes like this: In China or Japan the nail that stands up gets hammered, while in Silicon Valley the nail that stands up drives a Ferrari and has stock options. Underlying that adage is a certain American confidence that whatever we lack in preparing our kids with strong fundamentals in math and science, we make up for by encouraging our best students to be independent, creative thinkers.
I've always wondered if it the adage is a rationalization for poor U.S. performance in math and science, but apparently the belief has support in China as well:
...Even the Chinese will tell you that they've been good at making the next new thing, and copying the next new thing, but not imagining the next new thing. That may be about to change. Confident that its best K-12 students will usually outperform America's in math and science, China is focusing on how to transform its classrooms so students become more innovative. ...Harry Shum, a Carnegie Mellon-trained computer engineer ... said: "A Chinese journalist once asked me, '...what is the difference between China and the U.S.?...' I joked, '... the difference between China high-tech and American high-tech is only three months - if you don't count creativity.' When I was a student in China 20 years ago, we didn't even know what was happening in the U.S. Now, anytime an M.I.T. guy puts up something on the Internet, students in China can absorb it in three months.
How do you create imagineers?
"But could someone here create it? That is a whole other issue. I learned mostly about how to do research right at Carnegie Mellon. ... Before you create anything new, you need to understand what is already there. Once you have this foundation, being creative can be trainable. China is building that foundation. So very soon, in 10 or 20 years, you will see a flood of top-quality research papers from China." Once more original ideas emerge, though, China will need more venture capital and the rule of law to get them to market. ... Dr. Shum said. "... I will be teaching a class at Tsinghua University next year on how to do technology-based ventures. ... You have technology in Chinese universities, but people don't know what to do with it - how to marketize it." ...
How do you say "Ferrari" in Chinese?
Creativity is built like everything else of value is built, with long hard work and as the commentary notes it starts with the construction of the proper foundation, a thorough understanding of what is known and how it came to be known, what is unknown, and what among the unknown is the most important to solve.
November 03, 2005
John Snow Discusses the Budget Deficit
FT: .... At the outset of President Bush’s second term it was very clear to everyone what the domestic agenda was -- social security reform, make the tax cuts permanent and at some point move on to tax reform. I would be very hard pressed to tell you right now as an outside observer what the priorities are for this administration domestically for its last three years. What do you want to achieve? JS: A clear priority of this administration right now is the deficit. Making sure we achieve the president’s objective of cutting the deficit in half by the time he leaves office in 09 .... We remain convinced that the way to do that is... to sustain the low tax environment... And with all of that revenues have come in at a very strong level. We’ve got the highest revenues we’ve ever seen in the history of the United States now. .... Are low tax rates consistent with fiscally responsible behaviour? And I think the answer is clearly yes as long as there’s an intense focus on spending... And you’ve seen us doing that now. ... That’s what this effort is with the House and Senate leadership and the administration is all about now. We’re getting very good response from the Congress, very good response. So I would put at the top ... Number two is sustaining the low tax environment. ...
FT: Sorry are you going to make a big issue of that? Roy Blunt [acting House Republican leader] yesterday said they didn’t think they could do that in reconciliation. JS: Well, we’re going to press for it. You asked me what our policies are, and tax permanence is certainly at the forefront of our policies. ... On social security, it remains an important of objective for the administration. ... the longer-term deficit can only be addressed if we look at these unfunded obligations, and I think you’ll see the President continuing to make the case for reforms... We’ll continue to push health care initiatives.
FT: Just to push a bit more on the deficit. I presume you chose your words carefully because it was in the book where your predecessor [Paul O’Neill] was quoted extensively that Mr Cheney said deficits don’t matter. A lot of people are going to see this as a late conversion by the administration. Why is this suddenly so high up the list? JS: I’ve always wondered why that question gets raised. When the President asked me to take this job he knew I was a deficit hawk. I was then, I am now, and I’ll leave here as a deficit hawk. Did the deficit grow? Did we find the deficit growing to a level we didn’t like? Yes, but we did have homeland security needs, we had a war in Iraq, a war in Afghanistan and we had the revenue side of the equation hit hard by the collapse of the equity markets ... and by the recession. So I’ve never wavered in my view that deficits matter. ...
FT: Just on tax. Obviously there’s lots of work to do but also you’ve done lots of preparation all year. Both proposals put forward by the panel deal with the AMT [Alternative Minimum Tax] which obviously is a big problem. They largely do that by looking at the big reductions, housing, health and then the exemptions… Is that something you’re going to take on? JS: Well we’re certainly going to want to look at what they’ve said ...
FT: As an economist it seems like a very good idea to look at those deductions, broaden the base, lower the rates. But in terms of the politics of mortgage interest, health insurance and state exemptions…. JS: I don’t know at this point what we’re going to recommend and we’ve got to think this through carefully. ... We’re going to use the panel’s report as the starting place, ... when we bring these proposals to the President he will have a wide scope. ...
[Link (free) to Financial Times story accompanying the interview - the interview and article also cover other topics such as China.] [Brad DeLong comments on budget realities.] Once again, I posted this quickly and didn't have a chance to comment much. Fortunately, visitors today have been doing a good job of filling in the missing pieces.
[Update: macroblog has more.]
Mean score for the 63 students present in class today: 78.2 Mean score for the 17 students absent from class today: 63.3
What a surprise. Many of those who weren't there today will ask how they could do better. Uh, start by showing up and we'll go from there. I like this too from Hypothetical Bias. [Sorry. I needed to get that out. Back to work...]
Posted by Mark Thoma on Thursday, November 3, 2005 at 04:13 PM in Universities
Greenspan's Testimony before Congress on the Economic Outlook
Testimony of Chairman Alan Greenspan Economic outlook Before the Joint Economic Committee, U.S. Congress November 3, 2005: Mr. Chairman, when I last appeared before the Joint Economic Committee in early June, economic activity appeared to be reaccelerating after a slowdown in the spring. The economy had weathered a further run-up in energy prices over the winter, and aggregate demand was again strengthening. ... By early August, the economy appeared to have considerable momentum, despite a further ratcheting up of crude oil prices; pressures on inflation remained elevated. As you know, the economy suffered significant shocks in late summer and early autumn. Crude oil prices moved sharply higher in August, bid up by growth in world demand that continued to outpace the growth of supply. Then Hurricane Katrina hit ... causing widespread disruptions to oil and natural gas production... Because of a lack of ready access to foreign supplies, natural gas prices rose even more sharply. At the end of September, with the recovery from the first storm barely under way, Hurricane Rita hit, ... These events are likely to exert a drag on employment and production in the near term and to add to the upward pressures on the general price level. But the economic fundamentals remain firm, and the U.S. economy appears to retain important forward momentum. ... Except for the hurricane effects, readings on the economy indicate a continued solid expansion of aggregate demand and production. ... The longer-term prospects for the U.S. economy remain favorable. Structural productivity continues to grow at a firm pace, and rebuilding activity following the hurricanes should boost real GDP growth for a while. More uncertainty, however, surrounds the outlook for inflation.
The past decade of low inflation and solid economic growth in the United States ... is attributable to the remarkable confluence of innovations that spawned new computer, telecommunication, and networking technologies, which ... have elevated the growth of productivity, suppressed unit labor costs, and helped to contain inflationary pressures. .... Contributing to the disinflationary pressures ... over the past decade or more has been the integration of in excess of 100 million educated workers from the former Soviet bloc into the world's open trading system. ..., and of even greater significance, ... the freeing from central planning of large segments of China's 750 million workforce. The gradual addition of these workers plus workers from India ... would approximately double the overall supply of labor once all these workers become fully engaged in competitive world markets. ... Over the past decade or more, the gradual assimilation of these new entrants into the world's free-market trading system has restrained the rise of unit labor costs in much of the world and hence has helped to contain inflation. ... The effective augmentation of world supply and the accompanying disinflationary pressures have made it easier for the Federal Reserve and other central banks to achieve price stability in an environment of generally solid economic growth.
But this seminal shift in the world's workforce is producing, in effect, a level adjustment in unit labor costs... the suppression of cost growth and world inflation, at some point, will begin to abate and, with the completion of this level adjustment, gradually end. These global forces pressing inflation and interest rates lower may well persist for some time. Nonetheless, it is the rate at which countries are integrated into the global economic system, not the extent of their integration, that governs the degree to which the rise in world unit labor costs will continue to be subdued. Where the global economy is currently in this dynamic process remains open to question. But going forward, these trends will need to be monitored carefully by the world's central banks.
I want to conclude with a few remarks about the federal budget situation ... even apart from the hurricanes, our budget position is unlikely to improve substantially further until we restore constraints similar to the Budget Enforcement Act of 1990, which were allowed to lapse in 2002. Even so, the restoration of paygo and discretionary caps will not address the far more difficult choices that confront the Congress as the baby-boom generation edges toward retirement. As I have testified on numerous occasions, ... So long as health-care costs continue to grow faster than the economy as a whole, as seems likely, federal spending on health and retirement programs would rise at a rate that risks placing the budget on an unsustainable trajectory. Specifically, large deficits will result in rising interest rates and an ever-growing ratio of debt service to GDP. Unless the situation is reversed, at some point these budget trends will cause serious economic disruptions. We owe it to those who will retire over the next couple of decades to promise only what the government can deliver. ... Crafting a budget strategy that meets the nation's longer-run needs will become ever more difficult and costly the more we delay. The one certainty is that the resolution of the nation's demographic challenge will require hard choices and that the future performance of the economy will depend on those choices. .... The Congress must determine how best to address the competing claims on our limited resources. In doing so, you will need to consider not only the distributional effects of policy changes but also the broader economic effects on labor supply, retirement behavior, and private saving. The benefits of taking sound, timely action could extend many decades into the future.
I threw this together rather quickly - I will try to say more about this later. In other news, U.S. productivity was higher than expected in the third quarter at 4.1%, but unit labor costs, i.e. labor compensation, is dragging. That's good news for inflation fighting, but bad news if it's your take home pay. The remarks above on globalization offer one reason for lagging wages.
[Update: Brad DeLong has more on Greenspan's statements on entitlement spending, The Big Picture has more on Greenspan's statement that the yield curve is no longer useful, and a comment from Calmo wonders how "Dr Estrella feels about that remark: inverted yield curves are obsolete" given this from the NY Fed.]
I intended to say more, but the links above cover the issues fairly well. Unless I think of something different to add, I think I will leave it at that.
The Declining Role of Money in Monetary Policy
Rules vs. discretionary monetary policy, by Chairman Alan Greenspan, Stanford University, 1997: ...Although the ultimate goals of policy have remained the same over these past fifteen years, the techniques used in formulating and implementing policy have changed considerably as a consequence of vast changes in technology and regulation. Focusing on M1 ... was extraordinarily useful in the early Volcker years. But after nationwide NOW accounts were introduced, the demand for M1 in the judgment of the Federal Open Market Committee became too interest sensitive for that aggregate to be useful in implementing policy. Because the velocity of such an aggregate varies substantially in response to small changes in interest rates, target ranges for M1 growth in its judgment no longer were reliable guides for outcomes in nominal spending and inflation. ... As a consequence, by late 1982, M1 was de-emphasized... However, in recognition of the longer-run relationship of prices and M2, especially its stable long-term velocity, this broader aggregate was accorded more weight, along with a variety of other indicators, in setting our policy stance.
By turning to M2, the Fed stabilized the target monetary aggregate since much of the asset movement was between M1 and M2. But as he notes, this did not last long as financial innovation brought about highly liquid assets outside of the definition of M2 which began to attract financial investment:
As an indicator, M2 served us well for a number of years. But by the early 1990s, its usefulness was undercut by the increased attractiveness and availability of alternative outlets for saving, such as bond and stock mutual funds, and by mounting financial difficulties for depositories and depositors... The apparent result was a significant rise in the velocity of M2, which was especially unusual given continuing declines in short-term market interest rates. By 1993, this extraordinary velocity behavior had become so pronounced that the Federal Reserve was forced to begin disregarding the signals M2 was sending... Data since mid-1994 do seem to show the reemergence of a relationship of M2 with nominal income and short-term interest rates similar to that experienced during the three decades of the 1960s through the 1980s. ...however, the period of predictable velocity is too brief to justify restoring M2 to its role of earlier years... The absence of a monetary aggregate anchor ... has not left policy completely adrift. From a longer-term perspective we have been guided by a firm commitment to ... the ultimate goal of achieving price stability. ...
The period he talks about, 1990-1994, is evident in this graph from a recent post repeated for convenience:
What explains the behavior in the early 1990s? Here's one explanation from the Cleveland Fed (this is long already, so maybe I can get to the recent MZM results, e.g. here, some other time):
Results of a Study of the Stability of Cointegrating Relations Comprised of Broad Monetary Aggregates, by John B. Carlson, Dennis L. Hoffmanb, Benjamin D. Keenc, Robert H. Rasche, Federal Reserve Bank of Cleveland (1999): Abstract We find strong evidence of a stable “money demand” relationship for ... M2M through the 1990s. Though the M2 relation breaks down somewhere around 1990, evidence has been accumulating that the disturbance is well characterized as a permanent upward shift in M2 velocity, which began around 1990 and was largely over by 1994. Taken together, our results support the hypothesis that households permanently reallocated a portion of their wealth from time deposits to mutual funds...
But this is certainly not the only explanation. E.g., from the Dallas Fed:
What was Behind the M2 Breakdown?, Dallas Fed, 1999: A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993. In this paper, we argue that the financial condition of depository institutions was a major factor behind the unusual pattern of M2 growth in the early 1990s...
The unusual M2 growth pattern can be seen here in the graph from the post linked above. By targeting an interest rate rather than a monetary aggregate, the Fed has avoided the problems associated with targeting unstable aggregates, and interest rate targeting is also supported by the theoretical literature. Because of this, the focus on monetary aggregates has waned in recent years.
Opposition to the Administration's Proposed National Park Management Policy
A Thought for Interior, Editorial, NY Times: We would like to note ... some ... bipartisan common sense ... on the misguided draft of a new management policy for the national parks. Last week, six Republican senators told Interior Secretary Gale Norton that they were unhappy with the way the proposed changes de-emphasized the fundamental goal of preserving the parks. ... The Bush administration's arguments for revising the management policy left some committee members skeptical. "Frankly," said Ken Salazar, a Colorado Democrat, "we don't understand what the true motivation was." But the motivation isn't all that hard to find ... when you consider that one of the four witnesses was William Horn, a former assistant secretary at the Interior Department for fish, wildlife and parks in the Reagan era. Mr. Horn is also a lead attorney for the International Snowmobile Manufacturers Association... He was there, ostensibly, to interpret the Organic Act of 1916 - the founding legislation for the National Park Service - and show that "enjoyment" had suffered because of the emphasis on preservation. ... But there is no need to force snowmobiles or other motorized vehicles into the parks, and there is no need to rewrite management policy. Another witness, Denis Galvin, a retired deputy director of the National Park Service, said, "The national parks do not have to sustain all recreation; that is why we have various other federal, state, local and private recreation providers." The Interior Department would do well to try to keep that in mind.
There is quite a bit of privately held forest land suitable for snowmobiles. Shouldn't the administration's position be that the market rather than the government will solve this and other problems like it?
Who Receives the Interest Paid on the Debt?
Federal Outlays, 1962 to 2001 as a Percent of GDP
Is the interest of the debt a burden? Fifteen years ago, I would argue that only 10-15% of the debt was held by the foreign sector, so only 15% of the interest represented a burden. Why? If you tax everyone to pay the debt, money is collected in the form of taxes, then paid out to bondholders. In aggregate, this redistributes income, but there is no change in the amount of income due to the income transfer (I find it interesting that these types of income redistributions do not receive the kind of press that other types do). Only the 10-15% that flows out of the US wass a loss, but we held foreign debt too and when this is netted out the net interest flow was fairly small. That has changed. At the end of 2004, 44% of the federal debt was held by the foreign sector (see page 258), so it's much harder to argue that the debt does not represent a drain of resources to the foreign sector.
What is the net outflow? Here's one set of estimates from a Chicago Fed Letter based upon all assets, i.e. this is our net foreign debt position
We went from a position of net inflow prior to 1985, to a net outflow of 4.4% of GDP in 1994, to a 23% net outflow in 2004. 23% of GDP is more than a few pennies. The graph also shows why the net change has been so large in recent years. Foreign ownership has not accelerated. Instead, US purchase of foreign assets as a percent of GDP has fallen since approximately 1999.
November 02, 2005
Restoring Fiscal Discipline
Fiscal Phonies, by Robert J. Samuelson, Washington Post: The scramble by congressional Republicans and White House officials to show they're serious about dealing with the budget recalls the classic 1951 novel "The Catcher in the Rye," whose main character, Holden Caulfield, denounces almost everyone as a "phony." Well, on the budget, most Republicans are phonies. So are most Democrats. The resulting "debates" are less about controlling the budget than about trying to embarrass the other side. Anyone who's serious about curbing federal spending and budget deficits could fashion a plan that would do both without eliminating one penny of existing government benefits or raising any existing tax. Here's how: First, you'd repeal the Medicare drug benefit, scheduled to take effect in 2006. For the next five years ... the savings would total about $300 billion... Preserving an existing drug benefit for low-income recipients might reduce savings by 5 percent. Second, you'd repeal a tax cut scheduled for 2006 that would benefit mainly people in the top brackets ... savings: about $30 billion ... Third, you'd eliminate all "earmarks" in the recent highway bill. ... The highway bill contained $24 billion in earmarks... [T]his package would probably save more than $300 billion from 2006 to 2010 -- still not enough to eliminate prospective deficits. Its chances are close to zilch. .... Countless Democrats and Republicans routinely denounce deficits, but few will repeal a program that relies on literally trillions of dollars of future borrowing.
What have Republicans actually done? Last week the Senate Budget Committee endorsed spending "cuts" of $39 billion. That covers five years ... So the "cuts" amount to a mere 0.3 percent ... of projected spending. But wait. Many advertised "cuts" aren't cuts at all. In weird budget accounting, they're "offsetting receipts" ... It ... turns out that the $39 billion in "cuts" ... probably won't reduce the budget deficit by that amount. ... And Democrats? More phonies. They rant about President Bush's irresponsible deficits, which they blame on his tax cuts for the rich. ... Okay, let's restore them to their pre-Bush levels. From now until 2010, the extra revenue would average slightly more than $30 billion a year... Sure, you could squeeze the rich for a few more billion by repealing some other tax cuts, but the central point would remain: There's a basic mismatch between the existing taxes and existing spending commitments. Neither party yet faces this candidly, because the only way to solve it is either to raise taxes or cut benefits. ... But who cares about the truth? For most politicians, the real problem is to appear principled even when they're not. If that's not phony, what is?
Changes in M1, M2, and M3 over Time
The graph shows the increments for each aggregate, i.e., the yellow region is the part of M3 not in M2, and total M3 is the region shown by all three colors. The leveling off of M2 and M3 around 1990, the time period when aggregates became less useful as policy tools, and the steep growth in M2 and M3 since 1995 are interesting. Definitons of M1, M2, and M3 can be found in the Fed Education site glossary. The second graph shows M1, M2, and M3 as above as percentages of total M3 at each point in time. The constancy of size of the incremental part of M2 is interesting:
Tuition Reduction and Access to Higher Education
Building the Stock of College-Educated Labor, by Susan M. Dynarski, Harvard University, NBER WP W11604: Abstract Half of college students drop out before completing a degree. ... This paper establishes a causal link between college costs and the share of workers with a college education. I exploit the introduction of two large tuition subsidy programs, finding that they increase the share of the population that completes a college degree by three percentage points. The effects are strongest among women, with white women increasing degree receipt by 3.2 percentage points and the share of nonwhite women attempting or completing any years of college increasing by six and seven percentage points, respectively. A cost-benefit analysis indicates that tuition reduction can be a socially efficient method for increasing college completion. However, even with the offer of free tuition, a large share of students continue to drop out, suggesting that the direct costs of school are not the only impediment to college completion. [Free version of paper on author web site.]
I've been promoting education on this site, but I've never really explained my interest in this topic so, as the Oregon rain pours down this late afternoon, I thought I'd take a few moments to do so. This is a bit long, a bit personal, and I'm hesitant about posting it, so please feel free to scroll to the next post as I worry my story may not interest you.
I'm not sure everyone fully understands what that means, in my case at least, with respect to higher education. My parents spent a little time at a junior college, but they did not go to college in any formal sense, and their parents certainly did not go. College was mysterious and unknown to them, but quite necessary and they were determined I would go. My mom talked about it often and it never crossed my mind for as long as I can remember that I wouldn't go. College was an idea, a means to success, but my parents did not know the difference between Stanford, Berkeley, and Cal State Chico. They knew they were different, of course, but not how, and simply going to college was the key. Where you went didn't matter all that much. I see a lot of snobbishness concerning where people get their degree. But where I grew up the line was between those who went to college and those who didn't. They weren't going to be much impressed if your degree was from some fancy school rather than Cal State Chico - they already knew who you were. My high school wasn't much help either. There were 350 students in all grades and the counselor had been my mom's high school classmate, and most of the teachers had local roots as well. They all knew my family; one of my teachers lived across the street and several more within a few blocks, the dad of a friend was my English teacher. Some had left town for a few years during college, but most were as naive as my parents about higher education. Asking about graduate school and how to get there would not have been very useful. We received little guidance.
We were lower middle class and because of that my college choices were limited. My parents helped some, but mostly I worked summers and also during school and college choice was fully dictated by these constraints. This was the mid 1970's and I was fortunate that tuition at Cal State schools was cheap, very cheap (I recall around $100 a semester, maybe a little more, but can't recall for sure), and I could actually make enough myself to get by. And did. The other route was through junior college but that would have been a dead end for me. If I couldn't pay for college as a freshman, I still wouldn't have been able to pay for it as a junior. Looking forward two years, I would not have bothered to go at all and could have simply joined my dad and brother at the tractor store in town (I worked there in summers and at another tractor store in Chico during college and really, really hated it - that was great motivation in undergraduate and graduate school - I did not want to spend my life trapped there). I had friends who went the junior college route and some managed to go on, but most did not.
During my undergraduate days at Chico, I believe towards the end of my sophomore year after intermediate macro, the professor took me aside after class one day and said I should think about going to graduate school, but, he said, you need to transfer to a UC school. Staying here will not get you where you need to go. He said he could help. It made some impression on me, but because of my background, not enough. I didn't really understand you couldn't get some places from Chico. Nevertheless, the next time I was home I talked to my parents about it and told them what I had been told. They simply said, I still remember the words, "We can't afford that" and that was the end of it. I didn't press, didn't follow up, I simply accepted it. Maybe they could have pushed the financial edge some, I don't know, but they didn't understand the difference in schools - a degree was a degree - so I doubt they saw much benefit from doing so and the whole graduate school part was lost on them. Why didn't I go anyway and support myself, take out loans, etc.? I had no clue about how to get a loan. I don't think I was eligible for student loans until graduate school and there was no aid money available or anything like that. I didn't know how to find the money I would need. Now I could, and would have simply transferred and found a way, but it didn't seem possible then.
So I stayed at Chico. And though I should have done everything possible to go somewhere else, I am grateful for it. I was a bit wild when I was younger (those who know me can quit laughing at the word bit). Had I not gone to Chico, had I stayed in Colusa or gone to Yuba College, the local junior college 24 miles away, I shudder to think how I would have ended up. Idle minds and all that. I doubt society would be better off had it not provided me a heavily subsidized education. I wish there had been even more access to higher education, I would have taken advantage of it, and it did turn out there were places I couldn't go from Chico. But I went somewhere, and somewhere else from there, and here I am, hopefully paying society back in some small way for the investment it made in me by helping me through school. I have no complaints at all.
Given how tuition costs have risen since then, I often wonder how many people like me are now in dead end jobs at their tractor store, in jail, who knows where, all because they don't have the opportunity I had. I sometimes resent in fleeting moments that I didn't have the same opportunities others had, but at other times, most times, I laugh to myself that I made it this far given where I started. I'm not quite sure how it happened, and I am very indebted to California for making it possible by putting an easy road in front of a typical teenager coming out of high school. I needed an easy road to follow. So I feel compelled to keep the education access issue alive, to keep pushing it where I can, and to do what I can internally here to help those like me or those who face even larger hurdles. I know how hard it was for people in my town to get out of there and go to college anywhere, and I know how easy it would have been to slip through the cracks, how close I came to doing just that, so I hope you will bear with me when I push on educational issues. It made a huge difference in my life and I'd hate to see others miss out on their window of opportunity.
Who Will Replace Bernanke as Chair of the CEA?
Economist leads the field to replace Bernanke at CEA, by Andrew Balls and Caroline Daniel, Financial Times: Edward Lazear, a member of President George W. Bush’s advisory panel on federal tax reform, is a leading candidate to replace Ben Bernanke as chairman of the White House Council of Economic Advisers (CEA)... Mr Lazear, a Stanford University economist, would bring to the White House expertise on tax policy and in-depth knowledge of the panel’s deliberations and proposals – some of which will be highly controversial in Congress. The White House is seeking to put recent troubles behind it and return to its policy agenda. ... Mr Lazear ... is primarily known as a labour economist, but his long research record spreads over a range of microeconomic topics. He has strong conservative credentials as a fellow of the Hoover Institution, Stanford’s right-leaning research institution. He earned his PhD in economics from Harvard University in 1974...
November 01, 2005
TypePad in China
11.01.2005 TypePad Performance Update - 7:00 pm: ...We've confirmed that TypePad blogs are currently being blocked in China, similar to the block put in earlier this year and last year. Until access is restored, the only recommendations we can make for workarounds is to use any web proxies which are available for routing requests to TypePad through another site. In addition, third-party services for processing syndication feeds aren't currently being blocked, so if you're using another service to enhance your TypePad-published XML feed, it's likely the feed will still be available to audiences in China. To be clear, the availability of TypePad-powered sites in China isn't something we have control over, but we do hope that full access is restored quickly, as it was last year.
[The link above is dynamic and TypePad has been issuing occasional updates on this issue.]
Posted by Mark Thoma on Tuesday, November 1, 2005 at 07:19 PM in Weblogs
FOMC Raises Target Rate 25 bps to 4.00%
Notably (1) the committee stills sees policy as accommodative and believes output will continue to exhibit robust underlying growth, partly because of the accommodative stance and partly due to growth in productivity just as it did at the last meeting. (2) As before, the FOMC sees core inflation as low in recent months and inflationary expectations “contained.” Their view that productivity is strong will help to reduce inflation concerns. The main concern for the future is over energy costs. (3) The second part of the statement is identical to the last release. Interestingly, they still see the upside and downside risks as roughly equal and left in place the measured pace statement. The standard qualifier that future policy is data dependent was also left in place. Finally, unlike last meeting, the vote was unanimous and all district banks submitted requests to raise the discount rate. Whatever uncertainty existed about raising rates at the last meeting among some participants appears to have been reduced or eliminated. [11/1 Press Release, 9/20 Press Release, 8/9 Press Release]
For immediate release
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4 percent.
[9/20] 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.
[8/9] [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.]
Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. The cumulative rise in 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.
[9/20] 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.
[8/9] [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.]
[Identical to last release] 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.
[9/20] 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.
[8/9] [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; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.
[9/20] 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...
[8/9] [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...]
In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 5 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
[9/20] In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Richmond, Chicago, Minneapolis, and Kansas City.
[8/9] In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
As it stands, the message is to expect more rate increases in the future unless incoming data change the committee's current economic outlook.
The Boy Who Called a Hard Landing...
The rising risk of a hard landing, by Stephen Roach, Commentary, Financial Times: It never fails. Every ... speech I have made on the economics of global rebalancing over the past three and a half years almost always ends with the same question: “When will these adjustments ever occur?” The history of the past few years is littered with false alarms over the coming US current account adjustment. Call it the “boy-cries-wolf syndrome”. ... Yet there are new and increasingly urgent grounds for concern. ... [T]here is a dangerous asymmetry in the mix of these imbalances. America’s record current account shortfall will account for about 70 per cent of the total deficit positions in the global economy in 2005. By contrast, ... it takes some 10 economies to account for 70 per cent of the total global current account surplus in 2005. The world, in effect, is balanced on the head of the US external-imbalance pin. ... And the situation is likely to go from bad to worse. ... In a post-Hurricane Katrina, energy-shocked climate deterioration is likely in all three big components of domestic US saving – for households, for the government sector and for businesses. ...
There is also reason to worry about global imbalances from the other side of the equation. The impacts of America’s increased draw on the global savings pool are likely to be compounded by recoveries in ... Japan and ... Germany. To the extent that recoveries in Germany and Japan rely increasingly on support from domestic demand, surplus saving will be absorbed. ... Moreover, China ... is very focused on stimulating domestic private consumption. ... If the world’s dominant deficit economy – the US – goes even deeper into deficit at the same time that the world’s leading surplus economies start to absorb their domestic saving, the noose will tighten on America’s external financing pressures. This raises the distinct possibility that these pressures will have to be vented in ... the form of ... a weaker dollar and higher US interest rates.... [W]ith surplus economies beginning the long march of absorbing their excess saving, it could well become all the tougher for the US to avoid this treacherous endgame. ...
There are several possible event risks, or shocks, that I believe would be capable of triggering the rebalancing. They include an energy shock, an outbreak of US protectionism, the bursting of the US housing bubble, a US inflation problem and the uncertainty that always arises during the transition to a new Federal Reserve Board chairman. ... [T]he history of economic crises is clear on one important thing: the longer any economy holds off in facing its imbalances, the greater the possibility of a hard landing. In my view, ... there is now about a 40 per cent probability of a hard landing at some point in the next 12 months.
Relating this to the monetary policy theme, I am not worried about problems associated with Bernanke as the new Fed chair, and because I am not worried about the new Fed chair, I am not worried about "a US inflation problem." The housing boom, energy costs, and perhaps protectionism are more likely triggers.
Two Fed Chairs Talkin' the Simulated Talk and Some Other Stuff
With Bernanke at Bat, Fed Will Target Inflation, by Kevin Hassett, Bloomberg: ...Ben Bernanke ... has supported the adoption of inflation targets by the Federal Reserve. Some of the best work at the frontier of economics research has ... demonstrated that inflation targets can significantly improve the effectiveness of monetary policy. ... How big a difference would the adoption of a target really make? Economists Marc Giannoni and Michael Woodford of Columbia University ... constructed a fancy economic model, and plugged in optimal monetary policy rules, including inflation targets. ... Giannoni and Woodford's work suggests the Fed ...[should]... target inflation. Bernanke wouldn't, of course, remove the discretion of policy makers and advocate that some mechanical model replace the terrific system we have. But inflation targets would increase transparency, reduce uncertainties, and possibly improve the cyclical performance of the Fed with little downside risk. My guess is that ... in the next few years that the Fed will adopt an inflation target...
Edmund L. Andrews of the The New York Times makes the same point about increased transparency:
Chairman Nominee May Bring a New Openness to the Fed, by Edmund L. Andrews, NY Times: If Ben S. Bernanke has his way, the Federal Reserve is likely to become more open, less mysterious and perhaps less intriguing than it is right now. ... Under Mr. Greenspan, the Fed has already undergone a revolution in transparency. ... But Mr. Bernanke, ... has argued for years that the Fed should go even further in explaining itself and bind its policies to an explicit, publicly stated target for inflation. ..."Ben is going to unlock a lot of mystery," said Mark L. Gertler, ... of ... New York University and a co-author of numerous papers with Mr. Bernanke. "He's going to explain what he's doing and give an underlying rationale for it. The Fed will become less mysterious, and I think people will like that." ... In practice, Mr. Bernanke has embraced the idea of "constrained discretion," meaning that the Fed could depart from its normal rules to deal with unexpected shocks like a big jump in oil prices or the fallout from a terrorist attack. ...
Let's move from simulated models to simulated conversations. Bloomberg's Caroline Baum listens in as Alan Greenspan gives the newcomer some tips for success:
Alan Greenspan Gives Ben Bernanke Some Pointers, by Caroline Baum, Bloomberg: Ben Bernanke ... was not Alan Greenspan's first choice to succeed him, according to press reports. Boohoo. ... He's getting rave reviews in the media. And he's likely to meet with little opposition on Capitol Hill. One wonders, though, whether Bernanke's feelings were hurt by Greenspan's expressed preference for ... Don Kohn, now a Fed governor himself, as a successor. Imagine, if you will, what the current and prospective Fed chiefs might say to one another the next time they meet....
AG: Ben, I see you've made quite a splash in the press. Who would have thought there could be so much front-page news on someone who has spent most of his adult life in academia...? BB: It took me by surprise.
AG: How quickly they forget. I was hoping to bask in the Greenspan legacy a bit longer. You know, that ''greatest central banker who ever lived'' stuff is like a drug. BB: That was quite a compliment, considering the source. It took Alan Blinder a year and a half at the Fed to figure out that you were No. 1 and he didn't matter... Mr. Chairman, if I earn a 10th of the respect and confidence the market has in you, I will consider myself successful.
AG: That's it, Ben? No inflation target as your stamp on the Fed? You spent three years lobbing that grenade at me in public. I had to put 60 staff economists to work ... The best they could come up with was ... that an inflation target would reduce ... flexibility, which is tough to swallow when all the inflation-targeting central banks claim just the opposite. BB: Yeah, that was pretty lame. ...
AG: Ben, if I may, I'd like to give you some advice... To start with, ...rethink the helicopter money analogy. ... The last thing a central banker wants to be associated with is a printing press. BB: With all due respect, Mr. Chairman, Milton Friedman's teaching tool to explain how the Fed increases the money supply is on point.
AG: On point doesn't make it a good point, Ben. It conjures up the image of a banana republic ordering its central bank to buy government debt directly from the treasury. ... The Fed may choose to monetize the Treasury's borrowing, but we prefer to do it in broad daylight, in the open market. BB: Good point. There's so much to learn.
AG: ...[Y]ou will want to impress upon the governors ... that any intended dissents ... must be brought to your attention before the meetings. You don't want any surprises. Of course, there's not much you can do about those independent district bank presidents, other than ignore them between meetings. The distance from Washington to Richmond is farther than it appears. BB: So I've heard.
AG: Finally, make sure you enforce that two-week press blackout around meetings. The only unnamed Fed official in the press should be you. BB: I will keep that in mind, Mr. Chairman. Of course, you know my views on the subject. I've done extensive research on central bank transparency. Policy makers should be clear about their objective and clear about how they plan to achieve it...
AG: Ben, Ben, you have so much to learn. That transparency stuff is fine for academic research. In the real world, never giving the market too much information means never having to say you're sorry. Or that you were wrong. BB: I'll be sure to keep that under advisement, Alan. Enjoy your retirement. Don't worry, your Social Security benefits will be safe with me.
Fed Watch: Another Meeting, Another 25 Basis Points
The above title makes the Fed sound just a little too predictable. But the hawkish rhetoric from Fed officials has been quite clear, and last week’s data adds to the case for additional tightening at what we have come to know as the measured pace. Today we will see it again with, I suspect, little change in the accompanying statement.
Taken at face value, the GDP report confirms, once again, the resilience of the US economy. Final sales to domestic purchases clocked a 4.2% gain, virtually identical to the Q2 figure. Consumers prove, once again, they are down but not out. Investment spending looked a bit anemic, but this was foreshadowed in the most recent Fed minutes, as well as a lackluster September durable goods report. And while PCE inflation accelerated, core-PCE again decelerated, falling to a 1.3% rate. All in all, simply not much to worry about in this report see David Altig for a complete rundown on GDP blogging.
Still, if one were inclined to go looking for red flags in the report, where would they turn? The consumer certainly ended the quarter on a weak note, with real spending down a second consecutive month. The strong quarterly showing by consumers was driven by the July surge in durable goods spending, which in turn was driven by auto incentives. Any potential gain in September was lost to higher energy costs from Katrina and Rita. Consumers made it through the third quarter, but came out more bruised than the headline figure suggests.
But a strangled consumer is not a surprise for the Fed; the consumer confidence figures have been telling that story for two months now. Moreover, the Fed recognizes that some demand needed to be destroyed in response to the energy shock. The alternative would be a greater chance that energy inflation would spread into the core. And Fedspeak leaves no doubt on where policymakers stand on that issue. Also note solid growth – 0.5% ‑ in nominal income, after adjustment for Hurricanes Katrina and Rita. The means to spend was in their pockets, it was simply sucked away by higher energy costs. Indeed, with gasoline prices coming down, the consumer may be in better shape than expected despite higher heating costs this winter.
So, overall, incoming data suggests the economy remains on cruise control despite the series of speed bumps the Fed keeps laying down. Does this mean the Fed just keeps laying down more bumps? For the rest of this year, the answer appears to be yes. I think the Fed is comfortable chasing the 10 year bond. Indeed, the bond market has recently cleared the way for additional hikes, with the 10 year yield rising above 4.5%. Moreover, the minutes of the last meeting report that:
Even after today's action, the federal funds rate would likely be below the level that would be necessary to contain inflationary pressures, and further rate increases probably would be required.
Rate “increases,” plural, being the important point, and I see little reason to expect that the FOMC’s judgment has changed on that point. Beyond December, things get a bit fuzzier, in my opinion. Perhaps I am feeling the same unease reported by David Altig last week, as traders were paring bets of a January rate hike. But despite an economy that has remained resilient to what by tomorrow will be 300bp in rate hike, I would hate to forget one of the tried and true mantras of Wall Street:
Don’t fight the Fed.
Eventually, rate hikes will start to dampen real activity. The Fed, of course, is aware of this. Again, from the last minutes:
However, some sentiment was expressed to consider changes to forward-looking aspects of the statement at upcoming meetings, in part because of the considerable reduction in monetary policy accommodation that had already been accomplished.
While policymakers might see the need for additional rate hikes, they realize a lot is also in the pipeline as well. With a considerable amount of accommodation removed, the Fed, I suspect, will soon start paying more attention to data that comes in on the weak side.
So what will the Fed be looking for in that respect? The Fed will be watching for additional evidence of a slowing housing market. Again, the point is not housing itself, but the expected negative impact of a housing slowdown on consumer spending. I doubt the early data and anecdotal evidence is enough to convince them that the housing ATM is closed, but if the housing bears are correct, we could see evidence in that direction pile up over the next couple of months.
Another red flag for the Fed would be sputtering investment spending. Greenspan’s speeches and the minutes suggest that policymakers expected investment spending to hold strong, and they were a little disappointed by what they were seeing at the last meeting:
Meeting participants noted that, even prior to the hurricane, business fixed investment had been somewhat weaker than expected. The softness was somewhat puzzling, as sales were growing, business balance sheets appeared quite strong in the aggregate, profitability was high, and financing was readily available and relatively inexpensive for most firms. Although the apparent sluggishness could reflect only short-term fluctuations in volatile data series, some evidence suggested that it may also have stemmed from concern among business executives about the effects of high energy prices.
Fed Atlanta President Jack Guynn reiterated this unease about the course of investment spending in his Oct. 20 speech.
Another question is if the Fed will deliberately invert the yield curve. To date, policymakers haven’t expressed much concern about the yield curve. But I suspect some posturing was involved here – you can’t maintain expectations for further rate hikes while at the same time fretting over a recession indicator. I doubt that Greenspan & Co. – or a future Bernanke & Co. – will push the fed funds rate above the 10 year rate. If the curve inverts, I believe it will be the result of the long end slipping. Right now, the Fed would be willing to go to 4.25%, maybe even 4.5%, essentially cutting the gap to zero. But if the long rate overshot in a post-Bernanke announcement frenzy and is due for a pullback……?
Also, with rates back into the “4’s,” the Fed is eventually going to focus on actual inflation data. And so far inflation appears contained to headline numbers, with what looks like a solid deceleration of core inflation in place, at least in the GDP report. To be sure, the recent energy price spikes haven’t had time to work their way through the system, but neither have recent and expected rate hikes. Moreover, it is difficult to imagine that inflationary expectations become entrenched without wage inflation to back them up. And last week’s Employment Cost Index report sure does not point to runaway wage inflation, with a paltry 2.3% wage gain compared to last year. In fact, I can’t remember a period of ongoing monetary tightening in such a weak wage environment.
Still, the inflation story was – and will remain for the rest of this year – useful justification for normalizing the fed funds rate, and I continue to expect additional rate hikes. But as rates head into the midpoint of San Francisco Fed President Janet Yellen’s 3.5-5.5% neutral range, the bar for additional hikes will likely rise.
Of course, none of these bearish things might happen and the Fed could happily keep raising rates well into next year, chasing strong growth, higher inflation and a falling 10 year bond. They are just the things I would be watching out for at this point.
Update: David Altig has the probabilities for increases in the federal funds rate through January.
Update: Andrew Balls of the Financial Times has thoughts on the measured pace language:
Fed expected to raise interest rate to 4%, by Andrew Balls, Financial Times (non-sub.): The Federal Reserve is expected to raise interest rates on Tuesday and signal further increases... While there has been no indication that the Federal Open Market Committee will change its judgment that monetary policy remains “accommodative” and that it will continue to raise rates at a “measured” pace, there is a widespread feeling that part of the statement will need to change soon. ... One concern is that the federal funds rate is no longer obviously well below the so-called “neutral” level, at which monetary policy neither restricts nor stimulates activity. But there does not yet appear to be a consensus on what should happen next, and the current language in the Fed's statement is seen as acceptable for now, with the FOMC likely to raise rates again in December...