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February 28, 2006

February 2006

February 28, 2006

Martin Wolf: Time to Reevaluate the European Social Model

Has the time come?:

Decay and the welfare state, by Martin Wolf, Commentary, Financial Times: The time has come for Europeans to ask themselves the unthinkable: can their vaunted social model endure? ... Symptoms are not hard to find: this is a continent of high and persistent unemployment, declining productivity growth, rapid ageing and growing fiscal strains; it is also one whose once-proud role in knowledge-creation is in decline. But in one respect, western Europe remains pre-eminent: its states are the tax-and-spend champions of the world (see chart). ...

European social democracy looks increasingly unworkable in the long run. ... ChartIf one is to assess this possibility one must look not at where the model works least well but where it works best. The maternal state is most fully developed in the Nordic countries and particularly in Sweden. In a forceful new polemic, Johnny Munkhammar of Timbro, a free-market Swedish think- tank, convinces me that trouble abounds even in Sweden’s social democratic paradise. Indeed, its long-run performance shows this (see chart).

What, then, are the failings of the big state? The answers include: fiscal unsustainability; mediocrity of provision; slackening work effort; slowing productivity growth; resistance to economic adjustment; flight of valuable economic resources; difficulties in absorbing immigrants; and even the undermining of the family. A social system that protects people from the consequences of their own decisions is rife with moral hazard: in the long run, it changes not just behaviour but even values in a less productive direction.

Consider each of these points in turn.

First, the services the state provides – particularly education and health – are ones on which people wish to spend more money as they become richer. ... For these reasons, the ratio of public spending in gross domestic product must rise progressively if state-funded services are to meet the demands of the population. But such increases are politically impossible and, in practice, largely ceased two decades ago.

Second, financial stringency, combined with the difficulties in running public sector monopolies, generates rising dissatisfaction with the quality of what is provided. Waiting lists are endemic in Swedish health, for example. State-run schools provide a deteriorating quality of education..., while state-run universities are rapidly-growing but under-funded behemoths.

Third, output per hour in the European Union was 91 per cent of US levels in 2005 (at purchasing power parity), ... while GDP per head was 73 per cent. Lower work effort is the cause: fewer hours worked and lower employment. Taxes, regulations and benefits at least partly explain this. Chart

Fourth, since 2005, productivity in the EU has been losing ground to the US after a long-period of catching up. ...

Fifth, the job security provided in many countries lowers willingness to hire. This makes it more important for workers to hang on to existing employment. That, in turn, makes rapid economic change, including imports, more threatening. This is why countries with rigorous job protection are increasingly inclined towards protectionism.

Sixth, high taxes and the burden of regulations encourage the outflow of resources. ...

Seventh, high minimum wages, whether set by law, trade unions or welfare benefits, combined with heavy taxes on work, generate high levels of unemployment of relatively unskilled people. In Europe today many of these people are immigrants. ... The results are seen in criminality, rioting and social disorder.

Finally, for many mothers the welfare state is a substitute for a committed father. For fathers it is an excuse for abandoning their responsibilities. For both, it is a reason not to produce the children who might help look after them in old age. The result is lower overall investment – quantitatively and, in some respects, even qualitatively – in the posterity on which the sustainability of the welfare state itself depends.

The welfare state brings significant benefits. But it can also go too far. In much of western Europe, it now has. If present trends do not reverse, growing economic, social and even political difficulties threaten. No taboo can remain inviolate, including the most sacred one of all: that of the all-providing state.

As the welfare state pedulum begins swinging back in the other direction, and it does seem to have reached its apex, let's hope its momentum doesn't carry it too far.

    Posted by Mark Thoma on Tuesday, February 28, 2006 at 02:11 PM in Economics, Social Security

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    Krugman's Money Talks: When Education Doesn't Pay

    Paul Krugman responds to comments on his column Graduates Versus Oligarchs:

    When Education Doesn't Pay, by Paul Krugman, Money Talks, NY Times: ... Paul Krugman: Several people have asked whether the surge in incomes at the very top might be to a large extent a statistical illusion, due to lower marginal tax rates. The idea is that great fortunes went "underground" when top tax rates were high, and resurfaced when rates fell under Reagan and Bush.

    It's a good question, and has been studied by economists. Let me give you a quick explanation of why I think it's a fairly minor factor. The kind of income we'd expect to see surging if wealth was hidden would be from capital — dividends, interest, etc. But the big gains have, in fact, come in high-level compensation — C.E.O. paychecks and such. In fact, the growth numbers in my article referred to wage and salary income.

    Now, we can be reasonably sure that in 1970 the C.E.O. of General Motors wasn't receiving huge hidden compensation equal to several times his reported income. (C.E.O. compensation has gone from about 40 times average wages to about 400 times.) So the increase in incomes at the top is mainly a real phenomenon, not a story about tax avoidance.

    One other point: a few people have asked whether there are graduates and graduates — whether serious tech degrees have paid off more than liberal arts or whatever. The answer is, not dramatically. Having an engineering degree has no more been a ticket to big income gains than being at the 90th percentile.

      Posted by Mark Thoma on Tuesday, February 28, 2006 at 12:42 PM in Economics, Income Distribution, Universities

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      Existing Home Sales and Consumer Confidence Fall

      From the WSJ, worries that recent data are pointing to a slowing economy, particularly in housing. Also, fourth quarter GDP growth was revised upward from 1.1% to 1.6%:

      Weak Fourth-Quarter Growth Was Less Bleak Than Thought GDP for 4th Quarter Is Revised Higher, But Home Sales, Confidence Deteriorate, WSJ: The U.S. economy expanded at a slightly stronger pace at the end of last year than earlier estimated, and while growth is expected to rebound sharply to start 2006, fresh readings on home sales and consumer confidence hinted at bumps on the road ahead.

      The... broadest measure of all goods and services produced in the economy, rose at a 1.6% annual rate in the fourth quarter, better than the earlier reported 1.1% growth. ...

      The housing market ... is beginning to show signs of slowing down. The latest evidence arrived Tuesday in a report from the National Association of Realtors showing sales of existing homes fell 2.8% in January .... Sales of condominiums and co-ops were particularly weak, falling 10.6%. ... The data echoed a report Monday showing new-home sales dropped 5% last month, as slower sales and rising inventories pushed the number of unsold homes up 2.5% in January to the highest level in nearly a decade.

      Also Tuesday, the Conference Board, a private research group, said its index of consumer confidence for February fell to a reading of 101.7 compared with the revised 106.8 seen in January. ... Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote ... that while confidence readings appear to run in sympathy with the twists and turns in gasoline prices, "it is also possible that the softening housing market is beginning to affect people's views of the future."

      Though consumers' confidence has sputtered, they have continued to spend. ... retail chain-store sales index increased by 1.5% in the week ended Feb. 25 on a seasonally adjusted, comparable-store basis, according to data released Tuesday. The index increased 3.6% in annual terms. ...

      Though at a three month low, consumer confidence hasn't been very informative recently and some feel a slowdown in housing is needed to rebalance the economy. Even at a slower pace, the growth in housing remains high by historical standards. I don't see these reports by themselves as cause for alarm, but rather as part of an emerging and somewhat confusing picture of the strength of the economy.

        Posted by Mark Thoma on Tuesday, February 28, 2006 at 09:51 AM in Economics

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        The Rent-to-Ownership Society

        The administration is proposing that elderly patients purchase rather than rent oxygen equipment and hospital-style beds used at home:

        'Ownership' for Elderly's Oxygen Equipment, by David Rogers, WSJ: President Bush's "ownership society" is coming to one corner of Medicare: Live long enough, and a patient could have his or her own oxygen equipment and hospital-style bed at home. Congress paved the way this month with a budget bill mandating a "rent-to-own" rule requiring that Medicare home-care beneficiaries take title to their rented beds after 13 months. Now, Mr. Bush wants to apply the same standard to oxygen equipment in hopes of saving billions of dollars and empowering the elderly to bargain for cheaper respiratory-therapy services.

        The administration contends that the rental payments now are a waste of scarce government funds... Instead of renting, Medicare would in effect buy the equipment for a beneficiary, who then could bargain for services -- oxygen supplies and maintenance -- separately on the basis of service and price. Patients will now "own the means of delivery," says House Ways and Means Committee Chairman Bill Thomas...

        The change has angered Republican-friendly medical-equipment and home-care suppliers that rent equipment to Medicare but never surrender title. Malachi Mixon, a Bush supporter ... calls the proposed changes "absolutely crazy" and says they ignore the services provided by suppliers, financed through the rentals. "They think you drop it off like a stork," he says. ...

        Critics contend the administration is captive to a free-market ideology that ignores the frailty of the elderly, many of whom are in ill health ... "Republican delusions that health care can work like any other market apparently know no bounds," says Robert Berenson, a senior fellow at the Urban Institute and a top Medicare administrator under President Clinton. "They now even extend their notions of an ownership society to people in their last months of life."

        Mr. Mixon says one unintended consequence is the economic pressure to build cheaper, less durable products given the 13-month cap imposed on bed rentals. And Lawrence Higby, chief executive of Apria Healthcare Group Inc., says owning oxygen equipment is likely to be a burden rather than a boon for the elderly, many of whom are too weak to negotiate the savings on supply envisioned by Republicans.

        "The cornerstone of the misunderstanding is that all we are doing is providing equipment," he says. "Medicare's attitude is you only pay the police and fire departments when they come to the house. We maintain a 24-hour hotline. We have drivers named in wills."...

        Since they'll own the equipment, they'll be able to pass it along to their children too. After Medicare paid for it in full, it will end up sitting in a garage, attic, basement, etc. Wouldn't it be more efficient to pool the risk of being outlived by your equipment? Rental arrangement are one, but not the only way to do that. In addition, I'm imagining someone in a hospital-style bed at home linked to their respirator while haggling over the price of the next bottle of oxygen. Couldn't Medicare use its collective purchasing power to negotiate even better prices on their behalf and save them the trouble?

          Posted by Mark Thoma on Tuesday, February 28, 2006 at 02:37 AM in Economics, Health Care

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          The Fed's Communication Strategy

          St. Louis Federal Reserve president William Poole doesn't think the typical consumer of Fed speak has enough training in economics and monetary policy to understand unfiltered policy deliberations properly, so the statements need to be cleaned of potentially misleading technical language. I'm not sure I agree on this point. Here's a brief part of a much longer speech on Fed communication:

          Fed Communications, by William Poole, St. louis fed President, Feb. 24, 2006: ...Fed communications issues are often discussed under the general term “transparency.” What, literally, does transparency mean? ... Transparency must mean disclosing as much as possible without damaging the integrity of policy deliberations. That integrity is essential both to be sure that all issues are fully debated and to ensure that information ... remains confidential. But there is [an] aspect to transparency that is incompletely understood. ... Much of the FOMC deliberation consists of fairly technical discussions. Without an advanced degree in economics, or extensive policy experience, much of this material is simply incomprehensible. Thus, although policy experts can understand undigested material, the message that they would convey to the general public would likely not be timely and might not closely match, in emphasis and tone, the consensus message the FOMC would want to convey. ...Instead, the Fed needs a conscious communications strategy rather than a strategy of simply “opening up.” The purpose of a conscious strategy is not to hide anything but rather to have a clear transmission of information. ... FOMC transcripts ... require a substantial background in economics and the history of monetary policy to interpret correctly. ...

          What about members of the FOMC who do not have this background (see "Kevin Who?")? Should we be worried they might misinterpret technical material presented at meetings?

            Posted by Mark Thoma on Tuesday, February 28, 2006 at 12:09 AM in Economics, Fed Speeches, Monetary Policy

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            Chinese Economist Says Dollar Reserve Growth Should be Reduced

            Though it might help to answer questions about low long-term interest rates, I'm not anxious to find out will happen if China slows its accumulation of dollar based foreign exchange reserves:

            Economist urges cut in dollar reserves, China View: The country should reduce the U.S. dollar share of its foreign exchange reserves because of the risks posed by the instability of the U.S. currency, influential economics professor Xiao Zhuoji said in an interview published yesterday. ...Xiao also proposed a number of ways to slow the explosive growth in the country’s reserves, which rose 34 percent last year to US$818.9 billion. “U.S. dollars account for most of our reserves, and the instability of the dollar increases foreign exchange risk. So we should take measures to cool down this extraordinary reserve growth,” ... He proposed adjusting the structure of China’s reserves to reduce currency risk ... Xiao is a Beijing University professor and a member of the standing committee of the Chinese People’s Political Consultative Conference, a body that advises the National People’s Congress. ... China could slow reserve growth by strictly controlling capital inflows and speeding up exchange rate reform, he said. For example, companies could be allowed to hold more foreign exchange, instead of being required to sell it to the central bank, and individuals could be permitted to invest in foreign currencies. Xiao also said China could also cut its trade surplus, which tripled last year to US$102 billion, by reducing resource-intensive exports and importing more high-tech products. (Reuters/China Daily)

              Posted by Mark Thoma on Tuesday, February 28, 2006 at 12:07 AM in China, Economics, International Finance

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              More Baskets for the Eggs

              The government securities market is dependent upon just two banks and that worries the Fed:

              Fed in call for ‘stand-by’ Treasuries bank, by Jennifer Hughes, Financial Times: The US Federal Reserve has asked Wall Street dealers to develop a “stand-by” bank that would step in if one of the two leading Treasuries clearing banks encountered problems. The Fed and the US Treasury depend on the Treasuries securities market to implement monetary policy and fund the US government. But the market, in which $545bn is traded daily, depends on two banks, JPMorgan Chase and Bank of New York, to clear its trades. This situation concerns regulators. Don Layton, who retired recently as vice-chairman of JPMorgan Chase and will lead the project, said: “If one of these two had troubles of any kind, literally half the government securities market would not be able to function...” ... The stand-by facility, provisionally called “NewBank”, is designed to come into play only if there is a loss of market confidence in one of the clearers, and dealers became wary of clearing trades through it. ...

                Posted by Mark Thoma on Tuesday, February 28, 2006 at 12:06 AM in Economics, Financial System

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                February 27, 2006

                Economic Reform and Single Party Rule in China

                Will the market eventually undermine communist party power in China?:

                A fierce battle hobbles China’s march to the market, by Richard McGregor, Financial Times: Liu Guoguang, a once influential but long retired Marxist economist, recently burst back onto the scene with an incendiary warning for the Chinese government. If it did not rein in market reforms and deal with the growing, gaping rich-poor divide, China would “change its colour”: code for the “red” Communist party losing power. ... Almost overnight, symposiums were staged around the country to study his “economic thought”, including one at Ya’nan, the Communist party’s old revolutionary base.

                “The government has already lost control of many sectors and, of the state enterprises that are left, we seem to be willing to sell them, to foreigners or anybody,” says Liu Rixin, a longtime senior planning official. Nostalgia aside, the words of the retired economist resonated so widely because he explicitly linked the survival of single-party rule to the maintenance of a dominant role for the state in the economy. The nexus between the two is rarely so openly acknowledged but it is the central underlying issue in a ... very nasty battle over economic policy under way in China. It will have a bearing on all manner of reforms, such as privatisation and foreign investment in the finance sector. Some measures have already been delayed – such as a law to clarify private property rights...

                On one level, the attack by the elderly economist seemed to symbolise a backlash against Mr Hu’s government. But such straightforward interpretations no longer apply in a China ... How, after all, could Mr Hu be criticised for the rich-poor gap when he, along with Mr Wen, has made tackling it a centrepiece of his economic policy? ...

                China is now less equal than the US and Russia, according to the World Bank, and income inequalities are still widening. And while incomes have mostly risen across the board, the social wage ... which provided free health, education, housing and an old-age pension – has been drastically cut, all but disappearing in the countryside.

                China spends less than one-fifth of the developed-country average on health and education.... In rural areas, where China’s poorest communities live, nearly 90 per cent of health costs are borne by individuals. ... education researchers are discovering that drop-out rates among rural children from junior secondary schools average 30-40 per cent. “This is the most under-reported story in China – the country’s massive failure to educate its rural youth in the 1990s,” says Yasheng Huang of MIT Sloan School of Management. ...

                To old Marxists such as Mr Liu, Mr Hu and Mr Wen have not done enough to uphold government – and, by implication, party – control of the economy. Alongside them, as part of a loose ragtag coalition that marches under the “anti-reform” banner, celebrity economists such as Lang Xianping, who fronts a popular television show in Shanghai, have criticised privatisation as a slow-motion Russian-style theft of state assets.

                Many mainstream economists counter that the Hu-Wen administration is shaping up as a disaster precisely because it refuses to tackle the state’s still dominant role. For these economists, pushing the rich-poor gap to centre stage is simply a device by the leadership to increase the role of the state in business...

                Li Qingyuan, a veteran official and executive in the finance sector, takes a more sanguine view of where the current debate will lead. It is nothing like the “scary discussions” of the early 1990s, she says, when there was a genuine leftist resurgence in the wake of the 1989 Tiananmen Square crackdown. “This kind of argument comes up from time to time but I don’t think it will last long and obstruct the pace of reform,” she adds. “The general trend is irreversible.”

                But that is precisely what worries the Marxists the most. For the octogenarian Mr Liu, until recently written off as a dinosaur in the debate, it is the most powerful argument in years he has been able to muster for reining in the market economy. Such reforms mean a larger private sector and a smaller state – and, ultimately, greater pressure for a more pluralistic politics and institutions able to adjudicate economic disputes free of arbitrary political interference.

                But while Mr Liu and the party have allies among an entrepreneurial elite dependent on government favours to build their businesses, it is an alliance that is increasingly resented and under attack. “If westerners think the current growth model can be maintained,” says the Shanghai-based economist, “they are making a big mistake.”...

                  Posted by Mark Thoma on Monday, February 27, 2006 at 12:47 PM in China, Economics

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                  Posted at Environmental Economics

                  For my records, these are things I've posted at Environmental Economics recently:

                    Posted by Mark Thoma on Monday, February 27, 2006 at 09:00 AM in Economics, Environment

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                    New Home Sales

                    Calculated Risk has the details on today's housing report "U.S. New Home Sales Fell 5 Percent in January." His bottom line:

                    This report is still reasonably strong, except for the record inventory and months of inventory.

                    Update: Greg Ip, writing in the WSJ's Washington Wire, points out that due to a change in the sample, housing price data will be biased downward:

                    Tricky Housing Trends: New-home sale prices are always tricky to analyze because they are heavily influenced by the mix of homes sold: more luxury home sales will tend to bias up the figure, more homes sold in the south or Midwest, where prices are lower, will bias it down. But in the last year an additional issue has muddied the trend. In January 2005, for the first time since 1985, the Census Bureau updated the sample of local permit offices it checks to track new-home construction and prices. A lot changed between 1985 and 2005. Older, pricier areas became heavily built up and activity declined. In newer, outlying areas, where prices were generally lower, construction picked up. The 2005 sample thus has a larger share of those newer, cheaper areas. Comparing 2005 figures to those in 2004 will give the impression of a slowing in price gains, but that's somewhat artificial.

                    See Sample Change Damps New-Home Price Gains

                      Posted by Mark Thoma on Monday, February 27, 2006 at 08:49 AM in Economics, Housing

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                      Paul Krugman: Graduates Versus Oligarchs

                      Paul Krugman on the 80-20 fallacy:

                      Graduates Versus Oligarchs, Rising Oligarchy, by Paul Krugman, Commentary, NY Times: Ben Bernanke's maiden Congressional testimony as chairman of the Federal Reserve was, everyone agrees, superb. ... But Mr. Bernanke did stumble at one point. Responding to a question ... about income inequality, he declared that "the most important factor" in rising inequality "is the rising skill premium, the increased return to education."

                      That's a fundamental misreading of what's happening.... What we're seeing isn't the rise of a fairly broad class of knowledge workers. Instead, we're seeing the rise of a narrow oligarchy: income and wealth are becoming increasingly concentrated in the hands of a small, privileged elite. I think of Mr. Bernanke's position ... as the 80-20 fallacy. It's the notion that the winners in our increasingly unequal society are a fairly large group ... the 20 percent or so of American workers who have the skills to take advantage of new technology and globalization...

                      The truth is quite different. Highly educated workers have done better than those with less education, but ... real earnings of college graduates actually fell more than 5 percent between 2000 and 2004. Over the longer stretch from 1975 to 2004 the average earnings of college graduates rose, but by less than 1 percent per year.

                      So who are the winners from rising inequality? ... A new research paper by Ian Dew-Becker and Robert Gordon ... gives the details. Between 1972 and 2001 the wage and salary income of Americans at the 90th percentile of the income distribution rose only ... about 1 percent per year. So being in the top 10 percent of the income distribution, like being a college graduate, wasn't a ticket to big income gains.

                      But income at the 99th percentile rose 87 percent; income at the 99.9th percentile rose 181 percent; and income at the 99.99th percentile rose 497 percent. No, that's not a misprint. Just to give you a sense of who we're talking about: ... the 99th percentile will correspond to an income of $402,306, and the 99.9th percentile to an income of $1,672,726. The ... 99.99th percentile [is] probably well over $6 million a year. ...

                      The notion that it's all about returns to education suggests that nobody is to blame for rising inequality, that it's just a case of supply and demand at work. And it also suggests that the way to mitigate inequality is to improve our educational system — and better education is a value to which just about every politician in America pays at least lip service.

                      The idea that we have a rising oligarchy is much more disturbing. It suggests that the growth of inequality may have as much to do with power relations as it does with market forces. Unfortunately, that's the real story.

                      Should we be worried about the increasingly oligarchic nature of American society? Yes ... Both history and modern experience tell us that highly unequal societies also tend to be highly corrupt. There's an arrow of causation that runs from diverging income trends to Jack Abramoff ...

                      And I'm with Alan Greenspan, who ... has repeatedly warned that growing inequality poses a threat to "democratic society." It may take some time before we muster the political will to counter that threat. But the first step toward doing something about inequality is to abandon the 80-20 fallacy. It's time to face up to the fact that rising inequality is driven by the giant income gains of a tiny elite, not the modest gains of college graduates. [Link to Dew-Becker and Gordon paper, includes comments from Ian Dew-Becker on the paper]

                      Previous (2/24) column: Paul Krugman: Osama, Saddam and the Ports Next (3/3) column: Paul Krugman: George the Unready

                        Posted by Mark Thoma on Monday, February 27, 2006 at 12:09 AM in Economics, Income Distribution, Universities

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                        Turning Coal into Gold through Tax Breaks

                        There's gold in them thar halls of congress. Gold that starts out as coal and ends up, after being sprayed with diesel or some other substance, as a synthetic fuel tax break. Unfortunately for those exploiting this provision of the tax code, recent increases in oil prices threaten to trigger an end to the tax break bonanza. However, GOP senator Rick Santorum slipped a provision into the hurricane relief bill to ensure the tax breaks would continue and the provision is now in the reconciliation process:

                        A Magic Way to Make Billions, by Donald L. Bartlett and James B. Steele, Time: The wording is so bland and buried so deep within a 324-page budget document that almost no one would notice that a multibillion-dollar scam is going on. Not the members of Congress voting for it and certainly not the taxpayers who will get fleeced by it. And that is exactly the idea. ... Buried in the huge budget-reconciliation bill ... are a few paragraphs that accomplish an extraordinary feat. They roll back the price of a barrel of crude oil to what it sold for two years ago. They create this pretend price for the benefit of a small group of the politically well connected. ...[who] will walk away with billions of dollars in tax subsidies, not from oil but from the marketing of a dubious concoction of synthetic fuel produced from coal ...

                        To understand why Washington wants to backdate the price of oil for its friends, it's necessary to return to the oil shocks of the 1970s, when long lines formed at gas stations and people dialed down the thermostats ... so they could afford to pay their utility bills. In 1980, Congress enacted tax incentives ... to spur the development of a synthetic-fuel industry. The goal was to build huge plants using new technologies that would transform raw coal, which the U.S. has in abundance, into synthetic natural gas ... and--here comes the ever popular bromide--reduce U.S. dependence on foreign oil. ...

                        When oil prices fell, ... the synfuel credit remained on the books, dormant, until a group of enterprising entrepreneurs came across it in the 1990s and saw a way to transform coal into gold. The coal can look and burn like regular coal. The IRS rule for transforming coal into synfuel--and getting the tax credit--requires only that the substance be chemically altered in some way. The alchemy that satisfies the IRS is a simple process: some plants spray newly mined coal with diesel fuel, pine-tar resin, limestone, acid or other substances--a practice that industry critics call "spray and pray." Other operators mix coal-mining waste with chemicals, coat it with latex and blend it with untreated coal to form briquettes. ... Those synfuel operations were a far cry from the state-of-the-art plants that Congress had envisioned ...

                        For owners and operators, the whole point isn't creating a profitable new energy resource ...; it's about collecting the tax subsidy. Progress Energy Inc. ... reported ... that in 2002-04 its synfuel-production losses added up to $400 million. No problem: the company claimed $852 million in tax credits, magically transforming a money-losing operation into a money-making business with $452 million in profits--courtesy of the American taxpayer. .... And Progress Energy is not alone. ...

                        This was not what Congress had in mind in 1980 when it enacted the subsidy. The idea was to stimulate ... a new industry that would make synthetic fuel competitive with the price of conventional oil and gas. To achieve that end, lawmakers pegged the value of the credit to the price of crude oil. If oil prices ... rise above a certain level, the synfuel ... subsidy would be phased out. As long as oil prices were below $50 per bbl., synfuel producers could claim the full value of the credit. But in the past year, as prices have risen to as much as $66 per bbl., anxiety has spread through the synfuel ranks that their boondoggle is imperiled. ...

                        With so much at stake, the synfuelers have pumped money into a campaign to preserve their tax break. At the center of the synfuel lobby in Washington is a consortium called the Council for Energy Independence. It's a name worthy of the most successful Washington lobbies... Since 2002, the Council for Energy Independence has spent $2 million lobbying Congress to preserve the tax credit...

                        Last November the lobby scored a remarkable coup. Buried deep in a bill called the Tax Relief Act of 2005, passed by the Senate on Nov. 18, was Section 559... Section 559 ... says the synfuel credit will be based not on current oil prices--the yardstick used in the past--but on "the amount which was in effect for sales in calendar year 2004."

                        In 2004 oil prices were safely below the line to allow synfuel producers to claim the maximum credit. The stealth amendment ... was inserted in the Tax Relief Act, which provides aid for Hurricane Katrina victims ... With so many higher profile issues at stake, the clause on synfuels sailed right through with no discussion. Many lawmakers, if not most, don't even know it's there.

                        When asked about the provision's origins, Senate Finance Committee aides at first said they did not know ... Asked again by TIME to identify the author, the Senate Finance aide later wrote in an e-mail, "the provision originated as an amendment from Sen. [Rick] Santorum [a Pennsylvania Republican]. ... Chairman Grassley accepted the Santorum amendment ..." ...

                        The bill is now part of Congress's budget-reconciliation process. But there is no synfuel amendment in the House bill, meaning that it cannot become law unless the House conferees agree to the Senate provision. ... the odds are that synfuel may slip through again. ... The synfuel lobby contends that the exemption from the run-up in oil prices is necessary to create stability in the industry. ... And the synfuel lobby expects to carry the day too, largely because Congress has bigger issues to deal with. Kirk Benson, the chairman and CEO of Headwaters, told analysts that "in the world of Washington, D.C., what we want to do isn't material ... It's an afterthought." ...

                        We should continue to cut social, education, and health programs, maybe delay infrastructure spending too, in order to protect tax cuts that distort the allocation of resources towards scam synthetic fuel programs that make the people lobbyists represent rich.

                          Posted by Mark Thoma on Monday, February 27, 2006 at 12:04 AM in Budget Deficit, Economics, Politics, Taxes

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                          February 26, 2006

                          The New Silk Road

                          This isn't the first time China has accumulated a large stock of foreign currency reserves through a trade surplus:

                          China, a vortex for the world's gold, by Keith Bradsher, The New York Times/IHT: China has such a huge stash of other countries' money that it could, in theory, give bonuses equaling half a year's wages to all 770 million of its famously low-paid workers. China will soon release statistics showing that it has passed Japan as the biggest holder of foreign currency the world has ever seen. Its reserves already exceed $800 billion and are on track to reach $1 trillion by the end of the year, up from just under $4 billion in 1989. But China has held a similar position before.

                          The current pile, much of it invested in U.S. Treasury securities or mortgages on American homes, is a result of China's selling more goods than it buys and of foreign money pouring in for the building of factories, apartment towers, office buildings and shopping malls. China is not alone; oil exporters are also piling up cash and trying to figure out what to do with it, leading to disputes like the current one over a Dubai company's designation to run cargo terminals at American ports.

                          History offers parallels to the yawning U.S. trade deficit and the resulting accumulation of dollars in China. China sells to American companies almost six times as much as it buys from them, but this is not the first time China has been an export powerhouse. Ancient Rome, for example, found that it had little except glass that China wanted to buy. Nearly 2,000 years ago, Pliny complained about the eastward flow of Roman gold along the Silk Road in exchange for Chinese silk.

                          Long-distance trade collapsed during the early years of the Dark Ages. But through the next several periods of rapid growth in international commerce - from A.D. 600 to 750, from 1000 to 1300 and from 1500 to 1800 - China again tended to run very large trade surpluses. By 1700, Europe was paying with silver for as much as four-fifths of its imports from China because China was interested in little that Europe manufactured.

                          A longstanding mystery for economic historians lies in how so much silver and gold flowed to China for centuries for the purchase of Chinese goods yet caused little inflation in China. Many of China's manufactured goods remained much cheaper than those from other countries until the early 1800s, despite the rapidly growing supply of silver in the Chinese economy. One theory is that Chinese output was expanding as fast as the supply of precious metal. Another is that the Chinese were saving the silver and gold, not spending it.

                          The same phenomenon has appeared today, as dollars inundating China have resulted in practically no increase in prices for most goods and services - although real estate prices have jumped in most cities. China has an even easier time preventing domestic prices from rising these days because modern banking techniques allow its central bank to buy up the dollars and take them out of everyday circulation. The central bank has accumulated the country's immense foreign currency reserves in the process.

                          The British Empire in the 19th century worked out a way to maintain a large long-term trade surplus with China. So far, however, nobody has suggested that the United States also try getting millions of Chinese people addicted to imported opium.

                          What goods and services will we get China "addicted" to? What will our "opium" be?

                            Posted by Mark Thoma on Sunday, February 26, 2006 at 10:17 AM in China, Economics, International Trade

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                            Falling Wages

                            It's not getting any easier for middle class workers:

                            Two Tiers, Slipping Into One, by Louis Uchitelle, NY Times: Rick Doty is a 30-year veteran of Caterpillar, the big tractor and earth-moving equipment manufacturer. He is paid $23.51 an hour as a machinist, and he receives additional benefits worth almost as much. That sets him far above newly hired workers consigned to a much lower wage scale. To these fellow workers, Mr. Doty, who is also a local union leader, struggles to justify an inequality that he helped to negotiate. ... arguing that $12 to $13 an hour is good pay here. "And I assure them that five years down the road, when the present contract expires, we in the union are going to improve their lot in life."

                            That does not seem likely. After more than a decade of failed strikes and job actions ... the U.A.W. reluctantly accepted a two-tier contract that provides for significantly lower wages and benefits for newly hired employees. ... The trade-off is the promise of a manufacturing revival at long last in the old Rust Belt, as new hires come aboard at much lower labor costs. "What we've done is reposition ourselves to actually grow employment in our Midwestern plants," said Jim Owens, Caterpillar's chief executive. "We finally have a labor cost that is viable."

                            Caterpillar is adding a significant chapter to the labor cost-cutting that is widespread in America... Until recently, cutbacks in the wages and benefits of hourly workers were limited mostly to money-losing companies... They have said that their survival was at stake. Now, however, even healthy and highly profitable companies like Caterpillar are engaging in the practice, and as they do so, the longstanding presumption that factory workers at successful companies can achieve a secure, relatively prosperous middle-class life ... is evaporating. ...

                            As Caterpillar's managers see it, they have no choice. ... The new contract reflects the company's success in imposing a "market competitive" pay scale; that is, wages and benefits that attract enough qualified workers by being slightly better than the packages offered by others in each community or region where Caterpillar has operations. ...

                            In the new lower tier, ... easily replaceable workers will no longer earn more than $12.50 an hour, or $26,000 a year. They must work their way up toward middle-class jobs, Mr. Owens argues ... "I want people to have a higher income," Mr. Owens said. "But you do that by starting out maybe driving a forklift or working in a warehouse and then you get new skills. ..." Beyond that, he says, talented workers are encouraged to take courses to qualify for promotion to salaried jobs ... outside the union. ...

                            The trade-off for lower wages, Caterpillar's top executives counter, is more jobs for the region. ... But the company itself, he says, cannot succeed without the concessionary U.A.W. contract... Caterpillar, meanwhile, is prospering. ... Net income was up 40 percent last year, to $2.85 billion; it has nearly tripled since 2003. Tens of millions of dollars have gone into research to develop a great variety of Caterpillar products that sell against those of Komatsu and Volvo, the two biggest foreign competitors...

                            Fixed monthly pensions go now only to veteran workers, like Mr. Doty, and job security is effectively canceled for new hires, who must work 12 years without interruption to become immune to layoffs. Mr. Glynn notes that the arrangement gives Caterpillar leeway to shed the new workers when demand turns down for the company's products. ...

                              Posted by Mark Thoma on Sunday, February 26, 2006 at 12:42 AM in Economics, Income Distribution

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                              February 25, 2006

                              Rogoff: The Indian Tortoise and the Chinese Hare

                              India everywhere? Not without roads, bridges, and better health and education programs. Here's Kenneth Rogoff of Harvard University, formerly the chief economist at the IMF:

                              The Indian Tortoise and the Chinese Hare, by Kenneth Rogoff, Project Syndicate: “India everywhere” was the theme at this year’s World Economic Forum. ... The India media blitz was a huge success. In Davos, speaker after speaker touted the idea that even if China is ahead now, over the longer run, the race between Asia’s two giants is a toss-up. ... But what is the reality in the race between economies with more than a billion people each?

                              On the surface, China has opened up quite a lead on India. Twenty-five years ago, at the start of the contemporary wave of globalization, national output in India and China was about the same. Now, by any measure, China is more than twice as rich. ... [T]he real difference – whether we like to admit it or not – is that China’s communist government has succeeded in globalizing a much larger share of its population than India’s democratic government has managed to do.

                              Not that China is exactly egalitarian. It is only along the coast, home to roughly one in three Chinese citizens, that most people can be said to have really joined the twenty-first century. Much of rural China is still miserable... But caste-bound India’s record of exclusion is worse. Perhaps only one in five persons are integrated into the global economy. ... Whereas China probably has about 450 million people in its globalized economy, India has at most 200-250 million. It is this difference, more than anything else, that sets the two economies apart.

                              What can India do to close the gap? Its biggest shortcoming is its lack of roads, bridges, ports, and other infrastructure, where the contrast with China is just stunning. If your products can’t get to the global economy, you cannot conquer it. Over the past five years, China has multiplied its highway system five-fold. ... It is not just a matter of money – India’s central bank is rolling in cash, which it has mainly invested in low-yield foreign treasury bills.

                              The real problem is that China’s authoritarian system faces little opposition when it decides to bulldoze a shantytown that stands in the way of a new airport. India’s government, by contrast, has neither the power nor the inclination to trample over poor people to make rich people richer. Unfortunately, without infrastructure, the ... majority of India’s citizens will remain frozen out of globalization.

                              So, is the idea that India’s economy could overtake China’s hopeless romanticism? Not necessarily, if only because the areas where India excels, notably services, have far higher potential margins than manufacturing. Here, the Chinese, hampered by a vastly inferior legal system, will not be able to compete easily. Western companies are far more inclined to trust Indian firms with sensitive financial information or patents than they are in the case of China. Foreign companies know that if they outsource any high-tech process to China, they might as well publish their blueprints on the Internet.

                              India also has a much better developed financial system than China, an advantage that will be increasingly important ... Command and control financing ... works well when it comes to building bridges; it is a lot less effective when it comes to choosing what companies deserve to survive. ... If India is to ever catch up with China, it must globalize more of its citizens, through better provision of health, education and infrastructure. Only then will we truly start seeing “India everywhere.”

                                Posted by Mark Thoma on Saturday, February 25, 2006 at 01:46 PM in China, Economics, India

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                                Who Gets the Cookies?

                                The Economist asks how workers can maintain or increase their share of income when the forces of globalization are working against them:

                                Decoupled, by Ronald Gant, The Economist: "Nothing contributes so much to the prosperity and happiness of a country as high profits,” said David Ricardo, a British economist, in the early 19th century. Today, however, corporate profits are booming in economies, such as Germany's, which have been stagnating. And virtually everywhere, even as profits surge, workers' real incomes have been flat or even falling. In other words, the old relationship between corporate and national prosperity has broken down.

                                This observation has two sides to it. First, ... companies are no longer tied to the economic conditions and policies of the countries in which they are listed. Firms in Europe are delivering handsome profits that are more in line with the performance of the robust global economy than with that of their sclerotic homelands. ... Europe's and Japan's stockmarkets have outpaced those in America, despite the latter's faster GDP growth.

                                Second and more worrying, the success of companies no longer guarantees the prosperity of domestic economies or, more particularly, of domestic workers. Fatter profits are supposed to encourage firms to invest more, to offer higher wages and to hire more workers. Yet even though profits' share of national income in the G7 economies is close to an all-time high, corporate investment has been unusually weak in recent years. Companies have been reluctant to increase hiring or wages by as much as in previous recoveries. In America, a bigger slice of the increase in national income has gone to profits than in any recovery since 1945.

                                The main reason why the health of companies and economies have become detached is that big firms have become more international. ... With the profits of these firms so dependent on their global operations, it is not surprising that corporate prosperity has failed to spur “home” economies. ... If a large part of the spurt in profits comes from foreign operations, it is less likely to be used to finance investment or extra job creation at home. ...

                                Globalisation has also shifted the balance of power in the labour market in favour of companies. It gives firms access to cheap labour abroad; and the threat that they will shift more production offshore also helps to keep a lid on wages at home. This is one reason why, despite record profits, real wages in Germany have fallen over the past two years. ...

                                Workers can still gain from rising profits if they own shares, either directly or through pension funds. ... In America, capital gains on shares have played a big role in supporting household spending over the past decade. But ... workers in continental Europe are losing out... This is partly because of the smaller role played by institutional investors, such as pension funds, in Europe compared with, say, America.

                                If profits (and hence executive pay) continue on their merry way, while ordinary employees' real wages stand still and their health benefits and pensions are eroded, workers might well expect their governments to do something to close the gap. ... higher taxes on profits, restrictions on overseas investment, import barriers, or making it harder to lay off workers. The trouble is, in a globalised economy ... Firms would simply move operations' head offices to friendlier countries.

                                A more promising way of allowing workers to share in companies' prosperity is to encourage firms to introduce profit-sharing schemes for employees. But perhaps the most useful thing that governments can do is to ensure that consumers ... benefit from lower prices as a result of the shifting of production to low-cost countries. The prices of consumer goods have fallen by much more in America in recent years than in the euro area, where retailers are shielded from competition... Greater competition in Europe would allow workers to share in the gains of globalisation through lower prices. ...

                                The main reason given for stagnating wages is that earnings have higher expected returns when invested in foreign rather than domestic markets or when used to increase domestic wages, and a secondary reason is a shift in market power in labor markets toward firms. If so, firms won't voluntarily increase the share of profits going to domestic workers at the expense of more profitable opportunities elsewhere. Are tax breaks or some other form of government intervention needed to "encourage firms to introduce profit-sharing schemes for employees" or to encourage firms to put other policies in place to increase, or at least maintain, labor's share of income? I'm not there yet, but if politicians insist on implementing tax breaks, why not think along these lines?

                                  Posted by Mark Thoma on Saturday, February 25, 2006 at 01:47 AM in Economics, Income Distribution, Policy, Unemployment

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                                  Second Thoughts

                                  Tom Allison says deregulation of airlines has not turned out the way he expected:

                                  Now You Tell Us, IHT: ...Tom Allison, a former counsel to the committee of the U.S. Senate that wrote the law that deregulated the airline industry in 1980, ... say[s] that maybe free markets have their drawbacks. Specifically, Allison [said] lower fares as routes were opened up to competition also led to service deterioration and severe human costs. "I had no idea these things would happen," Allison said. ...

                                    Posted by Mark Thoma on Saturday, February 25, 2006 at 01:33 AM in Economics, Market Failure, Regulation

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                                    Greenspan: Nation Ripe for a Third Party Candidate

                                    Alan Greenspan, political pundit:

                                    Freed of the constraints of public office, Alan Greenspan has expanded from commenting on the economy to commenting on politics, by Greg Ip, WSJ Washington Wire (dynamic link): Speaking to a Wall Street gathering ..., the former Federal Reserve chairman decried the "polarization" of American politics and said the ground was ripe for a third party presidential candidate... A member of the audience asked Mr. Greenspan if he would endorse a candidate for president. Mr. Greenspan said he would not, "for now." But he went on to describe the two American parties now as controlled by their extreme wings, even though the voting public is far more centrist... He described the leadership of the parties as "bimodal," meaning clustered at the extreme ideological ends, whereas the voting public was "monomodal," meaning clustered near the middle. Such situations, he said, create an opening for a third-party candidate who appeals to the center. That, he said, could prompt the candidates of the other two parties to move back to the center, for fear of losing.

                                      Posted by Mark Thoma on Saturday, February 25, 2006 at 01:14 AM in Economics, Politics

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                                      February 24, 2006

                                      Friedman's Plucks and Capacity Utilization

                                      Not too long ago, I talked about Friedman's plucking model, an alternative to the natural rate of output view of the world. The typical view of business cycles is one where the economy varies around a trend value (the trend can vary over time also). In Friedman's model, output moves along a ceiling value, the full employment value, and is occasionally plucked downward through a negative demand shock. To get some idea of what this might look like, I regressed the log of real GDP on a constant, trend, and trend squared, then added .05 to the predicted value to shift the estimated trend line upward to make it a ceiling. This gives:

                                      I should say that this is not the best way to estimate the ceiling, but it is quick and easy relative to frontier estimation techniques. What made me think of this was the post earlier on capacity utilization. If a gap is calculated as gap = ceiling - rgdp, and then graphed on a two-scale graph along with capacity utilization, here is the result (this is actually the negative of the gap to make the correlation easier to spot visually):

                                      The last time I looked at this was ten years ago or so. As you can see from the diagram, at that time capacity utilization measures and the gap from Friedman's plucking model appeared to be very highly correlated. Given they are conceptually similar, i.e. both are deviations from a maximum value, and that both measures move with real GDP, this is expected. However, since around 1994 the correlation appears to have weakened somewhat, and then seems to have reestablished itself around 2000. The question is why. Here are graphs with the sample split arbitrarily from 1967 to 1985 and from 1986-2005 showing this:

                                      The reason for the poor association in the mid and later 1990s may be the estimation technique for the trend or changes in productivity growth during this time period. Globalization and the transition to a more service based economy are also possibilities.

                                        Posted by Mark Thoma on Friday, February 24, 2006 at 09:18 PM in Economics, Macroeconomics

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                                        Bernanke: The Benefits of Price Stability

                                        Ben Bernanke's delivered his first speech outside of Washington since becoming Federal Reserve Chair. This was given at at a symposium for the 75th anniversary of Princeton's Woodrow Wilson School of Public and International Affairs and marks his return to Princeton. [See Bloomberg for coverage of remarks made after the speech in response to questions]:

                                        The Federal Reserve Board eagle logo links to home page

                                        Remarks by Chairman Ben S. Bernanke, February 24, 2006

                                        The Benefits of Price Stability

                                        It is a great pleasure for me to return to Princeton today, to see so many friends and former colleagues, and to help celebrate the seventy-fifth anniversary of the founding of the Woodrow Wilson School of Public and International Affairs. I taught at Princeton for seventeen years--more often than not in Bowl 1, in the deep, dark basement of Robertson Hall--and my wife Anna and I raised our two children here. Like all good New Jerseyans, we will always think of our home address in terms of a Turnpike exit--in our case, Exit 9.

                                        As you know, the Woodrow Wilson School is named after a renowned Princeton professor of politics and law who, having determined from a stint as the University's president that the institution was essentially ungovernable, decided to try his hand at public service. I do not presume to draw any comparisons between myself and the nation's twenty-eighth President, of course; but besides the Princeton affiliation, we have in common a connection with the Federal Reserve System. President Wilson made the establishment of the Federal Reserve one of his early legislative priorities, signing the Federal Reserve Act into law in December 1913, less than a year after taking office. Wilson helped to negotiate the complex political compromises that finally gave the nation a permanent central bank, following two earlier failed attempts.

                                        To simplify a complex history, earlier attempts to stabilize the monetary arrangements of the United States had frequently been roiled by perceived conflicts of interest between (on the one hand) the farmers and tradespeople of Main Street America, who believed that they were most advantaged by policies of easy credit, and (on the other hand) the financial barons of Wall Street, who, as creditors and bondholders, preferred "hard-money," low-inflation policies. Recognizing that all parties would be served by a central bank that could help contain the periodic financial crises that afflicted the U.S. economy, Wilson worked with the Congress to develop a structure for the central bank that finely balanced competing interests and concerns. In particular, the Federal Reserve was given a regional structure, with twelve Reserve Banks that were distributed around the country and were empowered to represent sectional interests and to respond to local conditions. Although Wilson understood the political and practical advantages of decentralization, he also resisted some powerful proponents of a completely decentralized system by supporting the creation of a Board of Governors in Washington to oversee and coordinate the activities of the regional Reserve Banks.

                                        The mandate of the Federal Reserve System has changed since the institution opened its doors in 1914. When the System was founded, its principal legal purpose was to provide "an elastic currency," by which was meant a supply of credit that could fluctuate as needed to meet seasonal and other changes in credit demand. In this regard, the Federal Reserve was an immediate success. The seasonal fluctuations that had characterized short-term interest rates before the founding of the Fed were almost immediately eliminated, removing a source of stress from the banking system and the economy.1 The Federal Reserve today retains important responsibilities for banking and financial stability, but its formal policy objectives have become much broader. Its current mandate, set formally in law in 1977 and reaffirmed in 2000, requires the Federal Reserve to pursue three objectives through its conduct of monetary policy: maximum employment, stable prices, and moderate long-term interest rates.

                                        One of my goals today is to consider the relationships among the three apparently disparate objectives of monetary policy. In particular, I will argue for what I believe has become the consensus view, that the mandated goals of price stability and maximum employment are almost entirely complementary. Central bankers, economists, and other knowledgeable observers around the world agree that price stability both contributes importantly to the economy's growth and employment prospects in the longer term and moderates the variability of output and employment in the short to medium term.

                                        But that view did not always command the support that it does today. Notably, during the 1960s and early 1970s, some policymakers appeared to believe that price stability and high employment were substitutes, not complements. Specifically, some influential voices of the time argued that, by accepting higher inflation, policymakers could bring about a permanently lower rate of unemployment.2 As I will discuss a bit later, the demise of the view that higher inflation promotes employment in favor of the modern consensus that low inflation and strong employment are complementary goals resulted from the constructive interplay between academic research and practical policymaking experience, an interplay that significantly improved policy outcomes and economic welfare in the United States. Of course, fostering this sort of interaction between academic analysis and real-world policymaking is a principal objective of the Woodrow Wilson School.

                                        The Dual Role of Price Stability Price stability plays a dual role in modern central banking: It is both an end and a means of monetary policy.

                                        As one of the Fed's mandated objectives, price stability itself is an end, or goal, of policy. Fundamentally, price stability preserves the integrity and purchasing power of the nation's money. When prices are stable, people can hold money for transactions and other purposes without having to worry that inflation will eat away at the real value of their money balances. Equally important, stable prices allow people to rely on the dollar as a measure of value when making long-term contracts, engaging in long-term planning, or borrowing or lending for long periods. As economist Martin Feldstein has frequently pointed out, price stability also permits tax laws, accounting rules, and the like to be expressed in dollar terms without being subject to distortions arising from fluctuations in the value of money.3 Economists like to argue that money belongs in the same class as the wheel and the inclined plane among ancient inventions of great social utility. Price stability allows that invention to work with minimal friction.

                                        In principle, the problem of inflation could be reduced by the practice of indexing dollar payments such as interest and wages to the price level, but people seem to find indexing costly and avoid it when they can. It is interesting and instructive, for example, that the indexation of wages to prices in labor contracts has always been quite limited in the United States; some indexation was used during the high-inflation 1970s but the practice has been substantially reduced since then. Moreover, some countries that adopted indexing during high-inflation periods, such as Brazil and Israel, largely abandoned the practice when inflation receded. Borrowers and lenders likewise seem to prefer to contract in dollar terms, although inflation-indexed financial instruments have gained wider acceptance in recent years. Borrowing and lending in dollar terms, particularly for long periods, requires confidence that the purchasing power of the currency will be stable and predictable. The savings and loan crisis of the 1980s, which cost U.S. taxpayers roughly $150 billion, is an example of the kind of problem that can arise in the absence of price stability. An important source of the S&L crisis was the unexpected inflation of the 1970s, which greatly reduced the real value of mortgage loans made by the S&Ls in an earlier, low-inflation era. These losses effectively de-capitalized the savings and loans, helping to set the stage for the problems that followed.

                                        Although price stability is an end of monetary policy, it is also a means by which policy can achieve its other objectives. In the jargon, price stability is both a goal and an intermediate target of policy. As I will discuss, when prices are stable, both economic growth and stability are likely to be enhanced, and long-term interest rates are likely to be moderate. Thus, even a policymaker who places relatively less weight on price stability as a goal in its own right should be careful to maintain price stability as a means of advancing other critical objectives.

                                        Let me elaborate briefly on the relationship between price stability and the other two goals of monetary policy. First, price stability promotes efficiency and long-term growth by providing a monetary and financial environment in which economic decisions can be made and markets can operate without concern about unpredictable fluctuations in the purchasing power of money. As I have already noted, the dollar provides a reasonably secure gauge of real economic values only when inflation is low and stable. High and variable inflation degrades the quality of the signals coming from the price system, as producers and consumers find it difficult to distinguish price changes arising from changes in product supplies and demands from changes arising from general inflation. Because prices constitute a market economy's fundamental means of conveying information, the increased noise associated with high inflation erodes the effectiveness of the market system. High inflation also complicates long-term economic planning, creating incentives for households and firms to shorten their horizons and to spend resources in managing inflation risk rather than focusing on the most productive activities.

                                        Research is not definitive about the extent to which price stability enhances economic growth. We do not have controlled experiments in macroeconomics, and inflation and growth are both endogenous variables that respond jointly to many factors. Nevertheless, I am confident that the effect is positive and see the international experience as at least consistent with the view that, in combination with other sound policies, the maintenance of price stability has quite significant benefits for efficiency and growth. That view appears to be widely shared among policymakers, as governments around the world have made extensive efforts to bring inflation down over the past two decades or so, with substantial success.

                                        More recently, the evidence has mounted not only that low and stable inflation is beneficial for growth and employment in the long-term but also that it contributes importantly to greater stability of output and employment in the short to medium term. Specifically, during the past twenty years or so, in the United States and other industrial countries the volatility of both inflation and output have significantly decreased--a phenomenon known to economists as the Great Moderation (Bernanke, 2004). This finding challenges some conventional economic views, according to which greater stability of inflation can be achieved only by allowing greater fluctuations in output and employment. The key to explaining why price stability promotes stability in both output and employment is the realization that, when inflation itself is well-controlled, then the public's expectations of inflation will also be low and stable. In a virtuous circle, stable inflation expectations help the central bank to keep inflation low even as it retains substantial freedom to respond to disturbances to the broader economy.

                                        This mechanism can be illustrated by comparing the effects of the recent rise in oil prices to the effects of the oil price increases of the 1970s. Thirty years ago, the public's expectations of inflation were not well anchored. With little confidence that the Fed would keep inflation low and stable, the public at that time reacted to the oil price increases by anticipating that inflation would rise still further. A destabilizing wage-price spiral ensued as firms and workers competed to "keep up" with inflation. The Fed, attempting to gain control of the deteriorating inflation situation, raised interest rates sharply; however, initially at least, these increases proved insufficient to control inflation or inflation expectations, and they added substantially to the volatility of output and employment. The episode highlights the crucial importance of keeping inflation expectations low and stable, which can be done only if inflation itself is low and stable.

                                        By contrast, the oil price increases of recent years appear to have had only a limited effect on core inflation (that is, inflation in the prices of goods other than energy and food), nor do they appear to have generated significant macroeconomic volatility. Several factors account for the better performance of the economy in the recent episode, including improvements in energy efficiency and in the overall flexibility and resiliency of the economy. But, the crucial difference from the 1970s, in my view, is that today inflation expectations are low and stable (as shown, for example, by many surveys and a variety of financial indicators). Oil price increases in the past few years, unlike in the 1970s, have not fed through to any great extent into longer-term inflation expectations and core inflation, as the public has shown confidence that any increases in inflation will be temporary and that, in the long run, inflation will remain low. As a result, the Fed has not had to raise interest rates sharply as it did in the 1970s but instead has been able to pursue a policy that is more gradual and predictable. Of course, the relatively benign state of inflation expectations we enjoy today has not come automatically. The anchoring of inflation expectations in a narrow range has been the product of Fed policies that have kept actual inflation low in recent years, clear communication of those policies, and an institutional commitment to price stability.

                                        Price stability also contributes to the third component of the Fed's mandate, the objective of moderate long-term interest rates. As first pointed out by the economist Irving Fisher, interest rates will tend to move in tandem with changes in expected inflation, as lenders require compensation for the loss in purchasing power of their principal over the period of the loan. When inflation is expected to be low, lenders will require less compensation, and thus interest rates will tend to be low as well. In addition, because price stability and the associated macroeconomic stability reduce the risks of holding long-term bonds and other securities, price stability may also reduce the premiums that lenders charge for bearing risk, lowering the overall level of rates.

                                        The Origins of the Modern Consensus on Price Stability I have briefly laid out the modern consensus that price stability, besides being desirable in itself, tends also to increase economic growth and stability. As I noted earlier, however, this view is quite different from the one that prevailed forty years ago. At that time, the ascendant paradigm was that society faced a long-term tradeoff between price stability and high employment. Implied in this position was a potential conflict between defenders of "hard money" and supporters of easy credit that echoed, at least faintly, the political conflicts that Wilson faced in setting up the Federal Reserve. The development of the modern consensus was a fascinating example of the way economic science progresses through the interaction of academic research and policy experience--exactly the kind of activity that the Woodrow Wilson School was designed to promote. Thus I thought I might briefly describe the evolution of that consensus here today.

                                        The 1960s' idea that greater prosperity could be achieved if only we were willing to accept higher inflation had its origins in an academic study, although the author likely did not intend that outcome. In 1958, A.W. Phillips, using British data, showed that historically inflation had tended to be high in years in which unemployment was low. Similar results were subsequently reported for the United States.4 Phillips did not draw strong policy conclusions from his findings. But that did not stop others from doing so. In the decade following the publication of his paper, his empirical finding was sometimes interpreted (including, for example, by members of the Kennedy and Johnson Administrations) as showing that policymakers could choose (permanently) lower unemployment if they were willing to accept (permanently) higher inflation in exchange. Scholars disagree somewhat about the extent to which policymakers of the time tried actively to take advantage of this supposed tradeoff, but these ideas likely provided part of the intellectual rationale that made the authorities willing to allow inflation to rise throughout the 1960s and in the early 1970s.

                                        The idea of the permanent tradeoff did not go unchallenged, however. In 1967, economists Milton Friedman and Edmund Phelps independently produced influential critiques of this view. Their key contribution was to observe that, if inflation expectations react to changes in actual inflation in an economically reasonable way, then any tradeoff between inflation and unemployment would be short-lived at best. To illustrate their argument, let us suppose that firms and workers set nominal wages once a year but that, sometime during the year, the prices of firms' output rise unexpectedly as a result of stronger-than-expected demand. The combination of higher prices for their output and fixed nominal wages would raise the profitability of increasing production; thus, assuming that more workers are available at the previously fixed wage, firms would respond to the rise in prices by adding workers. Over a short period, then, higher inflation might bring lower unemployment, consistent with the empirical results found by Phillips.

                                        However, this logic applies only during the period in which wages and workers' expectations of inflation are fixed. If inflation were to rise persistently, Friedman and Phelps argued, workers' expectations of inflation would not remain unchanged but would adjust to match the actual rate of inflation. Higher inflation expectations would in turn lead workers to bargain for commensurate raises in nominal wages to preserve the real value of their earnings. With nominal wages rising as well as prices, firms would no longer have an incentive to hire additional workers, and employment would return to its normal level. An attempt to stimulate the economy by choosing a permanently higher level of inflation could thus not succeed, according to this analysis; such an attempt would leave the economy with higher inflation but a level of employment no different than it would have been otherwise. This work was both brilliant and prescient. In particular, among the seminal contributions of the Friedman and Phelps analyses was the identification of the key role of inflation expectations in determining the behavior of the economy, a point that remains central to our thinking today.

                                        Moreover, the performance of the U.S. economy soon bore out the predictions made by Friedman and Phelps. The inflationary policies of the 1960s led not to permanently lower unemployment, as the permanent-tradeoff theory predicted, but instead to persistently higher inflation with no improvement in unemployment. For example, in the 1970s, core inflation averaged 6 percent, compared with 2-1/4 percent in the 1960s, and unemployment in the 1970s averaged 6-1/4 percent, compared with the 4-3/4 percent rate in the 1960s. The volatility of output and (especially) inflation both increased, as the Fed struggled to contain inflation expectations. Other factors, including the aforementioned surge in oil prices, played a role in the deterioration of economic performance in the 1970s. Clearly, though, the theory that a long-run tradeoff exists between inflation and unemployment had sprung a serious leak.

                                        Despite a growing recognition that higher inflation provided no labor-market benefits, there was, until the end of the 1970s, little appetite for taking the actions necessary to reduce inflation. For one thing, economists and policymakers recognized that reversing the rise in inflation expectations that had occurred during the 1970s could take time and that, during the process, the nation could suffer ultimately transitory but still-serious increases in unemployment. Furthermore, at the time, it was widely believed among economists that any stable level of inflation would be as good as another. Although the efficiency costs associated with high inflation were acknowledged, the costs were thought to be associated mostly with changes in the underlying rate of inflation--particularly unexpected changes. In addition, many economists argued that the efficiency costs of inflation were not particularly large.5

                                        Milton Friedman once again was in the vanguard on this issue. In his 1977 Nobel Prize address, Friedman laid out the modern argument--that, because it harms the efficient operation of markets, high inflation is more likely to raise unemployment than to lower it--and he used the experience of the 1970s to illustrate his point.6 Indeed, by the late 1970s, even economists who were not part of Friedman's monetarist circle were beginning to study and acknowledge the costs to the economy associated with high inflation.7

                                        When Federal Reserve Board Chairman Paul Volcker embarked on his campaign to break the back of U.S. inflation in October 1979, he drew on this existing work in formulating and defending his program. (Volcker, by the way, was Princeton class of 1949, and he wrote his senior thesis on the Federal Reserve.) In his first testimonies and speeches after becoming Chairman, Volcker emphasized many of the arguments developed by academics for how inflation interfered with the efficient working of the economy. And he drew on Friedman's monetarist approach, both in its advocacy of low and stable inflation and in its prescriptions for policy implementation. In a speech given just after the Federal Open Market Committee announced its adoption of a monetarist-style policy approach in October 1979, Volcker dismissed the notion that lowering inflation meant accepting permanently higher unemployment and suggested instead that the reverse was more likely to be the case.8

                                        Until this point, academic research (or at least some of it) had paved the way for improved policymaking. After 1979, however, policymakers increasingly began to set the intellectual pace. Volcker's statements from this period in particular are remarkable in the extent to which they anticipate contemporary thinking about the crucial importance of low and stable inflation and inflation expectations. He repeatedly noted, for example, how instability in inflation and inflation expectations were "jeopardizing the orderly functioning of financial and commodity markets."9 Unlike academics, of course, Volcker was in a position to put his views into practice. Under the Volcker-led Federal Reserve, annual core inflation fell from more than 9 percent in 1980 to just below 4 percent in 1987.

                                        Alan Greenspan, who succeeded Volcker as Fed Chairman in 1987, continued to work to stabilize inflation and inflation expectations. Under Greenspan, the Federal Reserve gradually brought core inflation down further, to about 2 percent in recent years. The Greenspan era also saw important steps toward increased transparency at the Federal Reserve, which helped to clarify for the public the Federal Reserve's strong institutional commitment to price stability. In a sense, Chairman Greenspan had the harder sell: As an economist would say, we might expect diminishing marginal returns to inflation reduction. Yet I think subsequent events demonstrate clear benefits from the tenacity of the Fed under Greenspan. Lower inflation has been accompanied by inflation expectations that are not only lower but better anchored, so far as we can tell. Most striking, Greenspan's tenure aligns closely with the Great Moderation, the reduction in economic volatility I mentioned earlier, as well as with a strong revival in U.S. productivity growth--developments that had many sources, no doubt, but that were supported, in my view, by monetary stability. Like Volcker, Greenspan was ahead of academic thinking in recognizing the potential benefits of increased price stability. Indeed, in recent years, academic research on monetary policy has caught up with the policymakers, providing new support for what I have termed the modern consensus, that price stability supports both strong growth and stability in output and employment.

                                        Conclusion Price stability plays a dual role in monetary policy. Stable prices are desirable in themselves and thus are an important goal of monetary policy. But stable prices are also a prerequisite to the achievement of the Federal Reserve's other mandated objectives, high employment and moderate long-term interest rates. In particular, low and stable inflation and inflation expectations enhance both economic growth and economic stability.

                                        The complementarity of price stability with the other goals of monetary policy is now the consensus view among economists and central bankers. That consensus has not been achieved easily, however, but is the product of many years of policy experience, policy leadership, and sustained economic analysis. No doubt we will continue to learn about the economy and economic policy, even as we benefit from the insights of those who went before us. I am sure the Woodrow Wilson School, its faculty, and its students will continue to play an important role in that ongoing process.


                                        Bernanke, Ben S. (2004). "The Great Moderation," speech delivered at the meetings of the Eastern Economic Association, Washington, D.C., February 20.

                                        Feldstein, Martin (1997). "The Costs and Benefits of Going from Low Inflation to Price Stability," in Christina D. Romer and David H. Romer, eds., Reducing Inflation: Motivation and Strategy, University of Chicago Press, 123-56.

                                        Fischer, Stanley (1986). Indexing, Inflation, and Economic Policy. MIT Press.

                                        _____ and Franco Modigliani (1978). "Towards an Understanding of the Real Effects and Costs of Inflation," Weltwirtschaftliches Archiv 114, 810-33.

                                        Friedman, Milton (1968). "The Role of Monetary Policy," American Economic Review 58, 1‑17.

                                        _____ (1977). "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy 85, 451‑72.

                                        Miron, Jeffrey A. (1986). "Financial Panics, the Seasonality of the Nominal Interest Rate, and the Founding of the Fed, " American Economic Review 76, 125-40.

                                        Phelps, Edmund S. (1968). "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy 76, 678-711.

                                        Phillips, A. W. (1958). "The Relation between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861-1957," Economica 25, 283-99.

                                        Romer, Christina D., and David H. Romer (2002). "The Evolution of Economic Understanding and Post-War Stabilization Policy (PDF 439 KB)," in Federal Reserve Bank of Kansas City, Rethinking Stabilization Policy, 11‑79.

                                        Volcker, Paul A. (1979a). "A Time of Testing," October 9, in Addresses, Essays, and Lectures of Paul A. Volcker, 1979-81, volume 1, Federal Reserve Board.

                                        Volcker, Paul A. (1979b). "Statement before the Subcommittees on Domestic Monetary Policy and on International Trade, Investment and Monetary Policy of the Committee on Banking, Finance and Urban Affairs," U.S. House of Representatives, November 13, 1979, Federal Reserve Bulletin, December 1979, 958-962.


                                        1. Miron (1986).

                                        2. Romer and Romer (2002) provide historical documentation of policymakers' support for the idea of a permanent inflation-unemployment tradeoff.

                                        3. Feldstein (1997).

                                        4. Phillips' work actually focused on wage inflation rather than price inflation; subsequent work emphasized the latter.

                                        5. For example, Nobel-Prize-winning economist James Tobin is famously quoted as saying, "It takes a heap of Harberger triangles to fill an Okun gap," an admittedly jargon-laden way of saying that it was unlikely that the efficiency gains from lower inflation would compensate for the loss in output and employment associated with an aggressive effort to bring inflation down. Quoted in Fischer (1986, p. 3).

                                        6. Friedman (1977).

                                        7. Fischer and Modigliani (1978).

                                        8. Volcker (1979a).

                                        9. Volcker (1979b).

                                          Posted by Mark Thoma on Friday, February 24, 2006 at 07:55 PM in Economics, Fed Speeches, Monetary Policy

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                                          European Productivity Growth

                                          This is a summary of a paper by Gordon and Dew-Becker "Why Did Europe's Productivity Catch-up Sputter Out? A Tale of Tigers and Tortoises," one of the papers from a FRBSF conference on the causes and consequences of productivity growth:

                                          Productivity Growth: Causes and Consequences—Conference Summary, by Daniel Wilson, FRBSF: ...Gordon and Dew-Becker sought to determine the cause of the rather stark divergence in productivity growth in the European Union (EU) relative to the strong performance in U.S. since 1995. ... Previous research had shown that information technology (IT) played a big role in the U.S. acceleration in the second half of the 1990s, so one might think the slowing in EU productivity might be due to developments affecting the IT sector in Europe. On the contrary, Gordon and Dew-Becker show that the slowdown in Europe was quite broad-based and not due just to weakness in IT-related industries. A common explanation for the EU slowdown is that institutional and legal barriers limit flexibility, and it is frequently illustrated by a story about zoning laws in Europe that prevent big-box stores, like Wal-Mart and Target, from expanding and establishing the ultra-efficient distribution systems they have in the U.S.... Gordon and Dew-Becker offered a different story: Somewhat ironically, the labor market reforms enacted in the mid-1990s in many EU countries actually had a negative effect on productivity growth—at least temporarily. ... by relaxing rigid work rules and high wage floors, EU employers could hire more low-wage, low-productivity workers and substitute away from high-skill workers and capital. ... By opening the door to these low-productivity workers ... average productivity is pulled down, at least until the economy adjusts to the new composition of the workforce.

                                            Posted by Mark Thoma on Friday, February 24, 2006 at 07:03 PM in Academic Papers, Economics, Technology

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                                            Capacity Utilization

                                            I keep hearing that capacity utilization rates are entering the inflation danger zone, e.g. here in the discussion of today's advance durable goods report. The maximum usage was 89.4% in the first month in 1967 which is also the first observation in the sample. The mean, shown in the figure, is 81.4%. The last measurement was 80.9%. The graph is constructed using Fed data:

                                            Current usage is below the overall mean. Why is a value below the historical mean nearing the inflation danger zone? I must be missing something. Has structural change altered the definition of full capacity? Even by recent standards, e.g. since 1990, capacity looks low. Is it a problem in particular key industries rather than a general problem, is that the inflation worry?

                                              Posted by Mark Thoma on Friday, February 24, 2006 at 09:09 AM in Economics, Monetary Policy

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                                              Averting America’s Bankruptcy

                                              Laurence Kotlikoff proposes a New New Deal in Economist's Voice:

                                              Averting America’s Bankruptcy with a New New Deal, by Laurence J. Kotlikoff, Economist's Voice: The United States is essentially bankrupt and requires critical and immediate fiscal surgery thanks to decades of fiscal profligacy and the impending retirement of the baby boom generation. According to the latest projections ..., the difference between the federal government’s present value of projected expenditures and the present value of projected receipts is $63.3 trillion. This fiscal gap is 8.2 percent of the present value of GDP, meaning that we need to devote that share of GDP every year for eternity to cover the shortfall.

                                              Since federal personal and corporate income taxes represent 9.8 percent of GDP, one way to close the gap would be to immediately and permanently raise those taxes by roughly 84 percent (8.2 divided by 9.8). Advocating this hike is a political non starter. Enacting it could well be economically ruinous. Yet, doing nothing, and leaving this bill for our children and grandchildren to pay is neither feasible nor moral.

                                              What should we do? ... Neither the Republican or Democratic politicians are offering sensible solutions; and indeed present policies are making matters worse. Given this, it is time for academic economists, who care more for policy substance than for partisan advantage, to suggest sensible, efficient, and equitable solutions.

                                              So let me suggest solutions to our three most troubled fiscal institutions – our tax system, our Social Security system, and our government healthcare system. Each solution is radical, but simple. The three reforms, in conjunction with cutbacks in federal discretionary spending, would leave us with ... fiscal institutions that can reliably pay for what the government spends. ... Let’s start with the tax system.

                                              Tax reform – moving to a federal retail sales tax plus a rebate

                                              Not only does the current tax system raise too little revenue relative to the current level of expenditures; but it’s also woefully complex, expensive to use, highly inefficient, and, in my view, inter- and intragenerationally inequitable. ... The system is so complex that no one can claim to fully comprehend its provisions, incentives, or the degree to which it is redistributing resources across the current and future population. An army of well educated and highly talented lawyers, accountants, and auditors spends every hour of every working day coping with this miasma. Add to this all the taxpayer compliance costs and you’re talking hundreds of billions of dollars in annual wasted resources. This is not to mention the efficiency losses from the current system’s distorted incentives, which the GAO puts at 2 to 5 percent of GDP.

                                              What’s worse, the tax system is geared in many ways to take from the poor and young and give to the rich and old. ... There are several candidates for wholesale tax simplification and reform, including a value added tax (VAT), a flat tax, and a federal retail sales tax. The most straightforward reform is the federal retail sales tax... In principle the VAT and flat taxes would also tax only consumption; but in practice, they will likely ... leave us taxing not consumption, but rather wages. Such a "reform" would be highly inequitable, both on intra- and intergenerational grounds. Consequently, I favor the federal retail sales tax ... to tax all consumption (including services, food, and imputed rent on owner-occupied housing and automobiles).

                                              The specific plan is to replace the personal income tax, the corporate income tax, the payroll (FICA) tax, and the estate and gift tax with a federal retail sales tax plus a rebate. The rebate would be paid monthly to households, be based on the household’s demographic composition, and equal the sales taxes paid, on average, by households at the federal poverty line with the same demographics.

                                              Most Democrats assume that a sales tax would be regressive. But my proposed reform, which is very similar to the FairTax, has three highly progressive elements. First, thanks to the rebate, poor households would pay no sales taxes in net terms. Second, the reform eliminates our highly regressive FICA tax. Third, the sales tax will effectively tax wealth as well as wages: When the rich spend their wealth and when workers spend their wages, they will both pay sales taxes. By broadening the effective tax base to include the corpus of wealth, not just the income earned on it (much of which is currently exempted or taxed at a low rate), one can lower the required sales tax rate and, thereby, reduce the tax burden on workers.

                                              The single, flat-rate sales tax would pay for all federal expenditures. The tax would be highly transparent and efficient. It would save hundreds of billions of dollars in tax compliance costs. It would significantly reduce effective marginal taxes facing most Americans when they work and save. Finally, the federal retail sales tax would enhance generational equity by asking rich and middle class older Americans to pay taxes when they spend their wealth. The poor elderly, living on Social Security, would end up better off. They would receive the sales tax rebate even though the purchasing power of their Social Security benefits would remain unchanged thanks to Social Security’s automatic cost of living adjustment. ...

                                              A 25 percent effective sales tax rate would raise federal revenues to 21 percent of GDP – the ratio of revenues to GDP that prevailed in 2000. This is 5 percentage points more of GDP than we are now collecting ... On the other hand, the sales tax rebate would cost about 4 percent of GDP. Consequently, the net reduction in the fiscal gap from the tax reform would be only about 12 percent, or one percent of GDP.

                                              I’d close the remaining 88 percent of the gap with cuts in Social Security, healthcare, and discretionary spending. But cuts, by themselves, will not carry the day. We need to restructure Social Security and federal healthcare delivery to ensure that any cuts made today are not undone by spending increases tomorrow.

                                              Fixing Social Security – The Personal Security System

                                              My second proposed reform deals with Social Security. With 2528 rules in its Handbook, the system is a bureaucrat’s dream come true. It’s also significantly underfunded. ... Here’s what I would do. I’d shut down the retirement portion of the current Social Security system at the margin by paying in the future only those retirement benefits that were accrued as of the time of the reform. This means that current retirees would receive their full retirement benefits, but current workers would receive retirement benefits based only on covered wages earned prior to the reform....

                                              The current system will be immediately replaced by a fully funded and modern system of compulsory saving, which I call the Personal Security System (PSS). PSS has individual accounts, but one with very different properties from the scheme proposed by President Bush... All workers would be required to contribute 7.15 percent of their wages up to what is now the Social Security covered earnings ceiling ... into an individual PSS account. Married or legally partnered couples would share contributions so that each spouse/partner would receive the same contribution to his or her account. The government would contribute to the accounts of the unemployed and disabled. In addition, the government would make matching contributions on a progressive basis to workers’ accounts, thereby helping the poor to save.

                                              All PSS accounts would be private property. But they would be administered and invested by the Social Security Administration in a market-weighted global index fund of stocks, bonds, and real estate securities. Everyone would have the same portfolio and receive the same rate of return. The government would guarantee that, at retirement, the account balance would equal at least what the worker had contributed, adjusted for inflation... This would protect workers from the inevitable downside risks of investing in capital markets. ...

                                              Although this plan has individual accounts and market investment, neither Wall Street nor the insurance industry would get their hands on workers’ money. There would be no loads, no commissions, and no fees. Nor would there be all the risks associated with individual investing. Like the current Social Security system, PSS would take advantage of economies of scale in operating saving systems and the government’s unique ability to pool risk across generations.

                                              The switch from paying projected Social Security benefits to paying only accrued Social Security benefits would reduce the fiscal gap by roughly $15 trillion or roughly 24 percent. Together with the tax reform, I’ve now reduced the fiscal gap by 36 percent.

                                              Cutting Back on Discretionary Spending

                                              The federal government’s discretionary spending currently represents 7.8 percent of GDP. This is 1.5 percentage points higher than the year-2000 figure. I propose restoring the year-2000 discretionary spending rate. This would reduce the fiscal gap by another 18 percent, leaving 46 percent to be cut via my proposed healthcare reform.

                                              Healthcare Reform: MSS

                                              According to the Gokhale and Smetters, the combined unfunded liabilities of Medicare and Medicaid total roughly $120 trillion. The gargantuan size of these liabilities has everything to do with the projected growth in benefit levels. Limiting benefit growth to that of labor productivity would reduce the fiscal gap by roughly $36 trillion, or 57 percent, which would more than close the remaining fiscal gap.

                                              But cutting future benefit growth in these programs appears to be impossible under the current fee-for-service structure. Our government has tried all manner of ways to reduce healthcare benefit growth in recent decades, and all have failed. What we need is a foolproof means by which the government can set an expenditure limit in a given year and stick to it. At the same time we need a system that delivers healthcare to everyone in society, not just the aged and indigent. As is well know, some 45 million Americans currently have no health insurance coverage. This is unacceptable in a civilized society.

                                              Consequently, I propose moving to a universal healthcare system that limits benefit growth over time. This system will cost more money in the short run, but much less over time than our current system. My proposal, culled from earlier work by John Goodman and Peter Ferrara, would abolish the existing fee-for-service Medicare and Medicaid programs and enroll all Americans in a universal health insurance system called the Medical Security System (MSS).

                                              In October of each year, the MSS would provide each American with an individual-specific voucher to be used to purchase health insurance for the following calendar year. The size of the voucher would depend on the recipients’ expected health expenditures over the calendar year. ...

                                              Providing individual-specific vouchers based on full and accurate medical information obviously eliminates the adverse selection problem that has plagued private medical insurance provision ... Some readers are sure to worry about a possible invasion of privacy. Yet the government already knows about millions of Medicare and Medicaid participants’ health conditions because it’s paying their medical bills. This information has never, to my knowledge, been disclosed or abused.

                                              The beauty of this plan is that all Americans would receive healthcare coverage and that the government could limit its total voucher expenditure to what the nation could afford. Unlike the current fee-for-service system, under which the government has no control of the bills it receives, MSS would explicitly limit the government’s liability. In setting its voucher budget through time, the government would target to spend, in present value, no more than the current system were benefit levels to grow only with labor productivity.

                                              The MSS plan is also progressive. The poor, who are more prone to illness than the rich, would receive higher vouchers, on average, than the rich. And, because we’d be eliminating the current income tax system, all the tax breaks going to the rich in the form of non-taxed health insurance premium payments would vanish.

                                              A Final Word

                                              It’s high time we got our fiscal house in order. Economists have a key role in keeping our country from experiencing the fiscal and financial meltdown to which current policies are pointing. To do this, we need to unite as a profession around solutions to which our discipline points. The reforms presented here are neither entirely new nor wholly original. To me they represent solid economic engineering – straightforward solutions to clear cut problems. Yes, they are radical changes. But nothing short of radical changes will help us resolve our $63.3 trillion shortfall.

                                              Letters commenting on this piece or others may be submitted at

                                              Economists’ Voice January, 2006

                                                Posted by Mark Thoma on Friday, February 24, 2006 at 01:53 AM in Budget Deficit, Economics, Social Security, Taxes

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                                                Leave it to Bernanke

                                                Ben Bernanke discusses economic security in today's world in a speech from July 2005 reprinted in part in the latest issue of Economist's Voice:

                                                Skills, Ownership, and Economic Security, by S. Bernanke, Ph.D., Economist's Voice: I will address the issue of economic security—what it means in the context of today’s world and what we as a nation can do to help our citizens achieve it.

                                                The idea of what it means to be economically secure in America has changed over time. In our parents’ generation, people aspired to be like the family in the television show "Leave it to Beaver." Mom stayed home with the kids, and Dad worked at the same company from the day he completed his education until the day he got his gold watch. Within the company, workers moved predictably up the corporate ladder, earning higher incomes as their seniority increased. The company provided health care, training, and a defined-benefit pension, which, together with Social Security, provided the basis for a secure retirement. Government programs and the tax code were designed to promote these arrangements.

                                                It’s an idyllic picture, although it’s not entirely obvious that it was ever really an accurate description of life in America. Because of lack of education, racial discrimination, and other reasons, large portions of the population could not hope to enjoy this type of security in the decades after World War II. And the American economy has always been much more dynamic than this placid depiction suggests. Over time we have gone from being an agricultural economy to a manufacturing economy to an economy based largely on a diverse array of services. Technology and new products and services have radically changed the types of jobs that people hold. New occupations and professions have constantly emerged, with the U.S. labor market creating millions of new jobs each year to replace millions of others that have come to an end. In the new economy, Ward Cleaver might have left his company to start his own business, while June might have gone back to graduate school when Wally and the Beaver got older.

                                                Whatever its merits or historical accuracy, what is clear is that the Leave it to Beaver model of economic security is increasingly less viable in today’s world. Driven by technology, trade, and the emergence of new economic powers like China and India , the world’s economy is evolving at an increasingly rapid pace. Global economic dynamism creates enormous opportunities for entrepreneurship, trade, and investment, and there can be little doubt that globalization will be the engine of increased living standards for the foreseeable future, both in the United States and abroad. With historic patterns of production and trade changing, new competition, and the accelerated pace of innovation and technological progress, the traditional models of economic security must evolve to keep pace with global economic changes. ...

                                                Americans have heard calls for economic isolationism and for the institution of measures to block competition and change. However, retreating from the world in this way is at best a temporary solution and ultimately would be self-defeating... For the past century the United States has been the world economic leader, pioneering new industries and new technologies. We have the most productive workers, the deepest and most sophisticated capital markets, and the finest universities and research facilities in the world. Americans will not only be able to compete in a globalized economy, we will be able to play a leadership role...

                                                While we embrace the opportunities these changes bring us we must not ignore the consequences for the economic security of individual Americans. Risk and change cannot be eliminated, and Wally and the Beaver (and their children) may have very different lifetime employment patterns, with more changes in jobs, locations, and even in careers, than their parents did. However, these new forces notwithstanding, I believe that we can and should help American citizens achieve a level of security that will allow them to face the new economic world with confidence. We can do so by applying two broad principles.

                                                The first principle is that, in order to feel economically secure, American workers must be fully prepared to compete in a rapidly changing economic environment. We must assure that in this changing economy all Americans can obtain the requisite skills and knowledge needed to fill the jobs of the 21st century...

                                                The second principle is that American families should have more ownership opportunities so that they have more control over their own economic security. Ownership gives individuals a stake in their future and thus makes them more secure.

                                                President Bush has a broad and aggressive economic agenda that includes keeping taxes low, opening new markets to American products, stopping the spread of frivolous lawsuits, improving health care, and making energy more affordable and reliable. This agenda will improve our competitiveness and make families more secure. ...


                                                The first bulwark in the face of rapidly changing economies and job markets is the flexibility and adaptability of the labor force. This adaptability begins with the formal educational system, especially the public schools.

                                                In some respects the U.S. educational system has been successful in preparing our young people to enter the global marketplace. ... However, it is also true, unfortunately, that some public elementary and high schools do a poor job in preparing students...

                                                The No Child Left Behind Act, signed by President Bush shortly after he took office, has challenged our public schools to demonstrate quantifiable progress in teaching elementary and middle-school children. ...

                                                Strengthening our schools is important, but the pace of change in the modern economy means that job training and the acquisition of skills must be a lifetime endeavor. To participate fully in the modern economy, some people may need to acquire new skills in their forties, fifties, or beyond. How can we help make these opportunities available?

                                                Providing continuing training for the workforce should be a public-private partnership. On the public side, the government assists displaced workers by providing support for job training programs. ... President Bush recognizes the important role that vocational schools, technical colleges, and junior colleges can play in retraining the workforce. ...

                                                Although current job training programs are useful, we could improve outcomes for workers by updating the design of the current system. ...

                                                The President has also proposed Personal Reemployment Accounts to help unemployed Americans who face the greatest difficulty finding work. Under his proposal, these Americans would receive an account of up to $3,000 – above and beyond any traditional unemployment insurance benefits – to use in their job search. Individuals could then use this money to pay for job training assistance, child care, transportation, relocation, or other services that would help them find a new job. And if the worker finds a new job quickly, he or she would be able to keep the balance of the account as a reemployment bonus. ... The Department of Labor is currently administering PRAs on a small scale in a demonstration project in seven states. ...


                                                Let me turn to the second broad principle, that ownership gives Americans more control over their economic security in the face of a changing economy. For example, to achieve economic security, we should make it easier for people to keep their health insurance policies if they leave their job. ...

                                                One important step in this direction is the establishment of Health Savings Accounts, or HSAs... HSAs are tax-free saving accounts available to individuals when they purchase a high-deductible policy to cover major medical expenses. ...

                                                The President proposes to allow individuals to purchase insurance across state lines, creating a national, competitive marketplace for individual insurance. This measure would help to make individual health insurance more affordable.

                                                Economic change brings other economic challenges. For example, employees of some major corporations have recently found that they cannot count on the defined pension benefits that they were promised... However, firms should not be able to use their financial difficulties as an excuse to renege on the promises they have made to their employees.

                                                President Bush has proposed a comprehensive pension reform to ensure that companies’ promises will not be broken in the future. Central to the proposed reform is better, more market-sensitive accounting, which will ensure that corporations actually put aside the funds needed to make good on their pension promises. ...

                                                President Bush has a variety of proposals to increase the other pillars of our retirement system – Social Security and personal saving. His proposal to help close Social Security’s funding shortfall will help ensure retirement security for future generations and his proposal for voluntary personal retirement accounts in Social Security will increase ownership. ...

                                                The President’s proposal for Retirement Savings Accounts will reduce the maze of tax-advantaged retirement accounts and his proposal for Lifetime Savings Accounts will help workers create a rainy-day fund that they can use for any purpose...

                                                Promoting individual ownership is the key to providing portability and security. ...


                                                I began by pointing out that the traditional model of economic security, based on lifetime employment, has become increasingly less viable in the dynamic economy in which we live today. This change does not mean that we must abandon the idea of economic security, however. Through good policies we can help Americans feel secure economically even in the face of rapid economic change. Achieving this goal will not always be straightforward, but doing so has two major benefits. First, and very importantly, the economic wellbeing of American families depends on their conviction that they will retain some control and security even as they must adapt to changing conditions in the global marketplace. Second, the prosperity of the nation requires that we engage with the global economy, not retreat from it. The more secure individual Americans feel, the more willing they will be to support such engagement.

                                                Thank you.

                                                Letters commenting on this piece or others may be submitted at

                                                The Berkeley Electronic Press - - Economists’ Voice January, 2006

                                                  Posted by Mark Thoma on Friday, February 24, 2006 at 01:12 AM in Economics, Monetary Policy, Social Security

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                                                  Paul Krugman: Osama, Saddam and the Ports

                                                  Paul Krugman explains how the the administration is a victim of its own tangled web of deception:

                                                  Osama, Saddam and the Ports, by Paul Krugman, Commentary, NY Times: The storm of protest over the planned takeover of some U.S. port operations by Dubai Ports World doesn't make sense viewed in isolation. The Bush administration clearly made no serious effort to ensure that the deal didn't endanger national security. But that's nothing new — the administration has spent the past four and a half years refusing to do anything serious about protecting the nation's ports.

                                                  So why did this latest case of sloppiness and indifference finally catch the public's attention? Because this time the administration has become a victim of its own campaign of fearmongering and insinuation. Let's go back to the beginning. At 2:40 p.m. on Sept. 11, 2001, Donald Rumsfeld gave military commanders their marching orders. "Judge whether good enough hit S. H. [Saddam Hussein] @ same time — not only UBL [Osama bin Laden]," read an aide's handwritten notes about his instructions. ... "Hard to get a good case," the notes acknowledge. Nonetheless, they say: "Sweep it all up. Things related and not."

                                                  So it literally began on Day 1. When terrorists attacked the United States, the Bush administration immediately looked for ways it could exploit the atrocity to pursue ... a war with Iraq. But to exploit the atrocity, President Bush had to do two things. First, he had to create a climate of fear: Al Qaeda, a real but limited threat, metamorphosed into a vast, imaginary axis of evil threatening America. Second, he had to blur the distinctions between nasty people who actually attacked us and nasty people who didn't. The administration successfully linked Iraq and 9/11 in public perceptions through a campaign of constant insinuation and occasional outright lies. In the process, ... all Arabs were lumped together in the camp of evildoers. Osama, Saddam — what's the difference?

                                                  Now comes the ports deal. ... after all those declarations that we're engaged in a global war on terrorism, after all the terror alerts ... the administration can't suddenly change its theme song to "Don't Worry, Be Happy." ... This isn't just a Middle Eastern company; it's ... part of the authoritarian United Arab Emirates, one of only three countries that recognized the Taliban as the legitimate ruler of Afghanistan. ... [A]fter years of systematically suggesting that Arabs who didn't attack us are the same as Arabs who did, the administration can't suddenly turn around and say, "But these are good Arabs."

                                                  Finally, the ports affair plays ... into the public's awareness ... that Mr. Bush ... and his family have close personal and financial ties to Middle Eastern rulers. ... Mr. Bush shouldn't really be losing his credibility as a terrorism fighter over the ports deal, which ... may turn out to be O.K. Instead, Mr. Bush should have lost his credibility long ago over his diversion of U.S. resources away from the pursuit of Al Qaeda and into an unnecessary war in Iraq, his bungling of that war, and his adoption of a wrongful imprisonment and torture policy that has blackened America's reputation.

                                                  But there is, nonetheless, a kind of rough justice in Mr. Bush's current predicament. After 9/11, the American people granted him a degree of trust rarely, if ever, bestowed on our leaders. He abused that trust, and now he is facing a storm of skepticism about his actions — a storm that sweeps up everything, things related and not.

                                                  Previous (2/20) column: Paul Krugman: The Mensch Gap Next (2/27) column: Paul Krugman: Graduates Versus Oligarchs

                                                    Posted by Mark Thoma on Friday, February 24, 2006 at 12:23 AM in Economics, Iraq, Politics

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                                                    The New Socialist Countryside

                                                    Beijing attempts to quiet unrest in rural areas through income redistribution policies:

                                                    China launches ‘New Deal’ for farmers, by Richard McGregor, Financial Times: Beijing has launched an ambitious “New Deal” for China’s farmers, aimed at lifting stagnant rural incomes through a combination of crop subsidies, tax cuts and infrastructure spending in inland areas far from the thriving coast. The plan, called the “New Socialist Countryside”, is the centrepiece of the commitment by president Hu Jintao and premier Wen Jiabao to reduce gaping income inequalities split largely along an urban-rural divide.

                                                    The government also hopes to use the plan to rein in the widespread and often illegal confiscation of rural land for development... China has a thriving private property market in cities but does not permit rural residents to buy and sell farming plots, even though many see it as an essential step to aggregating rural land to make it more productive.

                                                    Mr Chen said this issue, a highly-sensitive and much-debated one in policymaking circles, was “still in the process of being considered.” One major obstacle to reform of rural land is the government’s fear that many farmers would immediately sell their plots and become part of a huge landless peasant class. ...

                                                    Not everyone believes that would be bad:

                                                    China’s drive to close wealth gap leaves questions, by Richard McGregor, Financial Times: ...China’s aim is to keep as much land in production [as possible] to ensure basic food sufficiency. Liu Fuyuan, the head of the think-tank attached to the planning ministry in Beijing, thinks this is misguided, unless it is also combined with incentives to get more rural workers off the land. “We should make farmers move into the cities,” he says. “That is the only way to get economies of scale in the countryside.”

                                                      Posted by Mark Thoma on Friday, February 24, 2006 at 12:22 AM in China, Economics, Income Distribution

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                                                      Fed Speeches: Santomero, Fisher, and Ferguson

                                                      There were several Federal Reserve speeches today. Philadelphia Fed president Santomero in his last speech before stepping down as president discusses The U.S. Economy: How Fast Can We Grow?. After the speech he indicated that the target rate is near the neutral range and that the Fed must begin to take seriously lags in the effects of policy at its next meeting:

                                                      "Actions take time to work through the system ... We have to be cautious. As we go about raising rates, it will take some time to be fully felt in the system," Santomero said ... "That is part of the logic that has to go into the next decision" on interest rates, he said.

                                                      Dallas Fed president Fisher also spoke today on Trade Deficits and the Health of the U.S. Economy. Finally, Roger Ferguson gave a speech on Globalization, Insurers, and Regulators and expresses worry that puzzlingly low long-term rates might suddenly increase.

                                                        Posted by Mark Thoma on Friday, February 24, 2006 at 12:12 AM in Economics, Fed Speeches, Monetary Policy

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                                                        February 23, 2006

                                                        Owning Less of the Ownership Society: Fed Verifies Fall In Household Income and Wealth Accumulation in Recent Years

                                                        I'm sure there will be lots written on this report from the Fed on changes in consumer finances since 2001, so here's some highlights to get things started from a WSJ report along with figures from the Fed study. The report shows that between 2001 and 2004, real household income is down, household wealth growth slowed sharply and fell for some groups, and household debt burdens are up. Not exactly the economic miracle from tax cuts and other administration policy we have been hearing about:

                                                        Fed Study Finds Drop In Household Incomes, WSJ: Average U.S. household incomes fell in the 2001-04 period after adjusting for inflation, and growth in household wealth slowed sharply from the previous three years, according to Federal Reserve data released Thursday. The Fed's most recent Survey of Consumer Finances shows real average household income shrank in the latest three-year period covered after

                                                        Average household net worth still rose 6.3% on an inflation-adjusted basis, "however, the measured gains in wealth in the 2001-04 period pale in comparison with the much larger increase of the preceding three years," according to a summary of the Fed survey results. In the 1998-2001 period, net worth surged 28.7%, and in the three years before that it grew 25.6%, the survey data show.

                                                        Household debt as a percentage of assets increased to 15.0% in 2004 from 12.1% three years earlier, with residential real estate's share of total debt holding steady at about three-fourths. "Even with interest rates lower in 2004 than in 2001, the (survey) data show a moderate increase in measures of debt burden," the Fed said.

                                                        The Fed also shows some signs of increased wealth inequality. The data show median wealth dropped for families with the bottom 40% of incomes, and rose for higher-income families. But on an average basis, net worth either held steady or increased for all income groups.

                                                        With interest rates generally lower and stock markets trending down in the latest three-year period, the overall share of financial assets in household portfolios declined. Families that held stocks directly or through managed funds fell to about 49% in 2004 from 52% three years earlier.

                                                        An increase in nonfinancial assets, primarily real estate, helped to balance the decline. Nonfinancial assets grew to 64.3% of total assets in 2004 from 58.0% three years earlier. Homeownership was up 1.4 percentage points to 69.1% in the latest three-year period, while home values rose dramatically in many areas, the survey shows.

                                                        See also Tom Bozzo at Marginal Utility, Washington Post, NY Times.

                                                          Posted by Mark Thoma on Thursday, February 23, 2006 at 09:14 AM in Economics, Income Distribution

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                                                          Too Much Time on Your Hands

                                                          Did you know you have considerably more leisure time than people had a few decades ago? Plenty of time to spend "Sitting outside ... basking in the sun ... drinking iced lattes":

                                                          Economic Scene The Work You Do When You're Not at Work, by Virginia Postrel, Economic Scene, NY Times: What would you be doing if you were not at work? Scrubbing the bathroom or watching the Olympics? Fixing the car or playing golf? Darning socks or doing crossword puzzles? The easiest way to measure leisure is to take survey data on how many hours a week people spend at work and subtract. Since 1965, the number of hours the average American works for pay has not changed much. By this simple measure, then, leisure has also stayed the same.

                                                          But are we really working as much as ever? "All time away from work is not equal," Erik Hurst, an economist at the Graduate School of Business at the University of Chicago, said... Some time off is actually just more work. To put it in economic terms, we spend some time off the job in consumption (watching TV, hanging out with our friends, reading for pleasure) and some in production (cooking dinner, cleaning the house, doing household repairs). Some activities, like sleeping and eating, fall somewhere in between, while others, including child care and gardening, combine pleasure and production.

                                                          The difference is not just that we enjoy some activities and dislike others. It is that we could, in theory, pay someone else to do the production for us. A cook or a restaurant can make dinner, but nobody else can play golf or watch TV for you. That distinction can make a big difference in predicting how ... people will respond to higher wages or lower taxes. Do they have to give up recreation to earn more money? Or are they trading one kind of work for another?

                                                          If they spend their off-hours cooking, Professor Hurst suggested, "when they get richer, they can buy a microwave or order takeout." That seems to be what has happened over the last few decades. Americans are not, in fact, working as much as they used to. They are just getting paid for more of the work they do...

                                                          Professor Hurst and Mark A. Aguiar, an economist at the Federal Reserve Bank of Boston [said] "Leisure time ... has increased significantly between 1965 and 2003," they write ... The increase in leisure is particularly striking for women. During this period, they entered the paid labor force in large numbers, yet gained just as much leisure as men. The difference is in where the gains came from.

                                                          Ninety-seven percent of men ages 21 to 65 had jobs in 1965, compared with 87 percent in 2003. That drop accounts for about 60 percent of men's increase in leisure time. By contrast, Professor Hurst said ..., "for the women, the entire gain in their leisure time is coming from declines in nonmarket work. The time women spend on cooking and cleaning and laundry and other household maintenance has been dramatically declining over the last 40 years." ...

                                                          More women working outside the home created more demand for such conveniences, which, in turn, enabled more women to work outside the home. By contrast, said Professor Hurst, "A woman who was working full time in 1965 was also working full time at home, almost — 40 hours in the market, 20 or 25 hours at home."...

                                                          In new research, the economists are looking at how much leisure time people of the same age have had in different periods. This is one early finding: Middle-aged people have a lot more free time than they used to. "The 40-year-olds in 1965 worked a lot, lot more than the 40-year-olds in 2003," said Professor Hurst.

                                                          And, of course, one of the biggest increases in leisure time is deliberately missing from the working paper, since it omits retirees. Longer life spans mean more retirement years. "It used to be that you worked till 65, and died at 66. Now you work till 65 and die at 80," said Professor Hurst. "The net increase in leisure is rather large."

                                                            Posted by Mark Thoma on Thursday, February 23, 2006 at 12:59 AM in Economics

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                                                            Perpetual Economic Motion from the Tax Cut Machine?

                                                            Bloomberg's John M. Berry wonders when the administration will adopt a reality based view of tax policy and the budget deficit:

                                                            Bush, Congress Make a Farce of the Debt Ceiling, by John M. Berry, Bloomberg: The scary, totally unfunny debt ceiling farce is playing once again in Washington. With the federal government debt about to hit the $8.18 trillion legal limit, the Treasury Department last week suspended sales of special securities bought by state and local governments so that regular auctions of Treasury bills and notes could continue. More such steps undoubtedly will have to be taken in coming weeks until Congress screws up the courage to increase the debt limit. At some point next month, Treasury will run out of such stop-gap measures and regular securities auctions may have to be postponed. ...

                                                            The problem, of course, is that voting to increase the debt ceiling is approving profligate behavior, even though they have little choice because of earlier tax and spending decisions. The reality is that taxes and spending are badly out of whack, and hardly anyone -- certainly neither President George W. Bush nor Vice President Richard Cheney -- wants to admit it. ... Instead, Bush continues to push Congress to extend earlier tax cuts that lowered the maximum personal income tax rate on dividends and long-term capital gains to 15 percent. Those cuts are set to expire at year-end.

                                                            Meanwhile, Cheney ... called for extending not just that pair of rate cuts, but all of the Bush-era cuts that under current law would expire in 2010... " relief is set to expire in the next several years. So if we do nothing, Americans will face a massive tax increase. That would be counterproductive, it would be irresponsible, it would be bad for the economy. Congress needs to make the Bush tax cuts permanent,'' he said.

                                                            Irresponsible? Bad for the economy? Not nearly as irresponsible as Cheney's claim in the speech that "despite forecasts to the contrary, the tax cuts have translated into higher federal revenues.'' ... In fact, total federal receipts in fiscal year 2005 were higher than in each of the prior two years. On the other hand, receipts as a share of gross domestic product were only 17.5 percent last year. Except for fiscal 2003 and 2004, that was the lowest share at any time since 1992. And since most of the cuts involved personal income taxes, the more telling comparison is in those receipts as a share of GDP. In fiscal 2005, individual income tax receipts were equal to just 7.5 percent of GDP. Again, except for the prior two years, that was the lowest share in 29 years. ...

                                                            Nevertheless, the administration is greatly enamored with the notion that tax cuts can more or less pay for themselves. For instance, the fiscal 2007 Bush budget would create a new Dynamic Analysis Division within the Treasury Department, at a cost of more than a half-million dollars, to analyze major tax proposals along those lines. Analyze? Why waste the money? ...

                                                            What if you don't want to increase growth because the economy might be nearing full employment? That's more than a passing concern at the Federal Reserve right now ... If tax cuts were a good way to stimulate the economy after the 2001 recession hit, might raising taxes be a good way to help restrain it when needed? Certainly the tight fiscal policies and budget surpluses of the late 1990s helped the Fed keep interest rates lower than they otherwise would have been.

                                                            And then there is the fundamental issue of balancing revenues and spending. At the moment, investors and analysts seem largely unperturbed by large continuing deficits, presumably because other forces are helping keep interest rates low. That's not likely to be the case indefinitely, and Federal Reserve Chairman Ben S. Bernanke gave this warning in his congressional testimony on Feb. 15.

                                                            "I am concerned about the prospective path of deficits,'' Bernanke said. "I believe that that does reduce national savings and therefore imperils, to some extent, the future prosperity of our country and increases the burden that'll be faced by our children and grandchildren.'' Bush and Cheney should keep it in mind.

                                                              Posted by Mark Thoma on Thursday, February 23, 2006 at 12:38 AM in Budget Deficit, Economics, Taxes

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                                                              February 22, 2006

                                                              Into Africa

                                                              China is making both economic and political gains in Africa:

                                                              China winning resources and loyalties of Africa, by David White, with Andrew England, Tony Hawkins, Dino Mahtani, John Reed and Andrew Yeh, Financial Times: Some see it as a late blossoming relationship, others as a new kind of colonialism. Either way, China is resolutely and rapidly extending its presence and influence across the African continent as its companies move into terrain where western businesses hesitate to tread. The Chinese advance – government-backed, led by state-run corporations and propelled by the drive to secure oil supplies – has in the span of a few years changed the pattern of Africa’s investment and trade. ... China is establishing a position as Africa’s top commercial partner behind the US and France, overtaking Britain.

                                                              For China, Africa offers an extra dimension: a continent three times its own size, less populated than itself and stocked with many of the raw materials it needs. Crude oil from Angola, platinum from Zimbabwe, copper from Zambia, tropical timber from Congo-Brazzaville, iron ore from South Africa: all are on China’s shopping list. In return, the Chinese offer advantages to African governments. They bring first-hand experience of fast development, are attuned to conditions in poor countries and are unconcerned by scruples over governance standards or human rights.

                                                              In a different way to the ideological competition that took place in Africa during the cold war, China is emerging strongly as an alternative option for governments more used to dealing with former European colonial powers and the US. At one level China is involved in a straightforward resources grab... But it is also engaged in a mix of influence-building and opportunism. ... Trade between China and Africa has almost quadrupled since the start of this decade, jumping 36 per cent last year ... About half of China’s exports are machinery, electronic and high- technology products. Tens of thousands of Chinese have moved to Africa... Chinese tourism to Africa has boomed... According to the Beijing government, more than 600 Chinese-funded companies have been set up in Africa in the last 10 years. ...

                                                              In war-ruined Angola, the Chinese have leapt into one of the world’s most inhospitable investment environments, offering a $2bn oil-backed credit at a time when ... [a]n agreement between Angola and the International Monetary Fund has been held up ... because of IMF concerns about how the government manages its oil money. ... “The Chinese are offering the loan as an alternative to working with the IMF,” says Princeton Lyman, director of Africa policy studies at the Council on Foreign Relations in Washington.

                                                              Up to now, the African view of China’s fast-growing involvement has been overwhelmingly positive. China is widely regarded as a model of modernisation, more responsive to African needs than western partners, able to build dams, roads and bridges more quickly and cheaply and providing consumer products better suited to African pockets. ...

                                                              But criticism is growing. Trades­people ... complain about a Chinese invasion. ... Companies from China are censured for preferring Chinese labour or, when they employ locals, providing poor conditions. China’s cheap consumer goods displace local production. Garment factories have been shutting across Africa... There is a clamour for protection. When South Africa’s Cosatu labour federation staged an anniversary celebration in December, participants peeled off their red union T-shirts in disgust when word went round that they were Chinese-made. ... Chris Alden, an expert at the London School of Economics, says of the relationship: “African actors are beginning to see this as a mixed blessing.” ...

                                                              A senior Nigerian foreign affairs official says: “...China is catching up with the level of engagement that western governments have . . . Being [is] a developing country, they understand us better. They are also prepared to put more on the table. For instance, the western world is never prepared to transfer technology – but the Chinese do. It is our view that, while China’s technology may not be as sophisticated as some western governments, it is better to have Chinese technology than none at all.” ... Zimbabwe, according to president Robert Mugabe, is “returning to the days when our greatest friends were the Chinese”. On independence day last year he told supporters: “We look again to the East, where the sun rises, and no longer to the West, where it sets.” ...

                                                                Posted by Mark Thoma on Wednesday, February 22, 2006 at 07:28 PM in China, Economics, International Trade, Politics

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                                                                Is Monetary Policy Already Restrictive?

                                                                Joachim Fels and Manoj Pradhan of Morgan Stanley warn that, according to their estimates of the natural rate of interest, current monetary policy is already slightly restrictive. Thus, any further increases in the target interest rate run the danger of pushing policy into an overly restrictive position:

                                                                Do not overlook natural interest rates, by Joachim Fels and Manoj Pradhan, Commentary, Financial Times: ...[T]he “natural” rate of interest, devised more than a century ago by Knut Wicksell, the Swedish economist, has enjoyed a renaissance in academic and central bank circles in recent years. Put simply, the natural rate of interest is the interest rate that keeps output at its potential and inflation stable, once any shocks to the economy have played out. ... His work foreshadowed and influenced the Austrian monetary business cycle theorists ..., most notably Ludwig von Mises and Friedrich von Hayek.

                                                                Following the Wicksellian approach, one can thus judge the stance of, say, the Federal Reserve’s monetary policy by comparing the actual level of the (real) Fed funds rate with the natural rate. If the actual interest rate is above the natural rate, Fed policy would be restrictive... Conversely, if the Fed keeps interest rates below the natural rate, the economy and inflation would be expected to accelerate. Yet, like another popular concept in economics, the output gap, the natural rate cannot be observed, it has to estimated.

                                                                Importantly, any estimate of the natural rate will have to take into account that it is a moving target. It may vary over time in response to, say, changes in technology or private households’ time preference. ... Using an approach first introduced by Thomas Laubach and John Williams, two Fed researchers, we combined a simple model of the US economy and a less simple statistical filtering technique to produce an estimate of the time-varying natural interest rate for the US. Here is the result of this exercise: the natural rate declined from a peak of nearly 4 per cent in the mid-1960s to a trough of slightly above 2 per cent in the first half of the 1990s, reflecting the long-run decline in US productivity growth over that period. Since then it has hovered between 2 and 2.5 per cent, reaching lows in the early 1990s and again in the early part of this decade when the equity bubble burst.

                                                                Our latest estimate puts the natural rate at 2.25 per cent. ... Whether monetary policy is expansionary, neutral or restrictive can be judged by the gap between the actual level of the real Fed funds rate and the natural rate. Between 2001 and 2005, this gap was strongly negative, indicating a very expansionary policy stance. ... However, the Greenspan-Fed’s 14 rate hikes have removed policy accommodation, with the real Fed funds rate rising to – and, more recently, even beyond – our measure of the natural rate of interest.

                                                                Judged by this yardstick, Ben Bernanke, the new Fed chairman, has inherited a monetary policy stance which is already slightly restrictive. Further increases in the Fed funds rate beyond the current 4.5 per cent, which he seemed to endorse in his testimony last week, would push policy further into restrictive territory.

                                                                Of course, any such estimates of the natural rate need to be taken with a large pinch of salt as the underlying model is fairly simple and the standard errors of such models are fairly large. Moreover, a restrictive monetary policy stance may be exactly what the doctor ordered for an economy that threatens to overheat – a risk that Mr Bernanke emphasised in his testimony. However, with looming downside risks to the US housing market, the Fed may well be forced to reverse course later this year. This would set the stage for a big rally in bonds and a re-steepening of the currently inverted yield curve.

                                                                I would quibble with the particulars, e.g. the trend filtering technique and other things, and the qualifications in the last paragraph are needed, but this is a good question to ask and a reasonable way to answer it. It makes me think again about whether further tightening is warranted, particularly given the lags between the time changes in the target rate are implemented and the subsequent impact on the economy.

                                                                  Posted by Mark Thoma on Wednesday, February 22, 2006 at 04:18 PM in Economics, Monetary Policy

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                                                                  Ferguson Resigns from Board of Governors

                                                                  This is a surprise:

                                                                  For immediate release: Roger W. Ferguson, Jr., submitted his resignation Wednesday as Vice Chairman and as a member of the Board of Governors of the Federal Reserve System, effective April 28, 2006. ... He will not attend the March 27-28 meeting of the Federal Open Market Committee. ... Ferguson, 54, was first appointed to the Board by President Clinton to fill an unexpired term ending January 31, 2000. He was then appointed by President Bush to a full term that expires on January 31, 2014. ...

                                                                  Ferguson is the only Democrat on the Board and his departure will give president Bush the opportunity to appoint all seven Board members. That is not how it was intended to work. One possible hint about the resignation comes from Bloomberg:

                                                                  The vice chairman had been publicly at odds with Bernanke on announcing a numerical inflation target. Bernanke described such a goal at his Nov. 15 confirmation hearing as a "possible step toward greater transparency.''

                                                                  Ferguson said in October 2004 that an inflation goal may limit the Fed's flexibility to respond to economic shocks, and two months ago said any progress toward such a change ``would be very slow.'' Edward Gramlich, who resigned as a Fed governor last year, has said their disagreement "never got acrimonious.''

                                                                  But I'm hesitant to jump to any conclusions on the reasons for the resignation until we know more. Here's the letter:

                                                                    Posted by Mark Thoma on Wednesday, February 22, 2006 at 11:55 AM in Economics, Monetary Policy

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                                                                    Consumer Prices Increase, Real Wages Fall

                                                                    Further increases in the target federal funds rate are increasingly data dependent, but there's nothing in this inflation report to indicate the Fed will pause at its next meeting. Inflation is up 4% over a year ago largely due to higher enrgy prices. This will keep energy cost pass-through concerns heightened. However, core inflation is better behaved increasing 2.1% which is down from a 2.2% year over year increase last month. Also, though it isn't grabbing the headlines, average weekly earnings of workers adjusted for inflation fell once again:

                                                                    Consumer Prices Jumped 0.7% As Food, Energy Costs Climbed, WSJ: Consumer prices surged last month on higher energy and food costs but underlying price pressures remained largely contained. The ... consumer price index rose by a seasonally adjusted 0.7% in January after decreasing 0.1% in December. The ... core index, which excludes food and energy, climbed 0.2%, after a 0.1% rise the previous month. ...

                                                                    Consumer prices stood 4% higher than a year ago. Core prices rose a more modest 2.1% in the 12 months ending January. Some economists say that quirks in the calculation of the CPI may be causing inflation to be overstated during the winter and understated in the rest of the year. The quirk appears only in the total index, not the core index... Though core inflation remains at what is thought to be the high end of the Fed's comfort zone, Wednesday's data suggest price pressures haven't yet taken firm hold throughout the economy, which may ease concerns of some Federal Reserve policy makers. ...

                                                                    In a separate report, the Labor Department reported that worker wages lost traction against the increase in prices. The average weekly earnings of U.S. workers, adjusted for inflation, fell 0.2% in January...

                                                                      Posted by Mark Thoma on Wednesday, February 22, 2006 at 07:22 AM in Economics, Monetary Policy

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                                                                      China's Monetary Report: Revaluation Will Be Gradual

                                                                      China's central bank issued a 2005 fourth quarter monetary report (the report is here, but it's not yet available in English). The report makes clear that China isn't changing its position on managing its exchange rate, at least not in its public pronouncements. They are working on building a system that will support more flexibility, but the yuan will float when market conditions within China dictate it, and not before. Will saying they are committed to improving the exchange rate system be enough? It's now Washington's move:

                                                                      China rebuffs US call for faster revaluation, by Richard McGregor, Financial Times: Beijing has rebuffed renewed US demands for a faster acceleration of its currency, saying it would maintain its policy of “gradualism” in building a flexible system suited to the development of its own economy. A statement published on the website of the central bank, the People’s Bank of China, part of its quarterly survey of the economy, said Beijing would maintain a “basically stable” renminbi.

                                                                      This phrase, often used by the government, is code for Beijing’s priority of bedding down reforms to its currency system at a pace that will allow traders and enterprises to adjust to a new regime before allowing a freer float. The government wants to avoid surprises for enterprises that have little experience in managing currency risk and build expertise in foreign exchange markets prone to speculation. “We will perfect the managed floating exchange rate system based on China’s needs for economic and financial development and stability,” the bank said in its statement. ...

                                                                      And, from The Standard in Hong Kong, more on the monetary report:

                                                                      Yuan to be kept stable in growth slowdown, by Greg Yang, The Standard: Beijing will keep the exchange rate of the country's currency at a stable level this year, while economic growth is expected to slow, the People's Bank of China said. The yuan will be kept at a reasonable and balanced level this year, with market forces playing a fundamental role in determining the exchange rate, the central bank said in its 2005 fourth- quarter monetary report Tuesday. ... "We'll optimize the managed-floating exchange rate system and widen the channels for capitals to flow out of the country," the bank said...

                                                                      The economy's excessive reliance on export and investment has become a major problem for China's economic development, the bank said. Fixed-asset investment and exports contributed 48.8 percent and 17.9 percent, respectively, of GDP growth last year... China ... has set a GDP growth target of 8 percent for this year, down from last year's 9.9 percent, the bank said. "The central bank is always conservative on releasing the full-year GDP target at the beginning of every year," said Standard Chartered economist Tai Hui in Hong Kong. "The final result shall be higher." ...

                                                                      "The central bank obviously sees inflation to go up, not down, despite concerns about deflation risks by some economists and officials," said Citigroup economist Huang Yiping in Hong Kong. "The expected pickup of inflation would further strengthen the case for more tightening." China has tightened lending to some overheated sectors such as steel...

                                                                      Monetary policy within the U.S. has one objective, domestic well-being. The Fed does not consider, except to the extent it feeds back to the U.S., the impact of its monetary policy decisions on other countries. That is not within its mandate. The Chinese central bank is no different. It is not its job to worry about economic conditions within the U.S., its job is to promote domestic stability and the bank intends to do that by stabilizing the exchange rate irrespective of our protestations. I doubt the Fed would follow the wishes of Chinese politicians and policymakers if the situation were reversed.

                                                                      So what is our solution? We have our purchasing power to play against China's fear of political unrest from economic instability. We can threaten protectionist measures and that is fine so long as the threat works and we do not have to actually put the tariffs or quotas in place. But what if our bluff is called? A trade war is not in either country's long-run interests. A more difficult but better solution is to convince the Chinese that it is in their best economic interest to allow the yuan to float sooner rather than later, an approach that requires effective persuasion rather than effective threats. But patience does have its limits.

                                                                        Posted by Mark Thoma on Wednesday, February 22, 2006 at 01:35 AM in China, Economics, Monetary Policy

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                                                                        Foreclosure Rates Rise for Minority Homeowners

                                                                        Not a good sign:

                                                                        For Minorities, Signs of Trouble in Foreclosures By Vikas Bajaj and Ron Nixon, NY Times: ...[I]in the last several years, neighborhoods with large poor and minority populations in places like Cleveland, Chicago, Philadelphia and Atlanta have experienced a sharp rise in foreclosures, in some cases more than a doubling, according to an analysis of court filings and other housing data by The New York Times and academic researchers. The black home ownership rate even dipped slightly last year, according to the Census Bureau.

                                                                        The increase in foreclosures could be the first of a wave of financial distress for many minority homeowners ... because they are twice as likely as whites to have taken out expensive subprime mortgages, most of which will jump to higher interest rates in the next two years... The Mortgage Bankers Association of America plays down the severity of foreclosures, noting that most new minority homeowners are doing well and that the Midwest is facing unique economic challenges. The trade group estimates that fewer than 1 percent of all loans were in foreclosure in the three months that ended last September...

                                                                        But broad national statistics can obscure hard local realities. In Cuyahoga County, which includes Cleveland, ... court filings by lenders seeking to foreclose on delinquent borrowers totaled more than 11,000 in 2005, more than triple the number in 1995. A similar pattern can be seen in Chicago... Loan data that mortgage lenders must disclose show that minorities are far more likely to receive subprime loans than whites. ... The disparities persist even when income is taken into account. ...

                                                                          Posted by Mark Thoma on Wednesday, February 22, 2006 at 01:18 AM in Economics, Housing

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                                                                          The McWages of Nations

                                                                          Orley Ashenfelter looks at the going rate for flipping burgers around the world:

                                                                          Ashenfelter devises inventive real-world tests to illuminate labor economics, by Eric Quiñones, Princeton Weekly Bulletin: To address the current debate about whether China’s and India’s growing economies will soon rival that of the United States, Princeton economist Orley Ashenfelter poses a simple question: What is the going rate for flipping burgers?

                                                                          Ashenfelter is conducting a study of McDonald’s employees’ wages in many countries to illustrate the relative strength of their economies, and early results indicate that developing nations still have a long climb. While the average hourly “McWage” is around $6 in the United States and other western nations, the same job in China, India and other developing countries pays less than 50 cents.

                                                                          “A Big Mac is the same everywhere. The job is the same,” Ashenfelter said. “What makes a country wealthy is the wage rate that the market can guarantee for someone who wants to work. To most people in the developed world, a $6 job would seem to not be much of an accomplishment — in fact, it is a huge accomplishment that most of the world cannot yet even aspire to.” ...

                                                                            Posted by Mark Thoma on Wednesday, February 22, 2006 at 12:18 AM in Economics, International Trade

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                                                                            February 21, 2006

                                                                            Martin Wolf on Modernizing the IMF

                                                                            Martin Wolf discusses how the IMF can avoid falling into obscurity and irrelevance:

                                                                            World needs independent Fund, by Martin Wolf, Financial Times: If the International Monetary Fund did not exist, we would not re-invent it. This is not because it is useless, but because today’s world lacks the courage and vision to create powerful multilateral institutions. That fact alone makes those we have inherited more valuable. Even so, they must be kept up-to-date. Otherwise, they risk suffering a lengthy senescence. This danger now threatens the Fund.

                                                                            Three questions need to be addressed. First, how has the world changed since the 1944 conference at Bretton Woods... where the Fund was created? Second, what (if anything) is its contemporary role? Third, what changes are needed if it is to play it? Mervyn King, governor of the Bank of England, addressed just these questions in a thought-provoking speech in New Delhi, on Monday.

                                                                            If the answer to the second question were “none”, we would need to go no further. It is not. An institution concerned with international monetary stability continues to have a role. But the world has changed in fundamental respects. The system of quasi-fixed exchange rates ... vanished in the 1970s. Controls on the capital account have disappeared in the high-income countries and are on the way out ... in many emerging countries. ... Finally, use of IMF resources has fallen to minimal levels, though this could change again...

                                                                            What are the public goods that such an institution might provide? They fall into six categories: information; analysis; advice to individual governments; advice on co-ordination of policies; management of defaults; and emergency lending. Being specifically concerned with international monetary stability, Mr King focuses on provision of the information, analysis and advice needed for international co-operation.

                                                                            Specifically, he recommends the execution of three tasks: first, the IMF “should provide and share information about the balance sheets of all major countries, their composition and size, and the links between them”; second, it should “encourage countries to abide by their commitments to each other by promoting greater transparency about national policies”; and, third, it should provide “a forum for national authorities to discuss risks to the world economy”. ...

                                                                            Mr King notes, however, that the Fund’s only asset is its power of analysis, persuasion and “ruthless truth-telling”, in the words of John Maynard Keynes. That phrase, he says, does not “conjure up many memories of any of the many international meetings I have attended”. If this is to change, the IMF needs an “independent, respected and clear voice”.

                                                                            Do Mr King’s three tasks exhaust the Fund’s role? The answer is “no”. First, the Fund continues to have a role as an adviser on fiscal, monetary and financial stability to countries that lack systemic significance. The view is often advanced that such advice only works when accompanied with loans. But this suggests that recipients do not value the advice. Second, the abandonment of an active role in dealing with insolvency and illiquidity would be a pity. ...

                                                                            If the IMF is to deliver, however, it must become credibly independent. ... Let us be brutal: the IMF is on the brink not just of “obscurity”, as Mr King suggests, but of irrelevance. ... Even if its role as lender of last resort is falling into abeyance, it can still guide national decision-making, particularly in strengthening global stability. If it is to do that, however, it must become a tough-minded and independent organisation, willing and able to criticise powerful governments both publicly and forcefully. Such an IMF is the last thing its powerful shareholders now desire. Yet it is also in their own long-run interests. They have increasingly recognised this logic in the creation of independent central banking. They should recognise the same logic in the creation of truly independent global surveillance.

                                                                              Posted by Mark Thoma on Tuesday, February 21, 2006 at 05:34 PM in Economics, International Finance

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                                                                              You're in Good Hands with Homeland Security?

                                                                              I am not an expert on port security. I have to place my faith in others. President Bush says, under the threat of his first veto, that we should allow a state-owned company from Dubai to take control of port terminals in six eastern cities. The Homeland Security Administration has checked this out thoroughly I am told, so there's no need to worry. Still, I wonder:

                                                                              'Security' Without Sense, by Scott Wallace, Sunday Outlook, Washington Post: It has been almost two months since I resigned from the Department of Homeland Security's Transportation Security Administration (TSA). I had served as a security screener at Dulles International Airport for more than three years. Even now, I can scarcely believe some of the absurdities I experienced as a screener. ... the TSA's policies regarding what is acceptable to carry onto an airplane mock security rather than enhance it. ...

                                                                              Visitors to Dulles see posters at the checkpoints with the word "WARNING" in large red letters, followed by the information that "passengers are advised that the secretary of the Department of Homeland Security has determined that Bandara Ngurah Rai International Airport, Denpasar, Bali, Indonesia, and Port au Prince International Airport, Haiti, do not maintain and administer effective aviation security measures." That's good to know, but what about Washington Dulles International Airport?

                                                                              At Dulles, an entry point to the "sterile" area, the part of the airport supposedly restricted to those who have gone through a security check, is known as the SIDA door (SIDA stands for Security Identification Display Area). Workers with airport badges can pass through this door with knapsacks, book bags, you name it, without going through the TSA checkpoints upstairs. But pilots, flight attendants and TSA employees -- all of whom have passed background checks before being hired -- are not permitted to access the sterile area through the SIDA door. They must go through the same TSA checkpoints used by passengers.

                                                                              The Department of Homeland Security might want to address an issue such as the SIDA door at Dulles before warning travelers about Bali and Port au Prince. At the TSA, truth indeed is stranger than fiction.

                                                                                Posted by Mark Thoma on Tuesday, February 21, 2006 at 04:46 PM in Politics, Terrorism

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                                                                                Krugman's Money Talks: No Menschen in Washington

                                                                                Paul Krugman responds to comments on his latest column, "The Mensch Gap":

                                                                                Krugman's Money Talks: No Menschen in Washington, Commentary, NY Times: ... Ken Shemberg, Bowling Green, Ohio: As usual, I think you have it right. This administration couldn't admit a fault if they were caught red-handed on videotape. But, to be fair, is that really different from other presidents? Your example of Ike's D-Day letter was written before he became a president. Maybe Lincoln admitted faults — he liked to poke fun at himself — and maybe Kennedy admitted fault on the Bay of Pigs. But in reading presidential biographies, it's hard for me to dredge up a time when a president said, yep, I was wrong — on a major issue, anyway. Can you think of one? Grover Cleveland did admit to having an illegitimate daughter. But that was a bit different, wasn't it?

                                                                                Paul Krugman: Fair enough; full-blown apologies from politicians are rare. But I think there are two distinguishing features of this administration. First, they don't even make tacit admissions that they made mistakes. Both Reagan and Clinton changed course and brought in better people when it became clear that their policies weren't working; these guys never do. In particular, it's obvious to everyone that Rumsfeld and Chertoff are incompetent. But they're loyal, and Bush chose them, so they stay.

                                                                                The other is that they don't even admit to themselves that they've made mistakes, and learn nothing from experience. I'll write soon about how looming problems with Medicare Part D were ignored in the months after Katrina, when any normal administration would have wondered what other things it was unready for.

                                                                                Max Wieselthier, New York.: A quite beautiful exposition with one minor defect. The plural for mensch is menschen.

                                                                                Paul Krugman: Yes, I know. What do you take me and my parents for, untermenschen? But it's become an English word for all practical purposes. And if The History Channel can pronounce Field Marshal Rommel's first name "Irwin", I can anglicize the plural of mensch. ...

                                                                                  Posted by Mark Thoma on Tuesday, February 21, 2006 at 04:12 PM in Economics, Politics

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                                                                                  FOMC Meeting Minutes Leave Room for More Rate Hikes

                                                                                  The Fed released its minutes from the last FOMC meeting. No surprises. While rates are nearing their destination, the committee expresses more worry about the inflation risk than the risk to output growth and is poised to raise rates again if needed. The bias is toward further rate increases, but all members agree that the next move is far more data dependent than other recent moves:

                                                                                  Minutes of the Federal Open Market Committee January 31, 2006: ...The information reviewed at this meeting suggested that underlying growth in aggregate demand remained solid, even though the expansion of real GDP was estimated to have slowed in the fourth quarter. ... Headline consumer inflation had been held down by falling consumer energy prices; more recently, however, crude oil prices climbed back up to high levels. Meanwhile, core inflation had moved up a bit from low levels seen last summer. ...

                                                                                  In their discussion of the economic situation and outlook, meeting participants noted the slowing in GDP growth in the fourth quarter of 2005, but believed that it probably owed in large part to transitory factors ... In that regard, several high frequency indicators of production, labor markets, and private demand suggested greater underlying strength of late than had been reflected in the most recent GDP data. ... Most participants expected core inflation to move up slightly in the near term, reflecting some pass-through of increased energy and other commodity prices. ...

                                                                                  In their discussion of major sectors of the economy, meeting participants noted that ... anecdotal reports contributed to a view that consumer spending had been solid over the holiday season and in recent weeks, while measures of consumer confidence remained high. Nevertheless, signs of slowing in the housing sector had become more evident... In some areas, home price appreciation reportedly had slowed noticeably, highlighting the risks to aggregate demand of a pullback in the housing sector. ... The most likely outlook, however, was for a gradual moderation in house price appreciation and in the growth of consumption, which would continue to be supported by increases in jobs and incomes. ...

                                                                                  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 4-1/2 percent ... Although recent economic data had been uneven, the economy seemed to be expanding at a solid pace. Members were concerned that, even after their action today, possible increases in resource utilization and elevated energy prices had the potential to add to inflation pressures. Although the stance of policy seemed close to where it needed to be given the current outlook, some further policy firming might be needed to keep inflation pressures contained and the risks to price stability and sustainable economic growth roughly in balance. In the view of some members, the possibility of additional policy moves was reinforced by readings on core inflation and inflation expectations that were somewhat higher than was desirable over the long run. However, all members agreed that the future path for the funds rate would depend increasingly on economic developments and could no longer be prejudged with the previous degree of confidence.

                                                                                  As this meeting marked Alan Greenspan's last ..., meeting participants took the opportunity individually and collectively to pay tribute to his many years of outstanding service to the Federal Reserve and to the nation. They expressed their appreciation for his collegial and successful leadership of the Committee and of the Federal Reserve System and emphasized the privilege and honor they felt in having served with him...

                                                                                  See also Washington Post, Bloomberg, WSJ, Financial Times, William Polley

                                                                                    Posted by Mark Thoma on Tuesday, February 21, 2006 at 03:51 PM in Economics, Monetary Policy

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                                                                                    Debating Dark Matter: Buiter Responds to Hausmann

                                                                                    Here's Willem Buiter's response to Ricardo Hausmann's defense of dark matter:

                                                                                    Martin Wolf's Economist's Forum, by Willem Buiter: Dear Ricardo, dear All,

                                                                                    ...I stress two points in my discussion of past and prospective future developments of the US net foreign asset position and net foreign investment income... First, it is not wise to assume that the total risk-adjusted rate of return ... on US foreign assets will in the future be systematically higher than the rate of return on US foreign liabilities. Second, evidence on the historical behaviour of these rates of return since 1980 presented by Hausmann and Sturzenegger ... is deeply suspect.

                                                                                    My note was actually supportive of the H&S Dark Matter hypothesis to the extent that it reported the only robust evidence on the existence of Dark Matter: the stock of US currency held abroad, estimated ... at between US$ 210bn and US$ 525bn at the end of 2004. This is a perpetual zero nominal interest rate loan to the US government by the rest of the world – a nice little earner...

                                                                                    The second category of Dark Matter identified by Hausmann and Sturzenegger are US holdings of emerging market debt (assumed to yield 8 percent for illustrative purposes by H &S) financed with US Treasuries (assumed to yield 5 percent). Identifying the yield differential between emerging market debt and US Treasuries with an expected excess return is plain wrong for two reasons. First, the ex-ante or expected rate of return on emerging market debt ... includes a margin to cover the expected default risk. With reasonable numbers for default risk and default cost, there is actually little room left for a true risk-premium... If default is an event that is both rare and costly when it occurs, the realised returns from holding emerging market debt during a period when no default actually occurs ... will exceed the expected returns on emerging market bonds. The lesson from such ‘Peso problems’ is that past realised rates of return may be poor guides to future expected returns ...

                                                                                    More important, the interest income data recorded in the investment income account are certain to overstate the actual interest income received by US investors holding emerging market debt. This is because of the simple fact, ignored by all other participants in this discussion, that interest is recorded on an accrual basis, not on a cash basis, in the balance of payments accounts. ... Hausmann is plain wrong when he asserts that the accrual problem only causes mismeasurement during the year(s) that the interest is accrued but not paid. At the end of the day, the interest measure in the income account will not be fine. The unpaid accrued interest never gets debited to the investment income account. Instead it gets debited to the capital account. ...

                                                                                    The final category of Dark Matter in the H&S analysis concerns the relative performance of US Direct Investment Abroad (USDIA) and Foreign Direct Investment in the US (FDIUS). The key fact to keep in mind about the market value data on FDI that play such a significant role in this discussion is that these are not data at all but made-up numbers. The equity obtained through FDI is generally not traded and often involves shares of companies that are not even listed. ...

                                                                                    It is clear that the market value of FDIUS is likely to be understated... The reason is that FDI anywhere indeed includes Dark Matter, through the control rights it brings and the often associated transfers of know how, skills and technology. In a reasonably efficient financial market like the US, portfolio equity should therefore, cet. par. have a lower risk-adjusted expected return than foreign direct investment in the US. One can see this for instance, in the superior performance of foreign direct investors in automobile manufacturing in the US, including Nissan, Toyota, Honda, Hyundai and Mercedes, compared to the miserable performance of domestic US automobile producers such as GM and Ford.

                                                                                    Not so in many of the emerging markets and developing countries to which a good chunk of USDIA is directed. It remains true, even in high-risk emerging markets, that FDI has associated with it control rights and technology, knowledge and skill transfers that are absent from portfolio equity investment. The positive excess returns that this conventional FDI dark matter generates ... are, however, likely to be dominated in many of the high-risk emerging markets, by negative excess returns caused by the greater vulnerability of FDI to predatory behaviour by the state or by private sector rivals. Insecure property rights, absence of the rule of law in commercial relations, unpunished illegal or extra-legal predatory behaviour by agents of the state or by private but better-connected competitors are less likely to affect the few companies that have managed to obtain a listing on the domestic stock markets. ... Listed companies in emerging markets are not randomly selected with respect to the factors that make for higher returns. ...

                                                                                    Is it impossible that there is a massive amount of Dark Matter hidden in the US external balance sheet? Everything is possible, but not everything is likely. As regards the contributions by H&S, my bottom line is the following: (1) except for the seigniorage component of Dark Matter, they have not provided us with any hard facts to support their case for massive exports of Dark Matter by the US in the past; (2) as regards future Dark Matter exports, the only sound advice is: don’t count on it. Paraphrasing something Ed McKelvey of Goldman Sachs wrote quite recently: blind faith in the existence of Dark Matter as an excuse for taking a relaxed attitude about the financial deficits of the combined US private and public sectors, would be evidence of a lack of Grey Matter.

                                                                                    Posted by Mark Thoma on Tuesday, February 21, 2006 at 10:33 AM in Economics, International Finance, International Trade

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                                                                                    The Government's Role in Wealth Creation and Redistribution

                                                                                    Should Democrats focus less on government as an agent of wealth redistribution and more on government's role in creating the means for individuals, particularly the disadvantaged, to create and accumulate wealth?:

                                                                                    Creating Wealth for the Poor, by E. J. Dionne Jr., Commentary, Washington Post: Ron Sims, the county executive in Washington state's King County, believes government's job is "to help create wealth more efficiently." That view comes naturally to a leader of the entrepreneurial Seattle region, which has improved the nation's experience of everything from technology to coffee. ... Meeting Sims ... provided a bracing reminder that there is an authentic search going on outside of conventional politics for the new ideas to animate a new political era -- precisely what Democrats are supposed to be seeking.

                                                                                    Sims is a ... Democrat... Sims's ... idea [is] that government, far from being a drain on the nation's wealth, ought to "provide the social infrastructure and the physical infrastructure to help wealth be created." He said during lunch here the other day that Democrats should run under the slogan: "Rebuild America."

                                                                                    Sims notes that after World War II, the federal government helped unleash an era of exceptional growth through investments in schools, interstate highways and higher education. Both India and China are "making intelligent moves for economic growth" and the United States cannot stand by and watch. "You need people and brains to create an economy," he says. "You need transportation to move an economy. And you need an environmental policy to create clean air and clean water."

                                                                                    Sims's idea reminds Democrats that a commitment to active government is not simply about redistributing wealth. ... effective government has always been essential to robust economic growth. Government, in the Sims formulation, should be a dynamic player in our nation's economic life. ... Democrats ... find themselves attacked for being too concerned about redistributing money, yet they are far too timid in committing themselves to lifting up the very poorest Americans. ...

                                                                                    The decline of manufacturing employment means the economy is producing fewer well-paying jobs for the less-skilled. These disconnected young men tend to go to the poorest schools, grow up amid concentrated poverty and in families that often lack fathers, and face persistent employment discrimination. Face it: The one expensive social program we have for this group is incarceration.

                                                                                    Can't we do better? [For example] ... reform education and training programs and work with employers and other intermediaries to connect these young men to the labor market. ... expand programs such as the Job Corps that have "proven track records," ... do far more to integrate ex-offenders into the world of work. ... [and] create much stronger work incentives through income supplements, higher minimum wages and changes in the child support system. ... Sims's practical focus on government's role in wealth creation ... is good public policy. My hunch is that it could also be good politics.

                                                                                    I'm reminded of this by Brad DeLong:

                                                                                    Social Justice, by Brad DeLong, TPM Cafe: ... Could it be that in America today framing one's issues in terms of "social justice" loses more votes than it wins in important political backgrounds?... That we are much better off talking about "social insurance" and "safety nets" and "equal opportunity" and "personal liberty" than "social justice"? Could it be that there are many more people in America who have a knee-jerk approval of equal opportunity and personal liberty ... than have a knee-jerk approval of social justice? Whew. It's over. I'm back to my real self again. It won't happen again--at least not for another month or so. Yours in struggle and solidarity, Brad DeLong

                                                                                      Posted by Mark Thoma on Tuesday, February 21, 2006 at 01:23 AM in Economics, Income Distribution, Politics

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                                                                                      Finding the Evidence That's Already In

                                                                                      The Washington Post joins those with suspicions over the motives behind the creation of the Division of Dynamic Analysis:

                                                                                      Undynamic Analysis, Editorial, Washington Post Online: "The evidence is in, it's time for everyone to admit that sensible tax cuts increase economic growth, and add to the federal treasury." That was Vice President Cheney the other day.... But Mr. Cheney is the one who needs to reexamine his evidence. Yes, tax policies can help promote economic growth. But no matter how many times the vice president and his tax-cutting allies proclaim their belief in the tax-cut fairy, she doesn't exist. Tax cuts do not magically pay for themselves...

                                                                                      Proponents of the magic tax cut have long argued that, if only the growth-enhancing effects of cuts were accounted for in the budgetary equation, this cost-free boon would become clear. Trouble is, responsible economists who have attempted to engage in this kind of "dynamic analysis" haven't come up with the unalloyed positive conclusion the administration wants...

                                                                                      Now the administration is moving to commission its own evidence, creating a "Division on Dynamic Analysis" in the Treasury Department. ... This measly budget item -- $513,000 -- may be just a sop to conservatives; after all, though Mr. Cheney may not know it, Treasury professionals have been doing dynamic analysis for some time. But it could be something more pernicious: an office set up in pursuit of a particular result. After all, Mr. Cheney says the evidence is in.

                                                                                        Posted by Mark Thoma on Tuesday, February 21, 2006 at 12:41 AM in Economics, Politics, Taxes

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                                                                                        February 20, 2006

                                                                                        Hidden Costs of SUVs, Education Outcomes, Discrimmination, and Disaster Dollars

                                                                                        These are from an article " A Wealth of Talent" in the San Diego Tribune on UCSD's move into the US News & World Report's top 10 (about which department chair Richard Carson says “I think we sent out an e-mail,” ... “We didn't throw a party or anything like that.”).

                                                                                        The brief articles are about the research of Michelle White on the hidden costs of SUVs, Julian Betts on classroom outcomes, Kate Antonovics on discrimmination, and Richard Carson on disaster dollars:

                                                                                        First, Michelle White:

                                                                                        Michelle White: The hidden costs of SUVs, Union-Tribune: While many a Honda Accord driver has shaken a fist and called the behemoth SUV in the next lane a highway menace, only Michelle J. White has proved it. A couple of years ago, White, an economics professor at UCSD, said she found herself “getting more and more terrified to drive” her Accord with all the big sport utility vehicles on the road. She eventually decided to find out how afraid she should be.

                                                                                        The answer? Very afraid. Analyzing 20 years of vehicle ownership and fatal accident records, White found that for every fatal crash a sport utility vehicle or pickup owner avoids for themselves, they cause fatalities in 4.3 more accidents involving pedestrians, bicyclists and other cars. “The damage you are doing outside your vehicle is far greater than the safety gained inside,” says the 60-year-old White to SUV and pickup owners. ...

                                                                                        White said the SUV study has received a lot of attention from other economists. “I was the first to take standard economic concepts and apply them to this area that everybody knows about,” she said. Her research showed that when 1 million light trucks replace an equal number of cars, between 34 and 93 additional car occupants, pedestrians, bicyclists or motorcyclists are killed each year. ...

                                                                                        Things get even worse, White says, when driver behavior is factored in. People drive more safely in cars than they do in pickups and SUVs, presumably to compensate for the greater danger they face. “For a long time, the number of fatalities on our roads had been going down,” said White, ... “Lately, however, it's been creeping back up.”

                                                                                        White said a typical minimum requirement for liability coverage is between $100,000 and $200,000. She is planning to write a journal article or newspaper editorial calling for SUV and pickup owners to pay for more coverage. “You could multiply that amount by 10 and still be underinsured relative to the harm you cause with a fatal accident.”

                                                                                        Next, Julian Betts:

                                                                                        Julian Betts: Classroom outcomes, Union-Tribune: Everyone pretty much agrees that some schools are better than others. What people can't agree on are the ingredients that make a good school. That's where Julian Betts comes in. One of the nation's top experts in the economics of education, the 45-year-old UCSD economics professor has studied the effects that class size, teacher credentialing and school choice have on student achievement. “Education has time and time again been shown to be the one factor controllable by government that has a positive impact on people's lives,” Betts said. “Getting help to students when they are young and still in school has very high payoffs. Not just to them, but to society in general.”

                                                                                        Some of his findings have reinforced prevailing thought. Others have turned conventional wisdom on its ear. Take, for example, the issue of teacher credentialing. One would think that in a state as diverse as California, teachers with a Crosscultural Language and Academic Development Certificate would create better outcomes than teachers without such a credential. Not so, says Betts' research.

                                                                                        “At the elementary level, we found that teachers with two years of experience, but no CLAD credential, were just as effective as those with that credential,” Betts said. He is not saying that a teacher's education doesn't matter. In fact, his research shows that it is very important, for example, for a high school math teacher to take the right courses in college. But he contends that the current credentialing system does a poor job of measuring a teacher's effectiveness, and that some characteristics, such as enthusiasm and empathy, aren't measurable.

                                                                                        And, according to Betts' research, a child's classmates are just as important to success as the teacher. “Some of the most important influences on whether a student is learning have to do with their peers,” Betts said. “The proverbial 'good class' really is good for individual kids within the class.”

                                                                                        Kate Antonovics is next:

                                                                                        Kate Antonovics: Tuning in discrimination, Union-Tribune: The racial tensions that characterized Kate Antonovics' Durham, N.C., junior high school in the early 1980s have stayed with her. So much so that she has dedicated her career to trying to make sense of them. ...

                                                                                        Antonovics, who is an assistant professor of economics at ... UCSD [and] white, said her childhood questions about racial discrimination eventually led her to study issues of workplace inequality... White men tend to earn more money than any other group. Is it because of discrimination? Or are white men better at their jobs than other groups, Antonovics and her colleagues wondered.

                                                                                        The only data economists can collect concerning a worker's productivity are wages, experience and education, she said. What they can't measure is performance. ... Frequently when the real world doesn't produce what economists want, they go to the laboratory.”

                                                                                        The laboratory in this case was “The Weakest Link” TV game show, and the result a unique look at discrimination issues. ... Eight contestants are given questions that test their general knowledge. Every time a contestant correctly answers a question, a community pot of money gets bigger. If a contestant gives a wrong answer, the pot goes to zero.

                                                                                        At the end of each round, each contestant gets to vote one person off the show. Whoever receives the most votes leaves the game. ... What made the show useful to Antonovics and her colleagues is that they could track the number of questions each contestant answered correctly. “So, in contrast to the labor market, we can get a look at performance,” she said.

                                                                                        The results were interesting, to say the least. “We found no discrimination of whites against blacks. No discrimination by men against women,” Antonovics said. “But we did find discrimination by women against men, and there was no evidence that men perform worse than women. It looks like women simply prefer to have other women on the show.”

                                                                                        Antonovics said the study, published last fall in the Journal of Human Resources, was criticized for not finding discrimination by men against women and minorities. “We were told that if you didn't find discrimination, then you must be studying the wrong thing,” she said. “I think the attitude should be, if you aren't finding discrimination, what are the things in this environment that are driving it in a way that we don't find in the workplace?”

                                                                                        Finally, Richard Carson:

                                                                                        Richard Carson: Disaster dollars, Union-Tribune: After disaster strikes, whether it be wildfire, hurricane or oil spill, Richard Carson can count on getting a call. One of the world's foremost environmental economists, Carson often is asked to put a dollar figure on disasters. He was the government's chief damage assessment expert in 1989 after the Exxon Valdez oil tanker ran aground and spilled 11 million gallons of oil into Prince William Sound. Carson eventually pegged the value of preventing the spill at $3 billion.

                                                                                        “We needed to determine the value of the resource before it was damaged, and what should have been spent to protect it,” said Carson... He also was one of the experts commissioned after Southern Pacific train cars carrying thousands of gallons of toxic chemicals toppled into the upper Sacramento River, destroying aquatic life for 40 miles downstream. “They flew me up there, and I figured out how to do things like count dead fish,” he said.

                                                                                        More recently, the 50-year-old Carson examined the costs associated with allowing the deterioration of wetlands that at one time buffered New Orleans from the Gulf of Mexico. A generation ago, Carson said, New Orleans had miles and miles of wetlands that would have largely protected the city from the kind of storm surge created by Hurricane Katrina.

                                                                                        “Allowing the large fraction of wetlands in New Orleans to disappear is an extremely expensive thing,” Carson said, noting that it would have cost between $5 billion and $10 billion to save the wetlands, compared to the hundreds of billions that Katrina recovery will cost. “Unfortunately that's the issue with natural resources,” he said. “They are expensive to fix, so they end up getting put off.”

                                                                                        Beyond his work with disasters, Carson, ... has studied ... ways to improve public enjoyment of parks, forests, streams and beaches. Carson works to eliminate what economists call “congestion externalities” and what the rest of us call “overcrowding.” “We don't want people standing on the bank of the river and hitting each other with their fishing poles. It's a miserable experience,” he said.

                                                                                          Posted by Mark Thoma on Monday, February 20, 2006 at 07:37 PM in Economics, Miscellaneous

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                                                                                          Robert Hall: "Inflation Targets Can and Should be Met Quite Strictly"

                                                                                          Robert Hall says the Fed can and should meet its inflation targets strictly. Tolerating inflation outside of a narrow band, even in the short-run, is at odds with maximal output stability:

                                                                                          Ben Bernanke: The Measure of the Man, by Robert E. Hall, Commentary, WSJ: The U.S. Constitution directs the government to regulate the value of money and to fix standards of weights and measures. In the modern federal government, the Fed sets the value of the dollar and the National Institute of Standards and Technology (NIST) sets standards such as the length of the yard. The Fed chairman is the second-most powerful person in the world and known to every newspaper reader in the U.S. When I last checked, Google News had 10,100 hits for Alan Greenspan, just retired, and 13,100 for Ben Bernanke, his successor. The director of NIST, William A. Jeffrey, enjoys no name recognition. One has to drill three layers deep in the NIST Web site even to find his name. Google News had zero hits for him.

                                                                                          How have the two agencies performed their constitutional assignments of providing stable units? The NIST and its predecessor agency, the National Bureau of Standards, have kept the length of the yard almost exactly constant. They have resisted pressure from the fabric industry, for example, to shorten the yard and improve profits. Yard-length-policy has been perfect. So perfect that we don't even think about the dangers of shrinkage in its length.

                                                                                          The Fed's job is to keep the purchasing power of the dollar at a stable level. The overall record of the Fed in this mission is dismal. From 1968 to 1982, the dollar fell in half -- as if the government had let the yard shorten to 18 inches. During that period, the Fed responded to political pressures for short-term expansion at the cost of neglect of its key function. Between 1982 and 1990, the dollar continued to shrink. But for the past 15 years, under Mr. Greenspan, the Fed has accomplished its goal. Its record during that period is almost as good as the NIST's. After allowing for a stable rate of inflation of 2.5% per year, the Fed has delivered a unit of purchasing power hardly less stable than the yard.

                                                                                          There can be no doubt that Mr. Bernanke is completely committed to continuing the policy of a stable dollar. Under his leadership, the Fed is likely to make this commitment more formal, perhaps even stating a target such as 2.5% inflation. Mr. Bernanke has been outspoken on the point that the inflation must be kept at the target -- it is as bad a failure of policy if it drops below as if it exceeds the target.

                                                                                          One of the important lessons of monetary policy in the U.S. and many other countries over the past decade is that inflation targets can and should be met quite strictly. Most economists thought that confining inflation to a narrow band, such as 1.5% to 3.5%, would be excessively destabilizing when oil or other volatile commodity prices spiked. Our advice was that the economy should roll with the punch, tolerating inflation during those episodes and then squeezing it out later. We thought that a stricter inflation policy would destabilize the real economy, resulting in high unemployment during oil shocks. But the worldwide result of the adoption of fairly strict inflation targeting has seen a pronounced reduction in fluctuations in GDP growth and unemployment. Stabilizing the value of the dollar (and the pound, the Euro, the New Zealand dollar, and many other currencies) has delivered a more stable economy in other dimensions.

                                                                                          Update: The WSJ changed the title to A Bore at the Fed and added this paragraph (as I noted earlier, the first version they posted repeated the penultimate paragraph twice):

                                                                                          One of the reasons that President Bush selected Mr. Bernanke was his sympathy for the administration's fiscal policy, which emphasizes structural reform with low marginal tax rates over concern with the deficit. It's unlikely that Mr. Bernanke will follow Mr. Greenspan in sounding off about non-monetary policy issues. He will stick to his mandate to keep the dollar stable. Monetary policy will recede from the front page to the inner pages of the C section under Mr. Bernanke's leadership. A stable dollar is just as boring (and desirable) as a stable yard. Mr. Bernanke's name recognition will shrink to William Jeffrey's level. With the problem of an unstable dollar permanently off the policy table, we can turn to solving other critical national problems, such as inducing people to save enough for retirement health care.

                                                                                            Posted by Mark Thoma on Monday, February 20, 2006 at 04:55 PM in Economics, Monetary Policy

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                                                                                            Assuaging the Barbarians at the Gate: Our "Roman Dilemma"

                                                                                            International trade is often viewed as a means to a stable, prosperous and integrated international society, but according to Harold James, an historian at Princeton University's Woodrow School, it can also result in the "Roman dilemma” where the outcome of liberalizing economic ties is one of conflict or even war. Can this dilemma be avoided?:

                                                                                            Modern America’s Roman predicament, by Harold James, Financial Times: Before September 11 2001, it was widely assumed that globalisation bred peace and stability. But over the past five years, there has been increased nervousness about this concept ... In particular, there is widespread mistrust of the world’s only superpower and increased doubt about the sort of politics that America tries to impose on the rest of the world.

                                                                                            As the Bush presidency gets bogged down in the quagmire of Iraq, there is still a widespread assumption that there might be a quick and easy fix. ... Such optimistic beliefs are mistaken but are characteristic of an ever-recurring dilemma of an interconnected world. Consider some historical parallels: in 1776, the year of the US Declaration of Independence, Adam Smith and Edward Gibbon published the first volumes of two works that both used history to illuminate Britain’s own problems with the globalisation of that age: The Wealth of Nations and The Decline and Fall of the Roman Empire.

                                                                                            In these monumental and parallel works, Smith and Gibbon explored what could be called the “Roman dilemma”. In essence, how peaceful commerce is frequently seen as a way of building a stable, prosperous and integrated international society. At the same time, however, the peaceful liberal economic order leads to domestic clashes and also to international rivalry and even wars. ...

                                                                                            The central problem identified by Gibbon and Smith is that complex societies need rules to function, whether on a national (state) level or in international relations. But we do not always comply voluntarily with rules and rules require some enforcement. In addition, they need to be formulated. The enforcement and the promulgation of rules are both consequences of power, and power is always concentrated and unequally distributed. ...

                                                                                            The propensity for subversion and destruction of a rule-based order comes about because – and whenever – there is a perception that rules are arbitrary, unjust and reflect the imposition of particular interests in a high-handed imperial display of power. ... The adage that power tends to corrupt itself affects the way in which the holders of power behave. Even if the wielder of power resists the addiction, other people suspect the addiction is there. ...

                                                                                            Both politicians and their critics find this hard to understand as they try to respond to global challenges, such as the threat of terrorism or the proliferation of nuclear weapons. They are about to be as baffled by Iran as they were by Iraq.

                                                                                            If the threat lies in discontent about modernity, and if poverty and marginalisation are the breeding grounds for violence and terrorism, then growth and a better distribution of wealth can hold a more effective cure. If, on the other hand, cultural differences are really so profound, then imperial conflict and conquest is the only adequate answer. Much contemporary debate, especially after the 9/11 terrorist attacks, fluctuates between these poles. Should the industrial world buy off or fight the barbarians at the gate?

                                                                                            Yet both options look like different aspects of the old but unsatisfactory Roman solution: conquer and provide prosperity. There is only a difference in emphasis. ... There exists an alternative to the “challenge and response” model that has as its outcome the clash of civilisations. The other path depends on dialogue within a shared natural law framework.

                                                                                            Instead of thinking that technical development will automatically produce prosperity and thus solve, as it were by a kind of magic, the problem of values, policymakers in the industrialised world need to think and talk explicitly about values and traditions. What does Islamic tradition have in common with western traditions that respects human dignity; and how can modern America show that it respects these values too? ...

                                                                                            To me, this is a big part of our problem:

                                                                                            The propensity for subversion and destruction of a rule-based order comes about ... whenever ... there is a perception that rules are arbitrary, unjust and reflect the imposition of particular interests in a high-handed imperial display of power.

                                                                                            We have not convinced the global community that our actions are in the world rather than our own narrow interest, and the world has yet to be convinced that the invisible international hand directs our self-interest to their benefit.

                                                                                              Posted by Mark Thoma on Monday, February 20, 2006 at 02:27 PM in Economics, International Trade

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                                                                                              Real-Time Model Uncertainty is Real

                                                                                              Brian Ironside and Robert Tetlow find a surprisngly large degree of model uncertainty in the principal macro model used by the Federal Reserve Board:

                                                                                              Real-Time Model Uncertainty in the United States: The Fed from 1996-2003, by Brian Ironside and Robert Tetlow, CEPR Discussion Paper No. 5305: Abstract We study 30 vintages of FRB/US, the principal macro model used by the Federal Reserve Board staff for forecasting and policy analysis. To do this, we exploit archives of the model code, coefficients, baseline databases and stochastic shock sets stored after each FOMC meeting from the model's inception in July 1996 until November 2003. The period of study was one of important changes in the US economy with a productivity boom, a stock market boom and bust, a recession, the Asia crisis, the Russian debt default, and an abrupt change in fiscal policy. We document the surprisingly large and consequential changes in model properties that occurred during this period and compute optimal Taylor-type rules for each vintage. We compare these optimal rules against plausible alternatives. Model uncertainty is shown to be a substantial problem; the efficacy of purportedly optimal policy rules should not be taken on faith. We also find that previous findings that simple rules are robust to model uncertainty may be an overly sanguine conclusion. [open link, outline of Lucrezia Reichlin discussion]

                                                                                                Posted by Mark Thoma on Monday, February 20, 2006 at 11:52 AM in Academic Papers, Economics, Monetary Policy

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                                                                                                Paid Punditry

                                                                                                The paid pundit story seems to have lost some of its momentum, but it still kicks up a little dust now and then. Hopefully, it won't fall off the radar screen altogether:

                                                                                                Cleaning house on opinions for hire, by Cathy Young, Commentary, Boston Globe: The fall of master lobbyist Jack Abramoff has had reverberations ... among journalists. In the wake of revelations that two right-of-center opinion writers had accepted payoffs from Abramoff to write articles favorable to his clients, other pundits have become targets of suspicion. Some in conservative circles want to clean house; others, to circle the wagons and protect their own. For the good of conservative and libertarian opinion journalism, the former should prevail.

                                                                                                First, in December, came the revelation that Doug Bandow, a senior fellow with the Cato Institute and a syndicated columnist with the Copley News Service, had taken money from Abramoff to write 12 to 14 articles in the past decade, for as much as $2,000 a column. A second opinion writer, Peter Ferrara, was implicated in similar payoffs. Laudably, the Cato Institute dismissed Bandow as soon as his misdeeds were confirmed. ... Bandow, who also lost his column, took responsibility for his ''lapse of judgment."

                                                                                                Not everyone followed that example. The Institute for Policy Innovation, where Ferrara is a senior policy adviser, kept Ferrara on the payroll; its president, Tom Giovanetti, was quoted as saying that critics of the payoffs were using a ''naive purity standard." That's a funny way to describe professional integrity.

                                                                                                The situation escalated recently when science journalist Michael Fumento became the latest casualty of the scandals. Fumento lost his syndicated column after Business Week reported that his 2003 book, ''Biotechnology," was subsidized with an undisclosed 1999 grant of $60,000 from the agribusiness giant Monsanto, which he repeatedly praised in the book and in several columns. Unlike Bandow and Ferrara, he was never accused of taking payments for op-eds...

                                                                                                Sadly, some conservatives are now defending the practice of opinion writers serving as hired guns (hired quills?)... Among others, Iain Murray in The American Spectator and Giovanetti in National Review Online ... claim that a witch-hunt against conservative writers is afoot. Liberal pundits, they whine, are subsidized by the media, major foundations, and the publishing industry, while conservatives and libertarians have nowhere to go but to the corporate trough. It is therefore in the interests of liberals to, in Giovanetti's words, ''isolate conservatives from their natural allies in the business community."

                                                                                                The payola defenders pooh-pooh concerns about journalistic ethics. Murray writes that an opinion piece ''does not seek to establish a fact, but to win people over to a particular viewpoint or opinion," and should be judged solely by the quality of the argument. ... The fallacy of this ought to be obvious. An argument should be not only convincing but intellectually honest. Undisclosed financial interest in the slant of an article compromises a writer's intellectual honesty and hence his or her credibility.

                                                                                                Part of the reason such arguments are possible is that journalistic ethics are already in a pretty sorry state. ... there are many pundits whose commentary could not be more biased if it was bought and paid for. Ideological zealotry can be no less detrimental to intellectual integrity than financial interest. ... Still, one must draw the line somewhere. Yes, some mainstream journalists have uncritically channeled dubious claims by liberal groups championing ... environmentalism or the fight against domestic violence. But would it really make no difference if they were secretly on these groups' payroll?

                                                                                                By Murray's and Giovanetti's logic, there is no essential difference between opinion articles and the paid ''advertorials" that lobbying groups, businesses, and political organizations sometimes place in newspapers and magazines. The day I believe that, I'll be looking for another line of work.

                                                                                                Full disclosure of financial ties to identify the "advertorials" doesn't seem like too much to ask.

                                                                                                  Posted by Mark Thoma on Monday, February 20, 2006 at 07:40 AM in Economics, Politics, Press

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                                                                                                  Paul Krugman: The Mensch Gap

                                                                                                  Everybody makes mistakes. But not everyone can admit them:

                                                                                                  The Mensch Gap, by Paul Krugman, Commentary, NY Times: "Be a mensch," my parents told me. Literally, a mensch is a person. But by implication, a mensch is an upstanding person who takes responsibility for his actions. ...

                                                                                                  Dick Cheney isn't a mensch. There have been many attempts to turn the shooting of Harry Whittington into a political metaphor, but the most characteristic moment was the final act — the Moscow show-trial moment in which the victim of Mr. Cheney's recklessness apologized for getting shot. Remember, Mr. Cheney, more than anyone else, misled us into the Iraq war. Then, when neither links to Al Qaeda nor W.M.D. materialized, he shifted the blame to the very intelligence agencies he bullied into inflating the threat.

                                                                                                  Donald Rumsfeld isn't a mensch. Before the Iraq war Mr. Rumsfeld muzzled commanders who warned that we were going in with too few troops, and sidelined State Department experts who warned that we needed a plan for the invasion's aftermath. But when the war went wrong, he began talking about "unknown unknowns" and going to war with "the army you have," ducking responsibility for the failures of leadership that have turned the war into a stunning victory — for Iran.

                                                                                                  Michael Chertoff, the secretary of homeland security, isn't a mensch. Remember his excuse ... "I remember on Tuesday morning," ... "picking up newspapers and I saw headlines, 'New Orleans Dodged the Bullet.' " There were no such headlines, at least in major newspapers, and we now know that he received — and ignored — many warnings about the unfolding disaster.

                                                                                                  Michael Leavitt, the secretary of health and human services, isn't a mensch. He insists that the prescription drug plan's catastrophic start doesn't reflect poorly on his department, that "no logical person" would have expected "a transition happening that is so large without some problems." In fact, Medicare's 1966 startup went very smoothly. ...

                                                                                                  I could go on. Officials in this administration never take responsibility ... it's always someone else's fault. Was it always like this? I don't want to romanticize our political history, but I don't think so. ... Dwight Eisenhower ... wrote a letter before D-Day accepting the blame if the landings failed. His modern equivalent would probably insist that the landings were a "catastrophic success," then ... blame ... their failure on the editorial page of The New York Times.

                                                                                                  Where have all the mensches gone? The character of the administration reflects the character of the man at its head. President Bush is definitely not a mensch; his inability to admit mistakes or take responsibility ... approaches the pathological. ... And as long as his appointees remain personally loyal, he defends their performance, no matter how incompetent. After all, to do otherwise would be to admit that he made a mistake in choosing them. ...

                                                                                                  But how did such people attain power in the first place? ... Whatever the reason ... it has horrifying consequences. You can't learn from mistakes if you won't admit making any mistakes, an observation that explains a lot about the policy disasters of recent years ...

                                                                                                  Above all, the anti-mensches now ruling America are destroying our moral standing. A recent National Journal report finds that we're continuing to hold many prisoners at Guantánamo even though the supposed evidence against them has been discredited. We're even holding at least eight prisoners who are no longer designated enemy combatants. Why? Well, releasing people you've imprisoned by mistake means admitting that you made a mistake. And that's something the people now running America never do.

                                                                                                  Previous (2/13) column: Paul Krugman: Debt and Denial Next (2/23) column: Paul Krugman: Osama, Saddam and the Ports

                                                                                                    Posted by Mark Thoma on Monday, February 20, 2006 at 12:15 AM in Economics, Politics

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                                                                                                    February 19, 2006

                                                                                                    Ricardo Hausmann Defends Dark Matter

                                                                                                    Ricardo Hausmann defends dark matter in Martin Wolf's FT Economist's Forum (the section of the Hausmann and Sturzenegger paper on page 5 called "What is Behind Dark Matter" is a good introduction if you are unfamiliar with the dark matter concept):

                                                                                                    FT Forum, by Ricardo Hausmann: Dear all: Martin Wolf is quick to dismiss the discussion of dark matter and side with Willem Buiter. However, Federico Sturzenegger and I still believe they miss the point big time. ... At this point of the debate I hope we all agree that there is a puzzle between the story that the current account deficit describes and what the financial income flows reflect. A correct descriptive explanation of this puzzle is that the rates of return on US liabilities is significantly smaller that the return on its assets. ...

                                                                                                    OK, so the question is why US assets abroad earn more than US liabilities at home. ... The profession must offer an interpretation of this puzzle. Our interpretation is that the US has a comparative advantage in providing insurance, liquidity and innovation to the rest of the World, and that the rest of the world is happy to pay for this. Willem Buiter and Martin Wolf buy the seignorage argument but point out that the magnitude is too small to compensate for the US deficit. They jump from this conclusion to the belief that therefore the US current account imbalance is unsustainable. But this does not solve the puzzle. They still owe us an explanation for why the US accumulated a deficit of over 5,000 billion dollars and is not paying for it. ...

                                                                                                    The key point is that we believe that for the purpose of assessing global imbalances this differential return ... should be considered as a regular income flow, the capitalized value of which we call the stock of dark matter. ... If the reasons for this return differential are and will be there, you need to take them into account when thinking about the future. One way to do so is to realize that this is like an asset and you may want to give it a value to get a better sense of your current asset position. In the technical version of the paper we show how this should be done in a complete market setup but we don’t need to worry about this here.

                                                                                                    Let me explain two additional reasons why our numbers for the stock of dark matter are large and correct. First, it is clear to us that BEA´s adjustment of the value of FDI abroad is very arbitrary and may seriously underestimate the problem. ... Second, it has been argued that our measure incorrectly uses the accrued income flows, rather than what is actually paid. ... What is clear is that at the end of the day the measure will be fine ... over a period of 25 years our measure stands and is really big.

                                                                                                    This takes us to our final point. Since we’ve circulated our paper many people have volunteered to us a prediction on the evolution of US net foreign debt obtained with conventional accounting exercises. They were trying to point to us that in spite of a large stock of dark matter the dynamics still look bleak. Fair enough. This may turn out to be true. But this misses our point. We show that the US has historically been exporting (and quite robust statistically at that) over 2% of its GDP in FDI know-how, insurance or liquidity services, call it as you wish. This number has gone up to around 5 percent over the last five years. So when we look forward, can we assume that from now on nothing of this will continue to happen? Again, that may very well be true, but you need a hell of an argument to say that what has been a steady trend over the last 30 years suddenly is about to disappear in 2006.

                                                                                                    What is our personal take on the question of whether dark matters exports may continue at their recent pace of close to 5% of GDP? Probably not... In any case, it may very well be the case that the US settles for its long run average of 2-3% of GDP of dark matter exports. No enough to cover a 7% of GDP deficit, but something that helps quite a bit. The point is that you cannot just assume it away without a pretty strong explanation.

                                                                                                      Posted by Mark Thoma on Sunday, February 19, 2006 at 03:48 PM in Economics, International Finance, International Trade

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                                                                                                      In DHS We Trust?

                                                                                                      I don't know if this compromises national security or not. What I do know is that I am no longer comforted by the assurances of Michael Chertoff:

                                                                                                      White House defends ports takeover stance, by Stephanie Kirchgaessner, Financial Times: The White House is embarking on a vigorous defence of its decision to approve Dubai Ports World’s ... takeover of P&O, the UK ports operator, in the face of mounting congressional opposition... by... lawmakers ... – both Republican and Democratic – that the deal, which will give Dubai-owned DP World five terminals along the east coast of the US, compromises national security.

                                                                                                      A Treasury official said the White House would call on the Department of Homeland Security (DHS) to assure critics on Capitol Hill that the deal was thoroughly investigated ... and that DP World had a long standing relationship with DHS. “You can be assured that before a deal is approved we put safeguards in place, assurances in place, that make everybody comfortable that we are where we need to be from a national security viewpoint,” Michael Chertoff, DHS secretary, said yesterday. ...

                                                                                                      It is unclear, however, whether the White House will be able to assuage an angry group of lawmakers who have expressed incredulity.... Republican senator Lindsey Graham ... said ... “It’s unbelievably tone deaf politically ..., four years after 9/11, to entertain the idea of turning port security over to a company based in the UAE who avows to destroy Israel,” ... He joins ... Richard Shelby, an Alabama Republican who ... is calling a hearing to discuss the issue, and Republican senator Susan Collins of Maine, who is also expected to voice concern on the issue. Senator Barbara Boxer of California ... said she would support a proposal by ... Hillary Clinton to pass legislation to block the transaction. ...

                                                                                                      In an interview published in the Washington Post, Michael Brown says:

                                                                                                      I don't think people outside the Beltway grasp how scripted this town is. People don't tell the truth; people feel boxed in so they can't tell the truth; people get dismissed for telling the truth. . . .

                                                                                                      And, on Chertoff in particular, Brown makes it very clear he's willing to carry the ball for the administration:

                                                                                                      I expect him to dump things on me. That's the way this town works. I'm very disappointed. ... I'm not sure it's the right thing to do, but it's the task he's been given.

                                                                                                      Is what Chertoff says on this the truth, or a "task he's been given"? With national security at stake, that's a question we should not have to ask. Even Republicans think a hearing is necessary to find out the true risks from the proposed takeover.

                                                                                                        Posted by Mark Thoma on Sunday, February 19, 2006 at 12:20 PM in Terrorism

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                                                                                                        China's Cyberdissidents and the 'Gang of Four'

                                                                                                        Peking Duck has Kristof's column on "China's Cyberdissidents and the Yahoos at Yahoo" in full, and AsiaPundit provides the commentary:

                                                                                                        kristof on the 'gang of four', by Myrick, AsiaPundit: Via Peking Duck, who has helpfully republished an un-linkble New York Times item, Nicholas Kristof weighs in on the four best-known companies that are assisting in the censorship of the internet in China, who are now unfortunately being referred to as the 'Gang of Four.'

                                                                                                        Yahoo sold its soul and is a national disgrace. It is still dissembling, and nobody should touch Yahoo until it provides financially for the families of the three men (ed: Three!?! AsiaPundit was still counting two.) it helped lock up and establishes annual fellowships in their names to bring Web journalists to America on study programs.

                                                                                                        Microsoft has also been cowardly, but nothing like Yahoo. Microsoft responded to a Chinese request by recently shutting down the outspoken blog of Michael Anti (who now works for the New York Times Beijing bureau). Microsoft also censors sensitive words in the Chinese version of its blog-hosting software...

                                                                                                        Cisco sells equipment to China that is used to maintain censorship controls, but as far as I can tell similar equipment is widely available, including from Chinese companies like Huawei. Cisco also enthusiastically peddles its equipment to the Chinese police. In short, Cisco in China is a bit sleazy but nothing like Yahoo.

                                                                                                        GoolagGoogle strikes me as innocent of wrongdoing. True, Google has offered a censored version of its Chinese search engine... (and thus will not be slowed down by filters and other impediments that now make it unattractive to Chinese users). But Google also kept its unexpurgated (and thus frustratingly slow) Chinese-language search engine available, so in effect its decision gave Chinese Web users more choices rather than fewer.

                                                                                                        Kristof is very close to AsiaPundit's own thinking on this. Google's move into the China market has received the most attention - in no small part due to the "don't be evil" target it has tattooed on its forehead. But its actions were the least objectionable. In the context of moves by its predecessors, Google could even be seen as progressive. Google's main portal does not redirect to the censored China service and it is more transparent than anyone else in the market about the fact that it censors its China site. Google did not damage freedom of speech or information in China - all it did was damage its brand.

                                                                                                        While Yahoo may have been unaware of the implications of its co-operation with Chinese authorities, after Shi Tao and Li Zhi 'incidents' it can no longer defend itself by claiming ignorance. It can properly claim that it has no legal liability when future incidents occur due to Alibaba's ownership of its China operations. As distasteful as that may seem, that is as things should be. Opening a minority shareholder to legal actions would set a dangerous precedent. But morally, as Yahoo does have a 40 percent holding in Alibaba, in AsiaPundit's view Yahoo will be 40 percent complicit should journalists or dissidents be jailed in the future.

                                                                                                        Michael Anti, translation via ESWN, pens a critique of Congress and defense of Microsoft and Google. However, he does save some venom for Yahoo.:

                                                                                                        At the end of my statement, I must state once again that I have mentioned only Microsoft and Google as the American companies, but it is definitely not Yahoo! A company such as Yahoo! which gives up information is unforgivable. It would be for the good of the Chinese netizens if such a company could be shut down or get out of China forever.

                                                                                                        ...(UPDATE: Would China better off without the censored Google? For a hint read Google vs Baidu. AsiaPundit thinks 'Would Google be better off without China?' is a better question.)

                                                                                                          Posted by Mark Thoma on Sunday, February 19, 2006 at 10:29 AM in China, Economics, Technology

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                                                                                                          Are You a Digital Pirate?

                                                                                                          If you make backup copies of CDs or DVDs, you may be. The media companies may try to stop you from making backup copies of CDs or DVDs and from transferring music or other digital entertainment from, say, a CD to an iPod:

                                                                                                          Who Owns Your CD/DVD Collection? A Follow-Up, LA Times Golden State Blog, by Michael Hiltzik: Back in December, I wrote a column ... about the efforts of big media companies to tighten the rules on fair use of purchased entertainment, all in the ostensible name of combating piracy. The evil is getting deeper. The ever-vigilant Electronic Frontier Foundation has vacuumed up a recent regulatory filing by the Recording Industry Assn. of America and several other media industry lobbies complaining about the now-common practice of transferring your purchased CDs to your iPod (or any other mp3 player). The filing states that they've never considered this behavior to be permitted under fair use; the implication ... is that they wish to reserve the right to outlaw it.

                                                                                                          A close reading of the document reveals that the industry isn't any happier about its customers' making back-up copies of their CDs, DVDs, or books for private purposes. What about preserving purchased content against the chance that the original disc or book might get damaged, or for the convenience of traveling light? These uses are not "compelling," ... and shouldn't be afforded a blanket permission. ... This despite the fact that making back-up copies of material for personal consumption has always been treated as a fair use in the past.

                                                                                                          The filing ... was made in connection with a rulemaking procedure at the U.S. Copyright Office under the Digital Millennium Copyright Act. ... and should be watched closely...

                                                                                                            Posted by Mark Thoma on Sunday, February 19, 2006 at 02:31 AM in Economics, Market Failure

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                                                                                                            Egg-Head Hunting

                                                                                                            China is making some progress in attracting quality academics to its universities, but the pace of change is slow:

                                                                                                            China hunts abroad for academic talent, by Pallavi Aiyar, ...[China] has ... turned its attention to transforming its universities into world-class institutions. "Our government realizes the connection between a nation's overall power and the quality of its higher education," said Dr Weiying Zhang, assistant president of Peking University. ... Chinese universities backed by massive injections of governmental funding are spending billions of dollars to attract top foreign-educated and overseas-born Chinese, ... and developing new programs taught in the international lingua franca - English...

                                                                                                            Han Bing ... said [Beijing Normal University] hosts 30-40 scholars from leading Western universities annually. ... The positions are open to all nationalities, although cultural affinities and language requirements have meant that so far only ethnic Chinese have been recruited ... as full-time staff. ... At Peking University's Guanghua School of Management, ... full professors with PhDs from prestigious universities abroad can expect ... anywhere from $30,000 to $300,000 and up (depending on the ... prominence and seniority of the individual involved). This year the school recruited its first non-ethnic-Chinese faculty member, a Canadian national ... The ability to offer internationally competitive salaries is key to attracting quality academics, said Zhang. ...

                                                                                                            As a result of its improved pay scales, the Guanghua school currently boasts some 50 "returned scholars" ... and more than half of the faculty hold foreign PhDs. ... In fact several ... research institutes at China's better universities have a minimum requirement of a foreign PhD for faculty members. ...[A]t Peking University..., Professor Feng Lu, recalled the Herculean efforts required to persuade quality academics to return to China a decade ago. In contrast, he said, there are now more than 50 applications for every vacancy advertised at the center. Examples of world-renowned academics choosing China as their new home abound. ... "For a world-class university, it's necessary to attract the best students and faculty internationally. ... we don't just want the best Chinese ..., but the best from around the world," said Zhang. ...

                                                                                                            For him, one of the most significant reforms pioneered at Peking University ... [is that since] 2003, professors ... are no longer promoted on the basis of seniority but with an eye to their research and publication records. If a new lecturer cannot make it to associate professor within six years, he or she is asked to leave. "This was the only way to change the orientation of our faculty towards academic research," explained Zhang.

                                                                                                            The combined results of these efforts are already paying off. Despite the common perception that Indian higher education, with such renowned institutions as the Indian Institute of Technology and the Indian Institute of Management, is superior to its Chinese counterpart, China's universities in fact beat India's in almost every international ranking. ...

                                                                                                            However, China still has a considerable distance to go before its aspirations to create truly world-class universities become a reality. According to the SJTU rankings, the United States had more than 50 universities in the top 100, compared with zero for China. ... Thus, despite having the funds available to make the cream of international academia fairly lucrative offers, even China's leading universities have so far only been able to recruit China-born or ethnic-Chinese scholars in any significant numbers. "We have been able to improve our hardware considerably," said BNU's Han. "But as is always the case in China, the software takes longer."

                                                                                                              Posted by Mark Thoma on Sunday, February 19, 2006 at 02:03 AM in China, Economics, Universities

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                                                                                                              Reviewing the Evidence on Health Savings Accounts

                                                                                                              Claims that HSAs do not disproportionately attract healthy and high-income individuals, and that they will reduce the number of uninsured appear to rely on a selective interpretation of the available evidence. How surprising to find that the administration would shade the evidence to support its case:

                                                                                                              Administration Defense Of Health Savings Accounts Rests On Misleading Use Of Statistics, by Edwin Park and Robert Greenstein , CBPP: To encourage wider use of Health Savings Accounts (HSAs), ... the Administration is proposing significant new HSA-related tax breaks that it estimates would cost $156 billion over ten years. Several important concerns have been raised about HSAs: most notably, that they are most attractive to people who are in better health and have higher incomes and that they would undermine employer-sponsored health coverage. In recent days, Administration officials, including the President, have argued that these concerns are belied by actual experience with HSAs over the past two years. This analysis examines the claims made by these officials ... and explains that they rest on the misleading use of statistics.

                                                                                                              Claim #1: HSAs are not disproportionately attractive to high-income households. Allan Hubbard, director of the White House’s National Economic Council, stated at a press briefing on February 1 that 40 percent of HSA enrollees have incomes below $50,000. Treasury Secretary Snow repeated this statement at a Senate Finance Committee hearing... and President Bush repeated it in a speech in Ohio... But they did not fully or accurately represent the data.

                                                                                                              First, data are available from three recent surveys of HSA enrollees. ... Mr. Hubbard and Secretary Snow ignored the two surveys with the lower figures and presented the 40 percent figure (from a survey by an online insurance broker) as though it were the only one available. Second, and more important, the survey cited by Hubbard and Snow was restricted to HSA enrollees in the individual health insurance market, who tend to have lower incomes than HSA enrollees who have employer-based coverage. Excluding the latter group makes HSA enrollees appear to have lower incomes than is actually the case. ...

                                                                                                              In addition, the survey cited by Hubbard, Snow, and the President may suggest the opposite of what they claim. ...[A] disproportionate proportion of HSA enrollees do, in fact, have higher incomes. ... other HSA data indicate this is the case. ... There can be no question that the tax benefits of HSAs are tilted toward high-income households ... Also, high-income households can afford to contribute much larger amounts to HSAs than people of more limited means. (For example, only higher-income households generally would be able to take full advantage of the President’s proposal to raise the annual HSA contribution limit to $5,250 for individuals and $10,500 for couples.) Moreover, for affluent individuals who do not expect to incur significant health-care costs, HSAs provide unprecedented tax-sheltering opportunities: they are the only savings accounts that feature both tax-deductible deposits and tax-free withdrawals. ...

                                                                                                              Claim #2: HSAs help reduce the number of uninsured Americans. Mr. Hubbard also said ... that 37 percent of people with HSAs were previously uninsured. Several days later, in a congressional hearing, Secretary of Health and Human Services Michael Levitt rounded this figure up to 40 percent. Here, too, Administration officials ignored the results from other surveys that found a smaller percentage of HSA users were previously uninsured. ... In any event, the statistic that 37 percent of HSA enrollees were previously uninsured ... is from data that are limited to HSA enrollees in the individual insurance market. ... A survey of people who have purchased any type of policy in the individual market would show that many of them had previously been uninsured. ... In fact, a Blue Cross/Blue Shield study that covered both employer-based coverage and the individual market found that only 12 percent of individuals who purchase high-deductible plans that qualify for a HSA previously were uninsured.

                                                                                                              More importantly, while the availability of HSAs ... should enable some uninsured people to afford coverage, the Administration’s proposals also would induce some employers — especially small-business owners — to drop coverage (or not to offer it in the first place), since the proposals would eliminate all of the tax advantages that employer-based insurance now has ... That would expand the ranks of the uninsured... If more people lost coverage (because their employer ceased to offer it) than gained coverage (because of the new tax breaks), the net effect would be to increase the ranks of the uninsured. The 37-percent statistic cited by the White House sheds no light on the question ... But a new study by M.I.T. economist Jon Gruber ... estimates that the President’s proposals would cause a net increase in the uninsured population of 600,000 people. ...

                                                                                                              Claim #3: HSAs are not disproportionately attractive to healthy individuals. On this issue, the Administration officials cited above have been silent. But some HSA proponents outside the Administration have cited a national Blue Cross/Blue Shield survey ... as showing that HSAs do not disproportionately attract healthier people. ... The Blue Cross/Blue Shield survey did not use control groups or employ other standard statistical methodologies to ensure it could obtain an unbiased answer ... Past studies have consistently found that plans with higher deductibles tend to attract a disproportionate number of healthier people. ... Preliminary studies indicate that this seems to be occurring with high-deductible policies tied to HSAs...

                                                                                                              Posted by Mark Thoma on Sunday, February 19, 2006 at 01:24 AM in Environment, Health Care

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                                                                                                              Accounting for Tax Cuts

                                                                                                              Creative accounting in the administration's budget proposal:

                                                                                                              Trillion-Dollar Gimmick Extending Bush's Tax Cuts Through Sleight of Hand, by David S. Broder, Washington Post: ...The latest ... is ... the Case of the Disappearing Trillion. The tip-off arrived last week in an e-mail from the Center on Budget and Policy Priorities. It is a Washington research organization with a distinctly liberal point of view but a deserved reputation for accuracy in its figures. In this case, the information the center cites ... involves the treatment in the budget of the Bush tax cuts passed by Congress in 2001 and 2003.

                                                                                                              Those rate reductions, when enacted, had expiration dates of 2010... The president is urging Congress to make those tax cuts permanent, but his proposal is controversial and has not yet passed. This year, however, the budget the president submitted ... simply assumes that the tax cuts have been made permanent -- and thus includes them in the "baseline" for all future years.

                                                                                                              The effect, according to the center's analysis, is that "legislation to make these tax cuts permanent will be scored as having no cost whatsoever." In fact, this analysis says, "The administration's proposal ... would ensure that the cost of continuing the tax cuts ... would never be counted. ... To fail ever to count the cost of the tax cuts ... would represent one of the largest and most flagrant budget gimmicks in recent memory." How large? The Congressional Budget Office scores the cost of making these tax cuts permanent at $1.6 trillion over the next decade. The administration's estimate is somewhat less -- $1.35 trillion.

                                                                                                              But, the folks at the OMB told me, it's wrong to claim that they are hiding that cost. They told me ... the ... $1.35 trillion. ... [is] assumed in the baseline... Those last four words conceal more than a trillion dollars worth of lost revenue. But that is not all, my OMB friends argued. If you turn to ... volume called Analytical Perspectives, ... you will also find acknowledgment of the change in the bookkeeping. ...

                                                                                                              In fact, it turns out that Bush tried to get Congress to go along with this bookkeeping switch back in 2004, actually submitting legislation to authorize the change. The House refused to accept it. He put it back in his budget last year, with the same result. But this year he's back again, with more urgency, as he presses the case to make these tax cuts permanent. Now that you know exactly how easy it is to find this all explained in the budget, I'm sure you are as reassured as I am about the candor of this administration.

                                                                                                              Here's the CBPP Report. In addition to a lot more detail on this issue, at the end of the report data are presented showing that recent tax cuts have caused a loss in tax revenue.

                                                                                                                Posted by Mark Thoma on Sunday, February 19, 2006 at 12:40 AM in Budget Deficit, Economics, Politics, Taxes

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                                                                                                                February 18, 2006

                                                                                                                The 11th Article of the Treaty of Tripoli

                                                                                                                It’s the weekend, so I’m going to venture a bit beyond the usual posts about economics in this and the post below it. I’m hoping the vast knowledge that is blogland can help me with this. I came across this quote about a year ago, but I haven’t been able to place it in its proper historical context and because of that, I don’t know what to make of it.

                                                                                                                When George Washington tells us this country was not based upon Christianity, how should we interpret those words? The 11th Article of the Treaty of Tripoli, signed by George Washington in 1796, and later signed by President John Adams after ratification by the Senate, states:

                                                                                                                As the government of the United States of America is not in any sense founded on the Christian Religion—as it has in itself no character of enmity against the laws, religion or tranquility of Muslims, and as the said States never have entered into any war or act of hostility against any Muslim nation, it is declared by the parties that no pretext arising from religious opinions shall ever produce an interruption of the harmony existing between the two countries.

                                                                                                                It is my understanding that since a large number of the founders were Deists, understanding the difference between Christianity and Deism is a start to placing this in context. Deism originated as a rejection of orthodox Christianity, and in the late 18th century Deism was accepted by many upper-class Americans, including the first three U.S. presidents. For example, when the Declaration of Independence mentions “the Laws of Nature and of Nature's God,” this is likely a Deist, not a Christian idea of God, though I’m guessing there are those who will disagree. My question is simple. What is the correct interpretation of this statement?

                                                                                                                Wikipedia has a bit more:

                                                                                                                The Treaty is notable for Article 11... Article 11 has been a point of contention regarding the proper interpretation of the doctrine of separation of church and state. It is generally considered as confirmation that the government of the United States was specifically intended to be religiously neutral. The United States Constitution specifically states that treaties with foreign powers have the force of law.

                                                                                                                In 1930, it was discovered that the existent original Arabic version of Article was gibberish and that the original Article 11 was not an article at all, but a letter from the Dey of Algiers to the Pasha of Tripoli. Nevertheless, Joel Barlow's English "translation" of Article 11, as recorded in the certified copy of January 4, 1797, is contained in the version of the treaty that was approved by President John Adams and Secretary of State Timothy Pickering and ratified by the Senate.

                                                                                                                There exists an additional certified copy of the original Arabic Treaty made by James Cathcart. This copy confirms that Article 11 was not a part of the Arabic original, but was for some reason revised in the English translation that was ultimately ratified. The Treaty was broken in 1801 by the Pasha of Tripoli and renegotiated in 1805 after the First Barbary War, at which time Article 11 was removed.

                                                                                                                The significance of this article that is often overlooked or ignored is that it stated categorically that the United States of America is not founded upon the Christian religion, and that this treaty, with that statement intact, was read before and passed unanimously by the United States Senate, and was signed by the President of the United States without a hint of controversy or discord, and remains the earliest and most definitive statement from the United States Senate and the President of the United States, on the secular nature of American government.

                                                                                                                  Posted by Mark Thoma on Saturday, February 18, 2006 at 11:16 AM in Economics, Miscellaneous

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                                                                                                                  "At Least You Never Shot Anybody"

                                                                                                                  An interview with Michael Brown, former head of FEMA:

                                                                                                                  A Conversation With Michael Brown, 'Taking Me Out Didn't Solve the Problems', Sunday Outlook, Washington Post Online: ...

                                                                                                                  What don't people know about you? You've become a cartoon character. Yeah, thanks.

                                                                                                                  Seriously, what don't people know about Mike Brown? I've become a caricature: I'm disengaged, I don't care, I'm a crony. All three of them are wrong. I care deeply. I worked hard. . . . I have a very strong belief about emergency management in this country and how it should work. I think my big mistake was staying inside and fighting it too long.

                                                                                                                  You're talking about your turf battles within the Department of Homeland Security. You think you should've left earlier. Frankly, I should've given up. In hindsight, there were points where I knew I was losing the battle...

                                                                                                                  I read your hearing transcript, and you're probably the first person in the history of Washington to admit you're an infighter. Nobody in Washington's an infighter, right? Right! Well, I was an infighter; I tried to fight battles within the system. I don't think people outside the Beltway grasp how scripted this town is. People don't tell the truth; people feel boxed in so they can't tell the truth; people get dismissed for telling the truth. . . . I don't think people who live in Washington believe the American people can handle the truth, and I think they can.

                                                                                                                  So let's give them the truth. Who's been loyal, and who's stabbed you in the back? Loyal? Friends, people inside and outside the administration. ... I'll run into members of the administration at the dry cleaners, or at a restaurant or something, and they've been very supportive, saying they feel badly about how I've been scapegoated...

                                                                                                                  At the hearing, [Minnesota Sen.] Norm Coleman really went after you. Do you feel bitter about that? I liken what Norm Coleman did to a drive-by shooting. It doesn't take a lot of manhood to walk into a hearing room and attack me, then when I asked him to point to specifics, to conveniently turn around and say: I have another meeting to go to and walk out. That's what gives American politics a bad name.

                                                                                                                  Can you name some of people who have been so supportive? Hmm. Well. Here I am complaining about people not telling the truth, but if they work in the administration, I hate to say their names. I don't want them to have recriminations because they've been supportive of me...

                                                                                                                  When this started, Democrats were calling for your head, and Republicans said: Everything's going fine. But the second you were gone, Democrats ... said you were being scapegoated, and Republicans started trying to blame everything on you. Did that teach you anything about Washington? ... It gets back to the whole lack of personal responsibility in Washington. I've said that yes, I made some mistakes in the response. And I made some mistakes in how I tried to shape the culture of DHS. But a lot of this has to do with the '06 and '08 elections, and the American public gets turned off by it...

                                                                                                                  Can your wife laugh about it? When you take out the garbage, does she say: Brownie, you're doing a heckuva job? It must be hard for her. It is hard for her. Some days she can laugh about it. Some days she gets very angry. She's a school counselor, so she knows how to deal with it. She's very good about throwing The Washington Post in the trash and turning off the television.

                                                                                                                  You know, you talked about how people can't handle the truth. When you first testified before Congress, you trashed the mayor and the governor. But when you came back and testified..., you trashed DHS. The first time, did you tell the truth? I think there's an important distinction to make. In the first hearing, I told the truth about the problems at the state and local level. In the second hearing, I told the truth about the problems at the federal level. In the first hearing, I was constrained, I was still working for the administration...

                                                                                                                  But you've been cast aside by the administration, and the decision came from the top. Do you feel betrayed? I don't think I've been betrayed. We had to do something. The quickest thing to do was move Brown out of there. ... I understand that.

                                                                                                                  There's now an effort to blame you. Brown was the problem; we got rid of Brown. If people think I alone was the problem, all they have to do is look at the memos I wrote, the continuing problems FEMA has with housing, the continuing problems FEMA has with financial matters, all issues we were aware of and were trying to fix. Taking me out didn't solve the problems.

                                                                                                                  You wrote memos saying that FEMA's falling apart. You said there's going to be a disaster and we're not going to be ready. Did you think you'd end up the scapegoat? That's why I made the decision to leave in the summer of '05. The mistake was that I didn't make the decision sooner. I predicted this thing, and lo and behold, it happened. I get no pleasure from being able to say I was right...

                                                                                                                  What about Homeland Security Secretary Michael Chertoff? He's dumping things on you. I expect him to dump things on me. That's the way this town works. I'm very disappointed. ... I'm not sure it's the right thing to do, but it's the task he's been given.

                                                                                                                  This all must have been a surreal experience for you. It's been totally surreal. I came to Washington to try to do a good job and serve the president. Now I see people staring at me in airports...

                                                                                                                  At least you never shot anybody. I've shot a lot of quail in my life, but I've never shot anybody.

                                                                                                                  [From The Economist, "Ready, fire, aim"]

                                                                                                                    Posted by Mark Thoma on Saturday, February 18, 2006 at 09:59 AM in Economics, Politics

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                                                                                                                    National Update from the Dallas Fed

                                                                                                                    The Dallas Fed paints a rosy picture of the U.S. economy in their National Update. This graph is from the analysis of the 4th quarter slowdown:

                                                                                                                    For an analysis of Friday's release of producer price and household inflation expectations, see Michael Bryan's post at macroblog.

                                                                                                                      Posted by Mark Thoma on Saturday, February 18, 2006 at 12:33 AM in Economics, Monetary Policy

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                                                                                                                      "Pro-Poor and Pro-Growth" Policy in Latin America

                                                                                                                      Will the World Bank adopt a new approach to poverty and economic growth in Latin America?:

                                                                                                                      A New Path on Latin Poverty?, by Marcela Sanchez, Commentary, Washington Post Online: The World Bank announced this week that Latin America needs to cut poverty to boost growth -- a conclusion that may be stating the obvious. But this is a big deal for the international lending institution. Since its inception, the bank has talked about reducing poverty. But for more than 15 years it has focused on market reform policies, offering loans to countries that promised to lift trade barriers, deregulate and privatize industry, and adopt austerity plans to stop deficit spending and reduce inflation. These reforms, which became known as the Washington Consensus, were supposed to unleash the economic potential of developing countries and spur growth. Growth, in turn, was to create opportunity for the destitute and lift them out of poverty.

                                                                                                                      Many Latin American countries took the loans and adopted the reforms, but they did not have the intended consequences. Latin America's performance has been disappointing, particularly in comparison with the dynamic economic growth and poverty reduction in Asian countries. The region now has "the highest measures of inequality in the world ... according to the World Bank. The authors of the World Bank report ... recognize that ... poverty can be a huge drag on ... growth. ... As the authors quantify it, when poverty levels increase by 10 percent, growth decreases by 1 percent and investment is reduced by up to 8 percent of a country's gross domestic product.

                                                                                                                      Two of their main conclusions are a breakthrough for the bank: that private-sector growth is not a panacea for the poor and that inequality must be targeted directly. A third conclusion is almost heretical for the bank: that the state needs to take on more responsibility rather than less. "Converting the state into an agent that promotes equality of opportunities and practices efficient redistribution is, perhaps, the most critical challenge Latin America faces in implementing better policies that simultaneously stimulate growth and reduce inequality and poverty," the report says.

                                                                                                                      By advocating state responsibility, particularly for redistribution of wealth, the World Bank seems to be bringing itself into greater alignment with other multilateral institutions and governments in the region. Jose Antonio Ocampo, U.N. undersecretary general for economic and social affairs, said ... "today the majority [of leaders in Latin America] recognize that the state has a function more important than ever in confronting the issue of inequality."

                                                                                                                      The great surge to the left in recent Latin American elections can be seen in this light. ... The authors of the World Bank report point out that there are specific "intervention" programs already in place in Brazil, Colombia and Mexico that manage to be "both pro-poor and pro-growth." These programs provide cash to very poor families on the condition that their children stay in school and that they take steps to improve their health. Rather than creating dependency or increasing birthrates, as some critics feared, the programs have "successfully increased human capital" in high-poverty regions.

                                                                                                                      Whether the World Bank will back up its new thinking with a change in process remains to be seen. After all, the report is not a repudiation of the Washington Consensus but simply an admission that it has been insufficient. ... If the World Bank were to make poverty reductions measures a condition for assistance, that would be a big change in the way it helps Latin America. It would be shifting from an approach that helped weaken governments to one that seeks to strengthen them.

                                                                                                                        Posted by Mark Thoma on Saturday, February 18, 2006 at 12:23 AM in Economics, Income Distribution

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                                                                                                                        High Household Saving in China

                                                                                                                        In China, factors such as underdeveloped financial markets and fear of large future expenditures due to both economic insecurity and expected inflation cause households to accumulate large savings balances:

                                                                                                                        High prices are eroding consumer confidence, by Zhang Shunyi, Shanghai Daily: Mounting household savings in China's banks is not necessarily the good thing it seems. According to the People's Bank of China, domestic individual bank deposits... hit 14 trillion yuan (US$1.72 trillion) by the end of 2005. The record-breaking amount of deposits indicates that the Chinese people are much wealthier on the whole. However, rapid accumulation of deposits also shows that people are reluctant to spend as the consumption rate has been on the decline for five consecutive years...

                                                                                                                        Last year, loans issued by China's banks only accounted for 53 percent of the total money they collected. Part of the other 47 percent was stored in the PBOC as the excess reserve. To make a comparison, loans took up 91 percent of the total a decade ago... Basically, there are two ways to deal with the problem of excessive household savings. One is to further encourage consumer spending thus reduce the deposits. The other, as was mentioned above, is to find more channels, which are profitable and safe, to digest the deposits. Easier said than done.

                                                                                                                        Both of these two measures require fundamental adjustments in the system of social and banking mechanism. The importance of results brought by these changes can never be understated - it links directly with economic stability. Why are people reluctant to spend? Chinese people are well-known for the habit of hoarding up valuable things. But under the current climate, worry about high prices is perhaps the most cited reason.

                                                                                                                        "What many people see is the rising price of seeing a doctor or studying in a good school. That makes them feel less safe," said Sun Lijian, a professor at Fudan University's School of Economics. According to a recent survey from Horizon Research, expensive medical services and changes in the pension scheme are listed among the top concerns that trouble Chinese people. If people lose their job, suddenly become ill, want to buy an apartment or hope to deliver better education to their kids, they have to splash out a great deal of money on those things.

                                                                                                                        The housing price provides a case in point. Even in second-tier cities such as Hangzhou, Wenzhou or Ningbo, people have to save their disposable income for 27 years to buy an 80-square-meter apartment on average. And compared with 1999, the cost of fees for a college student has jumped from 51,000 yuan to 131,000 yuan...

                                                                                                                        Reducing interest rates to induce people to spend money is difficult. "The PBOC is very prudent about making any more changes to the interest rate. It is nearly impossible to reduce the rate when it already stands at such low a level," said Wu. Perhaps the most important thing to do is to give people confidence about their basic life.

                                                                                                                        In addition to the measures to enhance economic security, it is also important to develop the financial services industry so that it doesn't take decades of saving to, for example, buy an apartment. In order to reduce its dependence on exports and aid in global rebalancing, China must increase domestic consumption. The "fundamental adjustments in the system of social and banking mechanism" won't happen overnight supporting Bernanke's view that it could be as long as ten years before imbalances are resolved.

                                                                                                                          Posted by Mark Thoma on Saturday, February 18, 2006 at 12:15 AM in China, Economics, Saving

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                                                                                                                          February 17, 2006

                                                                                                                          Tax Breaks for Oil Companies

                                                                                                                          The Chicago Sun Times is not happy about welfare payments to oil companies:

                                                                                                                          Now's a curious time to be dishing out oil welfare, Editorial, Chicago Sun Times: The U.S. government over the next five years will give a windfall of $7 billion to oil companies -- yes, the same oil companies that reported record profits last year. But wait, it gets worse: If one oil company that is suing the government succeeds, that windfall could hit nearly $35 billion. Oh, and one more thing: There appears to be little anyone can do about it. Think about that the next time you pay a small fortune to fill your tank.

                                                                                                                          There is nothing illegal about the program... In fact, some folks might argue its goals were laudable 10 years ago, when the federal government with bipartisan support tried to encourage oil companies to drill in the deep waters of the Gulf of Mexico by promising to forgo the normal 12 percent or 16 percent royalty payments on leases there. Oil and gas prices were relatively low at the time, and it was deemed too financially risky for oil companies to invest in deep water drilling without the incentive. But isn't taking risks in hopes of gaining future profits what the market is all about? This was a bad idea from the start. ...

                                                                                                                          Many companies stopped claiming relief when oil and gas prices rose above certain trigger points built into the leases -- about $35 per barrel for oil. But those price triggers were waived in leases signed in 1998 and 1999 because companies still weren't investing ... and those leases will account for most of the $7 billion windfall. And several companies are challenging whether the Interior Department had the authority to include those price triggers in the first place. ...

                                                                                                                          While some lawmakers said they will try to undo the terms of leases that are in some cases 10 years old, they will probably fail. ... While we don't favor a new tax on the oil companies' record profits, those firms aren't doing themselves any favors by refusing to pay royalties while they're rolling in the dough. They might find it hard to win incentives the next time their industry is in a slump. We can hope so. The oil industry can make plenty of money without the benefit of corporate welfare.

                                                                                                                          I don't know much about the challenges to the price triggers, but on the $7 billion I am not quite as shrill. This isn't what I think of as welfare, this was an attempt to use incentives to encourage more investment by oil companies. The debate on whether incentives should be offered in the first place aside, if profits are dangled in front of firms as an incentive to encourage investment or other behavior, then it undermines the policy the next time you try to use it if you take the profits away from the firms that act on the incentive because they are excessive by some definition. If excess profits are a worry, then write the policy to cap or limit profits up front (or in this case leave them in place) so that firms know the true reward for investment, don't take the profits away or use the profits as political weapons after the fact.

                                                                                                                            Posted by Mark Thoma on Friday, February 17, 2006 at 04:42 PM in Economics, Oil, Regulation, Taxes

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                                                                                                                            "I'm too ugly to get a job"

                                                                                                                            Crime is ugly. Does society's treatment of the less attractive make them more likely to commit crimes?:

                                                                                                                            The Ugly Face of Crime, by Richard Morin, Commentary, Washington Post Online:

                                                                                                                            "I'm too ugly to get a job." -- Daniel Gallagher, a Miami bank robber, after police captured him in 2003

                                                                                                                            ...Not only are physically unattractive teenagers likely to be stay-at-homes on prom night, they're also more likely to grow up to be criminals, say two economists... "We find that unattractive individuals commit more crime in comparison to average-looking ones, and very attractive individuals commit less crime in comparison to those who are average-looking," claim Naci Mocan of the University of Colorado and Erdal Tekin of Georgia State University... Cute guys were uniformly less likely than averages would indicate to have committed seven crimes including burglary and selling drugs, while the unhandsome were consistently more likely to have broken the law... controlling for ... characteristics known to be associated with criminal behavior.

                                                                                                                            Mocan and Tekin aren't sure why criminals tend to be ugly. Other studies have shown that unattractive men and women are less likely to be hired, and that they earn less money, than the better-looking. Such inferior circumstances may steer some to crime, Mocan and Tekin suggest. They also report that more attractive students have better grades and more polished social skills, which means they graduate with a greater chance of staying out of trouble.

                                                                                                                            [Suggested by Tim Duy.]

                                                                                                                              Posted by Mark Thoma on Friday, February 17, 2006 at 09:41 AM in Economics

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                                                                                                                              I Feel Your Pain Senator

                                                                                                                              Bernanke expresses sympathy with senators frustrated over China's currency policy, then tries to convince them that legislation imposing tariffs on Chinese goods "is not a good idea":

                                                                                                                              Bernanke Breaks With Greenspan, Sympathizes With China Critics, Bloomberg: Lawmakers frustrated over China's trade policies got something from Federal Reserve Chairman Ben S. Bernanke they seldom received from predecessor Alan Greenspan: sympathy. Bernanke told the Senate Banking Committee yesterday that he appreciates the ''frustration'' of legislators trying to push China into allowing greater fluctuations in its currency. In response to a question from Democrat Charles Schumer, who is seeking tariffs against Chinese goods entering the U.S., he said China may be delaying change partly to benefit its exporters.

                                                                                                                              ''It is important to make sure that trade that takes place is done on a fair and open basis,'' Bernanke told the House Financial Services Committee ... China should ''respect our intellectual property so that we receive the appropriate compensation.'' That's the sort of language lawmakers seldom heard from Greenspan, who had a consistent message during his tenure: Unfettered capitalism and trade are good ..., and policy makers need patience while China adopts a market-based currency.

                                                                                                                              Bernanke's different line ''was a really interesting nuance,'' said Jared Bernstein, senior economist at the Economic Policy Institute, a Washington think-tank partially funded by labor groups. While Bernanke ''is a dyed-in-the-wool free trader, he recognizes that some folks are not playing as fair as they ought to be,'' Bernstein said. ...' Bernanke ''is quite sensitive to the idea that when you open a market to free trade, yes, the pie gets bigger, but that doesn't mean everybody gets a bigger slice,'' said Robert H. Frank, an economist at Cornell University...

                                                                                                                              Bernanke spoke out on protectionism, saying at the Senate hearing that ''it is not a good idea to break down some of the gains we've made in terms of free and open trade.'' On China's currency policy, Bernanke was blunt about the need for change. ''China ought to move toward a more flexible exchange rate,'' he told Schumer, a New York Democrat. ''He was very direct,'' Schumer said in an e-mail in response to questions. ''When I asked him about China, he said he was frustrated, too.'' ...

                                                                                                                                Posted by Mark Thoma on Friday, February 17, 2006 at 01:35 AM in Economics, International Trade, Monetary Policy, Regulation

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                                                                                                                                Prices in the Waiting Room

                                                                                                                                A call to make health care prices public to allow increased competition in medical care. Blue light special on cardiac surgery in operating room eight!:

                                                                                                                                Doctors: Post Your Prices, by Scott W. Atlas, WSJ Online: If a goal of health-care reform is to empower the patient, why is there such a mystery about medical prices? ... In our current system, few patients are aware of the costs of their medical care, generally because patients have no reason to ask since it is paid for by third-party insurance programs. This has allowed hospitals and doctors to avoid public view. Patients, however, would greatly benefit if the government required that prices be posted for common medical procedures before the care is administered... When prices are openly stated and widely known, competition will ensue and prices will come down ... This would allow the price mechanism to function again. ...

                                                                                                                                I propose we start with the 10 to 20 most common procedures in both outpatient and inpatient medicine, such as MRI scans, a surgeon's bill for rotator cuff repair, or an anesthesiologist's bill for a cardiac surgery procedure. Procedure-based prices are more appropriate, because diagnosis-based prices would likely be too complicated to calculate and contain too many variables...

                                                                                                                                How would the price data be posted? The patient needs to know upfront, not after the fact. One way would be at the time when patients are handed the "medical information materials," such as brochures describing procedures and consent forms. Another way is to post them in the clinic offices and hospital admitting rooms. A third would be to put them on the Internet.

                                                                                                                                The idea of informed consumers knowing prices and controlling their health-care dollar is an extremely powerful one. And in those few cases where patients have had to pay for procedures out-of-pocket, and have had information about price -- for example, whole-body CT screening -- the cost did indeed come down, rapidly and dramatically. The price of whole-body CT procedures declined by more than 75% in a few years!

                                                                                                                                Ultimately, no commodity, no service industry, sells to consumers without openly disclosing prices. Doctors and hospitals might be forced to rethink their prices if they knew those prices would become part of the public domain. There should be no mystery to patients about what their own health care will cost.

                                                                                                                                It's difficult to argue with the premise that patients should be fully informed of the cost of medical care before treatment takes place if that is possible. Though this could help with simple routine care that is easy to compare across providers, what I care about most is quality. I would pay more if I was certain my physician had superior skill.

                                                                                                                                Health care markets lack an essential ingredient to make them fully competitive. Information on physician quality, treatment risks, and other aspects of care such as potential substitute treatments is not fully available. Because price is an imperfect signal of quality, there's some doubt about how well the price mechanism lauded in the article would function. For instance, individual doctors have considerable market power once trust is established and a doctor-patient relationship develops. Imperfect knowledge about quality of alternative physicians and treatments makes patients reluctant to switch providers simply to save a few bucks.

                                                                                                                                  Posted by Mark Thoma on Friday, February 17, 2006 at 01:11 AM in Economics, Health Care

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                                                                                                                                  More Competition for U.S. Automakers?

                                                                                                                                  It doesn't seem like it would be cheaper to move an entire engine plant over 8,000 miles from Brazil to China rather than to build a new one, but apparently it is. It's not going to get any easier for struggling U.S. automakers:

                                                                                                                                  China Seeking Auto Industry, Piece by Piece, by Keith Bradsher, NY Times: China is pursuing a novel way to catapult its automaking into a global force: buy one of the world's most sophisticated engine plants, take it apart, piece by piece, transport it halfway around the globe and put it back together again at home. .. [A] major Chinese company, hand-in-hand with the Communist Party, is bidding to buy ... a car engine plant in Brazil. Because the plant is so sophisticated, it is far more feasible for the Chinese carmaker, the Lifan Group, to go through such an effort to move it 8,300 miles, rather than to develop its own technology in this industrial hub in western China...

                                                                                                                                  If the purchase succeeds — and it is early in the process — China could leapfrog competitors like South Korea to catch up with Japan, Germany and the United States in selling some of the most fuel-efficient yet comfortable cars on the market, like the Honda Civic or the Toyota Corolla. ... Lifan says it is the sole bidder for the factory and wants to ... start producing engines in 2008.

                                                                                                                                  Though China's Communist Party is actively behind the effort, the bold moves are being driven by one of China's remarkable entrepreneurs: Yin Mingshan has become one of China's most successful and most politically connected corporate executives, with a hardscrabble upbringing that included spending 22 years of his earlier life in Communist labor camps and prison as punishment for his political dissent.

                                                                                                                                  Now the enormously wealthy ... and principal owner of Lifan, Mr. Yin has his sights on exporting to Europe in 2008 and the American market in 2009. ... Mr. Yin said he wanted to rebuild the factory on vacant land next door to his car assembly plant here. His goal is to understand the technology thoroughly so that he can supply engines not only for Lifan but also for other Chinese automakers. ... Any attempt to buy a comparable factory in the United States might be blocked. But Mr. Yin said that Brazil did not have comparable restrictions on the export of high technology. ...

                                                                                                                                  [S]everal more years of work is needed before the company is ready to compete in industrialized countries, Mr. Yin said. "Chairman Mao taught us: if you can win then fight the war, if you cannot win, then run away," he said. "I want to train my army in these smaller markets, and when we are ready, we will move on to bigger markets." .... Mr. Yin has no doubts that China can also compete with the United States. "Americans work 5 days a week, we in China work 7 days," he said. "Americans work 8 hours a day, and we work 16 hours."

                                                                                                                                  Update: Here's a chart from the Financial Times from an article on the rise of competition from Asian automakers:

                                                                                                                                    Posted by Mark Thoma on Friday, February 17, 2006 at 12:22 AM in China, Economics

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                                                                                                                                    William Poole on Inflation Targeting

                                                                                                                                    William Poole discusses inflation targeting. It's fairly long and is here. The key point is that he strongly supports an explicit inflation target. He also states his hawkish stance on inflation and says that properly measured, he favors zero inflation as a target, a statement that translates into a .5 to 1.5 range for measured long-term inflation. If you are interested in this topic, this is a fairly thorough treatment of the subject.

                                                                                                                                      Posted by Mark Thoma on Friday, February 17, 2006 at 12:08 AM in Economics, Fed Speeches, Inflation, Monetary Policy

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                                                                                                                                      A Rising Tide Lifts All Boats?

                                                                                                                                      The ice mass is melting twice as fast as previously believed.

                                                                                                                                        Posted by Mark Thoma on Friday, February 17, 2006 at 12:06 AM in Environment, Science

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                                                                                                                                        February 16, 2006

                                                                                                                                        Just Say No to Farm Subsidy Cuts in an Election Year

                                                                                                                                        Is anyone surprised?:

                                                                                                                                        It's Bipartisan: Hands Off Farm Subsidies!, by David Wessel and Scott Kilman, WSJ Washington Wire: The chairman and top Democrat on the House Agriculture Committee urged the House Budget Committee to ignore President Bush's money-saving proposals for farm programs this year. "We see no reason to make…changes in the last year of the 2002 farm bill -- especially as we just reduced funding for a number of non-dairy agriculture programs" by $2.7 billion, net, over five years. "This year is not an appropriate time to reduce the farm income safety net even more," Chairman Bob Goodlatte (R., Va.) and ranking minority member Collin Peterson (D., Minn.) wrote in a letter to the House Budget Committee, noting that farm income is down. ... Farm-state legislators complained about similar White House proposals last year when farm income was much higher. Goodlatte and Peterson vowed to scrutinize farm programs in 2007, when the farm bill comes up for reauthorization.

                                                                                                                                        The GOP along is worried about the farm income safety net? Fine, but what about the auto worker income safety net? Or, the globalization safety net? Will the budget axe fall on other social programs instead? Seems like the politicians who need votes in the next election safety net takes precedence here, like usual.

                                                                                                                                          Posted by Mark Thoma on Thursday, February 16, 2006 at 03:49 PM in Economics, Politics, Taxes

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                                                                                                                                          Kroszner, Warsh, Lazear Approved, Bernanke Testifies for Second Day

                                                                                                                                          Bernanke testifies for a second day and continues to establish his willingness to fight inflation, the nominations of Kevin M. Warsh and Randall S. Kroszner to the Federal Reserve Board of Governors are both approved unanimously, and Edward Lazear's nomination to the White House Council of Economic Advisers is also approved unanimously [Update: Bernanke comments on the trade deficit and WSJ Law Blog comments on Warsh have been added] :

                                                                                                                                          Bernanke Says Demand Could Fan Prices, Rates, WSJ: Federal Reserve Chairman Ben Bernanke said Thursday that while "substantial progress' has been made in removing policy accommodation, robust demand could lead to upward price pressures and higher interest rates. Mr. Bernanke was upbeat about the prospects for the U.S. economy...

                                                                                                                                          While "the news has been good" that long-term inflation expectations appear "well anchored," Mr. Bernanke warned in prepared testimony that "with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately -- in the absence of countervailing monetary policy action -- to further upward pressure on inflation."...

                                                                                                                                          As it stands, the FOMC's latest statement on policy ... was "some further policy firming may be needed." ... In his Congressional testimony, Mr. Bernanke called that assessment one "with which I concur."

                                                                                                                                          Also Thursday, the Senate Banking Committee approved in a 20-to-zero vote the nominations of Kevin M. Warsh and Randall S. Kroszner to fill two vacancies on the Federal Reserve's Board of Governors. ... The Committee also approved, by unanimous vote, the nomination of Edward Lazear to be a member of the White House Council of Economic Advisers.

                                                                                                                                          The committee's confirmation process looked like a rubber stamp rather than a serious attempt to assess fitness for the Fed Board and CEA jobs. Who is seated matters. It can affect the amount people pay for their houses, their cars, the interest return on investment, in a close vote on monetary policy a marginal member can swing the vote the wrong way and causing loss of jobs and other problems. Simply rubber stamping nominees is not what I expect from a confirmation committee when something so important to our economic futures is involved.

                                                                                                                                          For example, when Warsh says in his statement that "The capital markets, from which I come, are the transmission mechanism for monetary policy" did anyone follow up to see if he understands the monetary transmission mechanism? What theoretical model did he have in mind in making this statement? There's not just one transmission mechanism, it depends on the model you use. How does he see the transmission mechanism unfolding after it passes through capital markets? How and why does monetary policy affect employment, an important connection to understand? How are monetary shocks transmitted to prices? We don't know if he understands these and other basics of monetary economics, and nobody bothered to find out. He might well be qualified, but we should find that out before confirmation, not while he is already on the job.

                                                                                                                                          Update: From the WSJ Law Blog:

                                                                                                                                          Kevin Warsh Has Got It Going On, by Peter Lattman, WSJ Law Blog: Kevin M. Warsh was unanimously approved today by the Senate Banking Committee to fill a vacancy on the Federal Reserve’s Board of Governors. ... Warsh ... is a Harvard Law graduate who, according to his Senate questionnaire, was a summer associate at both Cravath, Swaine & Moore as well as the now-defunct Brobeck, Phleger & Harrison. In spite of what were surely summers filled with plum assignments and fancy lunches, Warsh never practiced, joining Morgan Stanley’s M&A department right out of law school. He spent half-a-dozen years at Morgan Stanley before joining the Bush White House as an economic adviser.

                                                                                                                                          Warsh’s Senate questionnaire has some good stuff. It appears that last November, just a couple of months before Bush nominated him to the post, he ended his memberships at the Union Club and the Brook, two tony private New York City clubs. But not to worry, he’s still a member of the Georgica Association, a private neighborhood in East Hampton that counts Steven Spielberg and Calvin Klein as residents, and the Chevy Chase Club, which we told you last week is the old-school Washington golf club where former fed chairman Alan Greenspan and former Supreme Court Justice Sandra Day O’Connor work on their short games.

                                                                                                                                          And since this post has devolved into sheer and utter gossip, here’s the best nugget of all: Warsh is married to Jane Lauder, granddaughter of Estee Lauder. Here’s a photo of the happy couple.

                                                                                                                                          Update: Here's Bernanke on the trade deficit from the WSJ's update of the article linked above:

                                                                                                                                          Bernanke Says Demand Could Fan Prices, Rates Fed Chairman Testifies to Senate In Second Day on Capitol Hill, by Greg Ip, WSJ: It could take a decade to shrink the huge U.S. trade deficit to more sustainable levels, Federal Reserve Chairman Ben Bernanke said. Noting it has taken 10 years for the ... current account deficit ... to reach 6% of gross domestic product, Mr. Bernanke told Congress "it might take that long to reverse." ... He said the current account deficit can't persist at 6% of GDP "indefinitely. It's desirable for us to bring down that ratio over time… But it's very hard to judge how long that's going to take." ...

                                                                                                                                          Sen. Charles Schumer (D., N.Y.) and Sen. Lindsey Graham (R., S.C.) have introduced a bill that would impose 27.5% across-the-board tariffs ... if Beijing fails to do more to strengthen its currency. Responding to a question from Mr. Schumer about that approach, Mr. Bernanke said: "It's not a good idea to break down some of the gains we've made in terms of freeing trade in the world economy."

                                                                                                                                          He offered few alternatives for prodding China to change, other than persuasion and technical assistance, which have prompted only a minuscule move to strengthen the yuan. "They have mixed views about the benefits to their own economy making that change," Mr. Bernanke acknowledged. "They see some benefits in what they view as stability, they see an advantage in exports. But … it's very much in their interest to move forward with a more flexible exchange rate...

                                                                                                                                          China has invested the billions of dollars accumulated through its surpluses in U.S. Treasury bonds, raising concerns it could hurt the U.S. by selling those bonds, which would push up U.S. interest rates. Mr. Bernanke, however, said U.S. capital markets are "sufficiently large and liquid that the impact of such changes would be mostly transitory and could be managed."

                                                                                                                                          As he did in his House testimony on Wednesday, Mr. Bernanke disputed that the low level of long-term interest rates relative to short-term rates is signaling a recession, as that situation often has in the past. ...

                                                                                                                                            Posted by Mark Thoma on Thursday, February 16, 2006 at 09:07 AM in Economics, Monetary Policy, Politics

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                                                                                                                                            A Gasoline Tax Proposal That Sounds Too Good to be True

                                                                                                                                            Robert Frank explains the virtues of a gasoline tax offset by a reduction in payroll taxes:

                                                                                                                                            A Way to Cut Fuel Consumption That Everyone Likes, Except the Politicians, by Robert H. Frank, Economics Scene, NY Times: Suppose a politician promised to reveal the details of a simple proposal that would ... produce hundreds of billions of dollars in savings for American consumers, significant reductions in traffic congestion, major improvements in urban air quality, large reductions in greenhouse gas emissions, and substantially reduced dependence on Middle East oil. The politician also promised that the plan would require no net cash outlays from American families...

                                                                                                                                            [I]f something sounds too good to be true, it probably is. So this politician's announcement would almost surely be greeted skeptically. Yet a policy that would deliver precisely the outcomes described could be enacted by Congress tomorrow — namely, a $2-a-gallon tax on gasoline whose proceeds were refunded to American families in reduced payroll taxes. Proposals of this sort have been advanced frequently in recent years by both liberal and conservative economists. Invariably, however, pundits ... dismiss these proposals as "politically unthinkable."

                                                                                                                                            But if higher gasoline taxes would make everyone better off, why are they unthinkable? Part of the answer is suggested by the fate of the first serious proposal to employ gasoline taxes to reduce America's dependence on Middle East oil. The year was 1979 ... To encourage conservation, President Jimmy Carter proposed a steep tax on gasoline, with the proceeds to be refunded in the form of lower payroll taxes.

                                                                                                                                            Mr. Carter's opponents mounted a rhetorically brilliant attack..., arguing that because consumers would get back every cent they paid in gasoline taxes, they could, and would, buy just as much gasoline as before. Many found this argument compelling, and in the end, President Carter's proposal won just 35 votes in the House of Representatives.

                                                                                                                                            The experience appears to have left an indelible imprint on political decision makers. To this day, many seem persuaded that tax-cum-rebate proposals do not make economic sense. But it is the argument advanced by Mr. Carter's critics that makes no sense. It betrays a fundamental misunderstanding of how such a program would alter people's opportunities and incentives. ...

                                                                                                                                            A second barrier to the adoption of higher gasoline taxes has been the endless insistence by proponents of smaller government that all taxes are bad. ... But as even the most enthusiastic free-market economists concede, current gasoline prices are far too low, because they fail to reflect the environmental and foreign policy costs associated with gasoline consumption. ...

                                                                                                                                            At today's price of about $2.50 a gallon, a $2-a-gallon tax would raise prices by about 80 percent ... Evidence suggests that an increase of that magnitude would reduce consumption by more than 15 percent in the short run and almost 60 percent in the long run. These savings would be just the beginning, because higher prices would also intensify the race to bring new fuel-efficient technologies to market.

                                                                                                                                            The gasoline tax-cum-rebate proposal enjoys extremely broad support. Liberals favor it. Environmentalists favor it. The conservative Nobel laureate Gary S. Becker has endorsed it, as has the antitax crusader Grover Norquist. President Bush's former chief economist, N. Gregory Mankiw, has advanced it repeatedly. In the warmer weather they will have inherited from us a century from now, perspiring historians will struggle to explain why this proposal was once considered politically unthinkable.

                                                                                                                                              Posted by Mark Thoma on Thursday, February 16, 2006 at 02:12 AM in Economics, Market Failure, Oil, Taxes

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                                                                                                                                              Feldstein on Economic Growth in India

                                                                                                                                              Martin Feldstein discusses India's prospects for future economic growth. His solution to attaining robust growth is no surprise - get government out of the way and let markets function freely:

                                                                                                                                              There's More to Growth than China, by Martin Feldstein, Wall Street Journal: ...India ... is making remarkable economic progress despite enormous structural problems. That progress will, however, be far less visible than it is in China. In India [you] will not see the ... general level of prosperity that [is] seen in urban China. But the progress in India is nevertheless real. ...

                                                                                                                                              India is handicapped by a socialist past, enormously powerful labor unions, and influential entrenched business interests. The tradition of state ownership that goes back to Nehru and Indira Gandhi is hard to reverse in a country where trade unions dominate employment in the public sector and in private industry. ...

                                                                                                                                              The current government is headed by Dr. Monmohan Singh, the reform-minded economist who started India's economic reforms in 1991, when he was finance minister. There should be no doubt about his commitment to reform... But the political constraints mean that the reforms are less than they should be. ...

                                                                                                                                              There has been a wide range of significant macroeconomic reforms. Sound monetary policy by the central bank has reduced inflation to less than 5% ... A floating exchange rate and the accumulation of ... foreign exchange reserves reduce the risk of the kind of currency crisis that hit Asia ... A complex system of state and federal taxes ... is being replaced by a unified national VAT. The budget deficit, although still too high, has been reduced ... India's gross national saving rate is a relatively robust 32% of GDP.

                                                                                                                                              The government's microeconomic policies have been less successful than its macroeconomic reforms. Energy remains a major weakness, with too little building of electricity generating capacity and a distribution system that wastes much ... The results are electricity shortages, brownouts and the ubiquitous small generators in shops and homes because the state electricity supply is so unreliable.

                                                                                                                                              In contrast, telecommunications is working well because of widespread use of privately supplied cellphones... It is ironic that cellphone service is widely available at low cost because it was regarded as a luxury and therefore left to the market, while electricity is hard to obtain because it has been regarded as a necessity and therefore managed by the government. Transportation is beginning to improve. A new "open skies" agreement with Washington allows U.S. airlines to fly to any city in India ... Road travel is still difficult in India but a national network of divided highways ... is cutting time for ... traffic among major cities. ...

                                                                                                                                              The system of primary and secondary public education is a terrible failure, especially for girls and low-income and rural households, with a resulting high level of illiteracy. In contrast, elite institutions of higher education produce world-class graduates among those who have been able to buy quality secondary school education. ... Despite this, high-tech industries are growing rapidly because of the combination of wages that are low even by Chinese standards, an absolutely large educated labor force and widespread knowledge of English. Information technology is only the most visible of these. ...

                                                                                                                                              But industrial activity in general, particularly employment-intensive manufacturing, is much less developed than in China. Industrial development is hampered by labor market rules ... and by the continued government ownership in a wide range of industries. ... The ... establishment of new firms is also hampered by the weakness of the banking system. The commercial banks are still largely state-owned... They devote much of their lending to the purchase of government bonds. Although new private banks are expanding, there is political resistance to selling the state banks or allowing foreign banks to enter the Indian market ...

                                                                                                                                              A few years ago, whenever I spoke to Indian officials about China's economic performance I was likely to hear that such comparisons were irrelevant because China was a dictatorship and India a democracy. I no longer hear that excuse. It is now common for officials to ... look at Chinese experience for guidance on what might be done in India.

                                                                                                                                              The optimistic mood in India's business community, the desire for reforms by the top leadership of the government, and the growing number of relatively middle-class households provide a force for change and a source of support for new entrepreneurial activities. If the political leaders can now persuade the traditional opponents of reform that growth can benefit their constituents and that better new jobs will replace the old, India will see decades of remarkable achievement.

                                                                                                                                                Posted by Mark Thoma on Thursday, February 16, 2006 at 01:22 AM in Economics, India

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                                                                                                                                                Who Cheats the Most on Taxes?

                                                                                                                                                A new IRS report on tax cheating, the first in fifteen years, looks at which groups cheat the most on taxes and how much revenue is lost because of it:

                                                                                                                                                Tax Cheating Has Gone Up, Two Federal Studies Find, by David Cay Johnston, NY Times: Historically, when income tax rates fall, so does tax cheating. But that is not what happened after President Bush started cutting taxes five years ago. A new report by the Commerce Department found ... a 37 percent increase in unreported income from 2000. In a separate report, the Internal Revenue Service looked at both unreported income and improper deductions and concluded that Americans shortchanged the government by $345 billion in 2001 — an amount almost equal to the projected federal budget deficit for 2007. ...

                                                                                                                                                The I.R.S. report concluded that proprietors of small businesses, investors and farmers cheated the most. Workers who had 99 percent of their wages reported to the government and taxes withheld from their paychecks were the least likely to cheat. Mr. Everson acknowledged that the estimate is probably low ... The biggest single revenue loss came from proprietors of unincorporated businesses ... who shorted the government an estimated $68 billion in 2001. Cheating by partnerships, most of whose members are wealthy professionals or investors, was put at $22 billion, while cheating by landlords and those collecting royalties was estimated at $13 billion. In percentage terms, farmers cheated the most ... failing to pay the government $6 billion, or 72 percent of the taxes they should have.

                                                                                                                                                  Posted by Mark Thoma on Thursday, February 16, 2006 at 01:14 AM in Economics, Taxes

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                                                                                                                                                  February 15, 2006

                                                                                                                                                  "A Compendious Dictionary of the English Language"

                                                                                                                                                  Interesting article on Noah Webster from the International Herald Tribune. His dictionaries were intended to be more than just spellings and definitions, they were also written to promote national unity and cultural independence from Britain:

                                                                                                                                                  Building a nation with words, by Adam Cohen, IHT: When Noah Webster published "A Compendious Dictionary of the English Language," purists were horrified.

                                                                                                                                                  Webster Americanized the British spellings in Samuel Johnson's famous dictionary, turning "defence" and "honour" into "defense" and "honor." Webster included new American words like "subsidize" and "caucus," and left out hoary Britishisms like "fishefy." John Quincy Adams, the future president, was shocked by the "local vulgarisms." ... Webster is remembered today almost exclusively as America's great lexicographer, but he was also a founding father of the first rank. The dictionaries he wrote actually helped shape the kind of nation America would become. ...

                                                                                                                                                  His great passion ... was politics, and he held many views that now seem surprisingly modern. He kept religion and God out of his spelling books. He argued that the Constitution should include universal compulsory education and abolish slavery. When the new nation formed, British culture was still dominant, and it was not yet clear what it meant to be American. Webster thought it was vital to shake off "foreign manners" and build an independent national culture. He believed that his dictionaries could contribute to this homegrown culture by reflecting the language that Americans were actually speaking. ...

                                                                                                                                                  Webster's other political purpose in writing his dictionaries was promoting national unity. He was disturbed to find, in his travels, that Southern whites, blacks, old-line Yankees and newly arrived immigrants were in many cases unable to talk to each other. He believed a "federal language" could be a "band of national union." ... He was troubled by the sharp political divisions he saw: North vs. South, rural areas vs. cities and, above all, his Federalist Party vs. Thomas Jefferson's Democratic-Republicans. During the bitter battles over the Embargo Act of 1807, Webster called on the parties to "renounce their present warfare, and unite on some general points of policy."

                                                                                                                                                  The United States has more than achieved the cultural independence Webster dreamed of. ... His hopes for national unity have proven more elusive. Today's red-state-blue-state divide, and Washington's vicious partisan battles, are an uncanny parallel of the war over the 1807 embargo. If Webster were here, he would be clamoring for leaders willing to look beyond party affiliation. The great wordsmith was never more eloquent than in his screeds against excessive partisanship.

                                                                                                                                                  "The party which, while in a minority, will lick the dust to gain the ascendancy," he warned, "becomes, in power, insolvent, vindictive and tyrannical."

                                                                                                                                                  This Webster guy seems to be pretty good with words.

                                                                                                                                                    Posted by Mark Thoma on Wednesday, February 15, 2006 at 05:48 PM in Miscellaneous

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                                                                                                                                                    Collusion Among Air Cargo Carriers?

                                                                                                                                                    Here's a follow up to a recent post on anti-trust enforcement. It seems authorities are investigating air cargo operations for collusive behavior. As the article notes, without an explicit document or some other solid piece of evidence, collusion can be hard to prove:

                                                                                                                                                    Inspecting the cargo, The Economist: The death of Sir Freddie Laker last week reminded the world’s air travellers of the high cost of flying before he took on, and helped to break, the transatlantic oligopoly enjoyed by the big airlines. The established carriers, their dominance threatened by the rock-bottom fares offered by Sir Freddie’s airline, colluded to slash prices and did their bit to bring down the interloper. His carrier went bust but he subsequently sued his rivals for predatory pricing, and won. So it is perhaps fitting that on Tuesday February 14th, just days after Mr Laker died, competition authorities launched investigations into possible price collusion by a number of large airlines. ... The suspected price-fixing relates to fuel surcharges and other costs at the airlines’ cargo arms. ...

                                                                                                                                                    Neither the European Commission nor America’s Department of Justice named the airlines concerned, but those raided include British Airways, Air France/KLM, Lufthansa, Luxembourg’s Cargolux, Cathay Pacific and Japan Airlines. United Airlines and American Airlines both said that they were approached to provide information as part of the probe. South Korean airlines admitted to visits from that country’s competition authorities. Some reports suggest that the alleged collusion goes back several years. ...

                                                                                                                                                    The air freight industry, worth some $50 billion last year, remains a mix of large, cargo-only companies (such as the parcel firms), smaller specialist operators and passenger airlines that operate cargo divisions. The latter’s freight arms tend to be small compared with their passenger operations. ... Even Korean Air, which was the leading freight operator among passenger airlines in 2004, derives only around 30% of its revenues from the cargo business. However, profit margins in cargo can be big. And the business is set to continue growing at a healthy pace ...

                                                                                                                                                    A spokesman for the European Commission pointed out that the fact that it is investigating the airlines does not mean that “the companies are necessarily guilty of anti-competitive behaviour ... The airlines have every reason to hope there is no case to answer. The European Union can levy a fine of up to 10% of worldwide revenues on any firm found guilty of participating in a cartel. That would hit airlines disproportionately hard, since their overall businesses are, by and large, so much bigger than their cargo divisions. In America, the threat of prison hangs over price-fixers.

                                                                                                                                                    The carriers concerned have vociferously protested their innocence. Some analysts have suggested that airlines are prone to copy one another’s pricing strategies without that necessarily involving direct collusion. Moreover, proving that firms have operated as a cartel is difficult without some sort of “smoking gun”, such as documents describing meetings in which price-fixing was discussed. ...

                                                                                                                                                      Posted by Mark Thoma on Wednesday, February 15, 2006 at 04:53 PM in Economics, Market Failure, Regulation

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                                                                                                                                                      Why Greenspan Retired

                                                                                                                                                      From the WSJ's Washington Wire reporting on Bernanke's testimony, news of why Greenspan retired even though legislation by Rep. Brad Sherman (D., Calif.) to extend his term was in the works. A sole but influential opponent stopped the legislation. In other notes, Bernanke opposes Wal-Mart's entry into banking services, wants tougher legislation for Sallie Mae and Freddie Mac, and refuses to comment on the propriety of Greenspan's dinner with clients of Lehman Brothers:

                                                                                                                                                      The Chairman Speaks Regularly, Washington Wire, WSJ: Bernanke endorses a bill ... to close a loophole that lets commercial companies own FDIC-insured "industrial loan corporations," like the one Wal-Mart Stores Inc. wants to operate in Utah. ... The bill, Bernanke said, would "relieve our anxieties considerably." But he didn't endorse a House bill that would tighten regulation of Fannie Mae and Freddie Mac. The measure ... "doesn't provide sufficient guidance" to regulators to limit their portfolios. "...these large portfolios represent a risk to financial stability,'' he warned.

                                                                                                                                                      Asked about former Fed Chairman Alan Greenspan's reported remarks to select audiences since leaving the Fed..., Bernanke said: "My only comment ... is that, according to government ethics rules and to FOMC rules, it's permissible for a retired governor to speak in public about the economy, so long as he or she does not divulge confidential information. And I have no indication that he has violated that rule. And I have no further comment on that."

                                                                                                                                                      Rep. Brad Sherman (D., Calif.) told Bernanke he was the only member of the House Financial Services Committee to work actively to thwart his appointment as chairman of the Federal Reserve Board. "Ben, it's nothing personal," the congressman said. "I simply authored legislation to extend your predecessor's term limits. You owe your office to that bill's sole and very powerful opponent: Andrea Mitchell."

                                                                                                                                                      Economist's react, me included, to Bernanke's testimony. There were also two Fed speeches over the last two days:

                                                                                                                                                      Jeff lacker, Richmond Fed President on Transition and Continuity at the Federal Reserve in 2006.

                                                                                                                                                      Richard Fisher, Dallas Fed President on Trade Deficits and the Health of the U.S. Economy.

                                                                                                                                                        Posted by Mark Thoma on Wednesday, February 15, 2006 at 02:13 PM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                        Will China be Branded a Currency Manipulator?

                                                                                                                                                        Treasury is sounding out the possibility of branding China a currency manipulator:

                                                                                                                                                        U.S. Considers Branding China as Currency Manipulator, Bloomberg: U.S. Treasury officials are sounding out investors about the potential impact of naming China as a currency manipulator... Treasury Undersecretary Tim Adams ... has asked strategists, investors and academics to assess the likely reaction of financial markets in the event the department cites China in its semiannual report on exchange rates... By talking to Wall Street firms before the report is completed, the Treasury is trying to minimize any disruption in currency, equity and bond markets... Treasury hasn't determined whether China is manipulating its currency... The administration may still balk at the description....

                                                                                                                                                        And, from the WSJ, Ying Ma of the AEI writes about China's not so swift boat to democracy:

                                                                                                                                                        Democracy's Slow Boat to China, by Ying Ma, Commentary, WSJ: The U.S. House Subcommittee on Africa, Global Human Rights and International Operations will hold a hearing today to examine the operating procedures of U.S. Internet companies in China. But at the heart of the matter rests a burning question that is unlikely to be answered: What if China does not democratize?

                                                                                                                                                        Congressional questions will not address this issue, and will instead focus on U.S. corporate behavior. Google, Yahoo!, Cisco Systems and Microsoft have all been widely criticized for aiding Chinese censorship... Buried amidst the condemnation of loose corporate morals, however, is a much broader issue ... The fact that something might be desperately wrong with U.S. policy toward China.

                                                                                                                                                        When the U.S. Congress granted Permanent Normal Trade Relations to China in 2000, proponents of expanded trade predicted that China's ongoing economic opening would ultimately lead to political liberalization. The Internet was supposed to be a crucial engine spurring such liberalization. ... Some five years later, Beijing has managed to upgrade its censorship techniques to adapt to the Internet age, intimidating both political dissidents and American companies alike. ...

                                                                                                                                                        [P]olicymakers must ... confront the unpleasant reality of democratization's slow boat to China. This in no way means that economic engagement with China should end. It does mean, however, that ... policymakers are not alleviated of the responsibility... So perhaps ... Congress can have a serious conversation about a strategy for democratization in China. ... It seems indefensible that an American company could escape legal consequences for helping to send a Chinese political dissident to prison. On the other hand, it's entirely unrealistic for U.S. companies to do what some human-rights activists are advocating: Walk out of China all together ... Before China gained permanent trade status, many argued that trade would help China democratize. Today, while not disavowing this possibility, the U.S. government should begin a serious search for Plan B.

                                                                                                                                                          Posted by Mark Thoma on Wednesday, February 15, 2006 at 07:26 AM in China, Economics, Politics

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                                                                                                                                                          Yes, But is it a Sport?

                                                                                                                                                          Scientific American takes a look at the new scoring system for figure skating:

                                                                                                                                                          Figure Skating Scoring Found to Leave Too Much to Chance, Scientific American: The overseers of international figure skating scoring instituted a new system in 2004, designed to reduce the chances of vote fixing or undue bias after the scandal during the Winter Olympics in Salt Lake City in 2002. Under the old rules eight known national judges scored a program up to six points with the highest and lowest scores dropped. Under the new rules, 12 anonymous judges score a program on a 10 point scale. A computer then randomly selects nine of the 12 judges to contribute to the final score. The highest and lowest individual scores in the five judging categories are then dropped and the remaining scores averaged and totaled to produce the final result. This random elimination of three judges results in 220 possible combinations of nine-judge panels, explains John Emerson, a statistician at Yale University. And according to his statistical analysis of results from the shorts program at the Ladies' 2006 European Figure Skating Championships the computer's choice of random judges can have a tremendous--and hardly fair--impact on the skaters' rankings. "Only 50 of the 220 possible panels would have resulted in the same ranking of the skaters following the short program," Emerson writes in a statement announcing his findings...

                                                                                                                                                          "A close figure skating competition will be decided by a computer choosing an anonymous panel of nine judges," Emerson says. "In fairness to the skaters, all twelve scores should be used in awarding medals. Let's leave the computer out of it." The statistics behind Emerson's analysis can be found at:

                                                                                                                                                          Isn't this the wrong question? The system was designed to be robust against biased judges. What I would want to know is how the rankings are impacted when one or several judges try to game the system.

                                                                                                                                                          Here's an extreme, simplified example to illustrate that the proposed solution will not always improve the outcome. Suppose there are four judges and three skaters named A, B, and C to be ranked first, second, and third. Judge 4 is biased for skater B and gives the skater a 10 when the skater deserves a 7. In all other cases, let the judges agree exactly (this is easily relaxed without altering the result):


                                                                                                                                                          Judge A B C
                                                                                                                                                          1 7.5 7.0 6.0
                                                                                                                                                          2 7.5 7.0 6.0
                                                                                                                                                          3 7.5 7.0 6.0
                                                                                                                                                          4 7.5 10. 6.0

                                                                                                                                                          Let the scoring system be to randomly eliminate one score to partially mimic the procedure above. One quarter of the time the biased score will be eliminated and the rankings will be A (7.5), B (7.0), and C (6.0) and unbiased (the average score is in parentheses). However, three quarters of the time the biased score will remain. The rankings then are B (8.0), A (7.5), and C (6.0). Thus, random selection eliminates bias one fourth of the time (the estimator is still biased on average though as it is right one quarter of the time and wrong three quarters).

                                                                                                                                                          A statistician looking at the scores would conclude that the outcome was "decided by a computer choosing an anonymous panel of ... judges." Is the solution to use "all ... scores ... in awarding medals" and to "leave the computer out of it" as recommended above? With all four scores counted, the averages and rankings are B (7.75), A (7.5), and C (6.0), a biased result in every case. Random elimination of one judge is better one quarter of the time and thus an improvement (but that does not imply this is the optimal way of filtering out bias).

                                                                                                                                                          Now take a second step. After random selection, eliminate the high and low score. If in the first step the biased score is eliminated, this step does not change the result, the ranking is still A, B, and C and unbiased. But suppose the biased score is chosen so that the set of scores for skater B is 7, 7, and 10. Then one of the 7's and the 10 will be eliminated when the high and low scores are trimmed and in every case the score for B will be 7, i.e. unbiased. This is certainly better than using all four scores which is biased in every case.

                                                                                                                                                          [More generally, with more than three judges in the second step, this procedure will pick off extreme scores but these may not always be the biased scores if randomness is allowed in the scoring. In this case the trimming of the high and low scores would reduce but not fully eliminate the bias in the outcome].

                                                                                                                                                          If the variation in scores is due to randomness, then leaving all scores in the averages cancels idiosyncratic variation and improves the outcome (or if bias is small relative to randomness). This is the case the Yale study cited in Scientific American looks at. But if the variation is due to judges gaming the scoring system, and that is one of the worries that prompted the new system, leaving all scores in the averages does not necessarily improve the outcome relative to a trimming procedure that is able to capture and eliminate a portion of the bias.

                                                                                                                                                            Posted by Mark Thoma on Wednesday, February 15, 2006 at 12:51 AM in Miscellaneous

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                                                                                                                                                            Who's to Blame for GM's Problems?

                                                                                                                                                            GM's management has pointed to the UAW and high wage and benefit demands as a major cause of their current financial predicament. However, management is finding the finger pointed back at them in the blame game over who caused the company's current ills. From the Washington Post, more along these lines:

                                                                                                                                                            Doing Good Jobs, But Losing Them, by Harold Meyerson, Commentary, Washington Post Online: From the outside, the Ford assembly plant ... isn't much to look at ... On the inside, though, Wixom is a thing of beauty, a marvel of American production. Most auto factories turn out the same basic car... At Wixom, three fundamentally different kinds of cars rolled off the line simultaneously. ... "No other plant built three different cars at the same time," says Dave Berry, president of the plant's United Auto Workers local.

                                                                                                                                                            Some years ago Ford established an annual audit of plant efficiency. For four years running, the Wixom plant had the highest score of any of Ford's North American assembly plants. In 2004 J.D. Power and Associates ranked the plant as the third-best auto factory in North and South America -- beating all the Mercedes and Toyota plants routinely touted as the be-all and end-all of auto production.

                                                                                                                                                            But there was a problem: the product. Wixom turned out lots of different cars, but chiefly it turned out Lincolns. For many years, Ford turned more profit on the Lincoln than on any of its other cars; it was the proceeds from Wixom that financed many of Ford's truck plants. But in recent years, Ford focused more on overseas acquisitions -- Jaguar, Volvo, Aston Martin -- than on improving the product it made in America.

                                                                                                                                                            "We kept arguing for a product that appealed to the customer," says Tony Brooks, a salty assembly-line worker ... "The quality of the plant is what kept us alive, not the cars. When did they last redesign the Lincoln Town Car? Ten years ago?" Cadillac, he notes, successfully updated its product line in the past few years. At Wixom, a fundamental adage of production was stood on its head. Making the sausage was a pleasure to behold; it was the sausage itself that ceased to appeal. On Jan. 23 Ford announced that it was closing factories across North America, and Wixom, its awards notwithstanding, was on the list...

                                                                                                                                                              Posted by Mark Thoma on Wednesday, February 15, 2006 at 12:44 AM in Economics, Unemployment

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                                                                                                                                                              Pervasive Stickiness

                                                                                                                                                              Mankiw and Reis on pervasive sticky information models:

                                                                                                                                                              Pervasive Stickiness (Expanded Version), by N. Gregory Mankiw and Ricardo Reis, NBER WP 12024, February 2006: Abstract This paper explores a macroeconomic model of the business cycle in which stickiness of information is pervasive. We start from a familiar benchmark classical model and add to it the assumption that there is sticky information on the part of consumers, workers, and firms. We evaluate the model against three key facts that describe short-run fluctuations: the acceleration phenomenon, the smoothness of real wages, and the gradual response of real variables to shocks. We find that pervasive stickiness is required to fit the facts. We conclude that models based on stickiness of information offer the promise of fitting the facts on business cycles while adding only one new plausible ingredient to the classical benchmark.

                                                                                                                                                              In the conclusion, Mankiw and Reis explain why this is an important alternative to theoretical formulations incorporating wage stickiness, price stickiness, habit formation in consumption, adjustment costs, and other rigidities to explain U.S. macroeconomic data:

                                                                                                                                                              ...Because monetary policy seems to have real effects, research has recently focused on a hybrid formulation of Calvo’s sticky price model in which either some price-setters are naive or all index their prices to past inflation. Because real wages are smooth in the data, research has looked into models with adjustment costs in using inputs, norms in labor bargaining, or direct real wage rigidities. Because consumption and output growth are positively serially correlated, research has considered modelling representative agents that form habits. In a prescient article, Christopher A. Sims (1998) noted that across all dimensions, to match the data, the classical model needed “stickiness.” It has become increasingly clear that stickiness is not just needed but must also be pervasive. Fixing the classical model with a series of isolated patches, however, runs the risk of losing the discipline of having a model altogether. Inattentiveness and stickiness of information have the virtue of adding only one new plausible ingredient to the classical benchmark. The results reported here suggest that such a model moves promisingly in the direction of fitting the facts on business cycles.

                                                                                                                                                                Posted by Mark Thoma on Wednesday, February 15, 2006 at 12:11 AM in Academic Papers, Economics, Macroeconomics

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                                                                                                                                                                Will India Grow Faster than China?

                                                                                                                                                                Martin Wolf lists the barriers India must overcome to surpass China's rate of economic growth:

                                                                                                                                                                What India must do to outpace China, by Martin Wolf, Commentary, Financial Times: The “India Everywhere” campaign ... took this year’s ... World Economic Forum, in Davos, by storm. ... Indians were indeed everywhere, while the Chinese were relatively invisible. Since Indian economic growth is now forecast at 8.1 per cent this fiscal year ..., confidence is running high. Yet ... It is far from certain that India’s growth rate is now durably and decisively above the average of the past quarter of a century. It is equally far from certain that India will do better than China in exploiting its potential. Much reform is still needed...

                                                                                                                                                                Why ... might a reasonable analyst anticipate a surge in India? There are three broad reasons: first, Indian demography is relatively favourable; second, India has better institutions than China; third, India has more room to improve its policies and investment performance. These points have force. But they also describe potential, not performance...

                                                                                                                                                                Unfortunately, India has done a particularly poor job of absorbing its labour force into productive employment. ... Crippled by restrictive labour regulation, employment in organised manufacturing has remained stagnant ... The much-vaunted information technology sector employs just 1m – a drop in the Indian Ocean. Unused labour is not an advantage, but a terrible burden.

                                                                                                                                                                It is true ... that India has a number of institutional advantages over China: a well-developed private sector; a relatively entrenched legal system; a stable democracy; and freedom of speech. ... But... on regulatory quality and government effectiveness... there can be little doubt: China’s ability to mobilise resources remains far greater than India’s, as demonstrated in its vastly superior performance in provision of infrastructure.

                                                                                                                                                                This brings us to the third reason – the potential for policy improvement. India has a large opportunity to raise the investment rate, which remains well below Chinese levels... The difference in investment rates is the proximate cause of the difference in growth rates between the two economies.

                                                                                                                                                                Behind the huge gap in investment are significant and enduring Indian policy failures. Huge fiscal deficits are one example. Still more important have been the deep-seated obstacles ... to rapid expansion of labour-intensive production. That, in turn, helps explain the biggest discrepancy between Chinese and Indian growth: Chinese manufacturing grew at close to 12 per cent a year between 1990 and 2003, while India’s grew at just 6.5 per cent, well below the 7.9 per cent achieved by India’s services.

                                                                                                                                                                This pattern, suggests an illuminating working paper from staff of the International Monetary Fund, is connected to a long-standing bias towards a skill-intensive pattern of economic development. Up to 1980 this bias generated a relatively small, and skill-intensive, manufacturing sector. Since then it has generated an exceptionally large, but also skill-intensive services sector. ... Both of these patterns were biased against mass employment ... This must change if India is to thrive.

                                                                                                                                                                The improved performance of the Indian economy in the last quarter century is both a fact and an achievement. Yet it could be better still. ... change must occur in five pivotal areas: deregulation of labour markets and an end to the reservation of production to the small-scale sector; revitalisation of agricultural growth; increased investment in infrastructure; elimination of fiscal deficits in the current budget; and, finally, across-the-board privatisation and further trade liberalisation...

                                                                                                                                                                  Posted by Mark Thoma on Wednesday, February 15, 2006 at 12:10 AM in China, Economics, India

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                                                                                                                                                                  February 14, 2006

                                                                                                                                                                  Lazear Will Leave Politics to Others

                                                                                                                                                                  This was expected from Ed Lazear, the nominee to head the CEA, but it's good to hear anyway:

                                                                                                                                                                  Economist Lazear Pledges to 'Leave Politics to Others' at CEA, Bloomberg: President George W. Bush's nominee for chief White House economist promised Congress he'll give unvarnished advice to the president and top advisers. The job is "to be straight and to bring the economics to the table, leaving the politics to others,'' Edward Lazear, the Stanford University economist picked to become chairman of the Council of Economic Advisers, told a Senate Banking Committee confirmation hearing today...

                                                                                                                                                                  [Click here to view hearing.][Statement.]

                                                                                                                                                                    Posted by Mark Thoma on Tuesday, February 14, 2006 at 05:51 PM in Economics, Politics

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                                                                                                                                                                    Hearings for Fed Nominees Warsh and Kroszner

                                                                                                                                                                    Here's Kevin Warsh's Statement for his nomination to the Board of Governors of the Federal Reserve System. He spends a lot of time talking about domestic finance, capital markets, banking, securities, and insurance markets but employment stability receives very little attention. I wonder whose interests he will represent?

                                                                                                                                                                    By contrast, here's Randall Kroszner's statement. It focuses much more on employment and connects issues such as capital market stability to employment and output stability, something Warsh did not do. Kroszner and I would differ on some fundamental issues and because of that I would have placed others higher on the list. But his qualifications are not in doubt, not at all, and there's no reason to oppose the nomination.

                                                                                                                                                                    As for Warsh, I understand that there is a place in monetary policy deliberations for the interests of financial markets to be represented and I don't want to leave the impression that because Warsh does not have an academic background, that automatically disqualifies him from serving on the Board of Governors. It doesn't. But I am still not convinced that Warsh is the right choice to represent the public interest as defined by the Fed's mandate. Had the White House expanded the applicant pool beyond White House aides whose father's-in-law gave large sums to the Republican Party, there are certainly people with non-academic backgrounds whose qualifications for the job would not be questioned. [Click here to view hearing.]

                                                                                                                                                                      Posted by Mark Thoma on Tuesday, February 14, 2006 at 04:39 PM in Economics, Monetary Policy, Politics

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                                                                                                                                                                      Krugman's Money Talks: Tax Cuts, Foreign Debt and 'Dark Matter'

                                                                                                                                                                      In response to comments on his latest column, Paul Krugman discusses tax cuts, Greenspan's ethical problems, trade deficits, and has some interesting comments on dark matter. He also gives Brad Setser a much deserved plug as the go to guy on the dark matter controversy:

                                                                                                                                                                      Krugman's Money Talks: Tax Cuts, Foreign Debt and 'Dark Matter', Commentary, NY Times: Readers respond to ... "Debt and Denial"

                                                                                                                                                                      Andrew Levin, Hilo, Hawaii: The president's top economic advisor was interviewed by Wolf Blitzer about a week ago, and said that the middle class now pays a lower proportion of our income taxes than do people in the upper income brackets. .... Is this true, and if so, is this an appropriate way to judge the impact of the Bush tax cuts?

                                                                                                                                                                      Paul Krugman: The Bush administration has tried a lot of number games in an effort to pretend that its tax cuts favor the middle class. Rather than deal with all the hocus-pocus, keep your eye on the ball: The question is whether the Bush tax cuts make the after-tax distribution of income more or less equal. And the answer, without question, is that they increase inequality... The latest estimates from the nonpartisan Tax Policy Center say that making the tax cuts permanent will increase the after-tax income of the top 0.1 percent of the population by 7.5 percent, which is more than three times the tax cut for families in the middle quintile...

                                                                                                                                                                      Jeffrey T. Atwood, Larchmont, N.Y.: Your column today ... managed to lay some responsibility on Alan Greenspan... It is probably not surprising that the Republicans, like many people in power, flaunt their rhetoric about accountability, taking ownership and responsibility, yet cannot apply these concepts to their own actions when it requires their accepting consequences or stopping the buck.

                                                                                                                                                                      Paul Krugman: Greenspan has two ethical problems here. One is small in the scale of things; it's very improper for him to be out there commenting on monetary policy for personal gain, when his successor is new to the office and needs to establish his own credibility. The larger point is that Greenspan cheered on the tax cuts and pooh-poohed talk of a housing bubble until he was on his way out, at which point he started lecturing us on the evils of deficits and warning of "froth" in housing. ...

                                                                                                                                                                      Martin Berger, Yorktown Heights, N.Y.: ...[M]y question ... has to do with balance of payments... You seem to equate purchases of foreign goods with debt. What's the connection? I would agree that accumulation of foreign debt is certainly problematic, especially when added to our growing domestic debt. But I don't see the connection between foreign purchases and debt. Are all foreign purchases financed by foreign banks? Could you explain this clearly?...

                                                                                                                                                                      Paul Krugman: The balance of payments always balances. If we don't sell enough goods and services to pay for our imports, we have to sell I.O.U.’s. Now, these don't have to be bonds. We could be attracting foreign companies that want to establish U.S. subsidiaries, or we could be selling stocks. In fact, however, we're paying for the trade deficit by selling bonds.

                                                                                                                                                                      Paul Krugman: Finally, I thought I should let readers know about a genuinely interesting dispute regarding the U.S. debt position and the balance of payments: the "dark matter" controversy. The starting point for this discussion is a curious fact. According to official measures, the United States is a big net debtor. That is, foreign assets in the U.S. are much bigger than U.S. assets abroad. But if you look at U.S. earnings on its overseas assets, they're still roughly as big as foreign earnings in the U.S.

                                                                                                                                                                      This has led some economists to argue that official debt statistics are wrong — that U.S. corporations have much bigger overseas assets than the numbers say. The proponents of this view say that these hidden assets are the "dark matter" of international economics, and that the U.S. debt and balance of payments position is much better than the usual numbers suggest. Dark matter, along with some other ideas that might make the U.S. picture brighter, was the basis of a recent Business Week cover story asserting that the U.S. economy is much stronger than people think.

                                                                                                                                                                      Interesting stuff. But there's a problem. When you look closely at the earnings numbers, U.S. corporations overseas aren't earning especially high profits. The funny number, instead, is the profits of foreign companies operating in the United States, which seem very low. So as the people doing this now say, there seems to be "dark antimatter," not dark matter. (Note to physicists: yes, I know that's wrong — antimatter still has positive gravity. Whatever.)

                                                                                                                                                                      What's going on? Brad Setser is the go-to guy on this. He thinks that what we may be seeing is the effect of tax avoidance strategies that understate foreign profits in the U.S. and make them pop up somewhere else. If you're into these things, read his blog for the implications. The overall deficit numbers, he suggests, are correct, but the division between trade and investment account may be distorted. Interesting stuff. But the bottom line — that we're spending way beyond our means as the day of reckoning approaches — probably doesn't change.

                                                                                                                                                                        Posted by Mark Thoma on Tuesday, February 14, 2006 at 03:03 PM in Economics, International Finance, International Trade, Monetary Policy, Taxes

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                                                                                                                                                                        An Impartial Observer Might Have Pause for Thought

                                                                                                                                                                        Brad DeLong has the "Dead-Eye Dick" Cheney story covered and I presume the divergence between highly misleading initial reports and subsequent developments will get adequate coverage as well, so here's another of Cheney's recent activities. Menzie Chinn of Econbrowser looks with wary eyes at Cheney's call for dynamic scoring of tax proposals:

                                                                                                                                                                        Dick Cheney on economics, by Menzie Chinn, Econbrowser: Vice President Cheney last week stated, according to Reuters:

                                                                                                                                                                        "'s time ... to consider using more dynamic analysis to measure the true impact of tax cuts on the American economy," ...

                                                                                                                                                                        This view is, apparently, the motivation for the President's proposal for a new unit in the Treasury Department to implement dynamic scoring. From the Washington Post:

                                                                                                                                                                        Treasury officials said yesterday that the president's proposed Division on Dynamic Analysis ... would go beyond the government's old "static" methods of analyzing proposed changes in tax policy only in terms of their direct effects on certain affected taxpayers. Instead, "dynamic" analysis looks at how tax changes cause consumers and businesses to behave differently in ways that affect the overall economy's growth.

                                                                                                                                                                        Dynamic scoring makes intellectual sense. And in proper hands, and with proper deference to our uncertainty regarding the correct model and model parameters, it can be a useful approach. Indeed in the CBO's analysis of the President's proposals in 2003, the results of dynamic scoring were reported (although not incorporated in the official forecasts). As it turned out, half of the estimates from the "dynamic" models implied higher revenue losses than those from static models criticized by the Vice President.

                                                                                                                                                                        Of course, if there is dynamic scoring of tax revenues, then for the sake of consistency, spending measures should be also scored. Even in real business cycle models with Ricardian equivalence, spending has effects (usually depressing economic welfare).

                                                                                                                                                                        So dynamic scoring, in the hands of a professional staff cognizant of the extent of model uncertainty, well insulated from political pressures, would be a good thing. However, WMDs, "last throes of the insurgency", the "Clear Skies" initiative, might give an impartial observer pause for thought.

                                                                                                                                                                        Update: More at Angry Bear

                                                                                                                                                                          Posted by Mark Thoma on Tuesday, February 14, 2006 at 12:34 PM in Economics, Taxes

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                                                                                                                                                                          The End of "disproportionate influence'' at the Fed?

                                                                                                                                                                          Many believe that Greenspan had a "disproportionate influence'' on Fed decisions either due to superior analytical skills or a domineering personality, and perhaps a little of both. I have never believed it to be healthy for the institution to be dominated by the views of a single individual and one of the hopes is that under Bernanke such domination will diminish:

                                                                                                                                                                          Bernanke's Fed Will Stress 'Solid' Analysis Over Personality, Bloomberg: Alan Greenspan dominated the Federal Reserve with the strength of his reputation. Ben Bernanke ... will win votes on the strength of his analysis. Power and influence are being redefined on the Fed's interest-rate committee as the Bernanke era begins. Analytical rigor and open debate may have a larger role in Bernanke's Fed boardroom than in Greenspan's, which former Vice Chairman Alan Blinder once called "autocratically collegial.''

                                                                                                                                                                          "My guess is that the views that will win out will be those that have the most solid logical and empirical foundation, just as in academic debate,'' said Mark Gertler ... "The survival of the fittest ideas'' will be the rule under Bernanke... "It would seem to me he would be more comfortable with a freer exchange of ideas, not coming in 100 percent convinced of what should be done,'' said Robert Parry, the former San Francisco Federal Reserve Bank president who sat at the policy table with Bernanke and Greenspan from 2002 to June 2004. ...

                                                                                                                                                                          Greenspan didn't squelch debate as chairman, Fed officials say; research flourished under him, and he "allowed for a much more open debate of ideas than has ever taken place in the Fed's history,'' said Harvey Rosenblum, executive vice president at the Dallas Fed. Even so, Greenspan's stature and forecasting skills had "disproportionate influence'' on Fed decisions, former Governor Laurence Meyer said ...

                                                                                                                                                                          Greenspan "more or less dictates the group 'consensus,''' Blinder, now a Princeton University professor, and economist Charles Wyplosz wrote in the 2004 paper in which they described his FOMC meetings as "autocratically collegial.'' Greenspan "may begin the meeting with the decision already made.'' ...

                                                                                                                                                                          The Fed's staff of 250 Ph.D. economists, which Bernanke has praised twice in recent weeks, may also have more influence in the new era. As a Fed governor ..., Bernanke would disregard central-bank protocol, grab a lunch tray and eat with the staff in the cafeteria. Eventually, the discussions evolved into a series of informal seminars that allowed young economists to argue their ideas before a policy maker.

                                                                                                                                                                          Macroeconomists such as Governor Donald Kohn, 63, who has worked at the bank for more than 30 years and was a close adviser to Greenspan, and San Francisco Fed President Janet Yellen, 59, a former governor, are also likely to sway the debate, economists said. So will other regional Fed bank presidents, who can draw on their own research staffs to help mold the committee's views.

                                                                                                                                                                          "All the reserve banks are going to be clamoring to be heard a little more,'' said the Dallas Fed's Rosenblum. ... "We try to identify the issues facing the FOMC for which our research staff can add the most value,'' said Daniel Sullivan, senior economist at the Chicago Fed. "The reserve banks provide an important independent perspective on the national economy.'' ...

                                                                                                                                                                            Posted by Mark Thoma on Tuesday, February 14, 2006 at 10:35 AM in Economics, Monetary Policy

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                                                                                                                                                                            The U.S. Pressures China to Alter Trade Policy

                                                                                                                                                                            Here's more on the administration promises to get tough with China over trade. From the WSJ:

                                                                                                                                                                            Bush Administration Promises Tougher Stance on China Trade, by Greg Hitt and Murray Hiebert, WSJ: ...U.S. Trade Representative Rob Portman is promising much tougher enforcement of trade laws... Mr. Portman flags concern with Beijing's ''unreported and extensive'' industry subsidies, and a network of trade barriers that he says keep out U.S. exports and helped fuel a record U.S. trade deficit. ...

                                                                                                                                                                            Mr. Portman concedes American consumers and businesses have reaped benefits from closer economic ties with China.... But absent ''tangible evidence'' that China is moving to address U.S. concerns, Mr. Portman says ''popular support for a twenty-five-year-old trade policy of constructive economic engagement with China could be in danger, with potentially damaging consequences for both countries.'' ...

                                                                                                                                                                            Officials from China's Ministry of Commerce said they wouldn't have any comment until they have had a chance to read the report. But a Chinese academic said he didn't think the review would have much impact in Beijing. Mei Xinyu ... called the report a "show to please Congress." He said China's export boom to the U.S. is caused by American domestic demand and not by any sinister schemes by Beijing. "It is American companies [that] are transferring manufacturing to China and American consumers are buying Chinese stuff on their own accord," he said.

                                                                                                                                                                            Still, senior Chinese officials went on the offensive Tuesday against U.S. critics. ...

                                                                                                                                                                            Every time Washington tries to publicly pressure China to let the yuan float, it seems to harden their resolve to do it at their own pace. The call to be treated as an equal partner, not an inferior to be lectured about trade policy, is telling, as is their claim that both the U.S. and China benefit from the current arrangement:

                                                                                                                                                                            China chides U.S. for criticism over trade, yuan, Reuters, China Daily: China responded ... to U.S. demands for a stronger yuan to reduce its trade surplus by saying market forces were already driving the currency and warning Washington not to make political capital out of the issue. Tensions over trade have become a regular irritant in Sino-American relations... Cheng Siwei, an influential law-maker and economist, said China and the United States should ease these frictions through consultations as equal partners. ...

                                                                                                                                                                            "We concede that China is running a relatively big trade surplus with the United States, but they shouldn't politicize the issue," Cheng, vice-chairman of the Standing Committee of the National People's Congress, or parliament, told a China-U.S. business forum. ... Foreign Ministry spokesman Liu Jianchao reaffirmed China's determination to continue with reform of the yuan -- code for eventually letting it float more freely -- but said Beijing would dictate the pace of change. ...

                                                                                                                                                                            Wu Xiaoling, a vice governor of the People's Bank of China, said China was in fact already letting market forces drive the yuan. The currency rose 0.14 percent last week, the biggest gain in any week since it was unshackled from the dollar. "...what we want is to let the market mechanism, based on supply and demand, play a role," Wu told Reuters ...

                                                                                                                                                                            Cheng urged Washington to acknowledge the benefits it reaps from trade with China. He quoted a study by ... Morgan Stanley estimating that U.S. consumers had saved $600 billion in the past decade from buying goods made in China. China had also plowed a lot of the earnings from its trade surplus into U.S. bonds, helping to lower interest rates for U.S. home buyers, Cheng said.

                                                                                                                                                                            He called on the United States to help reduce its deficit with China by relaxing rules on high-tech exports, which Washington fears could be adapted for military purposes. ... "If the United States doesn't want to export, how can we achieve balance in our trade?" Cheng asked.

                                                                                                                                                                            Vice Commerce Minister Yi Xiaozhun also tried to turn back Washington's complaints, telling the same forum that ... 83 percent of China's trade surplus reflected exports by foreign firms that had built factories in China to take advantage of its cheap labor. "If we look at the figures, it appears the United States is running a big trade deficit. But after doing some analysis, we can see it's mutually beneficial and that the United States and China share a roughly similar level of benefits," Yi said.

                                                                                                                                                                              Posted by Mark Thoma on Tuesday, February 14, 2006 at 09:16 AM in China, Economics, International Finance, International Trade

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                                                                                                                                                                              'Does Television Rot Your Brain?'

                                                                                                                                                                              Like mom used to say, "You kids quit wasting your time playing outside and come inside and watch some TV":

                                                                                                                                                                              Does Television Rot Your Brain? New Evidence from the Coleman Study, by Matthew Gentzkow and Jesse M. Shapiro, NBER WP 12021: Abstract We use heterogeneity in the timing of television's introduction to different local markets to identify the effect of preschool television exposure on standardized test scores later in life. Our preferred point estimate indicates that an additional year of preschool television exposure raises average test scores by about .02 standard deviations. We are able to reject negative effects larger than about .03 standard deviations per year of television exposure. For reading and general knowledge scores, the positive effects we find are marginally statistically significant, and these effects are largest for children from households where English is not the primary language, for children whose mothers have less than a high school education, and for non-white children. To capture more general effects on human capital, we also study the effect of childhood television exposure on school completion and subsequent labor market earnings, and again find no evidence of a negative effect. [Open link to paper on author web site]

                                                                                                                                                                                Posted by Mark Thoma on Tuesday, February 14, 2006 at 12:17 AM in Academic Papers, Economics

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                                                                                                                                                                                Channeling Bernanke

                                                                                                                                                                                Caroline Baum ghost writes a letter:

                                                                                                                                                                                Bernanke Sets Record Straight Before Big Debut, by Caroline Baum, Bloomberg: Dear Senator Shelby:

                                                                                                                                                                                Your recent comments suggest you may have unrealistic expectations for my debut appearance before your committee as Federal Reserve chairman this week. ... The last thing I want to do is disappoint you or your colleagues ..., so I thought I'd clarify a few points in advance.

                                                                                                                                                                                First, assuming you were quoted correctly, you said I would have to get involved ... by speaking out on budget deficits and other economic issues. You were quoted as saying, "If he doesn't, there will be a void.'' ... The departure of Alan Greenspan may have left a void -- the former Fed chief was willing to comment on just about anything -- but don't except me to fill it. ... Surely you haven't forgotten my testimony ... on the occasion of my confirmation hearing. Just to recap, I said, "I'm going to begin now, I think, a practice of not making recommendations on specific tax or spending proposals.''

                                                                                                                                                                                What part of not commenting on fiscal policy don't you understand? Do you really expect me to break that pledge two weeks into the best job any monetary economist could aspire to? Where I come from -- academia -- there is a premium placed on sticking to one's word and speaking the truth. ...

                                                                                                                                                                                Second, if you think tomorrow's testimony ... will be about me, think again. The Fed's twice-yearly report to Congress on monetary policy and the economic outlook is supposed to represent the views of the entire policy-setting Federal Open Market Committee. It may be true that the FOMC no longer knows what it thinks individually because it has been dominated for so long and so completely by Greenspan. However, I have full confidence that each committee member will soon find his or her own voice. And I will be sure to listen when they do.

                                                                                                                                                                                Third, be prepared to understand what I say. ... My predecessor once said something to the effect that if what he said was clear, his audience must have misunderstood him. That sort of humor may resonate in some circles, but for those of us for whom central bank transparency is something of a religion, there is no place for obfuscation. ... Eventually, with the full support of the committee, I hope to be able to tell you clearly and concisely what our objective is, expressed in terms of a numerical inflation target. ...

                                                                                                                                                                                I look forward to appearing before your committee now that we have agreed on the guidelines.

                                                                                                                                                                                With best regards,

                                                                                                                                                                                Ben S. Bernanke

                                                                                                                                                                                  Posted by Mark Thoma on Tuesday, February 14, 2006 at 12:09 AM in Economics, Monetary Policy, Politics

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                                                                                                                                                                                  China's Exchange Rate Management

                                                                                                                                                                                  Two views on the yuan. First from the Financial Times, the view from the U.S.:

                                                                                                                                                                                  US attacks China peg for trade deficit, by Andrew Balls and Christopher Swann, Financial Times: China’s “tightly managed pegged exchange rate” and “foreign exchange market intervention to limit currency appreciation” are partly to blame for the US’s record trade deficit, the Bush administration says in a flagship economic report. The 2006 Economic Report of the President ... used blunt language on China’s exchange rate management...

                                                                                                                                                                                  The Treasury Department ... has hinted it will be forced to brand China a currency “manipulator” in its twice-yearly report on international trade and foreign exchange unless the country demonstrates that its new currency system will lead to real appreciation over time. The report called for global action to reduce imbalances of trade and capital flows, including the need to raise US national savings. It defended US efforts to lower trade barriers...

                                                                                                                                                                                  Next, here's a report in China Daily on the view of a governor of the People' Bank of China:

                                                                                                                                                                                  Interest rate gap helps manage China's currency, The enlarging interest-rate gap between China and the U.S. helps keep the yuan stable, and serves against world pressures for China's currency to further appreciate. The rising gap also provides favorable conditions for China to adjust exchange-rate and economic policies, Bloomberg quoted a central bank official as saying.

                                                                                                                                                                                  The difference in key interest rates between the two countries is more than 300 basis points and growing, Yi Gang, assistant governor of the People' Bank of China, [said]... He referred to the yield on China's one-year treasury bill of about 1.8 percent, compared to the gain of one-year U.S. dollar bill of 5 percent. ... The interest-rate gap, which has been expanding since early 2005 and is likely to widen further, has helped curb foreign currency inflows to China by deterring speculators seeking to profit from betting on yuan appreciation, Yi said. ...

                                                                                                                                                                                  Central bank officials have repeated that the interest rate gap between the two countries favors a stable yuan several times in recent months, said Song Guoqing, economic professor at Peking University's China Economic Research Center. Yi's comments "indicate that the central bank may be willing to allow the yuan to appreciate by 2 to 3 percent this year,'' Song said at the seminar, according to the Bloomberg report. ...

                                                                                                                                                                                  China's high domestic savings ratio compared with that of the U.S. is an example of a fundamental factor that cannot be addressed by changing the yuan’s exchange rate, Yi said. Adjusting the yuan exchange rate would have only a limited effect in reducing the high savings ratio by spurring domestic demand and encouraging imports, he said. Lawmakers and manufacturers in the U.S. and Europe say an undervalued currency gives Chinese exporters an unfair advantage ...

                                                                                                                                                                                    Posted by Mark Thoma on Tuesday, February 14, 2006 at 12:06 AM in China, Economics, International Finance, International Trade

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                                                                                                                                                                                    Economic Forecasts and Monetary Policy

                                                                                                                                                                                    Cleveland Fed president Sandra Pianalto on the use of economic forecasts in monetary policy and the importance of structural interpretations of the numbers used to assess current and future economic conditions:

                                                                                                                                                                                    Economic Forecasts and Monetary Policy, by Sandra Pianalto, Cleveland Fed President: Today I would like to share with you some of my thoughts about economic forecasts and monetary policy. I will begin with some comments about the economy's recent performance and the outlook for 2006. Next, I will explain why making sound policy decisions requires me to think about both the demand and supply sides of the economy. Finally, I will describe how the stories behind the forecasts directly relate to the way I think about the appropriate course for monetary policy. ...

                                                                                                                                                                                    Although the national economy in 2005 was not as strong as it was in 2004, overall we saw solid growth for the year. ... Now, it is true that the advance estimate for fourth-quarter GDP growth was only 1.1 percent. Some may interpret this weak performance as a sign that the energy shocks may have finally taken their toll. However, ... these are preliminary numbers. Third-quarter GDP growth was substantially revised upward, so we may learn in a few weeks that fourth-quarter growth was not quite as weak as the initial estimate indicates. ...

                                                                                                                                                                                    Please understand that I am not suggesting we should be complacent about the weak statistic for fourth-quarter growth. I will be watching the incoming data very carefully over the next several months. In fact, the early data for January have been reasonably good.

                                                                                                                                                                                    Assuming the preliminary fourth-quarter report holds up, though, GDP still grew last year by 3.5 percent. For the year as a whole, it is clear that employment growth accelerated, business fixed investment was relatively strong, and core inflation remained subdued.

                                                                                                                                                                                    What about the outlook for 2006? Most forecasters are expecting another solid performance. Forecasts ... generally call for real GDP to expand by roughly 3-1/4 to 3-1/2 percent this year. Housing investment is generally expected to slow, while business fixed investment is expected to increase. These forecasts call for interest rates, the unemployment rate, and core inflation to remain steady...

                                                                                                                                                                                    Any forecast is only as good as our ability to look into the future and foresee the unforeseeable. ... Forecasting is a tough business, leading some people to question the value of forecasting altogether. I find forecasts to be helpful. However, achieving better forecast accuracy is less important to me as a member of the Federal Open Market Committee than understanding the forces that drive the economy. ... In other words, I need to think hard about the demand- and supply-side assumptions that underlie economic forecasts. ...

                                                                                                                                                                                    Here is an example. Just recently, a major newspaper ran an article that stated: "Largely because consumer spending slowed to a near halt in the fourth quarter last year, overall economic growth fell." On the surface, that statement seems pretty straightforward: If spending is strong, the economy grows. If spending is weak, the economy grows by less. Is that really the best way to think about U.S. economic performance in 2005?

                                                                                                                                                                                    It is certainly true that GDP growth last year was off the pace of 2004. But, as we are all painfully aware, energy prices rose dramatically over the course of the year. ... Clearly, energy-market disruptions - a supply condition - could go a long way toward explaining why economic activity, including consumer spending, was more restrained than in the recent past.

                                                                                                                                                                                    So, which interpretation is right? Did economic growth slow in 2005 because ... demand in the economy was too weak, or did it slow because productive capacity in the economy was reduced by adverse supply effects? For me, from a policymaker's perspective, these are important questions. My job is to help find the course of monetary policy that is consistent with price stability and with the economy ... growing at its potential.

                                                                                                                                                                                    This means that we have to have an idea of where "potential" is, and we have to be able to identify factors that affect potential, as opposed to factors that affect only aggregate demand. ... And the reason we must be able to make these distinctions is that demand and supply effects can have different implications for the appropriate course of monetary policy.

                                                                                                                                                                                    Now I will turn to how the stories behind the economic forecasts directly relate to the way I think about the appropriate course for monetary policy. ... Each story that I might consider rests on some hypothesis about potential GDP, full employment, and other concepts such as the neutral real rate of interest. ...

                                                                                                                                                                                    Let me suggest some concrete examples to help clarify what I mean. From 1997 through 1999, real GDP growth averaged almost 4.4 percent, which is well above most traditional estimates of how fast the economy can grow without accelerating inflation. But several members of the FOMC - among them, former Chairman Alan Greenspan and Jerry Jordan, my predecessor as president of the Federal Reserve Bank of Cleveland - argued that growth itself is not inflationary if it is driven by productivity gains. ... They saw favorable supply-side conditions as the cause of the rapid growth, while others saw overheated demand conditions. In my view, history has proven that the supply-side perspective was correct.

                                                                                                                                                                                    Consider a more recent example. Many people expected job growth to bounce back more quickly over the past four years than it did. .... A reasonable interpretation of this period is that demand for goods and services was not strong enough to create more robust demand for workers. That view implies that the economy had generally been operating below its potential. If an economy is operating below its potential because of weak demand, then a relatively more accommodative monetary policy is the right medicine - and it can be administered without fear of stoking inflation. Indeed, the FOMC followed this course for a considerable period of time.

                                                                                                                                                                                    It is true that even today, new jobs are still being created more slowly than the roughly 3 million jobs created each year between 1994 and 2000. How can we account for this performance? Does a demand-side story make the most sense? In this case, I think that trends on the supply side of the economy suggest that we might need to interpret sluggish labor markets differently today.

                                                                                                                                                                                    Perhaps the most interesting trend is the pattern of labor-force participation - that is, the fraction of people who either have a job or are actively seeking a job. Since 2001, the labor-force participation rate of all age groups, except those 55 and older, has declined. The change has been especially noticeable among younger workers - 16- to 24-year-olds. Those participation rates have declined by about 5 percentage points. That amounts to 1.9 million young people who, for now, are no longer potential workers.

                                                                                                                                                                                    Has this episode of slower employment growth resulted from demand conditions, supply conditions, or some combination of both? If it is defined as a demand condition, perhaps poor job prospects have discouraged people from even attempting to find work. ... And does that mean that monetary policy should be accommodative until the economy is once again generating substantially more than 2 million new jobs per year?

                                                                                                                                                                                    Alternatively, if the lower labor-force participation rate is defined as a supply condition, then it may be driven by younger workers' deferring entry into the labor force - perhaps to obtain more schooling and skills. If that is the correct explanation, then potential employment will be calculated much differently from the number we saw in the 1990s. In that case, ... an accommodative monetary policy is exactly the wrong thing to do. It will not accomplish the goal of maximum sustainable growth in the long run, and it may threaten our goal of price stability...

                                                                                                                                                                                      Posted by Mark Thoma on Tuesday, February 14, 2006 at 12:03 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                      February 13, 2006

                                                                                                                                                                                      The Power of the New Oligopolies

                                                                                                                                                                                      Whenever I've written about emerging market power in the global marketplace and made the point that free and open markets aren't necessarily the competitive markets needed for the invisible hand to direct resources efficiently, it hasn't generated much response. I was beginning to think that perhaps the real and potential competition provided by globalization had largely eliminated fears of dominant firms in the marketplace and that my worries about emerging market power were misplaced. But perhaps I should worry. More to the point, perhaps policymakers should take note of how market power is evolving in the global marketplace:

                                                                                                                                                                                      Wake up to old-fashioned power of new oligopolies, by Barry Lynn, Financial Times: What will it take to wake us up to the ever-tightening grip of oligopolies over ever more of our global marketplaces? Even though their power increasingly warps our production systems, and our free market systems, alarms are rare and fleeting. The collapse of an overly consolidated US flu vaccine system two years ago did not set off any bells. Nor did the revelation ... of deep fragilities in our hyper-rationalised medical and food supply systems. The mega-merger of Procter & Gamble and Gillette last year did not do it. Nor did the general consolidation of food processors; in the US, 10 groups account for half of all retail sales, with single companies often capturing more than 75 per cent of particular product markets. Neither the fact that Wal-Mart controls 30 per cent of sales for many goods in the US economy, nor that four companies account for 94 per cent of UK supermarket sales, seem to concern policymakers. What about Samsung’s effort to capture world markets for liquid crystal display screens and D-Ram computer chips? Or Tokyo’s rewriting of antitrust laws to allow companies to consolidate 100 per cent monopolies over key technologies? Or the capture of 60 per cent of the global sneaker market by Nike and Adidas? In every case, there has been almost no reaction. ...

                                                                                                                                                                                      There is no shortage of competition in many markets. Just ask Volkswagen or Delta Airlines. But the further down we look below the level of branded companies, the more consolidation we tend to find. This is true in commodities, services, industrial components and shipping. ...

                                                                                                                                                                                      As bad as these old-fashioned problems may be, many of our 21st-century global oligopolies appear to pose entirely new dangers. ... Alfred D. Chandler, an industrial scholar, has written that one of the main factors behind the rise of the huge, vertically integrated corporation early in the 20th century was enforcement of US antitrust law, which limited the horizontal growth of these companies. Unable to exert power over the market, many scrambled instead to internalise key functions, for competitive advantage.

                                                                                                                                                                                      This means we cannot ignore the effect ... of the radical relaxation of antitrust enforcement by the Reagan administration in 1981. One result of giving big companies a licence to grow horizontally was that many producers, once they captured control over their markets, opted to sell off or shut down expensive and risky ... operations and buy these “services” from outside suppliers with few or no other pathways to the marketplace. Over time, many of these top-tier companies relied ever more on their power to dictate prices to their suppliers ... In a production system marked by extreme outsourcing, oligopoly ... lead companies capture more power to set supplier against supplier, community against community and worker against worker. ...

                                                                                                                                                                                      So far, especially in America, the tendency has been to blame extreme competition on “globalisation”... The real explanation, however, is not ... mainly globalisation... as much as radical changes in the structure of industry. In other words, it is not the Chinese who destroy US and European jobs, ...[it is the] the world’s largest traders and retailers ...[who] pit producer against producer...

                                                                                                                                                                                      Outright monopoly is absolutely defensible – when granted temporarily to reward companies for bringing truly new ideas to market. But most of today’s powerful companies are not the result of new ideas, only the strategic reordering of markets. ... It will not be long until we realise that to save our free market system will require, among other actions, far more aggressive enforcement of antitrust. Simply stopping any further roll out of power will not be enough. True believers in the free market will admit there is no other choice than to roll the power back.

                                                                                                                                                                                        Posted by Mark Thoma on Monday, February 13, 2006 at 04:32 PM in Economics, Regulation

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                                                                                                                                                                                        Why Toyota is Better than GM and Ford

                                                                                                                                                                                        James P. Womack explains how Toyota beat GM and Ford. Unlike many, he does not cite aging factories, pension obligations, or unions as the cause. Instead, Toyota gained its advantage by following the lean business strategy he and others identified in the 1990s :

                                                                                                                                                                                        Why Toyota Won, by James P. Womack, Commentary, WSJ: ...Clearly MoTown needs a new approach and it's natural in the car industry to think that the secret must be a killer model -- a Toyota Prius hybrid or some other concept to replace the big pickups and SUVs that floated the American firms for 15 years. Actually, it's not a new car model that's needed. It's a new business model. Toyota is leading the charge against Detroit -- largely from inside the U.S. -- with a fundamentally different approach to business that my MIT research team in the 1990s labeled "lean" enterprise. Compared with these Toyota practices, GM and Ford's approach has five fatal weaknesses:

                                                                                                                                                                                        • GM and Ford can't design vehicles that Americans want to pay "Toyota money" for. And this is not a matter of bad bets on product concepts or dumb engineers. It's a matter of Toyota's better engineering system, using simple concepts like chief engineers with real responsibility for products, concurrent and simultaneous engineering practices, and sophisticated knowledge capture methods. The Prius is... the likely result of a development system that tries out many approaches to every problem, then gets the winning concept to the customer very quickly with low engineering cost, low manufacturing cost, and near perfect quality. (That's not to say that Toyota can't produce a dud ...but the likelihood of producing winners is higher ...)

                                                                                                                                                                                        • GM and Ford are clueless as to how to work with their suppliers. Sometimes they try to crush their bones -- which only works when the suppliers have any profits to squeeze, and few currently do. Then they embrace contentless cooperation that ... fails to produce lower costs, higher quality, or new and better technology. Toyota, by contrast, is getting brilliant results and lower prices from American suppliers like Delphi while also giving suppliers adequate profit margins. How? By relentlessly analyzing every step in their shared design and production process to take out the waste and put in the quality.

                                                                                                                                                                                        • GM and Ford have miasmic management cultures. These turn competent people into Dilberts. By contrast, Toyota does a brilliant job of making one person responsible for every key business process... A Dilbert-free environment naturally emerges, but not because everyone has received cultural training to spur teamwork. Rather, if ordinary people -- Dilberts even -- are put in a great business process they become great team players.

                                                                                                                                                                                        • GM and Ford cling to their wide range of brands: Chevy, Pontiac, Buick, Cadillac, Saab, GMC, and Hummer at GM; Ford, Mercury, Lincoln, Mazda, Jaguar, Volvo, Aston Martin, and Range Rover at Ford. And they still talk about brand revitalization as the way ahead. Yet the most successful car companies in the world -- Toyota and BMW -- have only two or three brands. And this is not an accident. Indeed, it's hard to see how any modern-day car maker can support more than three truly distinctive brands... A plethora of brands that can't pull their weight drains management energy and company coffers.

                                                                                                                                                                                        • GM and Ford still treat customers as strangers engaged in one-time transactions. Toyota's Lexus, by contrast, has created a new and better customer experience. Customers cheerfully pay more for the car and the service and then come back for more cars because they love the treatment. ...

                                                                                                                                                                                        But note: I haven't mentioned the creaky factories, vast pension obligations, and cranky unions that commentators ... seem obsessed with. In fact, Ford and GM's factories are now good enough to compete in terms of labor productivity and quality. They just can't support ... pension and healthcare benefits for retirees as the companies continue to shrink. Union and management both know this, yet ... their conversation has broken down. With zero confidence that management knows what it is doing, a union will try to get what it can now rather than look at the long term. In consequence, unless GM and Ford soon present a plausible path to a brighter future ... there may be no long term.

                                                                                                                                                                                        There is no mystery about the lean business model. All of the elements are operating in this country every day at Toyota and at many other American companies in a range of industries. What is mysterious is why GM and Ford can't embrace it. And what is dismaying is how many of their employees are likely to suffer if they don't. But finally, what is reassuring for the country is that if GM and Ford can't fix their problems, they will simply be replaced by new players in America, led by Toyota, who can.

                                                                                                                                                                                          Posted by Mark Thoma on Monday, February 13, 2006 at 01:41 AM in Economics

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                                                                                                                                                                                          Will this Year's Version of the Ownership Society Slip through Congress?

                                                                                                                                                                                          Sebastian Mallaby says the creation of health savings accounts is a bad idea that is more about the administration's vision of an ownership society than a serious proposal to meet our health care challenges:

                                                                                                                                                                                          Ownership Society Redux, by Sebastian Mallaby, Commentary, Washington Post Online: The ... "ownership society." ... You think George Bush would let go of this ... just because Social Security reform failed? Fuhgedaboutit. The ownership society is back, though it's got a new label. Bush may not be pushing individual Social Security accounts these days. But he is pushing things called health savings accounts, which turn out to be similar.

                                                                                                                                                                                          Health savings accounts are ostensibly supposed to fix the health system. .... Health savings accounts ... will shift control of medical spending into the hands of consumers, who will discipline overpriced hospitals and clinics. Or so goes the theory. In practice, probably less than half of all health spending outside Medicaid and Medicare would be affected ... Many hospital stays cost more than any deductible, so consumers would have no incentive to bargain; emergency-room patients aren't in a fit state to negotiate prices ...

                                                                                                                                                                                          But consider an even more basic question: Is the ostensible reason for health savings accounts the real one? ... [H]ealth savings accounts are not just about ending the tax bias in favor of traditional company health plans. The administration is proposing a new kind of 401(k) ... as an inducement to quit low-deductible insurance. Rich people, who gain most from the tax breaks ..., will be first to sign on; healthy people, who subsidize sicker people in company health plans, will be right behind them. Their exit may force traditional health plans into a death spiral. ...

                                                                                                                                                                                          The State of the Union address ... contained barely a mention of health savings accounts, but don't let that fool you. Because these accounts are being pushed modestly, with no grand Social Security-style talk of remaking the social contract, there's a chance that they'll be seen as just one of various bewildering tax tweaks and slip quietly through Congress. But the proposal cries out for a debate very much like last year's -- a debate about personal saving vs. collective insurance.

                                                                                                                                                                                          A rerun of last year's debate would show that health savings accounts are ... shockingly regressive: ... a poor family might get a subsidy of $150 while a rich one might get more than $4,000. They have not just a transition cost but a real cost: The tax breaks could widen the deficit by at least $132 billion over 10 years and a lot more after that. And health savings accounts pose a more formidable threat to traditional corporate health plans ... Market forces are already dislodging company health plans; an extra shove could cause an avalanche.

                                                                                                                                                                                          The limited consumer discipline that would come from health savings accounts could not justify these disadvantages...

                                                                                                                                                                                            Posted by Mark Thoma on Monday, February 13, 2006 at 01:07 AM in Economics, Health Care, Politics

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                                                                                                                                                                                            Paul Krugman: Debt and Denial

                                                                                                                                                                                            Paul Krugman is worried that Ben Bernanke has inherited a difficult set of economic conditions due to ballooning trade and budget deficits, housing bubble zones, and denial among economic agents creating these conditions. Because of this, Krugman is worried about a hard-landing outcome for the U.S. economy. I have more faith in the soft landing scenario than he does, but perhaps that's wishful thinking or denial on my part. In any case, this time I hope Krugman is wrong:

                                                                                                                                                                                            Debt and Denial, Commentary, by Paul Krugman, NY Times: Last year America spent 57 percent more than it earned on world markets. That is, our imports were 57 percent larger than our exports. How did we manage to live so far beyond our means? By running up debts to Japan, China and Middle Eastern oil producers. ... Sometimes large-scale foreign borrowing makes sense. ... But this time our overseas borrowing isn't financing an investment boom: ... business investment is actually low by historical standards. Instead, we're using borrowed money to build houses, buy consumer goods and, of course, finance the federal budget deficit.

                                                                                                                                                                                            In 2005 spending on home construction as a percentage of G.D.P. reached its highest level in more than 50 years. People who already own houses are treating them like A.T.M.'s, converting home equity into spending money: last year the personal savings rate fell below zero for the first time since 1933. And it's a sign of our degraded fiscal state that the Bush administration actually boasted about a 2005 budget deficit of more than $300 billion, because it was a bit lower than the 2004 deficit.

                                                                                                                                                                                            It all sounds unsustainable. And it is. Some people insist that the U.S. economy has hidden savings that official statistics fail to capture. I won't go into the technical debate about these claims ... except to say that the more closely one looks at the facts, the less plausible the "don't worry, be happy" hypothesis looks.

                                                                                                                                                                                            Denial takes a more systematic form within the federal government... Last week Mr. Cheney announced that a newly created division within the Treasury Department would show that tax cuts increase, not reduce, federal revenue. That's the Bush-Cheney way: decide on your conclusions first, then demand that analysts produce evidence supporting those conclusions.

                                                                                                                                                                                            But serious analysts know that America's borrowing binge is unsustainable. ... So how bad will it be? It depends on how the binge ends. If it tapers off gradually, the U.S. economy will be able to shift workers out of sectors that have benefited from the housing boom and ... into sectors that produce exports or replace imports. Given time, we could bring the trade deficit down and bring housing back to earth without a net loss in jobs.

                                                                                                                                                                                            In practice, however, a "soft landing" looks unlikely, because too many economic players have unrealistic expectations. This is true of international investors, who are still snapping up U.S. bonds ... seemingly oblivious both to the budget deficit and to the consensus view ... that the dollar will eventually have to fall 30 percent or more to eliminate the trade deficit.

                                                                                                                                                                                            It's equally true of American home buyers. Most Americans live in regions where housing remains affordable. But ... most of the rise in housing values has taken place in a "bubble zone" along the coasts, where housing prices have risen far more than the economic fundamentals warrant. ... houses in the bubble zone are overvalued by between 35 and 40 percent, creating trillions of dollars of illusory wealth.

                                                                                                                                                                                            So it seems all too likely that America's borrowing binge will end with a bang, not a whimper, that spending will suddenly drop off as both the bond market and the housing market experience rude awakenings. If that happens, the economic consequences will be ugly. All in all, Alan Greenspan, who helped create this situation, can consider himself lucky that he's safely out of office, giving briefings to hedge fund managers at $250,000 a pop. And his successor may be in for a rough ride. Best wishes and good luck, Ben; you may need it.

                                                                                                                                                                                            Previous (2/10) column: Paul Krugman: The Vanishing Future Next (2/20) Column: Paul Krugman: The Mensch Gap

                                                                                                                                                                                              Posted by Mark Thoma on Monday, February 13, 2006 at 12:15 AM in Budget Deficit, Economics, International Finance, International Trade

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                                                                                                                                                                                              February 12, 2006

                                                                                                                                                                                              Human-Electronic Hybrid Workers

                                                                                                                                                                                              I know my president will support me in this call to rid the earth of mutant human-electronic hybrids:

                                                                                                                                                                                              US group implants electronic tags in workers, by Richard Waters, Financial Times: An Ohio company has embedded silicon chips in two of its employees - the first known case in which US workers have been “tagged” electronically as a way of identifying them., ... said it was testing the technology as a way of controlling access to a room where it holds security video footage for government agencies and the police. ... “There are very serious privacy and civil liberty issues of having people permanently numbered,” said Liz McIntyre, who campaigns against the use of identification technology. ... The technology’s defenders say it is acceptable as long as it is not compulsory. But critics say any implanted device could be used to track the “wearer” without their knowledge. VeriChip ... said the implants were designed primarily for medical purposes. So far around 70 people in the US have had the implants, the company said.

                                                                                                                                                                                              I don't have a great argument against this if it's done on a voluntary basis, especially it it's reversible, but something about it 'bugs' me. Maybe it's because I doubt that it would be truly voluntary if firms are allowed to do this to promote more efficient operations. What if you were the only member of a work crew who wouldn't do it and it slowed the entire group down? Would peer pressure matter? What about the military or police where there are clear advantages to having all members tagged? Should embedded ID or more complicated electronics be required, particularly if not doing so puts lives at risk? This is a door I'd rather keep closed in both the business and government sectors.

                                                                                                                                                                                                Posted by Mark Thoma on Sunday, February 12, 2006 at 04:28 PM in Economics, Technology

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                                                                                                                                                                                                India, Infrastructure, and Resistance to Globalization

                                                                                                                                                                                                A commentary in the Financial Times says infrastructure and resistance to globalization in rural areas are issues that may limit India's ability to grow. How fast will the half-full or half-empty glass that is India's economy fill up with economic growth? Is the glass itself in danger of shattering?:

                                                                                                                                                                                                Infrastructure poses threat to India’s boom, by Jo Johnson, Financial Times: For those given to triumphalism about the inevitability of India’s emergence as an economic superpower, there is no better reality check than Delhi and Mumbai airports. Never far from the bottom of global passenger satisfaction rankings, the country’s two main hubs were even closer than usual to paralysis at the start of this month. ...

                                                                                                                                                                                                The contrast with the impression given at the World Economic Forum in Davos last month ... of a nation “on the move” could hardly have been crueler. The hard-selling “India Everywhere” campaign ... tells a different story to that relayed to despairing passengers locked in holding patterns in the sky. The “world’s fastest growing, free market democracy”, goes the brand-building blitz, is “open for business”. ...

                                                                                                                                                                                                The danger that India starts believing its own hype ... has never been more real. Reform-mongers worry that complacency may cause India to miss its best chance to convert global interest into investment, jobs and social development. ... Rajeev Chandrasekhar, a former telecommunications entrepreneur who is turning his attention to the freight business, says: “Business has been growing feverishly in India; now it is heading like a rocket into a dead-end. That dead-end is a lack of transportation infrastructure.” ...

                                                                                                                                                                                                Manmohan Singh, prime minister, did force through his plan to modernise the two airports with the use of private capital... It was a significant moment. But few analysts are confident that this signals a step-change in the pace of reform. Communist parties hold the balance of power in parliament and have shown themselves adept at blocking or diluting measures to liberalise the economy.

                                                                                                                                                                                                Nowhere is the danger of inaction more evident than in Bangalore, the country’s information technology capital and the city that has done most to transform India’s international image. The realities of Karnataka state politics are in danger of killing a global success. Neglect of Bangalore’s infrastructure by the state government has called into question India’s ability to maintain its market share in IT services and defend its status as the world’s default back office. ... “Bangalore is collapsing,” says Deepak Parekh, ... a member of the three-person Investment Commission set up by the prime minister to attract and facilitate foreign investment. ...

                                                                                                                                                                                                Things are unlikely to get better and may well get worse. The rural-urban divide that is present throughout India finds an acute expression in Karnataka. ... Ram Guha, a leading historian and Bangalore resident, says ... it is outsiders who have generated the vast bulk of new wealth in the state. Kannada speakers form a majority in rural Karnataka... “Bangalore is seen as a privileged class of non-Kannada speakers,” he says. “This explains why politicians don’t act, why they say ‘Bangalore is not our city’ and why they recently proposed to rename it Bengaluru. It’s a highly emotive issue.” ...

                                                                                                                                                                                                Just three years ago, for technology companies to locate in Bangalore was a “no-brainer” decision, according to Mr Ravichandra. ... As a result, 55-60 per cent of high technology companies in India are based in the city. “Today, if someone says Bangalore is a slam-dunk, they’d check his head. That’s the change . . . With double the number of cars of five years ago and no mass transit system in sight, the city no longer works in a way that unleashes the creative potential of those who live here. We have some distance to go before things get better.”

                                                                                                                                                                                                The crisis in Bangalore is played out in different ways and to differing degrees across India, reflecting a hardening belief that being seen as reformist has a high electoral cost, especially in rural areas, where 60-70 per cent of Indians live. ... “There is a standard kind of leftwing rhetoric that presents globalisation and reform as a zero-sum game,” says Mr Guha, who believes proponents of liberalisation have failed to argue their corner, allowing the belief to gain ground that Bangalore is somehow rich because rural areas are poor. ... “The intellectual argument for market economics has yet to be won in India,” Mr Guha says. “Pop-Marxist economics still hold quite an influence.”

                                                                                                                                                                                                Azim Premji, Wipro chairman and one of India’s richest men, says politicians who pander to the rural-urban divide in this way are underestimating the electorate in the villages. “I don’t think the villagers think that,” he says. “Poor people in India aspire to become rich people in India. It’s very fundamental. They also have a lot of respect for successful people in India. ... It’s not a Communist mindset. ...” ...

                                                                                                                                                                                                Update: See also When globalization leaves people behind from The International Herald Tribune.

                                                                                                                                                                                                  Posted by Mark Thoma on Sunday, February 12, 2006 at 02:43 PM in Economics, India

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                                                                                                                                                                                                  Who Profits from War?


                                                                                                                                                                                                  Do corporations have any responsibility besides the maximization of profit?

                                                                                                                                                                                                  Diplomat Without Portfolio in Davos, by William J. Holstein, NY Times: Dr. Daniel Vasella, chief executive of Novartis, the Swiss pharmaceutical giant, attracted attention in Europe when he questioned Secretary of State Condoleezza Rice ... at the recent World Economic Forum in Davos, Switzerland. He asked whether the United States was "playing into the hands of enemies" through its tactics in fighting terrorism. Here are excerpts from a recent conversation with him:

                                                                                                                                                                                                  Q. Are there winners and losers in the process of globalization? A. The concept of winners and losers is wrong. If one looks at economic growth, child mortality and other factors, which you can take as the measure of a country's health, you can see that the number of people living on less than $1 per day has declined steadily, from 38 percent of the world's population in 1970 to 20 percent today. But there has been a very different evolution of various parts of the world. ... The advanced countries have benefited more. If you look at Latin America, East Asia and South Asia, their average income per capita has increased significantly. There is one remarkable exception, where we see stagnation, which is Africa. In sub-Saharan Africa, there has been very slow and poor development.

                                                                                                                                                                                                  Q. Do you think the distribution of wealth needs to be improved? A. There is a maldistribution in the sense that we have about 20 percent of the richest 6.1 billion people in the world getting 74 percent of the income... If you take the poorest 20 percent, they only have 2 percent of the income. So there is no way we can say it is well distributed.

                                                                                                                                                                                                  Q. Why would you, as a chief executive, raise these issues with Secretary Rice and other world leaders? A. The first responsibility of a C.E.O. is to run his company successfully and generate products which are useful to your customers, resulting in economic value creation. We also have to act responsibly, respecting not only the law, but also fulfilling legitimate expectations that society has of us. Today these expectations in most instances go beyond short-term profit maximization. What people want is that businesspeople behave in a responsible way in communities in which they live, that they treat employees fairly, respect the environment and demonstrate sensitivity to the problems of other, disadvantaged people in the world. I think corporate social responsibility has taken a much more important role than it used to.

                                                                                                                                                                                                  Q. What did you say to Secretary Rice about the war on terror? A. It is not a question of whether one should fight terror or not fight terror. Terror is absolutely unacceptable. What we have to stand for is to create and maintain a free and open society. With terror, you destroy open societies.

                                                                                                                                                                                                  But in an open society, there must be a place for expressing one's opinion. Critiquing is in some ways an expression of respect. If you do not respect somebody, you do not bother to critique them. Having said that, I do believe that if you are economically, politically and militarily a superpower, then you have to be a role model for the world. If you talk about values and you stand for democracy and respect for human rights, then you have to act accordingly. The world will look very closely to see if there is consistency between what you say and how you act. You will empower your enemies and weaken your supporters if you deviate from your values and principles.

                                                                                                                                                                                                  Q. What do you mean specifically? A. You cannot fight a war without casualties and without taking prisoners. But other questions remain, like, Do you torture? We, the open societies in the world, have to apply the strictest standards. We need to treat people with respect. We need to be very thoughtful about not offering ground for anybody to be against us. We have to be thoughtful about the fact that poverty and the lack of education are excellent breeding grounds for terrorists. They can indoctrinate children. That's what's happening in many countries. The perception in people's minds about who we are gets very distorted.

                                                                                                                                                                                                  Q. So you're suggesting that there is a connection between poverty and terrorism? A. No question. You are more willing to risk one's life and one's family when you have nothing to lose. People become more thoughtful when they have something to lose. ...

                                                                                                                                                                                                  Q. Why do you think American chief executives are so reluctant to talk about poverty and the roots of terrorism? A. I don't know. You will have to ask them. I know that some of my fellow C.E.O.'s believe they should not express themselves on political issues at all. They should just do business. I think that is not the right attitude. First of all, we are citizens of whatever country we are from. We have a citizenship responsibility. Secondly, I do believe we have to examine our own beliefs and value systems regularly. We cannot act in a void. I think there is very clear responsibility.

                                                                                                                                                                                                  Q. Might expressing your views hurt your business in America? A. I don't believe so. I believe the Americans are tolerant and self-assured enough to stand up to these questions. ...

                                                                                                                                                                                                  Q. But do you think any American chief executive would publicly confront Secretary Rice on these issues? A. Why not? It depends on the understanding of your role as a business leader. Do you just have responsibility for your business and just your people?

                                                                                                                                                                                                  Or if you are given this kind of job as a result of fate, your skills or whatever circumstances, do you have also to take stands on subjects that are not directly linked to your business but are important? Many think that politics have supremacy over business, but does this also imply that business is just a tool for government? On this, history teaches us some interesting lessons.

                                                                                                                                                                                                  See here for more on the povery-terror connection from Alan Krueger.

                                                                                                                                                                                                    Posted by Mark Thoma on Sunday, February 12, 2006 at 09:53 AM in Economics, Iraq, Terrorism

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                                                                                                                                                                                                    Hal Varian: Unplugging the Undeveloped

                                                                                                                                                                                                    Which is the better investment for developing countires, cell phones or cheap laptops? Hal Varian argues that $100 laptops could have a big impact:

                                                                                                                                                                                                    A Plug for the Unplugged $100 Laptop Computer for Developing Nations, by Hal Varian, Economic Scene, NY Times: One of the more interesting technology sessions at Davos, Switzerland, this year was Nicholas Negroponte's presentation of a $100 laptop computer intended for developing countries. ... The mock-up that Mr. Negroponte demonstrated had a spill-resistant keyboard and a carrying handle. The final version will have a screen that can be read in direct sunlight, wireless networking capabilities and a hand crank to generate power. Despite the technological ingenuity of the device, it engendered considerable skepticism. One audience member asked what good a $100 laptop was when network connections cost at least $25 a month. Mr. Negroponte responded that the laptops would send and receive Internet data only when higher-paying commercial data was not being transmitted, leading to lower networking costs.

                                                                                                                                                                                                    Microsoft's vice president and chief technology officer, Craig J. Mundie, argued that a cellphone like device would make more sense than a laptop computer in developing countries... As he suggested, there are proven uses for cellphones in developing countries: migrant workers use them to call relatives back home and farmers use them to check crop prices. ... Often cellphone use among the poor in developing countries involves text messaging, which is much cheaper than voice. ... Mr. Negroponte emphasized the educational value of laptops, while Mr. Mundie and others focused on the business models enabled by cellphones. These views are not necessarily at odds: as with cellphones, there are many potential business models that can be built around cheap laptops. After all, the most important application for personal computers back in 1979 was ... an early spreadsheet used by businesses. ...

                                                                                                                                                                                                    Let me suggest that using the $100 laptop as a cash register could be quite attractive. These days, a cash register is nothing but a personal computer with a different interface. A simple cash register program plus accounting software would be useful to merchants ... If the computer was networked, there could be other valuable commercial applications. ... Such an application is quite compatible with the Hawala system of monetary transfer that has been used in the Middle East, Africa and Asia for more than 1,200 years... Low-cost laptops could also serve as a way to record and preserve contracts and other legal documents. The Peruvian economist Hernando de Soto has argued that the lack of formal titles to land and other property has prevented the poor from posting collateral to secure loans. Perhaps cheap, networked laptops could serve as repositories for such documents. ... trustworthy. ...

                                                                                                                                                                                                    Of course, written communication requires a literate population. But that is a good thing. If reading, writing and typing are the key to employment, people will be highly motivated to acquire those skills. And, circling back to Mr. Negroponte's education vision, the $100 laptop can help people become literate. ... The great thing about computers is that they are what economists call general-purpose technologies. That is, they provide a platform on which other applications can be built... Ultimately, both sides of the Davos debate are right: cellphones have proven uses and will continue to spread rapidly in developing countries. But cellphones have their limits. Offering general-purpose technologies like low-cost laptops is a riskier strategy, but it just might have a big payoff.

                                                                                                                                                                                                      Posted by Mark Thoma on Sunday, February 12, 2006 at 01:38 AM in Economics, Technology

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                                                                                                                                                                                                      "Greenspan is a Fox"

                                                                                                                                                                                                      What is Greenspan's contribution to monetary policy? In this speech, Greg Ip of the Wall Street Journal emphasizes Greenspan's use of risk management strategies - the conduct of policy in the face of uncertainty that avoids big and costly mistakes - and other traits that aided his success and provide lessons for those who follow in his footsteps:

                                                                                                                                                                                                      The Enigma of Alan Greenspan, Greg Ip, WSJ: In a speech early last year in Scotland, Alan Greenspan said, "In the broad sweep of history, it is ideas that matter. Indeed, the world is ruled by little else… Emperors and armies come and go; but unless they leave new ideas in their wake, they are of passing historic consequence." Ever since Greenspan gave this speech, I've been asking myself: what ideas has Greenspan left us?

                                                                                                                                                                                                      Many ordinary people are familiar with Keynesianism, Reaganomics, and Milton Friedman's doctrine of monetarism. Many economics students, by the time they've graduated, will have studied the Phillips curve and the Taylor rule. But 20 years from now, will students study "Greenspanism" or "the Greenspan rule?" I suspect the answer is no because the essence of Greenspan's thinking is his distrust of any "ism" or rule.

                                                                                                                                                                                                      Anyone who knows anything about Greenspan's early years would snort in disbelief to hear him described as non ideological. He was of course a hard-core libertarian, opposed to government interference in almost any aspect of society. As an associate of the libertarian philosopher Ayn Rand in the 1960s, he inveighed against the Food and Drug Administration, the Securities and Exchange Commission, and antitrust laws, which he called a "jumble of economic irrationality and ignorance."

                                                                                                                                                                                                      Yet in his later years, he was more likely to describe himself as a follower not of Ayn Rand but of Thomas Bayes. Thomas Bayes was an 18th-century British Presbyterian minister who had early insights into decision making under uncertainty. Some things are relatively straightforward to predict: for example, the probability that a flipped coin will come up heads or the percentage of boys born last year who will grow up to be at least six feet tall.

                                                                                                                                                                                                      But many complex things like the U.S. economy are inherently uncertain because so many factors affect its performance and they are always changing. A Bayesian accepts that rules based on history can easily break down when applied to the future. He makes a decision based not on the most probable outcome but on a range of possible outcomes.

                                                                                                                                                                                                      Greenspan declared in August, 2003, "Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape." At the Fed, he and his closest colleagues would describe their work as "epistemology," the study of knowledge and its limits. This committed agnosticism may be the most important factor in Greenspan's success.

                                                                                                                                                                                                      He does use models of the economy, but avoids getting invested in any. That makes it easier to shift gears when the model stops working. In 1996, he concluded that productivity growth in the United States had accelerated, and thus the economy could grow faster and unemployment fall further without generating inflation than some of his colleagues maintained. The Fed delayed raising interest rates, which probably helped extend the 1990s expansion – though critics say it also contributed to a stock bubble.

                                                                                                                                                                                                      Listen to this passage from a Fed meeting in 1999 where Greenspan explains how he's concluded that productivity growth must be higher than generally realized:

                                                                                                                                                                                                      "As we all know, when econometricians get regression results that appear out of line with the real world … they have to look for the missing variable. I submit that there is a missing variable… I think it may be about time to try to substitute this variable for NAIRU (the non-accelerating inflation rate of unemployment). Let me put it this way: Neither one is an observable phenomenon, but neither was the planet Pluto before 1930. Scientists figured out that there had to be something there, given the extent to which Uranus and Saturn were deviating from their forecast orbits. Well, I submit that at some point we are going to come to the conclusion as statisticians that the simultaneity of a falling inflation rate and an ever tightening labor market is trying to tell us something."

                                                                                                                                                                                                      This was just one case of his "missing variable" methodology. Another was in the early 1990s, trying to understand why the economy was growing so slowly. He concluded it was the credit crunch. Then, in the mid-1990s, when he was puzzled by the failure of wage growth to pick up as unemployment dropped, he struck upon the insecure worker hypothesis. And more recently, in trying to understand the low level of long-term interest rates and inflation world wide, he has concluded it must be globalization.

                                                                                                                                                                                                      In addition to these insights Greenspan also had a lot of duds. In the year 2000, he argued that the economy would slow down of its own accord after consumers had bought all the cars and houses they could possibly want. In fact, housing sales went on to break annual records, automobile sales remained well above their 1990s average, and we are still waiting for consumers to reach their saturation point. Greenspan, as far as I know, hasn't repeated this theory lately.

                                                                                                                                                                                                      At least since the 1960s he has argued that the ability of homeowners to "extract" the equity in their homes through the mortgage market represents a unique channel of stimulus to the economy separate from the "wealth effect" of higher home prices. Though he has won many converts to this view, most of the Fed's professional staff are not among them. As Greenspan himself has admitted, the theory is as yet unproven.

                                                                                                                                                                                                      Even Greenspan's productivity insight in 1996 had come to him in an earlier, less successful form. Back in February, 1987, at Townsend Greenspan, the consulting firm he ran before joining the Fed, he wrote, "Indirect evidence suggests that productivity growth in many key nonmanufacturing areas of the economy, where high tech predominates, may have been significantly underestimated in recent years."

                                                                                                                                                                                                      The problem was that the economy wasn't behaving like this was true. As growth approached its old speed limit, inflation pressures emerged. I recite these examples not to play down the significance of Greenspan's successful insights but to try to identify something important about the way he thinks. He had a lot of ideas. He tested them. And when an idea didn't hold up, he discarded it.

                                                                                                                                                                                                      When his productivity thesis failed to explain the economy's behavior in 1987, he applied the old rules and tightened monetary policy. Indeed, in September, 1987, at one of his first FOMC meetings, another governor posited that "inflation may behave in an untraditional way" because productivity growth might be under-measured. Greenspan's responded: "There is always something different (about an economic cycle). But there is nothing very unusual about this one." On the other hand, when the economy's behavior suggested in 1996 that productivity had accelerated, he acted accordingly by not tightening monetary policy.

                                                                                                                                                                                                      In general, it's difficult for anyone, most of all policy makers, to constantly question their views of how the world works. Most of us have presumptions and preconceptions that we use to make sense of the world and to make decisions. We will cross the street because we assume a car will not come at us from the wrong way. We will not buy a used car from that man because we assume used car salesmen can't be trusted. Moreover, we often gravitate to people with strong, confident visions, even as others find those very same visions completely wrong.

                                                                                                                                                                                                      "People for the most part dislike ambiguity," Philip Tetlock, a University of California at Berkeley psychologist, has written. "Human performance suffers because we are, deep down, deterministic thinkers…. We insist on looking for order in random sequences." Tetlock has undertaken some fascinating empirical research on what makes someone a good decision maker. His book Expert Political Judgment chronicles a 16-year experiment testing the predictions of 284 experts in geopolitics, on questions as diverse as whether Japan would recover from its early 1990s stock market collapse, whether Quebec would secede from Canada, or whether Nigeria would collapse into interethnic violence. Tetlock concludes: "What experts think matters far less than how they think." Experts on either the right or left who have a single, unified view of the world are more likely to be wrong, and badly wrong. Such "hedgehogs," as Tetlock calls them, "know one big thing."

                                                                                                                                                                                                      They are less prone to self-doubt, more likely to dismiss evidence that contradicts their vision, and less likely to admit to mistakes. "Foxes," on the other hand, "know many little things." They "draw from an eclectic array of traditions, and accept ambiguity and contradictions as inevitable." (He attributes the hedgehog-fox labels to philosopher Isaiah Berlin, who in turn traced them to ancient Greece.)

                                                                                                                                                                                                      Some hedgehogs turn out to be great leaders, businessmen or scientists precisely because they doggedly adhered to a single, simple belief that turns out to be right. Foxes can be maddeningly hard to pin down.

                                                                                                                                                                                                      Greenspan is a fox. He spoke in opaque prose and avoided precision because he thought the constantly shifting structure of the economy made certainty and precision impossible. In 2004 he said one of the few things an economic forecaster can count on is that a company's inventories can't go below zero. That, he said, is "probably the full state of my knowledge about how to make a forecast."

                                                                                                                                                                                                      Indeed, as Fed chairman Greenspan was always circumspect about forecasts, such as those developed by his very capable staff at the Fed. Perhaps that's because of his own unimpressive forecasting record. Back in 1984, Greenspan and a partner got into the money management business. According to an article in Forbes Magazine, the fund's selling point "consisted mainly of Greenspan's macroeconomic analysis of secular and cyclical trends." But the fund's performance, according to the magazine, was "barely passable … In 1985 … (it) turned in one of the least impressive records of all pension fund advisers."

                                                                                                                                                                                                      At his 1987 confirmation hearing, one of the Senators quoted from this article. Greenspan's response to this critique was, "All I can suggest to you, senator, is that the rest of my career has been somewhat more successful." Milton Friedman once told me he thought Greenspan was very good at reading economic trends. When I pointed out to him that some had found his forecasting record to be unimpressive, Friedman replied, "I was only judging by the fact he was able to make a living at it."

                                                                                                                                                                                                      Indeed, Tetlock finds that foxes are not especially good forecasters. But, he says, they make fewer big mistakes than hedgehogs. For a central banker, that means having the occasional recession but avoiding catastrophes like the Great Depression of the 1930s or the Great Inflation of the 1970s. Greenspan calls his own flavor of Bayesian decision-making "risk management." It amounts to deliberately risking small mistakes to avoid much bigger ones. An example of this came quite recently. In early 2003, the recovery seemed stalled and inflation, already low, was going lower. Though the Fed discussed deflation, the risk of it seemed remote: it could probably have raised interest rates later that year without much harm. But if in fact deflation had occurred, such a strategy could have been disastrous: once prices and wages start falling, companies and individuals are crushed by their debts, and even zero interest rates may not stop the downward spiral. To be sure, keeping interest rates low to prevent this remote possibility risked inflation. But as Greenspan told Congress: "We know how to deal with inflation." By contrast, on deflation, he said, "our knowledge base was virtually nonexistent."

                                                                                                                                                                                                      We do know how the economy performed under Greenspan: extremely well. He left office with unemployment and inflation both lower than when he took office. There were just two mild recessions and the longest expansion on record. Growth in the last few years has been the strongest of the major industrial countries.

                                                                                                                                                                                                      We are not, however, certain what Greenspan did to bring this about. It could be partly luck. In the 1970s, we had a massive oil price shock and a decline in productivity growth. In the 1990s, we had low oil prices, an acceleration in productivity growth, and the integration of China into the world economy, all of which made it easier to keep inflation down. Moreover, the U.S. was hardly alone in enjoying strong economic performance. In the last 15 years, inflation has fallen in most countries, from Italy to Congo, in some dramatically. Australia, Canada, the United Kingdom and Spain have done as well or better than the U.S. in reducing inflation and unemployment since 1987.

                                                                                                                                                                                                      Nor is Greenspan's paradigm of risk management entirely new. Allan Meltzer, a Fed historian and economist at Carnegie Mellon University, has noted that in the mid 19th century, British economist Walter Bagehot said that during financial crises the Bank of England should suspend the gold standard and lend freely. "Call it risk management," Meltzer says.

                                                                                                                                                                                                      All that said, it seems unlikely the U.S." good economic performance can all be attributable to luck. There were many dark economic moments during Greenspan's tenure and the fact that the U.S. came out of them as well as it did seems likely to have something to do with how Greenspan approached each challenge.

                                                                                                                                                                                                      It may be true that much of what Greenspan preaches now is standard operating practice for many central banks, but I think Greenspan has done a good job articulating it, and other central bankers have often said how much they've learned from watching Greenspan.

                                                                                                                                                                                                      This brings me to the final question. Is Greenspan's way of thinking learnable? Can it be passed on to future generations? And can Fed chairman Ben Bernanke emulate Greenspan and continue his track record?

                                                                                                                                                                                                      One of the advantages of being a hedgehog is that your ideas tend to be memorable, even if they aren't right. One of the disadvantages of being a fox is that it's harder to sum up your way of thinking in a succinct, memorable way. A few years ago Harvard University economist Greg Mankiw dug up a scholarly paper Greenspan published in 1964 called "Liquidity as a determinant of industrial prices and interest rates." Mankiw said he liked this paper because it foreshadowed many of the hallmarks of Greenspan's Fed chairmanship: an intense look at the data, and a desire to "integrate various points of view" that showed "a lack of dogma and a nimbleness of mind." But, Mankiw wondered if it presaged Greenspan's career in another, less favorable way: it "left no legacy:" it had not been cited even once in subsequent academic literature.

                                                                                                                                                                                                      Ben Bernanke, on the other hand, has produced lots of memorable, often-cited papers. For example, in 1983 he came up with what later became known as the "financial accelerator" theory of the Great Depression. According to this theory, deflation, debt and the banking system interacted in such a way as to dry up the supply of new loans to households and businesses. He argued this could explain, in a way that other theories could not, why the Depression was so long and deep. This was a rather bold statement from such a young academic. John Gunn, professor emeritus of economics here at Washington & Lee, just today reminded me how the Great Depression is a phenomenon not readily explained by a single, unitary hypothesis.

                                                                                                                                                                                                      One is tempted to conclude from this that Bernanke is more hedgehog like, or at least less fox-like, than Greenspan. But is he? A little over a decade after these initial insights, Bernanke was crediting other scholars for advancing our understanding of the Great Depression by looking at how different countries performed depending on their adherence to the gold standard. As you know, Bernanke advocates a public, numerical inflation target, which Greenspan did not. This is often cited as evidence that he is more attracted to rigid rules than Greenspan. But as ex-Fed Vice Chairman Alan Blinder, who was a colleague of Bernanke at Princeton University, noted a few weeks ago, "Like Judaism, inflation targeting comes in reform, conservative and orthodox variants."

                                                                                                                                                                                                      Blinder said Bernanke once was somewhere between conservative and orthodox but "it's very clear while on the FOMC (from 2002 to 2005) he migrated to reform inflation targeting." Bernanke's time as governor on the policy-making Federal Open Market Committee exposed him to how the Fed's dual mandate – to maintain both full employment and stable prices – and its committee-centered decision making would constrain the establishment and pursuit of an inflation target. Finally, it's worth noting that Bernanke says one of the most important lessons of the Great Depression is to be flexible and creative in the face of big challenges.

                                                                                                                                                                                                      When he delivered the H. Parker Willis Lecture in Economic Policy here at Washington and Lee University here almost two years ago, he concluded by saying: "One lesson (of the Great Depression) is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy."

                                                                                                                                                                                                      On another occasion, he said of FDR's response to the Depression: "Roosevelt's policy actions were, I think, less important than his willingness to be aggressive and to experiment -- in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done."

                                                                                                                                                                                                      I think these statements suggest that Bernanke is aware of the danger of hedgehog-like thinking. I'll conclude by suggesting we not be too quick to use someone's early views as a template for what kind of central banker he will be. Consider the following quotes, from a much longer essay defending the gold standard published in 1966: "Gold and economic freedom are inseparable… Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights."

                                                                                                                                                                                                      Who would have guessed then that Alan Greenspan, the author of those words, would eventually become a central banker whose hallmark was his avoidance of rigid rules such as the gold standard?

                                                                                                                                                                                                        Posted by Mark Thoma on Sunday, February 12, 2006 at 12:59 AM in Economics, Monetary Policy

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                                                                                                                                                                                                        'When a Muslim Paints Nude Hindu Gods'

                                                                                                                                                                                                        This is a commentary from the Asia Times on India's battle with extremism:

                                                                                                                                                                                                        When a Muslim paints nude Hindu gods, by Siddharth Srivastava, Commentary, Asia Times: New Delhi - Fortunately, there have not been virulent protests in India against the publication of cartoons of the Prophet Mohammed, though close to 150 million Muslims reside in the country. However, attention is being drawn to Hindu fundamentalists taking umbrage at India's top artist, M F Husain, who has been booked by police for "hurting sentiments of people" with paintings that depict nude gods. ...

                                                                                                                                                                                                        He is not new to controversy and has invited the ire of right-wing sections in the past because of his naked and provocative paintings of various Hindu deities ... The fact Husain is a Muslim who chooses to depict Hindu gods the way he wants has always angered Hindu extremists. This time the fury is over a painting that depicts Bharatmata ("Mother India") in the nude. ... The opposition Bharatiya Janata Party (BJP), which subscribes to Hindu majority rule, has severely criticized Husain, with party general secretary Vinay Katiyar demanding the arrest of the painter. Extremist Hindu organizations have been more aggressive. ...

                                                                                                                                                                                                        A case has been registered against Husain ... by radical Hindu organizations ...for hurting sentiments of people. ... The deputy chief minister of Maharashtra state, R R Patil, has said state police are conducting a probe into the allegations. ... Husain, meanwhile, has apologized... At one level such intolerance to free expression is a reflection of the way India is - a multi-layered and cultural cauldron of classes, castes and religion, liberal and conservative opinions. It is also a sad commentary that radical and extremist elements hold people to ransom whenever they wish, a wasted vengeance that is often buttressed by politicians to fulfill their own narrow gains. ...

                                                                                                                                                                                                        Fundamentalist Hindus ... have attacked movie halls that screen controversial films and art galleries ..., as well as protested India-Pakistan cricket matches, couples holding hands, women wearing jeans and celebrations linked to Western influences such as Valentine's Day. And all in the name of cleansing society for a higher social value system. Last year, Sikhs protested against the Bollywood film, Jo Bole So Nihaal, starring top actor Sunny Deol. What followed were bomb blasts, believed by the police to be the handiwork of Sikh extremists, at movie halls in New Delhi that killed and crippled many. ...

                                                                                                                                                                                                        Emboldened, Muslim clerics continue to issue irrational diktats. They include the instance of the alleged rape of a Muslim woman, Imrana, by her father-in-law. The clerics declared that Imrana should treat her husband as a son and move in with her alleged rapist. ... India's tennis sensation Sania Mirza has been a victim. While Mirza is a national icon because of her tennis victories, fatwas (edicts) that she "covers up" have continued to fly... They want her, as a devout Muslim, to wear long pants and full-sleeved shirts, the way it is with sportswomen of Muslim countries such as Iran or Pakistan.

                                                                                                                                                                                                        Issues related to sex, too, invite as much attention as religion. Recently, Khusboo, rated among the top actresses in southern India ... said in a magazine interview that premarital sex was okay provided it was safe, consensual and between adults. The brouhaha included statewide protests, rallies, burning and beating of her effigies with chappals (slippers) as well as court cases. Local politicians keen to play the caste card because of upcoming elections in the state fanned the fire. ...

                                                                                                                                                                                                        In another instance, an Israeli couple who kissed after marrying according to Hindu rituals ... were in for shock and harassment after priests filed a complaint with the police that they defied Hindu religious norms by doing so. There are reports of more foreign couples being victimized by priests at Pushkar. A hotel was forced to shut down ... after pictures appeared in the media of a couple kissing at a party in the premises. ...

                                                                                                                                                                                                          Posted by Mark Thoma on Sunday, February 12, 2006 at 12:03 AM in India

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                                                                                                                                                                                                          February 11, 2006

                                                                                                                                                                                                          The Employment to Population Ratio for Males Aged 25-54

                                                                                                                                                                                                          Following up on Brad DeLong's post commenting on General Glut's view that employment to populatiopn statistics show weakness in the labor market, here is the employment to population ratio for males age 25-54 along with an estimated cubic trend. NBER dated expansions are shown in green, contractions in blue (these are annual data so the association is imperfect). The model used to estimate the trend is

                                                                                                                                                                                                          EmpToPop = β0 + β1t + β2t2 + β3t3 + εt

                                                                                                                                                                                                          The estimated trend is the curved black line in the graph. I also eyeballed a piecewise linear version as shown in red:

                                                                                                                                                                                                          In general, this ratio rises during expansions and falls during contractions. Notably in reference to the current episode, the ratio generally rises above trend during a recovery. The most recent observations are below the trend level estimated by the (simple) cubic trend model, and this would be true even if the trend sloped slightly downward at the end. Consistent with Brad and the General's claim, this indicates we aren't there yet...

                                                                                                                                                                                                            Posted by Mark Thoma on Saturday, February 11, 2006 at 06:47 PM in Economics, Unemployment

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                                                                                                                                                                                                            Wolf, Reisen, DeLong, and Buiter on Global Imbalances

                                                                                                                                                                                                            Martin Wolf's economists' forum on global imbalances. It's a bit long, but worth it, e.g. see the DeLong versus Buiter debate at the end:

                                                                                                                                                                                                            Global imbalances, Martin Wolf's economists' forum: ...I suggest the discussion needs to be focused around five questions: first, what is actually happening? Second, why has the US developed such large current account deficits? Third, in what sense, if any, are these deficits a matter for concern? Fourth, what is likely to happen and over what time period? Finally, to the extent that they are a concern, what actions should be taken to deal with them and by whom?

                                                                                                                                                                                                            Let me outline below what I see as the issues under each of the questions I have listed.

                                                                                                                                                                                                            First, what is happening? Over the past fifteen years, the US current account has shifted from balance to a deficit of over 6 per cent of gross domestic product. Over the same period, the US has moved from being a small net debtor to the rest of the world, to one with net liabilities at the end of 2004 of 21.7 per cent of GDP. One of the remarkable features of this story, however, is that US net liabilities have slightly improved, from 23.1 per cent of GDP in 2001, despite ongoing current account deficits averaging 5 per cent of GDP. There are two explanations: dollar devaluation and the appreciation of US-owned foreign assets, in terms of their domestic currencies, at a faster rate than of US dollar liabilities, in dollars. How long will foreigners be prepared to make such generous “gifts” to the US?

                                                                                                                                                                                                            Ricardo Hausmann and Frederico Sturzenegger have argued, however, that there is no current account deficit, because the US is exporting “dark matter”. This is shown, they claim, in the continuation of the US surplus on investment income, despite the supposed move into a net liability position. Willem Buiter has responded by arguing - correctly, in my view - that the only dark matter is to be seen in the seignorage on foreign holdings of US currency, which accounts for at most a sixth of the number advanced by Profs Hausmann and Sturzenegger.

                                                                                                                                                                                                            Second, why is this pattern of “imblances” emerging? One view is that a savings surplus (or “glut”) has emerged in the rest of the world - defined as a surplus of savings over investment, even at exceptionally low real interest rates. The US is offsetting this surplus, by running a corresponding deficit sufficient to sustain “full employment” or, to use contemporary terminology, “a zero output gap” at home. This need has, in turn, dictated US monetary policy and has led to the high-spending, low-saving household sector we see today.

                                                                                                                                                                                                            Another view is that US public and private profligacy is driving the external deficit, to which the rest of the world is adjusting. Under that view, the US should start by adjusting its fiscal position and, some would argue, trying to prick the alleged house price bubble.

                                                                                                                                                                                                            Third, are the deficits a source of concern? One view is that if deficits are a concern it can only be because of US fiscal policy or currency manipulation abroad. The latter is easily demonstrated, however, by the scale of the accumulation of foreign currency reserves in recent years: since the end of 2001, global foreign currency reserves have risen by roughly $2 trillion.

                                                                                                                                                                                                            An alternative view is that the market itself can make mistakes. Foreigners may be buying more dollar assets than makes sense for them. Again, US households may be taking on more debt and saving less than they would if they had a clearer idea of long-term prospects. If either of these perspectives are correct, the adjustment may be painful and abrupt.

                                                                                                                                                                                                            Fourth, a big difference has emerged between those who regard what is happening as sustainable in the medium to long term and those who see it as a short-term phenomenon.

                                                                                                                                                                                                            Among the former, one can identify several perspectives. Richard Cooper of Harvard University argues, for example, that the savings surpluses in Japan and parts of Europe are structural, while US savings are adequate. A not dissimilar view comes from Ricardo Caballero of MIT, who argues that foreigners buy US assets because of the failure of their own financial systems to generate financial assets of a suitable quality. Alan Greenspan has expressed comparable views on the impact of the decline in home-country bias on capital flows. Michael Dooley of the University of California at Santa Cruz and colleagues at Deutsche Bank argue that China is using fixed exchange rates as a way of building up an internationally competitive industrial sector, just as Japan and Germany did under Bretton Woods.

                                                                                                                                                                                                            The majority of economists who have worked on this topic conclude, however, that present trends cannot continue. A turnaround is required fairly soon if US indebtedness is not to explode.

                                                                                                                                                                                                            Fifth, what should be done? The answer depends on whether there is any reason for concern. If there is, the big question is who starts the process - markets or governments? If the latter, again, who starts - the debtor or the creditors? The likelihood, in practice, is that it is the former who will trigger the change. The greatest disaster, however, would be a tightening in the US, unmatched by expansionary policy elsewhere. The result would probably be a global recession.

                                                                                                                                                                                                            It is over to you now.


                                                                                                                                                                                                            Your comments by Reisen:


                                                                                                                                                                                                            at the Lacea 2005 meeting held last year in Paris, I have argued along the following lines:

                                                                                                                                                                                                            1. Asian economies have cut back on investment after the Asian financial crisis 1997/98, built up huge official reserves (often invested in US treasuries) and then warmed to ‘exchange-rate protection’.China’s savings and investment rates have exploded to extraordinarily high levels, with savings outstripping investment. 2. Low interest rates that coincide with falling saving rates in the OECD area suggest that the driving force for global 'imbalances'has been an increase in the surplus of savings over investment particularly in emerging Asia and, more recently, in the oil exporting countries. 3. A core model of economic development, the Lewis- Ranis - Fei or surplus labour model might point to an overlooked, but crucial feature: China’s modern sector – and by extension the world economy (!) – faces an unlimited supply of labour at wages not far from the subsistence level. 4. As the value of the marginal product of labour in the modern sector exceeds the wage rate, profits are high, saved and reinvested. 5. China is still miles away from reaching the point where wages would start to converge between the rural and the urban sector. In the quarter century from 1978-2003, urban per capita income has risen much faster than rural income. With employment at ca. 750 million in China and an estimated annual employment growth of 1 percent. over the coming 20 years China’s rural surplus labour will not be exhausted. 6. The rapid export growth of low-skill and labour-intensive manufactures has increased the market competition for these goods and hence exerted a downward pressure on their prices. The saving segments of OECD populations will keep on saving little, thanks to wealth effects as a result of high real estate, bond and stock prices – as long as wages remain depressed and/or unemployment high. 7. So probably more of the same in the next two decades: The Asian producer saves, the OECD consumer issues further debt.

                                                                                                                                                                                                            From Helmut Reisen, OECD

                                                                                                                                                                                                            by Brad DeLong:


                                                                                                                                                                                                            Let me tackle number 4: "What is likely to happen and over what time period

                                                                                                                                                                                                            Japan's central bank is likely to keep buying several hundred billion a year of dollar-denominated assets--it wants to avoid any severe yen appreciation that will threaten exports. China's central bank is likely to do the same: China's State Council wants to preserve full employment at Shanghai at all costs. China's central bank, however, cannot keep borrowing $300 billion worth a year from the good burghers of Shanghai for more than another couple of years. So it will start printing money--and a wave of domestic inflation in China will appreciate the real value of the renminbi even without nominal appreciation. Similarly, Japan's central bank will welcome inflation

                                                                                                                                                                                                            The most likely scenario, I think, is that over the next half decade price levels in Asia will rise substantially enough to curb imports into the U.S. and boost exports, and that the U.S. trade deficit will thus shrink back down to sustainable levels without any great macroeconomic upset in the U.S.--as happened in the late 1980s with the unwinding of the trade deficits produced by the policy mistakes of the Reagan era, as happened in the late 1970s with the unwinding of the Middle East's petrodollar surpluses

                                                                                                                                                                                                            Of course, large-scale money printing and internal price rises of 50% or so in Asia in the course of a few years may well cause significant macroeconomic upset on the western side of the Pacific

                                                                                                                                                                                                            And this is, I think, only the most likely scenario. It is also, I think, the calmest and least distressing

                                                                                                                                                                                                            Brad DeLong

                                                                                                                                                                                                            by FT Economists Forum: From Willem Buiter


                                                                                                                                                                                                            It is strange that opinions on this issue are so far apart. The fundamental inputs required to reach a conclusion are the following: (1) the magnitude of the US net foreign liabilities; (2) the rate of return the US will have to pay in the future on these net external liabilities; (3) the future growth rate of the US economy; (4) the size of the current US external deficit; and (5), the real exchange rate depreciation required to achieve a given reduction in the US external (primary) deficit. Differences in opinions should be reducible to different estimates for these 5 key numbers.

                                                                                                                                                                                                            I start from the following premises: (a) Past US current account deficits have not been massively overstated through a failure to record US exports of 'Dark Matter' (see my Goldman Sachs Global Economics Paper No: 136 "Dark Matter or Cold Fusion" at for the details); (b) the US is a net external debtor, but the existence of a stock seigniorage Dark Matter (US currency held abroad) of between 1.7% and 4.3% of GDP in 2004 means that the true net external liabilities are likely to be just under 20% of GDP rather than just over it; (c) recent recorded current account deficits of just over 5% of GDP in 2005 and around 6.5% of GDP in 2005 are not seriously over-stated.

                                                                                                                                                                                                            To be sustainable, the value of net external US liabilities cannot exceed the present value of current and future US primary surpluses. The US primary surplus is its current account surplus excluding net foreign investment income - effectively the trade balance surplus plus net current transfer payments to the US. The US has run primary deficits every year since 1982, except of a small primary surplus in 1991. In recent years, with net foreign factor income a small positive number, the US has run primary deficits just slightly smaller than the steadily growing current account deficits. That is the bad news.

                                                                                                                                                                                                            The (prima facie) good news is that if the rate of return on the US net external debt is low enough, the future primary external surpluses the US will have to generate to ensure external sustainability and solvency, need not be large. Assuming that primary surpluses can grow in line with GDP, the key factor determining the future net external transfers the US will have to make is the gap between the real rate of return on its net external liabilities and the growth rate of US real GDP. US real GDP grew at an annual rate of 2.9% over the period 1986-1995, and at 3.4 percent between 1996 and 2004. Looking forward, a trend growth rate of 3.0 percent does not appear wildly optimistic.

                                                                                                                                                                                                            What about the future real rate of return on net foreign liabilities? Ten-year nominal interest rates on Treasury bonds are around 4.5 percent. The real yields on index-linked US government 10-year and 30-year bonds hover around 2.0 percent. If 2.0 percent is indeed the rate of return the US will pay on its net external liabilities in the future, we have a true ‘don’t worry, be happy’ scenario. With the real cost of external borrowing below the growth rate of the real economy, any net external debt stock is sustainable.

                                                                                                                                                                                                            Therefore, those who, like myself, argue that there is something to worry about must argue either that the future growth of US real GDP will be much less than its historical average over the last two decades, or that the rate of return that will be paid on US net external liabilities in the future will be significantly above the level of current US sovereign borrowing rates (at all maturities). My money is on future returns being higher than current sovereign borrowing rates. There are two reasons for this. First, sovereign borrowing rates everywhere are more likely to rise than to fall going forward. Without being in the UK league (where 50 year index-linked gilts yielded all of 0.35% at the end of January 2006), US long-term real rates appear low today. Second, foreign purchasers of US assets will continue to purchase private assets as well as US government securities. Between 1982 and 2004, the stock of Foreign Direct Investment in the US increased (at market value) from $130bn to $2,687bn. Expected returns on FDI and on portfolio equity in the US can be expected to exceed the return on long-term government debt.

                                                                                                                                                                                                            That said, it is not easy to rationalize a long-term real rate of return much over 4.0%. With a 4.0% long-run real rate of return and a 3.0% long-run growth rate of real GDP, an average future long-run primary surplus of 0.2 percent of GDP suffices to make a current net external debt burden of 20% of GDP sustainable. From a 2005 primary deficit of over 6.0 percent of GDP, this means a permanent reduction in the US primary deficit of just over 6.0 percent of GDP. That is a big number. The number gets bigger the longer the reduction in the primary deficit is postponed.

                                                                                                                                                                                                            The required six percent of GDP increase in the balance of US saving over US investment will be economically and politically painful. If US capital formation is cut significantly, future growth prospects will be diminished. If private and public consumption are cut, political heads will roll.

                                                                                                                                                                                                            Policy measures or other shocks that raise US saving relative to US capital formation are likely to be associated with a decline in every measure of the US real exchange rate; the relative price of non-traded goods to traded goods will fall in the US and so will the relative price of US exports to US imports. How large these real depreciations will be to support a six percent of GDP reduction in the primary external deficit depends on the responsiveness of demand and supply to changes in these key relative prices. With the US still a relative closed economy as regards trade in goods and services (exports plus imports amounted to 25% of GDP in 2004), standard export and import price elasticities (say, 2 for the sum of the export and import price elasticities) give large numbers for the real exchange rate depreciation required to achieve a sustainable US external position. The numbers just given imply a 25 percent real depreciation for the dollar.

                                                                                                                                                                                                            This still leaves open a number of key questions. (1) When will these required reductions in the primary deficit have to start if the markets are to keep their faith in the ability and willingness of the US private and public sectors eventually to reduce their financial deficits to sustainable levels? My guess is not immediately, but probably before the next decade. (2) Will the depreciation in the real exchange rate come through a depreciation of the nominal exchange rate or through US inflation below that in the rest of the world? My strong prior is: mainly through the nominal exchange rate. (3) Will this be an orderly process or will it be accompanied by nominal exchange rate overshooting and other manifestations of financial market neuroses? My view is that everything is possible but that not everything is likely. Asset markets will no doubt over-react..

                                                                                                                                                                                                            Best, Willem Buiter

                                                                                                                                                                                                            by Brad DeLong:

                                                                                                                                                                                                            Dear Willem--

                                                                                                                                                                                                            Why is it your strong prior that adjustment will be accomplished mainly through a shift in the nominal exchange rate rather than through differential inflation, especially in Asia?

                                                                                                                                                                                                            Both Japan's and China's central banks will at some point face the choice between (a) going to their respective governments and saying that the low-yen or low-renminbi policy is over, and (b) printing the money to buy one more month's worth of dollar-asset supply and postponing their unpleasant meeting with the cabinet or the state council for an extra month.

                                                                                                                                                                                                            It is a very brave--and very unusual--central bank head to abandon an effective nominal exchange rate target and let the exchange rate swing free before dire necessity. And in this case there will never be any dire necessity--neither China or Japan will run out of reserves to support their currencies because it is not their currencies they are supporting...

                                                                                                                                                                                                            by FT Forum - Willem Buiter:

                                                                                                                                                                                                            Dear Brad,

                                                                                                                                                                                                            These are the reasons I expect the forthcoming real depreciation of the US dollar to come mainly through a depreciation of the nominal effective exchange rate of the US dollar rather than through differential inflation.

                                                                                                                                                                                                            * With Bernanke at the helm of the Fed, the US rate of CPI inflation will not be much below 2 percent per annum for the foreseeable future. He will not go in for serious, sustained inflation. * The ECB and the UK will amble along at around two percent per annum CPI inflation until the cows come home. * In Japan, the odds on the BoJ targeting (let alone achieving) an inflation rate much in excess of the US inflation rate over an appreciable period of time is negligible. The same holds for South Korea, Taiwan and India. * That leaves the great unknown, the People’s Republic of China. It has probably the least independent Central Bank in the known universe. Part of the political leadership is economically literate/sophisticated, but there remain a large number of Neanderthals in influential economic policy positions. The authoritarian/totalitarian nature of the regime makes decision making opaque and hard to predict. It is therefore certainly possible that it will become increasingly difficulty to sterilise the continuing huge inflows of foreign exchange reserves and that this will give a major boost to monetary growth and to the expansion of credit to enterprises and households. Should that happen, there would no doubt be attempts to use command and control methods, including price controls, to suppress the resulting inflationary pressures. Such methods will fail (watch Nestor Kirschner in Argentina), and open inflation will roar along. * Such a scenario is possible, but unlikely. It is much more likely that the renminbi will be allowed to appreciate, possibly quite sharply, vis-à-vis the US dollar. This could happen as early as 2007 and certainly before the beginning of the next decade. The gradual liberalisation of the capital account of the PRC means that the attractiveness of a nominal exchange rate target is steadily diminishing. When push comes to shove, most policy makers will opt for stability of the internal value of the currency over the stability of its external value. With a more liberal capital account, that choice becomes a no-brainer. For a largish economy, with an openish capital account, there is only one workable exchange rate regime - a float, possibly a dirty one. * Whatever happens to Chinese inflation or to the bilateral exchange rate of the renminbi and the US dollar, the Chinese currency currently has a weight in the US dollar's effective (trade-weighted) exchange rate, as measured by the Fed's broad index for the US dollar, of just over 10 percent. The renminbi is therefore an interesting but not overwhelmingly important piece of the US dollar effective exchange rate puzzle.

                                                                                                                                                                                                              Posted by Mark Thoma on Saturday, February 11, 2006 at 01:44 AM in Budget Deficit, Economics, International Finance, International Trade

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                                                                                                                                                                                                              Check the Henhouse Without DeLay

                                                                                                                                                                                                              Is this appropriate?:

                                                                                                                                                                                                              Smoking Dutch Cleanser, by Maureen Dowd, Commentary, NY Times: ...A final absurd junction of dysfunction was reached ... when Republican Party leaders awarded Tom DeLay with a seat on the Appropriations subcommittee overseeing the Justice Department, which is investigating Jack Abramoff, including his connections to Tom DeLay...

                                                                                                                                                                                                                Posted by Mark Thoma on Saturday, February 11, 2006 at 01:35 AM in Politics

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                                                                                                                                                                                                                Tim Duy: The Labor Force – Views From the Trenches

                                                                                                                                                                                                                Tim Duy has some observations on the labor market:

                                                                                                                                                                                                                A couple of observations regarding the great labor market debate.

                                                                                                                                                                                                                First, I was discussing the issues surrounding declining labor force participation rates (recently, see David Altig here and here and William Polley here) with our colleague, Robin McKnight. She pointed me to the following paper:

                                                                                                                                                                                                                Autor, D.H. and Duggan, M.G., The Quarterly Journal of Economics, Volume 118, Number 1, 1 February 2003, pp. 157-205(49) Abstract: Between 1984 and 2001, the share of nonelderly adults receiving Social Security Disability Insurance income (DI) rose by 60 percent to 5.3 million beneficiaries. Rapid program growth despite improving aggregate health appears to be explained by reduced screening stringency, declining demand for less skilled workers, and an unforeseen increase in the earnings replacement rate. We estimate that the sum of these forces doubled the labor force exit propensity of displaced high school dropouts after 1984, lowering measured U. S. unemployment by one-half a percentage point. Steady state calculations augur a further 40 percent increase in the rate of DI receipt.

                                                                                                                                                                                                                The paper is definitely worth a read. The authors argue that a combination of factors drove a significant number of low-skilled workers out of the labor force over the past two decades, starting with a liberalization of the Disability Insurance program. The DI benefits formula is indexed to the mean wage in the economy. Widening income differentials raised the relative benefits for low-skilled workers. This was accentuated by the rising real value of medical benefits also provided. The impact of these events was to increase the likelihood that a low skilled job loser would seek and receive DI benefits.

                                                                                                                                                                                                                Notably, the authors contend the adjustment is only partially complete. Their calculations suggests an “additional 40% increase in DI recipiency rates over the next decade, which is likely to be concentrated among less skilled workers.”

                                                                                                                                                                                                                Unfortunately, the authors do not examine the 16-24 age group identified by David Altig and William Polley.

                                                                                                                                                                                                                Second, yesterday I was in Salem, Oregon to discuss the economic outlook with the local economic development group. In talking with the participants, I was once again struck by the wildly different views of the labor market. I will warn that many of the sentiments passed on to me are at odds with the views of many of the regular readers of these pages.

                                                                                                                                                                                                                Consider for a moment how you would answer the following question:

                                                                                                                                                                                                                “What is the “true” unemployment rate?”

                                                                                                                                                                                                                Would you provide the headline number, 4.7%? Or unemployment for just 15 weeks or more, 1.5%? Or unemployment including marginally attached and part-time workers, 8.4%?

                                                                                                                                                                                                                In order to answer the question, I have to probe a bit deeper into the questioner’s view of the labor market. (I suppose this implies that my answer is contingent on the questioner’s priors.) Invariably, one group of questioners will complain about the quality of jobs or inability to find jobs – arguing the statistics simply overstate economic strength. (They also point to rising rolls of persons on public benefits as evidence of job market weakness. To some extent, the paper Autor-Duggan paper hits on this point.)

                                                                                                                                                                                                                The people who are doing the hiring, however, tell the exact opposite story. They simply do not believe that there are any potential employees available. For instance, one employer described the difficulty finding entry level workers for jobs that pay $30-35k with benefits. The jobs required something equivalent to an associate’s degree, and they would pay for education if they could find suitable candidates. Higher level workers were equally difficult to find. Another employer described a maintenance technician opening that had been unfilled for 8 months. The job was initially offered at $18/hr, rising to $22/hr currently.

                                                                                                                                                                                                                The upshot of these two sides appears to be that (local) employers are not really facing a shortage of workers per se. They are facing a shortage of what they view as qualified workers. Note that qualified workers could be of both the skilled and unskilled variety. The skills mismatch story is not really new, and is consistent with the challenges of structural change and education processes. But every employee placement firm tells me another story: They reject 90% or more of the applicants for one or more of the following three reasons:

                                                                                                                                                                                                                Fails the drug test. Felony conviction in the past 7 years. Lack of work history – work history is seen as evidence that the potential employee can get out of bed and show up to work on a regular basis.

                                                                                                                                                                                                                The suggestion from employers then is that an interconnected set of social problems is increasingly a barrier to employment. And if one can’t find employment, what is the likelihood of overcoming the challenges to employment? And how does one move out of the lower reaches of the income distribution?

                                                                                                                                                                                                                These are just stories I hear when I actually leave campus, not carefully collected statistical evidence. And there are likely local dynamics at play. Job growth in Oregon is running at twice the national rate, suggesting that the pool of available labor is drying up quickly. But I hear these types of stories frequently and consistently from a broad range of employers. And I repeatedly hear concerns about the health of the economy from those who work most closely with the disadvantaged. Overall, it suggests to me that the labor market and financial strains on the lower ranges of the income distribution in particular are the result of a complex and long running mix of social forces and policy impacts that we don’t fully understand.

                                                                                                                                                                                                                  Posted by Mark Thoma on Saturday, February 11, 2006 at 01:05 AM in Academic Papers, Economics, Health Care, Unemployment

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                                                                                                                                                                                                                  'The False Promise of Private Pensions'

                                                                                                                                                                                                                  Sticking with the recent theme of the changing social contract among individuals, government, and firms, here's Brad DeLong from a few weeks ago (this is an updated version of this draft posted at his site, another version here):

                                                                                                                                                                                                                  The false promise of private pensions, by J. Bradford DeLong, Daily Times: One of the strangest claims made in the debates about social insurance now roiling the world’s richest countries is that government-funded defined-benefit pension programs (such as America’s Social Security system) are outmoded. These programs were fine, the argument goes, for the industrial economy of the Great Depression and the post-World War II generation, but they have become obsolete in today’s high-tech, networked, post-industrial economy.

                                                                                                                                                                                                                  Advocates of this argument propose a different model. Just as corporations today are much happier supporting workers’ pensions by contributing to employees’ private accounts, so governments today should offer (or require) contributions to privately owned accounts. The value of these accounts would fluctuate with the market rather than resting on a defined-benefit scheme that guarantees a fixed real sum of resources available upon retirement.

                                                                                                                                                                                                                  This argument is strange because it gets the economics of the situation backward. When there are lots of companies offering workers long-term defined-benefit retirement pensions, there are fewer advantages to the government in setting up a parallel defined-benefit scheme and requiring workers to participate in it. After all, in such a world, workers who set great value on a defined-benefit pension can go to work for firms that offer such pensions.

                                                                                                                                                                                                                  The major benefits that arise from the government’s requiring that workers also participate in a national Social Security system accrue to those workers who really ought to value a defined-benefit pension highly but have not been able to figure out what their true preferences are. They also accrue to relatively poor workers who lack the bargaining power to induce bosses to offer the pensions they really want – and need.

                                                                                                                                                                                                                  But there aren’t a lot of companies today that are willing to offer long-term defined-benefit pension schemes. One reason is that companies nowadays are much more aware of their own long-run fragility than they were in the post-World War II decades. Not even America’s IBM – which prides itself on stability – wants to take the risk of offering defined-benefit schemes.

                                                                                                                                                                                                                  The risk from defined-benefit pensions used to be offset by two benefits for companies that offered them. First, the fact that leaving the company usually meant cashing in one’s pension at a discount increased worker loyalty. Second, complaisant accountants’ optimistic assumptions about returns on pension reserves, together with large firms’ greater risk-bearing capacity, brightened the financial picture that companies could report to investors. Today, the risks are seen to be much greater, and the benefits are seen to be less. As a result, an ever-smaller slice of employers are offering anything like defined-benefit pensions.

                                                                                                                                                                                                                  This fall-off in private defined-benefit pensions all across the rich core of the world economy is a bad thing, because the configuration of asset prices suggests that young and middle-aged workers value defined-benefit pensions extremely highly. Historically, the gap between expected returns on low-risk assets like government or investment-grade bonds and high-risk assets like stocks and real estate has been very high. To some degree, as economists like Harvard’s Robert Barro and mathematicians like Benoit Mandelbrot argue, this may be because high-risk investments are in reality much more risky than the theories and math of standard finance techniques suggest.

                                                                                                                                                                                                                  In my opinion, at least, this is partly because the memory of years like 1930 and 2000, when stocks performed very badly, occupies too large a place in investors’ minds. Workers and other asset holders place a very high value on safety, security, and predictability, so a defined-benefit pension plan is extremely valuable.

                                                                                                                                                                                                                  But in today’s world, only national governments are large enough to be able to do so with any assurance that the pension assets will actually be there when workers retire. I am enough of a social democrat to believe that if there is an economic service or benefit that citizens value extremely highly and that only the government can provide, then the government should provide it.

                                                                                                                                                                                                                  We economists know that there are many drawbacks to expanding government beyond its basic role of providing true public goods like defense, public safety, and justice, as well as providing citizens with incentives to counterbalance the effects of true market failures. If the private market has the flexibility of two hands, government bureaucracy has at best two thumbs. But the collection of payroll taxes from tens of millions of workers and the writing of tens of millions of pension checks is the kind of routine, semi-automatic task that government can do well. With private companies backing away from defined-benefit programs, it is even more important and valuable that government do it in our post-industrial network-age society than it was in the past.

                                                                                                                                                                                                                    Posted by Mark Thoma on Saturday, February 11, 2006 at 01:04 AM in Economics, Social Security

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                                                                                                                                                                                                                    Bush's Proposed Program Cuts

                                                                                                                                                                                                                    Program cuts proposed in the Bush budget:

                                                                                                                                                                                                                    Programs Bush Wants to Cut or Kill, Associated Press: The 141 programs that President Bush proposed to eliminate or cut in his 2007 budget, with potential savings in millions:



                                                                                                                                                                                                                    • Microbiological data program, $6 million.
                                                                                                                                                                                                                    • Community Connect broadband grants, $9 million.
                                                                                                                                                                                                                    • Commodity supplemental food program, $107 million.
                                                                                                                                                                                                                    • Research and extension grant earmarks, $196 million.
                                                                                                                                                                                                                    • Ocean freight differential grants, $77 million.
                                                                                                                                                                                                                    • Forest service economic action program, $10 million.
                                                                                                                                                                                                                    • High cost energy grants, $26 million.
                                                                                                                                                                                                                    • Public broadcast grants, $5 million.
                                                                                                                                                                                                                    • Watershed protection and flood prevention operations, $75 million.

                                                                                                                                                                                                                    Total $511 million


                                                                                                                                                                                                                    • Advanced technology program, $79 million.
                                                                                                                                                                                                                    • Emergency steel guarantee loan program $49 million
                                                                                                                                                                                                                    • Telecommunications construction grants $22 million

                                                                                                                                                                                                                    Total $150 million


                                                                                                                                                                                                                    • Educational technology state grants, $272 million
                                                                                                                                                                                                                    • Even Start, $99 million
                                                                                                                                                                                                                    • High school programs terminations:
                                                                                                                                                                                                                      • Vocational education state grants, $1,182 million
                                                                                                                                                                                                                      • Vocational education national programs, $9 million
                                                                                                                                                                                                                      • Upward Bound, $311 million
                                                                                                                                                                                                                      • GEAR UP, $303 million
                                                                                                                                                                                                                      • Talent search, $145 million
                                                                                                                                                                                                                      • Tech prep state grants, $105 million
                                                                                                                                                                                                                      • Smaller learning communities, $94 million
                                                                                                                                                                                                                      • Safe and Drug-Free Schools state grants, $347 million
                                                                                                                                                                                                                    • Elementary and secondary education program terminations:
                                                                                                                                                                                                                      • Parental information and resource centers, $40 million
                                                                                                                                                                                                                      • Arts in education, $35 million
                                                                                                                                                                                                                      • Elementary and secondary school counseling, $35 million
                                                                                                                                                                                                                      • Alcohol abuse reduction, $32 million
                                                                                                                                                                                                                      • Civic education, $29 million
                                                                                                                                                                                                                      • National Writing Project, $22 million
                                                                                                                                                                                                                      • Star Schools, $15 million
                                                                                                                                                                                                                      • School leadership,$15 million
                                                                                                                                                                                                                      • Ready to Teach, $11 million
                                                                                                                                                                                                                      • Javits gifted and talented education, $10 million
                                                                                                                                                                                                                      • Exchanges with Historic Whaling and Trading Partners, $9 million
                                                                                                                                                                                                                      • Comprehensive school reform, $8 million
                                                                                                                                                                                                                      • Dropout prevention program, $5 million
                                                                                                                                                                                                                      • Mental Health integration in schools, $5 million
                                                                                                                                                                                                                      • Women's Educational Equity, $3 million
                                                                                                                                                                                                                      • Academies for American History and Civics, $2 million
                                                                                                                                                                                                                      • Close-Up fellowships, $1 million
                                                                                                                                                                                                                      • Foundations for Learning, $1 million
                                                                                                                                                                                                                      • Excellence in Economic Education, $1 million
                                                                                                                                                                                                                    • Higher Education Programs:
                                                                                                                                                                                                                      • Education demos for students with disabilities, $7 million
                                                                                                                                                                                                                      • Underground Railroad Program, $2 million
                                                                                                                                                                                                                      • State grants for incarcerated youth offenders, $23 million
                                                                                                                                                                                                                    • Postsecondary Student Financial Assistance Programs:
                                                                                                                                                                                                                      • Perkins Loan cancellations, $65 million
                                                                                                                                                                                                                      • Leveraging educational assistance programs, $65 million
                                                                                                                                                                                                                      • Byrd Scholarships, $41 million
                                                                                                                                                                                                                      • Thurgood Marshall Legal Educational opportunity, $3 million
                                                                                                                                                                                                                      • B.J. Stupak Olympic scholarships, $1 million
                                                                                                                                                                                                                    • Vocational rehabilitation programs:
                                                                                                                                                                                                                      • Supported employment, $30 million
                                                                                                                                                                                                                      • Projects with industry, $20 million
                                                                                                                                                                                                                      • Recreational programs, $3 million
                                                                                                                                                                                                                      • Migrant and seasonal farmworkers,$2 million
                                                                                                                                                                                                                      • Teacher Quality Enhancement, $60 million

                                                                                                                                                                                                                    Total $3,468 million


                                                                                                                                                                                                                    • University nuclear energy program, $27 million
                                                                                                                                                                                                                    • Oil and gas research and development, $64 million
                                                                                                                                                                                                                    • Geothermal technology program, $23 million

                                                                                                                                                                                                                    Total $114 million

                                                                                                                                                                                                                    HEALTH AND HUMAN SERVICES

                                                                                                                                                                                                                    • Centers for Disease Control preventive block grant, $99 million
                                                                                                                                                                                                                    • Real Choice System Change grants, $25 million
                                                                                                                                                                                                                    • Community services block grant, $630 million
                                                                                                                                                                                                                    • Community economic development, $27 million
                                                                                                                                                                                                                    • Rural community facilities, $7 million
                                                                                                                                                                                                                    • Job opportunities for low-income individuals, $6 million
                                                                                                                                                                                                                    • Maternal and child health small categorical grants, $39 million
                                                                                                                                                                                                                    • Urban Indian Health Program, $33 million

                                                                                                                                                                                                                    Total $866 million

                                                                                                                                                                                                                    HOMELAND SECURITY

                                                                                                                                                                                                                    • Office of grants and training, $229 million

                                                                                                                                                                                                                    HOUSING AND URBAN DEVELOPMENT

                                                                                                                                                                                                                    • HOPE VI, $198 million


                                                                                                                                                                                                                    • Bureau of Indian Affairs Johnson-O'Malley assistance grants, $16 million
                                                                                                                                                                                                                    • Land and water conservation fund state recreation grants, $28 million
                                                                                                                                                                                                                    • National Park Service statutory aid, $7 million
                                                                                                                                                                                                                    • Rural fire assistance, $10 million

                                                                                                                                                                                                                    Total $61 million


                                                                                                                                                                                                                    • Byrne discretionary grants, $189 million
                                                                                                                                                                                                                    • Byrne justice assistance grants, $327 million
                                                                                                                                                                                                                    • Community Oriented Policing Services technology grants, $128 million
                                                                                                                                                                                                                    • Juvenile accountability block grants, $49 million
                                                                                                                                                                                                                    • National Drug Intelligence Center, $23 million
                                                                                                                                                                                                                    • State Criminal Alien Assistance Program, $400 million

                                                                                                                                                                                                                    Total $1,116 million


                                                                                                                                                                                                                    • America's Job Bank, $15 million
                                                                                                                                                                                                                    • Denali Commission job training earmark, $7 million
                                                                                                                                                                                                                    • Migrant and seasonal farmworkers training program, $79 million
                                                                                                                                                                                                                    • Reintegration of youthful offenders, $49 million
                                                                                                                                                                                                                    • Susan Harwood training grants, $10 million
                                                                                                                                                                                                                    • Work incentive grants, $20 million

                                                                                                                                                                                                                    Total $180 million


                                                                                                                                                                                                                    • National defense tank vessel construction program, $74 million
                                                                                                                                                                                                                    • Railroad rehabilitation financing loan program, $0 million (no funds were enacted in 2006)

                                                                                                                                                                                                                    Total $74 million

                                                                                                                                                                                                                    ENVIRONMENTAL PROTECTION AGENCY

                                                                                                                                                                                                                    • Unrequested projects, $277 million

                                                                                                                                                                                                                    OTHER AGENCIES

                                                                                                                                                                                                                    • National Civilian Community Corps, $22 million
                                                                                                                                                                                                                    • President's Freedom scholarships, $4 million
                                                                                                                                                                                                                    • National Veterans Business Development Corporation, $1 million
                                                                                                                                                                                                                    • Small Business Administration microloan program, $14 million
                                                                                                                                                                                                                    • Postal Service forgone revenue appropriation, $29 million

                                                                                                                                                                                                                    Total $70 million

                                                                                                                                                                                                                    MAJOR REDUCTIONS:


                                                                                                                                                                                                                    • Conservation operations, $77 million
                                                                                                                                                                                                                    • Resource conservation and development program, $25 million
                                                                                                                                                                                                                    • State and private forestry, $100 million
                                                                                                                                                                                                                    • In-house research, $123 million
                                                                                                                                                                                                                    • Environmental quality incentives program, $270 million
                                                                                                                                                                                                                    • Market access program, $100 million
                                                                                                                                                                                                                    • Rural Economic development grants, $89 million
                                                                                                                                                                                                                    • Watershed rehabilitation program, $ 65 million
                                                                                                                                                                                                                    • Farmland protection program, $47 million
                                                                                                                                                                                                                    • Value-added marketing grants, $40 million
                                                                                                                                                                                                                    • Wildlife habitat incentives program, $30 million
                                                                                                                                                                                                                    • Agricultural management assistance, $14 million
                                                                                                                                                                                                                    • Broadband, $10 million
                                                                                                                                                                                                                    • Ground and surface water conservation, $9 million
                                                                                                                                                                                                                    • Renewable energy program, $3 million
                                                                                                                                                                                                                    • Biomass research and development, $2 million

                                                                                                                                                                                                                    Total $1004 million


                                                                                                                                                                                                                    • Manufacturing extension partnership, $59 million
                                                                                                                                                                                                                    • Technology administration, $5 million

                                                                                                                                                                                                                    Total $64 million


                                                                                                                                                                                                                    • Perkins Loans Institutional Fund recall, $664 million
                                                                                                                                                                                                                    • Teaching American history, $71 million
                                                                                                                                                                                                                    • Physical education, $47 million
                                                                                                                                                                                                                    • Mentoring program, $30 million

                                                                                                                                                                                                                    Total 811 million


                                                                                                                                                                                                                    • Environmental management, $762 million
                                                                                                                                                                                                                    • Weatherization assistance program, $79 million
                                                                                                                                                                                                                    • Clean Coal Power initiative, $45 million

                                                                                                                                                                                                                    Total $886 million

                                                                                                                                                                                                                    HEALTH AND HUMAN SERVICES

                                                                                                                                                                                                                    • Health Resources and Service Administration- Children's Graduate Medical Education, $198
                                                                                                                                                                                                                    • HRSA Health professions, $136 million
                                                                                                                                                                                                                    • HRSA Poison control centers, $10 million
                                                                                                                                                                                                                    • HRSA Rural health, $133 million
                                                                                                                                                                                                                    • Social Services block grant, $500 million
                                                                                                                                                                                                                    • Substance abuse and mental health programs, $71 million

                                                                                                                                                                                                                    Total $1,048 million

                                                                                                                                                                                                                    HOMELAND SECURITY

                                                                                                                                                                                                                    • Office of grants and training, $694 million

                                                                                                                                                                                                                    HOUSING AND URBAN DEVELOPMENT

                                                                                                                                                                                                                    • Public housing capital fund, $261 million


                                                                                                                                                                                                                    • BIA school construction, $50 million
                                                                                                                                                                                                                    • Bureau of Reclamation reductions, $127 million
                                                                                                                                                                                                                    • USGS Mineral Resources program, $22 million

                                                                                                                                                                                                                    Total $199 million


                                                                                                                                                                                                                    • State job training grants consolidation, $514 million
                                                                                                                                                                                                                    • International Labor Affairs Bureau, $61 million
                                                                                                                                                                                                                    • Office of Disability Employment Policy, $8 million

                                                                                                                                                                                                                    Total $583 million


                                                                                                                                                                                                                    • Amtrak, $394 million
                                                                                                                                                                                                                    • Federal Aviation Administration, Airport improvement program, $765 million

                                                                                                                                                                                                                    Total $1,159 million


                                                                                                                                                                                                                    • Internal Revenue Service business systems modernization, $30 million

                                                                                                                                                                                                                    ENVIRONMENTAL PROTECTION AGENCY

                                                                                                                                                                                                                    • Alaska Native villages, $19 million
                                                                                                                                                                                                                    • Clean water state revolving fund, $199 million

                                                                                                                                                                                                                    Total $218 million

                                                                                                                                                                                                                    INTERNATIONAL ASSISTANCE PROGRAMS

                                                                                                                                                                                                                    • Assistance for Eastern European democracy, $83 million
                                                                                                                                                                                                                    • Assistance for the state of the former Soviet Union, $68 million

                                                                                                                                                                                                                    Total $160 million

                                                                                                                                                                                                                    NATIONAL AERONAUTICS AND SPACE ADMINISTRATION

                                                                                                                                                                                                                    • Aeronautics Mission Research Directorate, $160 million

                                                                                                                                                                                                                    OTHER AGENCIES

                                                                                                                                                                                                                    • Corporation for Public Broadcasting, $114 million
                                                                                                                                                                                                                    • Denali Commission, $47 million
                                                                                                                                                                                                                    • National Archives and Records Administration, $8 million

                                                                                                                                                                                                                    Total $169 million

                                                                                                                                                                                                                      Posted by Mark Thoma on Saturday, February 11, 2006 at 12:59 AM in Budget Deficit, Economics, Taxes

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                                                                                                                                                                                                                      February 10, 2006

                                                                                                                                                                                                                      Krugman's Money Talks: Tax Cuts Without Representation

                                                                                                                                                                                                                      Paul Krugman has questions for the editors of the Wall Street Journal:

                                                                                                                                                                                                                      Krugman's Money Talks: Tax Cuts Without Representation, Commentary, NY Times: Readers respond to Paul Krugman's Feb. 10 column, "The Vanishing Future" ...

                                                                                                                                                                                                                      B. Moss, New York: Here are two excerpts from recent Wall Street Journal edit pages that go to the heart of Bush supporters' thinking:

                                                                                                                                                                                                                      “The latest chapter of this story the Reagan Revolution is the 2003 income and investment tax cuts enacted by the current President Bush. As in 1981, opponents insisted those tax cuts would harm the economy by increasing the deficit and driving up interest rates. But in the two and a half years since those tax cuts passed, the economy and tax revenues have both surged.”

                                                                                                                                                                                                                      [In a separate editorial]

                                                                                                                                                                                                                      “… since the investment tax cuts of 2003 were one of the triggers for the surge in asset values, business investment, and job growth, extending the 15 capital gains and dividend tax rates should be Congress's first order of business. Opponents of those lower rates will moan about the deficit, but the truth is that those tax rates corresponded with a record $284 billion increase in tax revenues in Fiscal Year 2005 and a $100 billion decline in the budget deficit.”

                                                                                                                                                                                                                      What is your answer to this line of reasoning?

                                                                                                                                                                                                                      Paul Krugman: I thought it might be worth saying something about the Wall Street Journal-type argument that, since the economy grew after the 2003 tax cut, tax cuts are vindicated, and should be made permanent.

                                                                                                                                                                                                                      First point: if we give tax cuts credit for whatever happens to the economy in the next two years, what can we say about the 2001 tax cut? Employment actually dropped over the two years following that cut. So I guess we should say that the 2001 cut was bad for the economy, and should be allowed to expire — maybe even cancelled ahead of time. Right? Hello, WSJ, where are you?

                                                                                                                                                                                                                      Bear in mind that the 2001 cut was the big one; most of the extra cost from extending the cuts comes from the 2001 legislation, not the 2003 legislation. So using growth after 2003 to argue for making the tax cuts permanent, when most of the cost of doing that comes from a tax cut that clearly did little for the economy, is a form of bait-and-switch.

                                                                                                                                                                                                                      But seriously: yes, the economy grew after 2003. The overwhelming source of that growth was the housing boom — which had nothing to do with either the 2001 tax cut or the 2003 tax cut.

                                                                                                                                                                                                                      More generally, sometimes it may make sense to cut taxes to boost the economy when it's depressed. But you have to pay for that by raising taxes or cutting spending when the economy is doing well. Otherwise, you're perpetually running up government debt, and eventually there will be a fiscal crisis. And the Bushies have apparently calculated that as long as that crisis is on someone else's watch, they don't care. [Column here.]

                                                                                                                                                                                                                        Posted by Mark Thoma on Friday, February 10, 2006 at 02:22 PM in Budget Deficit, Economics, Politics, Taxes

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                                                                                                                                                                                                                        Kevin Who?

                                                                                                                                                                                                                        I agree. Who is this guy and what qualifies him to serve on the Federal Reserve Board of Governors?:

                                                                                                                                                                                                                        Bush's Nomination of Warsh to Fed Draws Criticism, Bloomberg: Most of President George W. Bush's nominees to the Federal Reserve have earned accolades from across the economic and political spectrums. And then there's Kevin Warsh. Bush's nomination of the 35-year-old White House aide -- a lawyer by training who would become one of only two members of the Fed's seven-member board of governors without a Ph.D. in economics -- has been greeted by criticism and bewilderment by some former Fed officials and economists. They point to his political connections and inexperience, and say the White House could have found a better-known, more qualified choice.

                                                                                                                                                                                                                        "Kevin Warsh is not a good idea,'' said former Fed Vice Chairman Preston Martin, who was appointed by Republican President Ronald Reagan in 1982. "If I were on the Senate Banking Committee,'' which must approve Fed nominees, "I would vote against him.'' ...

                                                                                                                                                                                                                        The nomination of Warsh, who has been executive secretary of the president's National Economic Council, was one of two that Bush made ... to fill vacancies on the Fed. The other nominee, Randall Kroszner, 43, is a University of Chicago professor and a former Fed visiting scholar with a doctorate in economics from Harvard University.

                                                                                                                                                                                                                        "Kroszner is a distinguished academic,'' said former governor Edward Gramlich, who left the Fed in August. "The other one, Kevin, I don't know.'' Martin said that "Kroszner is absolutely at the top of the list.'' If Warsh and Kroszner are confirmed, Bush will have appointed all seven members of the Fed board. ...

                                                                                                                                                                                                                        Warsh is married to Jane Lauder, a granddaughter of cosmetics pioneer Estee Lauder; Jane Lauder's father, Ronald Lauder, was U.S. ambassador to Austria under Reagan and has donated $104,000 to the Republican National Committee since the 2000 election campaign...

                                                                                                                                                                                                                        If both Warsh and Kroszner are confirmed, said Fed-watcher Schlesinger, "for the first time in recent decades, and maybe the first time ever, the board would include three governors who recently served in the administration that appointed them.'' That, he said, "unavoidably make the board a more political cast.'' ...

                                                                                                                                                                                                                          Posted by Mark Thoma on Friday, February 10, 2006 at 09:33 AM in Economics, Monetary Policy, Politics

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                                                                                                                                                                                                                          Scatterplot of Business Sector Hours versus Output

                                                                                                                                                                                                                            Posted by Mark Thoma on Friday, February 10, 2006 at 01:35 AM in Economics, Macroeconomics, Unemployment

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                                                                                                                                                                                                                            Did Anti-Anti-Dumping Activity Lead to Antitrust Accusations?

                                                                                                                                                                                                                            Accusations of price fixing against Chinese firms:

                                                                                                                                                                                                                            As China's Trade Clout Grows, So Do Price-Fixing Accusations, by John R. Wilke and Kathy Chen, Planned Economy, WSJ: Ten years ago, China's pharmaceutical firms had a sliver of the world's market for vitamin C. Today, China is the OPEC of vitamin C. Chinese manufacturers currently supply more than 85% of the vitamin C used in the U.S. Just like the oil cartel, they can heavily influence world prices. After a 2001 agreement among China's four largest producers, spot prices for vitamin C rose to as high as $9 a kilogram from lows of less than $3. Cooperation among competitors is illegal in the U.S. when it leads to higher prices for consumers. So far, about half a dozen civil antitrust suits have been filed against Chinese vitamin C manufacturers in various U.S. courts...

                                                                                                                                                                                                                            Chinese companies deny breaking U.S. law ... The companies are expected to argue they are acting as agents of the Chinese government and therefore aren't subject to antitrust law. A Chinese industry executive says the companies raised prices to stave off accusations they were "dumping," or illegally selling products abroad at below cost to win market share.

                                                                                                                                                                                                                            There are signs the vitamin C model is migrating to other Chinese exports. ... Chinese makers of saccharin, rayon and magnesite ... recently formed similar alliances. Magnesite producers also are being sued in the U.S. ... Some attorneys maintain that antitrust law still is largely an alien concept for Chinese companies. "China today is where Japan or [South] Korea were a decade ago -- they don't fully appreciate the seriousness of these lawsuits and possible criminal investigations," says Kirby Behre, a Washington, D.C., lawyer with Paul, Hastings Janofsky & Walker LLP, which has numerous clients in China. ...

                                                                                                                                                                                                                              Posted by Mark Thoma on Friday, February 10, 2006 at 01:23 AM in China, Economics, Market Failure

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                                                                                                                                                                                                                              Moskow: Inflation Pressures May Force Further Increases in the Target Interest Rate

                                                                                                                                                                                                                              Chicago Fed president Michael Moskow says rates may need to go up further to reduce inflationary pressures. Here's the Bloomberg report (full speech):

                                                                                                                                                                                                                              Moskow Says Rates May Need to Rise to Stem Inflation, Bloomberg: The Federal Reserve may need to keep raising the benchmark U.S. interest rate to prevent inflation from accelerating, Chicago Fed Bank President Michael Moskow said. "There are risks to the inflation outlook -- namely, the potential for energy cost pass-through, pressures from increases in resource utilization, or rising inflationary expectations,'' Moskow said in a speech... "If inflation or inflation expectations were to rise persistently, then policy clearly would have to be tightened further.'' ... "The economy is operating close to potential,'' he said. "We need to carefully monitor for the emergence of any economy-wide resource pressures.'' ... Decisions about future changes will depend on incoming information on the economy, Moskow said. If economic growth stalls as the housing market slows, the Fed may even have to reduce rates...

                                                                                                                                                                                                                                Posted by Mark Thoma on Friday, February 10, 2006 at 12:20 AM in Economics, Fed Speeches, Inflation, Monetary Policy

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                                                                                                                                                                                                                                Paul Krugman: The Vanishing Future

                                                                                                                                                                                                                                No sense letting inconvenient facts get in the way of the administration's determination to make tax cuts permanent:

                                                                                                                                                                                                                                The Vanishing Future, by Paul Krugman, Commentary, NY Times: At this point we've had six years to grow accustomed to Bush budget chicanery. ... What still amazes me, however, is the sheer childishness of the administration's denials and deceptions. Consider the case of the vanishing future. The story begins in 2001, when President Bush was pushing his first tax cut through Congress. At the time, the administration insisted that its tax-cut plans wouldn't endanger the budget surplus ... But even some Republican senators were skeptical. So the Senate demanded a cap on the tax cut: it should not reduce revenue over the period from 2001 to 2011 by more than $1.35 trillion.

                                                                                                                                                                                                                                The administration met this requirement ... by "sunsetting" the tax cut, making the whole thing expire at the end of 2010. This was obviously silly. For example, under the law as written there will be no federal tax on the estates of wealthy people who die in 2010. But the estate tax will return in 2011 with a maximum rate of 55 percent, creating some interesting incentives. I suggested, back in 2001, that the legislation be renamed the Throw Momma From the Train Act.

                                                                                                                                                                                                                                It ... quickly became clear that the budget forecasts the administration used to justify the 2001 tax cut were wildly overoptimistic. The federal government faced a future of deficits, not surpluses, as far as the eye could see. ... What were budget officials to do? You almost have to admire their brazenness: they made the future disappear. Clinton-era budgets offered 10-year projections of spending and revenues. But the Bush administration slashed the budget horizon to five years. This ... greatly aided the campaign to make the 2001 tax cut permanent because ... the ... budget analyses no longer covered the years after 2010, the revenue losses from extending the tax cut became invisible.

                                                                                                                                                                                                                                But now it's 2006, and even a five-year projection covers the period from 2007 to 2011 — which means including a year in which making the Bush tax cuts permanent will cost ... $119.7 billion... Has the administration finally run out of ways to avoid budget reality? Not quite. ... until this year budget documents contained a standard table titled "Impact of Budget Policy," ... But this year, that table is missing. So you have to do some detective work to figure out what's really going on.

                                                                                                                                                                                                                                Now, the administration has proposed ... cuts that are both cruel and implausible. For example, ... the budget calls for a 13 percent cut in spending on veterans' health care, adjusted for inflation, over the next five years. Yet even these cuts would fall far short of making up for ... making the tax cuts permanent. The administration's own estimate, which can be deduced from its budget tables, is that extending the tax cuts would cost an average of $235 billion in each year from 2012 through 2016.

                                                                                                                                                                                                                                In other words, the administration has no idea how to make its tax cuts feasible in the long run. Yet it has never ... allowed unfavorable facts to affect its determination to make the tax cuts permanent. Instead, it has devoted all its efforts to hiding those awkward facts from public view. (Any resemblance to, say, its Iraq strategy is no coincidence.) ... The 2007 budget makes it clear, once and for all, that the tax cuts can't be offset with spending cuts. But Bush officials have decided to ignore that unpleasant fact, and let some future administration deal with the mess they have created.

                                                                                                                                                                                                                                Previous (2/6) column: Paul Krugman: The Effectiveness Thing Next (2/13) column: Paul Krugman: Debt and Denial

                                                                                                                                                                                                                                  Posted by Mark Thoma on Friday, February 10, 2006 at 12:15 AM in Budget Deficit, Economics, Politics, Taxes

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                                                                                                                                                                                                                                  February 09, 2006

                                                                                                                                                                                                                                  What Did Volcker Do?

                                                                                                                                                                                                                                  We know what Alan Greenspan did after his term as Fed chair ended - he began cashing it out. So I was curious what Paul Volcker did after stepping down when his term ended on August 11, 1987. From the NY Times archives, here's an announcement one month later on September 11, 1987:

                                                                                                                                                                                                                                  Washington Talk: Briefing; Volcker's Spotlight Fame is fleeting, NY Times Archive: When Paul A. Volcker, from 1979 until last month the immensely powerful and widely respected chairman of the Federal Reserve Board, held a news conference yesterday to announce the membership of the new National Commission on Public Service that he has agreed to head ... Mr. Volcker is the latest in a line of retired officials, like former Chief Justice Warren E. Burger, ... to seek to use their prestigious name to focus the public spotlight on a cause. ... He spoke yesterday of the need for a talented, committed and professional Civil Service...

                                                                                                                                                                                                                                  He, like Greenspan, did immediately become a consultant:

                                                                                                                                                                                                                                  Washington Talk: Briefing; Volcker at Work, NY Times Archives: Although Paul A. Volcker is officially a former chairman of the Federal Reserve Board, he is still employed there. At the request of the new chairman, Alan Greenspan, and other board governors, Mr. Volcker has become a consultant to the Federal Reserve for ''a couple of weeks during the transition time,'' said Joseph R. Coyne, the chief spokesman. Mr. Volcker has moved out of the chairman's office, which he occupied for more than eight years, and is working down the hall...

                                                                                                                                                                                                                                  Quite a difference.

                                                                                                                                                                                                                                    Posted by Mark Thoma on Thursday, February 9, 2006 at 02:52 PM in Economics, Monetary Policy

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                                                                                                                                                                                                                                    'Medicare, Don't Go There'

                                                                                                                                                                                                                                    Continuing with the recent social safety net theme, here's Jared Bernstein writing at MaxSpeak on the president's proposed cuts to Medicare:

                                                                                                                                                                                                                                    Medicare, Don't Go There, by Jared Bernstein [We have coopted EPI labor market genius Jared Bernstein into contributing the following post...], MaxSpeak: An interesting and disconcerting theme is evolving in the discussions of the Bush budget for FY2007... It involves the proposal to slow the growth of Medicare spending by $36 billion over five years, and by $105 billion over ten. Liberal types with little positive to say about the Bush budget have been praising this cut. The Washington Post, for example, ran an editorial called “Budget Bravery” where they credited the administration for at least modest steps in restraining Medicare’s growth.

                                                                                                                                                                                                                                    This is a mistake. Yes, anyone paying attention recognizes that it’s Medicare, not Social Security, that’s on an unsustainable path ... (it’s not just demographics; the main problem is that health costs are growing so much faster than the rest of the economy). But that doesn’t mean capitulating to the Bush Medicare cuts is good policy or good strategy for those who want to protect this venerable program...

                                                                                                                                                                                                                                    First, what’s being cut? ... the Bush plan would slow spending growth in Medicare by cutting payments to ... hospitals, hospices, nursing homes, and home-health agencies. ... [Y]ou’ve got to worry about reduced access to health services if providers are paid less, especially for seniors on fixed incomes and those without “wrap-around” policies that pick up where Medicare leaves off. It at least seems plausible that these cuts would hurt real people.

                                                                                                                                                                                                                                    Second, why even entertain cuts in Medicare while the administration is pushing to make the tax cuts permanent (which the Center on Budget and Policy Priorities says will cost $1.7 trillion over ten years)? It's the totally transparent “starve the beast” strategy: cut revenues and then force cuts based on the growing gap between revenues and outlays. Like my grandma said, “Eat first, then we’ll talk.” I say nobody budges on spending cuts until they stop their tax cut lunacy...

                                                                                                                                                                                                                                    None of this is to deny that Medicare is on track to swamp the economy. But, according to the Congressional Budget Office, under plausible assumptions, the swamping doesn’t start for a while (even assuming low tax revenue levels and continued excess medical cost growth, Medicare grows from 3% of GDP this year to 4% in 2012—and to 16% by 2050; that’s the unsustainable part). So we’ve got some time... We may ultimately need to ration care, reign in spending, raise revenues, or nationalize health care coverage like every other advanced economy... I’m not suggesting these steps will be easy or will come without a big fight, but we’ll never even get to have the argument if, in the spirit of “compromise,” we accept these cuts right out of the box.

                                                                                                                                                                                                                                      Posted by Mark Thoma on Thursday, February 9, 2006 at 11:11 AM in Economics, Health Care, Policy

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                                                                                                                                                                                                                                      Fresh Evidence for Life on Mars?

                                                                                                                                                                                                                                      The intelligent designer may have been more prolific than we realized:

                                                                                                                                                                                                                                      Fresh Evidence for Life on Mars?, ScAm Observations: Life on Mars is a theory that refuses to die. From Percival Lowell's Mars and Its Canals to NASA's Opportunity roving robot's confirmation that water may once have existed on on its Meridiani Planum, astronomers, astrobiologists and science fiction writers have loved to speculate about the possibility of extraterrestrial life on the red planet. Even we have gotten in on the act, reporting on the methane found on Mars that just might have a living source. Some of the first possible proof of life on Mars came in 1996 from a meteorite found in Antarctica. Blasted from our neighbor's surface it came to rest here bearing odd, microscopic structures that call to mind fossilized remnants of bacteria.

                                                                                                                                                                                                                                      Subsequently, scientists have decided these structures most likely represent contamination from Earth-dwelling biota. But now the BBC is reporting that researchers from the U.K. have cracked open another Martian meteorite from Egypt and found material that resembles the filling left behind by microbes in cracks on the bottoms of the ocean. Solid veins of such "carbonaceous material" was found inside the meteorite, quashing objections that it could represent contamination from contact with earth, the researchers claim. And according to the BBC, previous scientists who examined the rock found that more than 75 percent of the meteorite's carbon is not one of the most common isotopes of carbon--carbon-14. That means it could be the relic of the action of alien microbes toiling in unimagined seas on ancient Mars.

                                                                                                                                                                                                                                      Skeptics are sure to abound--let the war of the words commence--and the research won't be presented until the middle of March at the Lunar and Planetary Science Conference in Houston, let alone reviewed by other scientists. Nevertheless, the finding gives one of the most popular extraterrestrial hypotheses ever a new lease on life.

                                                                                                                                                                                                                                        Posted by Mark Thoma on Thursday, February 9, 2006 at 10:18 AM in Science

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                                                                                                                                                                                                                                        Duh, Shut-Up Doc...

                                                                                                                                                                                                                                        The Republican war on science continues. Isn't it comforting to know that the Bush administration gave someone who didn't even graduate from college authority over NASA scientists? But at least we can be sure that only qualified people will be appointed to important government agencies like FEMA:

                                                                                                                                                                                                                                        The Politics of Science, Editorial, Washington Post: ...[A] 24-year-old NASA spokesman ... George C. Deutsch tendered his resignation. Mr. Deutsch had, it emerged, lied about his (nonexistent) undergraduate degree from Texas A&M University. Far more important, several New York Times articles ... have exposed Mr. Deutsch as one of several White House-appointed public affairs officers ... who tried to prevent senior NASA career scientists from speaking and writing freely, especially when their views on the realities of climate change differed from those of the White House.

                                                                                                                                                                                                                                        Mr. Deutsch prevented reporters from interviewing James E. Hansen, the leading climate scientist at NASA, telling colleagues he was doing so because his job was to "make the president look good." Mr. Deutsch also instructed another NASA scientist to add the word "theory" after every written mention of the Big Bang, on the grounds that the accepted scientific explanation of the origins of the universe "is an opinion" and that NASA should not discount the possibility of "intelligent design by a creator."

                                                                                                                                                                                                                                        The spectacle of a young political appointee with no college degree exerting crude political control over senior government scientists and civil servants with many decades of experience is deeply disturbing. More disturbing is the fact that Mr. Deutsch's attempts to manipulate science and scientists, although unusually blatant, were not unique. ... In every administration there will be spokesmen and public affairs officers who try to spin the news to make the president look good. But this administration is trying to spin scientific data and muzzle scientists toward that end. NASA's Mr. Hansen was right when he told the Times that Mr. Deutsch was only a bit player. "The problem is much broader and much deeper and it goes across agencies," he said. We agree.

                                                                                                                                                                                                                                        And there's this from the WSJ. It's not just a war on science, it's a war on contrary opinion of any sort:

                                                                                                                                                                                                                                        Expert on Congress's Power Claims He Was Muzzled for Faulting Bush, by Yochi J. Dreazen, WSJ: A dispute involving a researcher at the nonpartisan Congressional Research Service is fueling a debate over whether analysts throughout the government are being muzzled to prevent criticism of Bush administration policies. Louis Fisher, a 36-year veteran of the agency and an expert on the separation of powers, said his superiors wrongly punished him for giving interviews and publishing scholarly articles under his own name that contained criticism of the White House. Top officials deny those allegations, saying they were simply trying to protect the agency's reputation for nonpartisanship and objectivity.

                                                                                                                                                                                                                                        The dispute has thrust the research service, a branch of the Library of Congress, into a debate about whether the Bush administration is trying to control the flow of information to lawmakers and the public. ... A spate of investigations by the service into hot-button issues, like the administration's domestic spying program, have raised its visibility and led to renewed scrutiny of its work. ... Mr. Fisher has testified before Congress 38 times and recently took the extraordinary step of filing his own friend-of-the-court brief at the Supreme Court, where he told the justices that President Bush had overstepped his authority in establishing a system of special military courts to try suspected foreign terrorists. He has written 16 books and hundreds of scholarly articles. "His writings are considered the gold standard," said Robert Spitzer, the State University of New York scholar who edited the book. "If he has a slant of any kind, it's a pro-Congress one. He believes that Congress should stand up for itself more against the administration."

                                                                                                                                                                                                                                          Posted by Mark Thoma on Thursday, February 9, 2006 at 02:02 AM in Economics, Politics, Science

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                                                                                                                                                                                                                                          Greenspan's Private Dinner

                                                                                                                                                                                                                                          More on Greenspan's "private" dinner with clients of Lehman Brothers:

                                                                                                                                                                                                                                          'Greatest Central Banker Ever' Comes Down a Peg, Caroline Baum, Bloomberg: ...Former Federal Reserve Chairman Alan Greenspan ... was back to his old tricks of moving financial markets ... At a Tuesday night gathering hosted by Lehman Brothers Holdings Inc. for a handful of key clients, including some of the largest hedge funds, Greenspan held court on the economy and interest rates... Greenspan said that the changes wrought by globalization and the effects -- low long-term interest rates -- are a challenge to the Fed, necessitating more increases in short-term interest rates than are currently reflected in market prices.

                                                                                                                                                                                                                                          "What a scam,'' said Bill Fleckenstein, president of Fleckenstein Capital in Seattle. "It's influence peddling at its finest.'' ... Greenspan didn't violate any laws or Fed regulations when he talked to Lehman's clients. "Board members who complete their term may meet with and speak to groups without restriction, provided they reveal no confidential information,'' a Fed spokesman said. The only other prohibition is representing another party (lobbying) before the Fed for a year after departing.

                                                                                                                                                                                                                                          So Greenspan was well within the letter of the law in talking to clients. What about the spirit? ... At minimum, Greenspan evinced bad judgment by not letting some time pass before reasserting himself. His refusal to cede the limelight gracefully to his eminently qualified successor left a bad taste in people's mouths, many of whom refused to comment for the record. (Is it fear of reprisal, even without the force of the Fed behind him?)

                                                                                                                                                                                                                                          Unlike other Fed governors, who honored the convention of not attending the final policy meeting before their departure, "Greenspan attended the last meeting and dictated the vote,'' said Joe Carson, director of economic research at Alliance Bernstein. ... Greenspan reportedly commented at the Lehman dinner on the housing market (slowing but the effects won't be obvious for another six months); the consumer (retail and auto sales are surprisingly strong); and inflation (contained thanks to the effects of globalization).

                                                                                                                                                                                                                                          It was his comments on the likely future course of interest rates that will tarnish his legacy as "the greatest central banker who ever lived,'' ... Greenspan's choice exposed his real agenda all these years, for those who haven't been able to see it: the cult of his own personality at the expense of the institution. "He's addicted to power,'' Fleckenstein said. "If there is a silver lining in all of this, it's that the more he opens his mouth, the sooner he will be discredited.''

                                                                                                                                                                                                                                          This is disappointing. To me, this behavior so soon after stepping down as Fed chair detracts from the dignity of the institution.

                                                                                                                                                                                                                                            Posted by Mark Thoma on Thursday, February 9, 2006 at 01:07 AM in Economics, Monetary Policy

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                                                                                                                                                                                                                                            Free Assembly

                                                                                                                                                                                                                                            This article argues that trade figures for China are misleading indicators of its global competitiveness:

                                                                                                                                                                                                                                            Some Assembly Needed: China as Asia Factory, by David Barboza, NY Times: ...[O]ften these days, "made in China" is mostly made elsewhere — by multinational companies in Japan, South Korea, Taiwan and the United States that are using China as the final assembly station in their vast global production networks. Analysts say this evolving global supply chain, which usually tags goods at their final assembly stop, is increasingly distorting global trade figures and has the effect of turning China into a bigger trade threat than it may actually be...

                                                                                                                                                                                                                                            It may look as if China is getting the big payoff from trade. But over all, some of the biggest winners are consumers in the United States and other advanced economies who have benefited greatly as a result of the shift in the final production of toys, clothing, electronics and other goods from elsewhere in Asia to a cheaper China. American multinational corporations and other foreign companies, including retailers, are the largely invisible hands behind the factories pumping out these inexpensive goods. And they are reaping the bulk of profits from the trade...

                                                                                                                                                                                                                                            The real losers, it seems, are mostly low-wage workers elsewhere, like ... in Japan, along with workers in other parts of Asia who suffered as employers began relocating plants to China. Blue-collar workers in the United States have also lost out. ... "The biggest beneficiary of all this is the United States," said Dong Tao, an economist at UBS in Hong Kong. "A Barbie doll costs $20, but China only gets about 35 cents of that." Because so many different hands in different places touch a particular product, Mr. Dong said, you might as well throw away the trade figures. "In a globalized world, bilateral trade figures are irrelevant," he argued...

                                                                                                                                                                                                                                            And so while China has something in the range of a $200 billion trade surplus with the United States, it also has a $137 billion trade deficit with the rest of Asia... Chinese officials rarely miss an opportunity to argue that the trade statistics showing huge surpluses are misleading indicators of the country's prosperity. "What China got in the past few years is only some pretty figures," said Mei Xinyu, of the Commerce Ministry's research institute. "American and foreign companies have gotten the real profit."...

                                                                                                                                                                                                                                            This point is explored further here.

                                                                                                                                                                                                                                              Posted by Mark Thoma on Thursday, February 9, 2006 at 01:03 AM in China, Economics, International Trade

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                                                                                                                                                                                                                                              February 08, 2006

                                                                                                                                                                                                                                              Proposed Bush Budget Cuts Threaten to Reignite Battles over Logging

                                                                                                                                                                                                                                              Here's the problem. In some counties in western states, most of the land is federal timberland and these counties are not able to collect property taxes on the government owned land leaving few options to finance schools, roads, and public safety. Because of this, federal aid has been used to help finance necessary services in these areas. Under the Bush budget proposal, these funds are scheduled to be cut in half and then eliminated. This threatens a return to days not so long ago when revenues for rural counties were linked to timber sales and all the bad incentives this method of funding brings about:

                                                                                                                                                                                                                                              Swinging a budget ax at Oregon's timber towns, Editorial, The Oregonian: President Bush's proposed budget hits ... where it most hurts:... in ... cash-strapped schools and ... struggling rural communities. The Bush administration's ... budget ... includes a plan to cut in half, and ultimately phase out, the program that compensates rural, timber-dependent counties in 39 states for federal timberlands that generate no property taxes.

                                                                                                                                                                                                                                              Bush's proposal threatens ... federal aid now received by rural ... counties and schools. It also promises to rip open old wounds by linking support for rural counties to the sale of public lands and eventually reconnecting federal aid to timber harvest. Bush and his undersecretary of agriculture, Mark Rey, are proposing to lead ... the West back to the days when rural towns -- and particularly schoolkids -- were used as pawns in fierce battles about public-lands logging. ...

                                                                                                                                                                                                                                              It's not just the money, although the Bush proposal will bite deep into road, school and public safety funds. The cut also threatens a newfound cooperation across much of timber country. ... The Bush administration seems intent on reigniting the public-land disputes of the past. Its plan to require the selloff of unidentified "isolated or inefficient to manage" public lands to fund the compensation of counties is pure ideological genius, if one of your objectives is to liquidate public lands...

                                                                                                                                                                                                                                              For decades the money provided to counties came from a share of the receipts from federal timber sales. Then timber sales on federal lands collapsed because of the spotted owl protections and other environmental restrictions. Timber receipts plunged. ... [A] bipartisan coalition of lawmakers pushed through the county payments program in 2000, even though environmentalists attacked the idea of creating local forest planning groups.

                                                                                                                                                                                                                                              There still is no better way to compensate forest counties, or to encourage local people ... to come together to support forest improvement projects. These communities have suffered wrenching economic changes. They have struggled to keep their schools open five days a week, and to maintain their roads and other basic public services. Many urban [residents] have long forgotten them.

                                                                                                                                                                                                                                              Now the president has, too.

                                                                                                                                                                                                                                                Posted by Mark Thoma on Wednesday, February 8, 2006 at 06:27 PM in Budget Deficit, Economics, Oregon, Politics

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                                                                                                                                                                                                                                                Changes in Elderly Disability Rates and the Implications for Health Care Utilization and Cost

                                                                                                                                                                                                                                                One common proposal to help with Social Security solvency is to increase the retirement age. People do live longer, but does that mean they are more able to perform work than in the past during their later years? While not dealing with this issue directly, and I haven't found anything yet that does, one source of information on this is the NCHS statistics on functional status and disability among the elderly. These measure activities of daily living (ADLs), instrumental activities of daily living (IADLs), and other measures of physical function.

                                                                                                                                                                                                                                                Are the elderly healthier? If so, will that lower health care costs? The Department of Health and Human Services has a report on this issue prepared by the Urban Institute. Here's a small part of the executive summary and a link to the actual report:

                                                                                                                                                                                                                                                Changes in Elderly Disability Rates and the Implications for Health Care Utilization and Cost, Executive Summary, Brenda C. Spillman, Urban Institute, February 3, 2003:

                                                                                                                                                                                                                                                BACKGROUND Recent research has provided promising evidence that aggregate age-adjusted disability among older Americans has decreased. There also is evidence that cognitive impairment and physical limitations, such as lifting 10 pounds, walking short distances, and climbing a flight of stairs, which may be precursors to disability, may have declined in recent years. On the other hand, some studies show increases in chronic disease, increases in the use of paid long term care, and increasing disability levels within the disabled population. This study was undertaken in order to better understand these trends...


                                                                                                                                                                                                                                                CONCLUSIONS The disabilities that saw the most improvements over the 15-year study period were not ones that necessarily imply better health and lower health and long term care costs among the elderly. Rather, a substantial part of disability declines may reflect improvements in the external environment that make it easier to perform such activities as managing money, shopping, and telephoning, regardless of physical state. Help with ADLs changed only slightly from the beginning to the end of the study period. ... These findings suggest a need to examine directly both Medicare costs and hours of paid and unpaid long term care for different subgroups of the elderly and the elderly disabled in order to understand the cost implications of disability changes since the mid 1980s.

                                                                                                                                                                                                                                                The growth in the percent of persons who manage various ADL activities with only equipment also suggests the need to know more about which types of equipment are being used and whether the equipment substitutes for or supplements hours of human assistance. ... Better understanding of the real implications of aggregate disability changes is not an academic exercise as policymakers consider changes in Social Security and Medicare to ensure their long-range financial health. Many argue that declines in disability need to be taken into account in projecting future spending. Until there is a better understanding of these trends and their cost implications, however, it is not clear how they should be taken into account.

                                                                                                                                                                                                                                                The Full Report is also available from the DALTCP website ( or directly at

                                                                                                                                                                                                                                                  Posted by Mark Thoma on Wednesday, February 8, 2006 at 04:38 PM in Economics, Health Care, Policy

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                                                                                                                                                                                                                                                  Greenspan Says Rates May Need to Rise Further

                                                                                                                                                                                                                                                  Greenspan's "private" dinner with clients of Lehman Brothers:

                                                                                                                                                                                                                                                  Greenspan, at Lehman Dinner, Suggests Rates May Rise, Bloomberg: ...Alan Greenspan suggested at a private dinner yesterday that short-term U.S. interest rates may need to rise further, a person briefed by a participant at the meeting said. ... Greenspan told about a dozen clients of Lehman Brothers Holdings Inc. in New York that low long-term rates were limiting the Fed's ability to manage the economy. Homeowners are borrowing more against the value of their homes to finance spending, the person said.

                                                                                                                                                                                                                                                  Greenspan went on to suggest that the Fed may need to raise short-term rates more to keep the economy from overheating... Greenspan told the Lehman clients the economy was doing well and in particular pointed to robust chain store and light vehicle sales... In his talk with the investors, Greenspan said he expects consumer spending to slow later in the year as the housing market cools and homeowners find it harder to borrow against their real estate, according to the person. ...

                                                                                                                                                                                                                                                  The former Fed chairman also told Lehman's customers that globalization had played a major role in driving inflation down .... That's holding down workers' wage demands in the U.S., helping to contain inflation even with higher energy prices...

                                                                                                                                                                                                                                                    Posted by Mark Thoma on Wednesday, February 8, 2006 at 02:17 PM in Economics, Monetary Policy

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                                                                                                                                                                                                                                                    Transitional Dynamics at the Fed

                                                                                                                                                                                                                                                    There is no necessary "honeymoon" period for the new Fed chair:

                                                                                                                                                                                                                                                    On The Record A Conversation with Harvey Rosenblum: The Fed’s Changing of the Guard, Dallas Fed: ...Harvey Rosenblum, the Dallas Fed’s director of research and a 35-year veteran of the Federal Reserve, discusses what happens during the transition from one chairman to another. ...

                                                                                                                                                                                                                                                    Q: The chairman has one vote, just like every other member of the Federal Open Market Committee. So why is he so important?

                                                                                                                                                                                                                                                    A: Sherman Maisel, who served on the Board of Governors from 1966 to 1973, returned to the University of California, Berkeley, and wrote a book called Managing the Dollar. ... Maisel gave the chairman 45 percent of the power within the FOMC. He gave another 25 percent to the committee staff because they write the documents that everybody has to react to. It turns out that all the important staff members are directed by the chairman, so give the chairman 70 percent of the power. ... Considering his influence over the staff and ability to set the agenda and represent the committee before Congress, the chairman probably gets 80 percent of power in the Federal Reserve System. It’s an enormous amount of influence. But, yes, at the end of the day, the chairman still has only one vote.

                                                                                                                                                                                                                                                    Q: Does a new chairman obtain all the power on his first day, or does he have to earn it?

                                                                                                                                                                                                                                                    A: The chairman’s power depends on the individual as well as the office. When Greenspan became chairman in 1987, it was obvious that most committee members were used to following Volcker and were very comfortable with Volcker. They didn’t know Greenspan, and they weren’t sure they were ready to follow him. So a new chairman doesn’t come in with all the power of the one he replaces. He really has only his one vote and the aura that surrounds the chairman. ... It’s only his ideas and his powers of persuasion that allow him to be the leader.

                                                                                                                                                                                                                                                    Q: How does a new chairman go about establishing his leadership style and his role on the FOMC?

                                                                                                                                                                                                                                                    A: The chairman has to become the intellectual leader of the group, and that is not easy. The FOMC includes several of the country’s most renowned macroeconomic experts. With Bernanke, everybody knows him. He served as a governor for roughly three years and quickly established himself as one of the committee’s intellectual leaders. Interestingly, I think he became intellectually influential within the committee by giving important speeches on critical topics at just the right time... Several of the speeches have actually become somewhat famous.

                                                                                                                                                                                                                                                    Q: What’s in store for Bernanke in his first FOMC meeting as chairman in March?

                                                                                                                                                                                                                                                    A: ...An agenda is set out and followed—to the letter. The meeting starts with a report from the Open Market Desk of the New York Fed, followed by questions and answers. A staff report analyzes the economy and gives a forecast. Then there’s a go-round in which all the members of the committee talk about what’s going on in the economy. Usually the Federal Reserve Bank presidents go first, adding a district perspective, followed by the governors.

                                                                                                                                                                                                                                                    There’s usually a coffee break, then another staff report going over the policy alternatives. And then, finally, the chairman gets to speak—after having heard each person’s view of what he or she thinks is happening in the economy, with many having set out their views on policy as well. ... Everybody says the chairman has all this power, but if everybody has already spoken and kind of outlined where they stand, how do you change minds that are already made up? That is the difficulty every chairman faces. Greenspan has somehow managed to go through the last seven to eight years with maybe 10 dissents over the course of 50 to 60 meetings. ...

                                                                                                                                                                                                                                                    Q: Is that kind of unanimity unusual?

                                                                                                                                                                                                                                                    A: ...Volcker was once on the losing end of a 4–3 vote on the discount rate. There were a few close votes at other FOMC meetings, with Volcker on the winning side—but just barely. In recent years, we’ve gotten very used to unanimity. People have been following Greenspan—they’re under no compulsion to necessarily follow Bernanke just because he is the chairman. ...

                                                                                                                                                                                                                                                    Q: The transition from Volcker to Greenspan was smooth, but what about the arrival of Volcker?

                                                                                                                                                                                                                                                    A: Well, Volcker was the right person in the right place at the right time. .... He showed remarkable focus—as far as he was concerned, the Fed’s only job was controlling inflation. It was a difficult time for the Fed. It was necessary to run the federal funds rate up near 20 percent. It’s hard for businesses to operate at those kinds of interest rates. The monetary policy of the day meant hardships for the automobile industry and the housing industry. It wreaked havoc on the savings and loan industry. Was it worth it? I think the answer is yes. ... We’ve had healthy and stable economic growth, and we’ve had very stable and fairly low inflation. ... But as you went through it, you weren’t sure it would be worth the cost.

                                                                                                                                                                                                                                                    Q: Despite the smooth transitions, didn’t Greenspan have his mettle tested early in his tenure?

                                                                                                                                                                                                                                                    A: Quite early in his tenure, and right here in Dallas, by the way. He had come to give a speech to the American Bankers Association, which was scheduled for a Tuesday morning. He flew in on Monday evening, Oct. 19, 1987. The stock market had fallen 508 points that day, or roughly 20 percent—a record decline that still stands. Greenspan quickly decided what to do. ... He took immediate action, going through the necessary cuts in the federal funds rates to add liquidity to the system. It established his reputation as being quick, decisive and doing the right thing at the right time. As soon as the market recovered somewhat, monetary policy got back on its long-term track of fighting inflation.

                                                                                                                                                                                                                                                    Q: So the new chairman is not guaranteed a honeymoon?

                                                                                                                                                                                                                                                    A: There is no honeymoon—not in a financial system like ours, not in this country where people are free to take risks and reap the consequences.

                                                                                                                                                                                                                                                      Posted by Mark Thoma on Wednesday, February 8, 2006 at 07:11 AM in Economics, Monetary Policy

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                                                                                                                                                                                                                                                      WSJ Econoblog: Stitching a New Safety Net

                                                                                                                                                                                                                                                      Andrew Samwick and I just finished an Econoblog for the Wall Street Journal Online. The issue we were asked to address is:

                                                                                                                                                                                                                                                      WSJ Econoblog: Stitching a New Safety Net: For many years, workers could manage their medical expenses with employer-provided health insurance and Medicare and look forward to underwriting their golden years with payments from a defined-benefit pension and Social Security.

                                                                                                                                                                                                                                                      But the landscape of social insurance is shifting. Many large corporations are moving their employees from traditional pensions to riskier 401(k)s and asking workers to pay more out of their own pockets for health insurance. At the same time, Social Security and Medicare, the two venerable entitlement programs, are facing growing demographic strains as the vast baby boom generation reaches retirement age.

                                                                                                                                                                                                                                                      The Wall Street Journal Online asked economist bloggers Mark Thoma and Andrew Samwick to explore how we how arrived at this point and discuss what workers and retirees might expect in the future, as the composition of the social safety net continues to shift.

                                                                                                                                                                                                                                                      Here's the free link once again. And thanks to Andrew for an enjoyable discussion.

                                                                                                                                                                                                                                                        Posted by Mark Thoma on Wednesday, February 8, 2006 at 12:33 AM in Economics, Health Care, Policy, Politics, Regulation, Social Security

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                                                                                                                                                                                                                                                        Fat Chances

                                                                                                                                                                                                                                                        Remember all that tasty food you sacrificed for your health? The expected benefit just changed:

                                                                                                                                                                                                                                                        Low-Fat Diet's Benefits Rejected Study Finds No Drop In Risk for Disease, by Rob Stein, Washington Post: Low-fat diets do not protect women against heart attacks, strokes, breast cancer or colon cancer, a major study has found... The findings run contrary to the belief that eating less fat would have myriad health benefits... Although the study involved only women, the findings probably apply to men as well... Several experts cautioned, however, that the study hints that there still may be some benefits to reducing the total amount of fat in the diet... [R]esearchers fear that the findings will leave the public skeptical about all health advice, or will be misinterpreted to mean that diet and lifestyle are unimportant. ...

                                                                                                                                                                                                                                                          Posted by Mark Thoma on Wednesday, February 8, 2006 at 12:06 AM in Economics, Miscellaneous

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                                                                                                                                                                                                                                                          What Housing Bubble?

                                                                                                                                                                                                                                                          John Weicher, director of the Centre for Housing and Financial Markets at the Hudson Institute was assistant secretary for housing and federal housing commissioner at the US Department of Housing and Urban Development from 2001-05. He is not worried about the housing bubble bursting, in part because he doesn't' think a bubble ever existed. I'm not overly concernend, but I'm not this optimistic either:

                                                                                                                                                                                                                                                          Rumours of US housing bubble are hot air, by John Weicher, Financial Times: Some economists are watching ... with concern about the impending end of the housing bubble and its impact on the US economy. This is rather odd, because two months ago the consensus seemed to be that the housing bubble had already been pricked. ... The worriers should take heart: reports of the death of the housing bubble are premature. Indeed, reports that there was a bubble at all were premature.

                                                                                                                                                                                                                                                          Certainly there is evidence that the housing market is at a peak. ... Moreover, mortgage rates have been rising. ... new home construction dropped in December and housing starts were down about 8 per cent since June. ... If the market is peaking, there could be problems. The past few years have seen a proliferation of new mortgage instruments that shift risk to the homebuyer... In a declining market, many of those borrowers are likely to default on their mortgage and lose their homes.

                                                                                                                                                                                                                                                          Not all the evidence points to a peak, however. The OFHEO price index, which is based on mortgage originations, has shown much sharper price increases over the past year for homes that are being refinanced than for homes being bought and sold. The home purchase price index has been rising more slowly and much more smoothly, by 10.9 per cent over the past year, more than the 10.4 per cent rate increase for the year before. The steadier growth suggests that the prices people are actually paying, and receiving, have not peaked.

                                                                                                                                                                                                                                                          The current mortgage rate increase is the third time in three years that rates have started to rise, accompanied by consensus among analysts that the housing boom was over. Both times previously, rates rose for a while and then dropped to a new low, while the boom continued. That of course may not happen this time. Yet even if rates continue to rise, house prices may also climb. ...

                                                                                                                                                                                                                                                          A longer view suggests that the US is seeing a blip in a long-term bull housing market, not a bubble about to be pricked. ... What seems to be happening is that home sellers are overshooting the market, incorporating a further expected increase in their asking price. Buyers are a little more cautious, quite reasonably. At the current rate, typical American homeowners will see the value of their homes double in six years. That would be nice for them, but the US is not likely to see continuing double-digit house price increases while the inflation rate remains low. Nonetheless, home prices are likely to keep rising.

                                                                                                                                                                                                                                                          The current demand for homeownership in the US is very different from the housing boom of the 1970s, when erratically accelerating inflation depressed stock prices and drove everyone into tangible assets in self-protection. This time, it is real.

                                                                                                                                                                                                                                                          Update: Here's a more sober view from the WSJ:

                                                                                                                                                                                                                                                          Finding a House Gets Easier, WSJ: With the key spring selling season about to get under way, the inventory of homes on the market is climbing sharply in a number of major cities. It is the latest sign that the balance of power between buyers and sellers is shifting as the once red-hot housing market continues to cool. ... Yesterday, the nation's largest builder of luxury homes, Toll Brothers Inc., reported a 29% decline in new orders in its first quarter, which ended Jan. 31. That was below many analysts' expectations ...

                                                                                                                                                                                                                                                          The changing climate is particularly noticeable in once-hot markets such as Miami, Phoenix and Washington, D.C., and in areas such as Detroit, where price increases have been modest but the job market is weak. ... The sharp rise in inventories isn't universal. In Seattle, inventories have declined modestly over the past 12 months as a robust job market sustains demand. .... In Dallas, inventory has edged up slightly, but the pace of sales is up. ... Still, the pinch is being felt in many corners of the housing market. ...

                                                                                                                                                                                                                                                            Posted by Mark Thoma on Wednesday, February 8, 2006 at 12:03 AM in Economics, Housing

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                                                                                                                                                                                                                                                            February 07, 2006

                                                                                                                                                                                                                                                            Krugman's Money Talks: Democrats More Divided than United

                                                                                                                                                                                                                                                            Here are comments on Paul Krugman's recent column "The Effectiveness Thing" from Money Talks:

                                                                                                                                                                                                                                                            Democrats: More Divided than United: Readers respond to Paul Krugman's Feb. 6 column, "The Effectiveness Thing"

                                                                                                                                                                                                                                                            Michael Shirts, New York: Could it be that the same generalized qualities that would make the Democrats better at government — deliberation, discussion, open-mindedness, the valuing of a diversity of opinions — are indeed the same qualities that keep them from presenting a uniform political platform? And the qualities that make the current incarnation of the Republican party good at winning elections — party loyalty and discipline, connections to money and power, a focus on core constituencies — worse at governing? Perhaps the fundamental problem is that our electoral system doesn't actually reward those who are good at governing; it rewards those who are good at winning elections.

                                                                                                                                                                                                                                                            Edward J. Szewczyk, Granite City, Ill.: I can give you another reason for the Democrats' recent electoral futility in one word: gerrymandering. I can give you another reason in two words (one hyphenated): right-wing media.

                                                                                                                                                                                                                                                            Linda Metzke, St. Johnsbury, Vt.: ...[I]sn't it a bit frightening to think that the party of ideas, debate and other very democratic concepts needs to avoid disunion to win elections? In a democracy, shouldn't we be debating and discussing and respecting differences of opinion? To have everyone following the party line feels more like a definition of a dictatorship than a democracy.

                                                                                                                                                                                                                                                            Michael Siteman, Agoura Hills, Calif.: ...In reference to today's column, ... it also occurred to me that the continued failing of the Democratic party seems to be that they have no idea how to build a grass-roots organization which galvanizes mass support for its platform. This may be a result of the lack of charismatic candidates ... Not that the current administration can boast of having charismatic characters or good communicators. George W. Bush is probably the most inarticulate president by whom this country has ever allowed itself to be governed.

                                                                                                                                                                                                                                                            Jeffrey Werbock, Cherry Hill, N.J.: Why are the Democrats unable to get their acts together? One possible reason: no central charismatic figure. Their last Big Guy embarrassed them with his Oval Office hijinks, and they — actually, all of America — are still paying the price. ...

                                                                                                                                                                                                                                                            John Dowd, Santa Cruz, Calif.: ...You're a bright guy, but not the only bright guy. If you can figure out, as you're beginning to write, about the media becoming blind to the “real” stories, so can Rove, et al. And they do. They know they can lie with impunity, because two or three days later certain stories are off the news cycle and no one really remembers what they say.

                                                                                                                                                                                                                                                            They organize well-orchestrated attacks from many fronts — the attack on Hillary Clinton on ABC was an example of something we'll see more of. The Swift Boat story was not about Kerry, it was about the willingness of the right to use the media in such a completely cynical way, and it worked.

                                                                                                                                                                                                                                                            Keep it up. As I said before, the media are being used by some very clever operatives and, for the most part, the media seem unaware of it. ...

                                                                                                                                                                                                                                                            David Tolwinski, Newport, R.I.: Yes, the present administration is frighteningly and dangerously incompetent. Also cynical, and probably both ignorant and stupid. But I'm not optimistic that the Democratic party will ever articulate a coherent, concise and credible strategy for the major concerns of our time. ... Witness Kerry's campaign. The man simply could not take a clear position on any issue! He characterizes the Democratic party's impotence today. ... The Democratic party as constituted is largely ineffective and must be dramatically reformulated. It is the incompetence of the majority of registered voters party that has allowed an opportunistic and cynical Bush administration to grab power.

                                                                                                                                                                                                                                                            Robert Perl, Silver Spring, Md.: Many Republican friends of mine really do not care that the present government is totally incompetent. By bungling federal programs, the administration is more readily able to argue against the necessity of those programs and then to chop their budgets. The only thing that matters to my Republican friends is how much they will have to pay in taxes. Otherwise, they couldn't care less about anything else — absolutely nothing! ... I despair because no Democrat, except Bill Clinton, has been able to argue effectively against the Republican self-serving and crony-enriching nonsense.

                                                                                                                                                                                                                                                            Niki Fox, Bass Harbor, Maine.: I think the disunity is a strength, not a weakness — if people could only see it that way. It's the ideological hardline of the Republican party that has weakened them. Democrats, fortunately, have a less well-defined profile. We think, we reason, we adapt, and most important, we understand. We are not clones of one another.

                                                                                                                                                                                                                                                              Posted by Mark Thoma on Tuesday, February 7, 2006 at 01:27 PM in Economics, Politics

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                                                                                                                                                                                                                                                              The Changing Social Contract

                                                                                                                                                                                                                                                              Nissan provides yet another example of the changing social contract between workers and firms in its move to reduce health and pension benefits for workers:

                                                                                                                                                                                                                                                              Nissan Will Cut Benefits for Retirees, by John O'Dell, LA Times: In a first for a Japanese automaker, Nissan Motor Co. is curtailing its retiree health insurance and pension programs in the U.S., saying it needs to cut costs to "remain competitive." The move comes as concerns mount that such expenses are crippling the competitive efforts of U.S. automakers, particularly General Motors Corp. and Ford Motor Co. ... Nissan will limit healthcare coverage for retirees from its U.S. manufacturing plants and will no longer pay a guaranteed monthly pension to new hires in this country...

                                                                                                                                                                                                                                                              Initially, Nissan's plan won't affect many workers. None of the Japanese automakers has a large number of retirees in the U.S. because their first assembly plants did not open here until the 1980s. But Nissan, Toyota Motor Corp. and Honda Motor Co. all have expressed concerns about future healthcare costs. ... Spokesmen at Toyota and Honda said Monday that they had no plans to alter their benefit programs. ...

                                                                                                                                                                                                                                                                Posted by Mark Thoma on Tuesday, February 7, 2006 at 12:20 AM in Economics, Health Care, Social Security

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                                                                                                                                                                                                                                                                The FDA "endorses the quantitative potential in modern social science"

                                                                                                                                                                                                                                                                Score one for social science and quantitative methods:

                                                                                                                                                                                                                                                                New scrutiny plan for US drug ads, by Christopher Bowe, Financial Times: Drugs companies have long studied the effects their advertisements and promotions have on consumer behaviour, and now US regulators are aiming to catch up. The Food and Drug Administration is working to expand its regulatory arsenal with an unprecedented use of sociological methods to measure perceptions and communication of risks. The agency overseeing food, drug and medical devices is making a big push into social science, according to people familiar with the matter, with the hope of using this expertise to better measure, understand and regulate product risks and consumers’ and doctors’ responses to those risks.

                                                                                                                                                                                                                                                                It also aims to add a social science element to a range of FDA regulatory responsibilities, including monitoring the pharmaceutical industry’s sophisticated marketing and advertising and foodmakers’ claims about their products. FDA officials consider this an emerging priority. ... they see the embrace of social science as a necessary counterweight to industry, catching up with drugmakers’ long-running and expensive efforts at understanding how to place their products in the best possible light. ... The agency’s new emphasis on sociological tools is also a sign that it endorses the quantitative potential in modern social science and social psychology.

                                                                                                                                                                                                                                                                Several current and planned studies by the FDA highlight its early steps to increase use of sociological tools in regulation. The agency expects to begin a study soon on whether coupons and other free offers used for drug advertising in print media affect consumers’ perceptions of the products’ risks. ...

                                                                                                                                                                                                                                                                Another example of sociological tools that interest the FDA came in one of two hearings late last year on advertising and risk communication. In a presentation, Ruth Day, a cognitive psychology researcher from Duke University, analysed drug advertising showing how media techniques could make consumers less likely to remember side effects. She added that similar techniques were used on drug websites, leaflets and labels.

                                                                                                                                                                                                                                                                Techniques included “chunking”, where benefits are described in simple sentences, and side effects described in long complex sentences. Moreover, risk information was discussed three-quarters of the way into the ad, making it more likely to be forgotten. Ms Day also showed that distracting graphics can coincide with discussion of side effects to lower comprehension.

                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Tuesday, February 7, 2006 at 12:03 AM in Economics, Health Care, Methodology, Policy

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                                                                                                                                                                                                                                                                  February 06, 2006

                                                                                                                                                                                                                                                                  Dallas Fed President Fisher Dons the Foam Finger: We're #1!!!

                                                                                                                                                                                                                                                                  Dallas Fed president Richard Fisher speaking in London, though at the end it might be better described as lecturing, says economic conditions look strong strong in the growth rim, the megastate, and the uberstate. Although growth looks to be a bit more chilly up north, there is every reason to believe the U.S. will continue to fuel the world economy, a situation that will persist so long as foreign leaders fail to achieve open and flexible markets:

                                                                                                                                                                                                                                                                  The United States: Still the Growth Engine for the World Economy?, by Richard W. Fisher, Dallas Fed President: ...My kind hosts, who had no idea that this event would follow ... the meager growth estimate reported for last year’s fourth quarter, have asked me to address the question: Is the United States still the growth engine for the world? The answer is yes. ... The American economy has been on an upswing for more than four years. ... I would not be surprised if GDP were revised upward when we take a more definitive look at the fourth quarter. ... We have weathered hurricanes’ fury and record-high energy prices while continuing to grow and keep inflation under control. ...

                                                                                                                                                                                                                                                                  This is especially true in what I call the “growth rim”—an arc of population centers with favorable demographics that begins in Virginia, runs down the southeastern seaboard through Georgia to Florida, then through the megastate of Texas and on to the uberstate of California and up to Seattle. I use “mega” and “uber” to describe the two largest states for a reason: to illustrate the depth and breadth of our economy. In dollar terms, Texas produces 20 percent more than India, and California produces roughly the same output as China. To the extent there is weakness in the U.S. economy, it is in the Northeast and North Central states.

                                                                                                                                                                                                                                                                  Netting all this out, the consensus of most economic forecasters is that growth in the first quarter will rebound to a rate well above 4 percent. To understand what this kind of growth means, we need ... to “do the math.” The United States produces $12.6 trillion a year in goods and services. Be conservative ... and assume that in 2006 we grow at last year’s preliminary rate of 3.5 percent. The math tells us we would add $440 billion in incremental activity—in a single year.

                                                                                                                                                                                                                                                                  That is a big number. What we add in new economic activity in a given year exceeds the entire output of all but 15 other countries. Every year, we create the economic equivalent of a Sweden—or two Irelands or three Argentinas. ... Of course, our growth is driven by consumption, a significant portion of which is fed by imports, which totaled $2 trillion last year. Again, do the math: Our annual import volume ... exceeds the GDP of all but four other countries—Japan, Germany, Britain and France.

                                                                                                                                                                                                                                                                  So, yes, the United States is the growth engine for the world economy. And it is important that it remain so because no other country appears poised to pick up the torch if the U.S. economy stumbles or tires. Are there reasons to worry it might do so? In fashionable circles and at various “chat shows” like Davos, you certainly hear many.

                                                                                                                                                                                                                                                                  Of immediate concern is the potential bursting of the so-called housing bubble. ... Again, it is important to do the math. Currently, 80 percent of U.S. homeowners have fixed-rate mortgages. Just one in five has a variable-rate mortgage. ... It is true that homeowners with variable-rate loans borrow larger amounts. It is also true that they have higher incomes. ...

                                                                                                                                                                                                                                                                  In recent years, the analytically nettlesome Interest-Only—or IO—mortgages have become a significant percentage of housing loans in some markets. ... Many of these mortgages, however, have long periods during which the interest rate and IO period are locked up. ... many houses will be sold or refinanced before the amortization period ever kicks in. Given this, I will let you draw your own conclusions about whether the housing market’s financial dynamics will strain the U.S. economy as interest rates rise in response to Federal Reserve tightening. ...

                                                                                                                                                                                                                                                                  The other preoccupation is the U.S. current account deficit, a subject second only in popularity to the ongoing saga of Brad Pitt and Angelina Jolie. America’s large trade deficits have been discussed for so long by so many eminent analysts that I have little to add—except to remind you that it takes two to tango. Those urging the United States to rein in its spending should be equally full-throated in prodding countries with excess savings and trade surpluses to create conditions for growing their domestic demand.

                                                                                                                                                                                                                                                                  If they fail to do so, and the U.S. suddenly becomes virtuous on its own, the global economy would sink into a deep funk. So if there is a ready substitute for the United States as the consumer of first and last resort for many developing economies, I would like someone to tell me which country, or group of countries, might fill the bill. ...

                                                                                                                                                                                                                                                                  The key to the American economy’s success in recent years ... has been a unique combining of money and brains to enhance productivity ... New technology fed the productivity surge. The microprocessor led to a host of productivity-enhancing tools ... The Information Age technologies were available in nearly all countries, but few reaped the same productivity gains as the United States. ... The key to wringing more from the new technologies lies in the American economy’s adaptability. ... We have not saddled the private sector with regulations that interfere with hiring and firing or dictate outmoded methods of production. ...

                                                                                                                                                                                                                                                                  I would like to think that America’s greatest asset is the wisdom and steady hand of its central bank. But truth be told, wise and temperate monetary policy is a necessary but insufficient condition for America’s success. Our greatest asset is our inherent flexibility ... As long as the Federal Reserve does its job of holding inflation at bay, and as long as our political leaders resist protectionism and other forms of interference..., we will remain a productive economic machine. ...

                                                                                                                                                                                                                                                                  It is up to the continent’s political leaders to create conditions that liberate the private sector to reignite the combined mass of Europe’s economies as an engine of growth while the ECB ensures that business remains undistracted by inflation. Until then, the task of being the world’s economic engine falls to the United States.

                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Monday, February 6, 2006 at 05:46 PM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                                                                                                    More Guns for the Military, Less Butter for Grandma

                                                                                                                                                                                                                                                                    The Bush budget proposal is out:

                                                                                                                                                                                                                                                                    Bush's $2.77 Trillion Budget Proposal Boosts Defense, Cuts Social Programs

                                                                                                                                                                                                                                                                    There are proposed cuts to Medicare, farm subsidies, and the Pension Benefit Guarantee Corporation. There are proposals to create Health Savings Accounts, and tax-free "lifetime'' and "retirement'' savings accounts. The budget didn't specify how the coming war with Iran will be paid for, but I assume the plan is to use tax cuts like before and let it pay for itself. On that note, here's John McCain this weekend: "There is only one thing worse than military action," he said, "and that is a nuclear-armed Iran.

                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Monday, February 6, 2006 at 12:22 PM in Budget Deficit, Economics, Taxes

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                                                                                                                                                                                                                                                                      An Equilibrium Model of "Global Imbalances" and Low Interest Rates

                                                                                                                                                                                                                                                                      This paper explains three fundamental facts about the U.S. economy. First, the U.S. has run a persistent CA deficit since around 1990, second, long-term real interest rates have declined, and third, the importance of U.S. assets in world portfolios has risen. According to the authors, most previous work ignores fact 2, takes fact 3 as given, then asks what will happen if the anomaly represented by fact 1 corrects itself. This paper uses a fairly standard framework to analyze these three issues theoretically.
                                                                                                                                                                                                                                                                      Their model divides the world into three regions, U (countries like the U.S.), E (countries in Europe and Japan), and R (rest of world). The paper looks at the consequences of a slowdown in E and an asset market collapse in R and finds that when coupled with heterogeneity in the ability supply financial assets, the model is consistent with the facts.

                                                                                                                                                                                                                                                                      The two shocks put downward pressure on the real interest rate (fact 2 ). If there is high demand for financial assets from R due to rapid growth in that region, and if region R cannot supply them domestically, they will need to get them from U and E, and if more come from U, it's share will rise (explaining fact 3). In addition, in the model, U's CA never turns positive (explaining fact 1).

                                                                                                                                                                                                                                                                      Importantly, because facts 1-3 are equilibrium outcomes and not anomolies, unless there are large changes in the factors leading to facts 1- 3, the growth differentials between countries and the differences in the ability to supply financial assets, there is no reason to expect a sudden change in the CA deficit, low real rates, or the increased share of U.S. assets in international portfolios, i.e. there is no reason to expect a hard-landing scenario:

                                                                                                                                                                                                                                                                      An Equilibrium Model of "Global Imbalances" and Low Interest Rates, by Ricardo J. Caballero, Emmanuel Farhi, Pierre-Olivier Gourinchas, NBER WP 11996, February 2006: Abstract Three of the most imprtant recent facts in global macroeconomics -- the sustained rise in the US current account deficit, the stubborn decline in long run real estate, and the rise in the share of US assets in global portfolio -- appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) heterogeneity in these ragions' capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. Unlike the conventional wisdom, in the absence of a large change in (a) or (b), our model does not augur any catastrophic event. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment. [Open link]

                                                                                                                                                                                                                                                                        Posted by Mark Thoma on Monday, February 6, 2006 at 09:39 AM in Economics, International Finance

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                                                                                                                                                                                                                                                                        Paul Krugman: The Effectiveness Thing

                                                                                                                                                                                                                                                                        Paul Krugman has an explanation for why Democrats have been unable to take advantage of recent Republican missteps:

                                                                                                                                                                                                                                                                        The Effectiveness Thing, by Pal Krugman, Democrat Disunion, Commentary, NY Times: We are ruled by bunglers. Every major venture by the Bush administration ... has turned into an epic saga of incompetence. In retrospect, the Clinton years look like a golden era of good government. Given the Bush administration's evident inability to govern, Democratic electoral victories should be a sure thing. But they aren't. Why?

                                                                                                                                                                                                                                                                        Before I try to answer that question, let me justify my assertion ... that Bill Clinton knew how to govern, while George W. Bush doesn't. ... [C]onsider the rise and fall of the Federal Emergency Management Agency. Under the elder George Bush, FEMA was used as a dumping ground for political cronies, with predictable results. Descriptions of FEMA's response to Hurricane Andrew in 1992 sound just like the response to Katrina: for three days FEMA was nowhere to be found, and when it finally arrived its relief efforts were utterly incompetent.

                                                                                                                                                                                                                                                                        Bill Clinton changed all that by choosing James Lee Witt, who knew a lot about disaster management, to run FEMA, and encouraging him to run the agency professionally. The result was a spectacular improvement in performance. ... But George W. Bush restored the practice of stuffing FEMA with cronies; the ludicrous Michael Brown is gone, but others remain. And the agency has reverted to impotence and incompetence.

                                                                                                                                                                                                                                                                        As FEMA went, so went government as a whole. ... [W]hat happened to FEMA starting in 2001 is typical: politicization and cronyism have become standard operating procedure ... That's one main reason President Bush has failed at everything he's tried except cutting taxes — and winning elections.

                                                                                                                                                                                                                                                                        Which brings me to the political puzzle. ...more than half of Americans say that the Bush administration has been a failure. Yet it's not at all clear that Democrats can translate this sentiment into large political gains — because despite the governing skill of the last Democratic administration, the public doesn't think of Democrats as being effective.

                                                                                                                                                                                                                                                                        A lot of this has to do with the way the news media cover politics: ... many news organizations ... prefer to do horse-race stories rather than discuss policy issues. And from that point of view, the Democrats present a sorry spectacle. Not only are they a minority ...; they're an undisciplined minority constantly facing defections from their own ranks on crucial issues.

                                                                                                                                                                                                                                                                        The issue of Iraq epitomizes the political paradox. The war has been a monstrous policy failure, but it remains a political asset to the Bush administration, because it divides the Democrats and makes them look ineffectual. Yet if the Democrats could present a united front on Iraq, they'd probably have a lot of public support. You'd never know it from the ... Sunday talk shows, but a majority of Americans believes both that the administration deliberately misled the nation about W.M.D.'s and that we should set a timetable for withdrawal.

                                                                                                                                                                                                                                                                        And the public's views on other issues seem to favor the Democratic position ... even more strongly. For example, the public believes by two to one that the government should guarantee health insurance for all Americans. The point is that Democrats are largely winning the battle of ideas: on the issues, public opinion is shifting in their direction. But to take advantage of that shift, they have to overcome an image of ineffectiveness that is partly the fault of the news media, but largely the result of their own disunion.

                                                                                                                                                                                                                                                                        Next (2/10) column: Paul Krugman: The Vanishing Future Previous (2/3) column: Paul Krugman: State of Delusion

                                                                                                                                                                                                                                                                          Posted by Mark Thoma on Monday, February 6, 2006 at 12:15 AM in Economics, Politics

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                                                                                                                                                                                                                                                                          Variable Pricing of Electricity

                                                                                                                                                                                                                                                                          The ability to use peak load pricing to regulate electricity usage is coming to California. That's good, except for the large number of meter readers that will lose their jobs:

                                                                                                                                                                                                                                                                          New Power Meters Show Users the Money, by Marc Lifsher , LA Times: ...California regulators and two of the state's biggest utilities. Pacific Gas & Electric Co. and San Diego Gas & Electric Co. plan to spend $2 billion over the next several years installing millions of the advanced meters in homes across the Golden State. ... The meters are actually mini-computers that communicate with a utility's central data center, providing real-time information on how much electricity a customer is using and when it's being used. Data provided by the meters enable utilities to offer voluntary "variable pricing" plans. Under the plans, customers are charged more for power used during peak periods ... and less ... when demand and prices are lower.

                                                                                                                                                                                                                                                                          The goal is to alleviate the state's power crunch by giving customers a financial reward for running their dishwashers at night — or dinging them for jacking up the air conditioning on hot afternoons. There's a bonus for utilities: They currently employ thousands of meter readers who periodically slip into backyards to manually record customers' electricity use — jobs that would go the way of the milkman if advanced metering became universal. "I always knew this was coming. Technology has pretty much taken over," said Mike Boyle, a PG&E worker who says he reads as many as 1,300 meters a day in Vacaville, northeast of San Francisco. ...

                                                                                                                                                                                                                                                                          In the state-sponsored pilot project, high-tech meters were installed in 2,500 homes and the customers were billed under a variety of variable-pricing plans. Electricity use fell by an average of 13%. "The old straw that electricity demand [isn't affected by price] is not true at all," said Roger Levy, a consultant with the energy commission. ... The utility expects to recover most of the $1.6-billion cost of the program by eliminating its 900 meter readers and by shrinking other operational costs. ...

                                                                                                                                                                                                                                                                            Posted by Mark Thoma on Monday, February 6, 2006 at 12:06 AM in Economics, Oil

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                                                                                                                                                                                                                                                                            Health Savings Accounts

                                                                                                                                                                                                                                                                            That Bush will push Health Savings Accounts is not surprising:

                                                                                                                                                                                                                                                                            Bush Seeks to Increase Health Savings Accounts, by Christopher Lee, Washington Post: In his State of the Union speech last week, President Bush gave short shrift ... to ... health care. Still, administration officials say finding an antidote to rising costs will be a priority for the White House this year. Bush's prescription includes promoting health savings accounts (HSAs) and "consumer-driven" health plans that he says will trim expenses by prodding Americans to assume greater responsibility for their health care choices. ...

                                                                                                                                                                                                                                                                            Not everyone is a fan. Dan Adcock, assistant legislative director for the National Active and Retired Federal Employees Association, said such plans could drive up costs for some workers. "You are going to have a migration to the consumer-driven plans by people who tend to be lower users of health care, and people who tend to be higher users of health care will remain in the comprehensive plans," Adcock said. "When that happens . . . those plans have to increase premiums or cut benefits, or both of those things, in order to stay in business." A Government Accountability Office report last week found that enrollees in federal consumer-driven plans were younger and wealthier than those in other plans. ...

                                                                                                                                                                                                                                                                            The LA Times is unimpressed. I share the lack of enthusiasm:

                                                                                                                                                                                                                                                                            Shopping for healthcare ... , Editorial, LA Times: President Bush spoke ... last week about the need for healthcare reform, but his concrete proposals are not unlike his plan for Social Security last year — modest steps that affect individuals but don't address the broader problem. Bush wants to help individuals ... pay for more of their own medical expenses with cash from individual health savings accounts. The idea is that by giving patients more skin in the game, they'll become better consumers and drive down prices in the process. ...

                                                                                                                                                                                                                                                                            It's increasingly clear that the healthcare marketplace ... is not working. Nearly 46 million Americans live without health insurance, a fact that has large social and financial implications... On Tuesday night, Bush said that "for all Americans, we must confront the rising cost of care … and help people afford the insurance coverage they need." But what he offered as a solution — mostly sweeteners for health savings accounts — would help only a small share of the population.

                                                                                                                                                                                                                                                                            Health savings accounts are mainly attractive to healthy people who can afford to pay high deductibles and don't suffer from expensive chronic conditions. ... It may be foolish to think that a president with about three years left in the White House can make substantial changes. But Bush, if he truly wants to take this on, needs to offer more ambitious reforms.

                                                                                                                                                                                                                                                                              Posted by Mark Thoma on Monday, February 6, 2006 at 12:02 AM in Economics, Health Care

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                                                                                                                                                                                                                                                                              February 05, 2006

                                                                                                                                                                                                                                                                              Turmoil at the Social Security Administration

                                                                                                                                                                                                                                                                              The Social Security Administration is in turmoil due, in part, to the Medicare Part D program:

                                                                                                                                                                                                                                                                              Internal Documents Reveal That Medicare Drug Benefit Is Causing Chaos At Social Security Administration, Representative Waxman: In a letter to Speaker Hastert, Rep. Waxman asks for hearings on new revelations that budget cuts and the Medicare Part D program are overwhelming the Social Security Administration. Letter to the Speaker Letter to the Speaker.

                                                                                                                                                                                                                                                                              And here is the letter (pdf, Word):

                                                                                                                                                                                                                                                                              February 3, 2006

                                                                                                                                                                                                                                                                              The Honorable J. Dennis Hastert Speaker of the House of Representatives Washington, DC 20515

                                                                                                                                                                                                                                                                              Dear Mr. Speaker:

                                                                                                                                                                                                                                                                              I am writing regarding an urgent problem that appears to be overwhelming the Social Security Administration. I have obtained a January 21, 2006, email that the Deputy Commissioner of Operations for Social Security, Linda McMahon, sent to all Social Security Administration Operations employees. The message reads as follows:

                                                                                                                                                                                                                                                                              Ordinarily I would be sending you a Happy New Year note at this time, but the circumstances we are facing seem to call for a different message. I didn’t want you to think I’m out of touch with reality and don’t know about the significant challenges you are experiencing.

                                                                                                                                                                                                                                                                              Ever since the Medicare Modernization Act passed, those of you on the front line have been expressing your deep concern that SSA is not positioned well to help people understand, enroll in and negotiate the new Medicare Part D Prescription Drug Program. Now we are seeing the consequences of that fact. Our National 800 Number Network has been overwhelmed for weeks, with busy rates running above 35 percent many days. In the last few weeks, those folks who can’t get us on the phone have been coming into our field offices in large numbers. In fact, during the first two weeks in January, we had nearly 200,000 visitors a day — as many as 60,000 more than we saw in the fall. We already had large backlogs in our Processing Centers, and those will be exacerbated ...

                                                                                                                                                                                                                                                                              It’s not a rosy picture, and the news doesn’t get better. Congress finally passed our FY06 budget in late December, and they gave us $300 million less than the President requested. That means we will not be able to replace all the employees we lose to retirement this year or accomplish all the automation projects we had intended to do to streamline work processes. At the same time, we have been given new mandates ...

                                                                                                                                                                                                                                                                              I won’t try to kid you. This is going to be a very difficult year, and the budget picture for next year doesn't look any better. ... Thanks for doing your best to cope ...

                                                                                                                                                                                                                                                                              Other emails and communications confirm the chaos that the Medicare prescription drug program has caused for the Social Security Administration, describing “hemorrhaging” at Social Security call centers and the provision of inaccurate information to seniors. ... Additional documents that I have obtained bolster the concerns raised by Ms. McMahon, and raise new issues. ...


                                                                                                                                                                                                                                                                              Henry A. Waxman Ranking Minority Member

                                                                                                                                                                                                                                                                              There is quite a bit more, including documentation, in the original.

                                                                                                                                                                                                                                                                                Posted by Mark Thoma on Sunday, February 5, 2006 at 04:02 AM in Economics, Politics, Social Security

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                                                                                                                                                                                                                                                                                "Laura and John, get ready to take on Ravi and Xiao Ping"

                                                                                                                                                                                                                                                                                Chidanand Rajghatta, the Washington DC. based Foreign Editor of The Times of India: scoffs at the idea that India and China are a threat to the U.S. - so long as the children of immigrants continue to pick up the slack:

                                                                                                                                                                                                                                                                                The Axis of Praxis, by Chidanand Rajghatta, Indiaspora, The Times of India: Laura and John, get ready to take on Ravi and Xiao Ping. On three consecutive days this past week, President Bush has invoked India and China as new economic competitors to the US. ... There is already a book called Three Billion New Capitalists: The Great Shift of Wealth and Power to the East by Clyde Prestowitz, a Reagan administration official, which clubs the three nations whose cachet now seems to be education, just about the time Americans appear to be signing off from school.

                                                                                                                                                                                                                                                                                So there we are, three billion versus 300 million. The US population is now pegged at 297,900,000. With a baby born every eight seconds, someone dying every 12 seconds and the country gaining an immigrant every 31 seconds, American population is growing by one person every 14 seconds. Which means the 300 millionth American, perhaps just conceived, is due in October this year. ... When the 200 millionth American arrived in 1967, Life magazine positioned 23 photographers to record the moment. The milestone infant was deemed to be Robert Ken Woo, the son of Chinese immigrants who went on to graduate from Harvard, became a model citizen, and lives in Atlanta now with three US born children.

                                                                                                                                                                                                                                                                                My money for the 300 millionth American is on a Patel or a Sanchez. Jokes aside, the threat of China and India as economic adversaries seems overblown. By every metric — PhDs, inventions, patents, research spending, you name it — the US remains the leader by far. Statistics about the growth of China and India are bandied around ignoring the low base they start from. For instance, someone breathlessly reported that the numbers of patents filed in the US from India is up by 2000% over the last decade. Yeah right, it went up from 70 to 1,300. Americans meanwhile file 200,000 patents annually.

                                                                                                                                                                                                                                                                                Similarly, American scaremongers are crying hoarse over the number of engineers being graduated by China and India on the basis of some very dodgy numbers ... they are not even considering that the two countries contribute perhaps 100,000 engineers annually to the US pool. Come down sometime to the Bay Area or any engineering school in the US and take a look. Sure, it's true that fewer American students are taking to math and science. It's smart on the part of American leaders to blow the whistle on this. You don't remain No 1 by being complacent.

                                                                                                                                                                                                                                                                                But Asians are picking up the slack, both children of new immigrants and second generation kids. You can see this in many annual school contests, my favourite being the Intel Science Talent Search. Of the 40 finalists this year, about a dozen are of Indian and Chinese origin. You can see the rise of Asian-Americans at many levels — from school competitions to college degrees to PhDs. Asians rock — academically. So as long as the US remains open to immigrant talent and nurtures its melting pot, there's little to fear. Given the growing interdependencies in the world, it's likely that India and China will be allies of the US rather than adversaries.

                                                                                                                                                                                                                                                                                If not John and Laura, Usha and Li in the US will be collaborating with Ravi and Xiao Ping in Asia.

                                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Sunday, February 5, 2006 at 04:00 AM in China, Economics, India

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                                                                                                                                                                                                                                                                                  February 04, 2006

                                                                                                                                                                                                                                                                                  Fed Watch: Placing Bets on Bernanke’s First Move

                                                                                                                                                                                                                                                                                  Tim Duy's Fed Watch:

                                                                                                                                                                                                                                                                                  The Greenspan era ended peacefully. I somehow expected that colors would look a bit dull, or the chirping of birds would become melancholy. Things instead seemed pretty much unchanged – we slid into the Bernanke era with an FOMC statement that contained little new information. We need to assume policy continuity until the new top dog says otherwise. In my mind, I think Fed policy is running on two competing planks:

                                                                                                                                                                                                                                                                                  1. With a full 350bp of tightening in the pipeline, and some indications of softening in housing, Fed officials would like the opportunity to pause to assess their handiwork.
                                                                                                                                                                                                                                                                                  2. Increases in resource utilization and the omnipresent threat of higher energy price leave policymaker’s uneasy about pausing at this point.

                                                                                                                                                                                                                                                                                  The term “conundrum” comes to mind. My bet is that plank number 2 will be the winner – the solid economic data with the continuous threat of inflation suggests the Fed will still draw another arrow from its quiver.

                                                                                                                                                                                                                                                                                  Last week I said the Fed would not take such a dim view of the Q4 GDP report in light of anecdotal evidence and the higher frequency data. The statement of last week’s FOMC meeting conforms to this view:

                                                                                                                                                                                                                                                                                  Although recent economic data have been uneven, the expansion in economic activity appears solid.

                                                                                                                                                                                                                                                                                  The “uneven” data is likely a reference to the weak GDP report. Still, the Fed did not seem as concerned about the uptick in core-PCE as I thought:

                                                                                                                                                                                                                                                                                  Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained.

                                                                                                                                                                                                                                                                                  Regarding future policy:

                                                                                                                                                                                                                                                                                  Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.

                                                                                                                                                                                                                                                                                  The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.

                                                                                                                                                                                                                                                                                  As others have noted, the shift in language was expected and provides maximum flexibility for Bernanke & Co. to maneuver. The identification of resource utilization rates (see my Fed watch two weeks ago) and energy costs indicates the bias is to tighten further, in my view. The “may be needed” phrases indicates, however, that no tightening is guaranteed. The Fed did not send up an all’s clear signal. Instead, we need to shift through two months of data to determine the degree of resource utilization. And the tone of recent data suggests the Fed will tighten yet again when Bernanke presides over his first FOMC meeting as chairman and the end of March.

                                                                                                                                                                                                                                                                                  The January employment report adds another piece of evidence in favor of additional tightening. True, it was not a blockbuster report. Instead, it suggested a certain continuity – the slow gradual tightening of the labor market. Employers added just under 200k workers to the payrolls with gains well spread throughout the economy. The weak spot was retailing, and construction was an unexpected strong point considering evidence of softening in that sector. Recent months were revised higher as well.

                                                                                                                                                                                                                                                                                  The unemployment rate fell to 4.7%, a low enough number that some FOMC members will be getting increasingly nervous about “resource utilization.” Some will point to the slight uptick in the employment to population and low labor force participation rates as evidence that the labor market is weak. I think that is a difficult argument to make – see also David Altig’s thoughts on this point. There are likely secular trends in the labor markets that are not fully accounted for yet. Another potential weak spot in the report was the flat work week.

                                                                                                                                                                                                                                                                                  Overall, however, my take on the data suggests a relatively strong labor market. In addition to steady job growth and low unemployment, wages gains are accelerating, with January’s 7 cent gain pushing wages up 3.3% compared to last year (and 2 consecutive 0.4% monthly gains, or an annualized 5.3% gain in January). And buried within the data are further bright spots, such as a solid decline in long term unemployment (more than 27 weeks):


                                                                                                                                                                                                                                                                                  Also, the unemployment rate including marginally attached persons and those employed part time for economic reasons continued its steady march down as well:


                                                                                                                                                                                                                                                                                  Now, one does have to be careful with unemployment rates as they are lagging indicators. But initial jobless claims – a leading indicator – remain low (in Oregon claims have dropped to the lowest level in over 10 years). Moreover, I am picking up anecdotal evidence that employers are sensing a change as well. Paraphrasing one employer, “My employees are asking for higher wages, and actually expecting they will get them. And they do.”

                                                                                                                                                                                                                                                                                  When employers complain about lack of potential workers, I tell them they need to raise wages. This doesn’t make them happy, either.

                                                                                                                                                                                                                                                                                  Note that I am not attributing a stronger labor market to any specific economic policies. And it is true that the labor market remained lackluster for an extended period of time. But it does look like conditions have significantly improved over the past year, and the Fed will take note. For a different view, and another potential measurement problem, changes in the rates of non-responders, see Dean Baker at MaxSpeak.

                                                                                                                                                                                                                                                                                  In addition to the employment report, the bulk of this week’s data has also been supportive of another rate hike. Productivity growth stumbled (see David Altig) and unit labor costs gained. I would be somewhat careful about overreacting to this report. The Q4 GDP report looked weak due to a number of factors that all came together at once, but are probably not indicative of the underlying economic trend. This would of course also apply to the productivity numbers. Still, the best days of high productivity growth look behind us. The Fed will be wary that firms are having an increasingly difficult time improving productivity, providing additional incentive to push higher costs down the line.

                                                                                                                                                                                                                                                                                  The Institute of Supply Management also provided its snapshot of manufacturing and non manufacturing activity. In both cases, the outcome was slightly weaker than expectations, but still suggestive that the economy remains on solid footing. The details of the manufacturing report suggested the “resource utilization” in growing – inventories were contracting, customer’s inventories were too low, prices paid edged up, and the backlog of orders continued to grow. More meat to feed the inflation hawks at the FOMC. But perhaps they will be softened somewhat by the non manufacturing report, which indicated that inventories were too high. Calculated Risk provides his thoughts and points out the discontinuity of reports of a contracting construction industry with the expansion in employment in that industry.

                                                                                                                                                                                                                                                                                  Two weeks ago I said that barring any significant shifts in the bond markets, the Fed was ready to pull the trigger on a complete inversion of the yield curve when policymaker’s pushed the overnight rate to 4.5%. Since then, bonds have fallen substantially, with the 10 year rate currently hovering around 4.55% (the curve is inverted at the 10 year – 2 year horizon). A slim margin, to be sure, but a margin nonetheless.

                                                                                                                                                                                                                                                                                  Will longer term interest rates move up again? Or will the negative factors waiting on the sidelines – the lagged impact of previous rate hikes, a softening housing market, low saving rates, and possible consumer fatigue – turn against us and put the FOMC firmly into pause mode? Many, I think would prefer to see the Fed wait it out a meeting or two – see Jim Hamilton, for instance. But the steady, mostly supportive flow of data suggests not just yet, with the odds still on the Fed will raise rates to 4.75% on March 28th.

                                                                                                                                                                                                                                                                                  Still, two months of data is a lot to chew on, and it is likely we will all be scratching our heads between now and then. [All Fed Watch posts.]

                                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Saturday, February 4, 2006 at 01:26 AM in Economics, Fed Watch, Monetary Policy

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                                                                                                                                                                                                                                                                                    Paul Krugman's Money Talks: Abramoff and the Media

                                                                                                                                                                                                                                                                                    Paul Krugman responds to comments on his column on the Abramoff scandal:

                                                                                                                                                                                                                                                                                    Abramoff and the Media , Paul Krugman's Money Talks, Commentary, NY Times: Readers respond to Paul Krugman's Jan. 30 column, "A False Balance"

                                                                                                                                                                                                                                                                                    Steven Schafersman, Midland, Tex.: I am a scientist. I have long been frustrated and angry about the way the press treats cultural controversies as science controversies and gives equal time to non-scientists, psuedo-scientists and anti-science activists, who are usually pro-business... or pro-Bush administration. This happens with the evolution-creationism controversy, the global warming controversy, the environmental destruction controversy, the humans vs. robots in space controversy, the stem cell controversy and many others. The controversy about tobacco being harmful to human health has finally been resolved, but for decades tobacco companies had scientific reports that tobacco wasn't dangerous. In each case, there is an overwhelming scientific consensus about the correct scientific position in each controversy, but a few individuals -- some of whom have scientific credentials but who mainly have a political, economic or ideological agenda -- take the opposite position but get half the press attention.

                                                                                                                                                                                                                                                                                    Reporters are trained to present both sides equally, when in fact -- from a knowledgeable scientific perspective -- only one side is actually valid. Thus, most news reports about cultural controversies involving science are biased, giving the false or inferior side much greater legitimacy than it deserves. The result is that the public is often poorly informed about the correct scientific understanding of many important topics, some of which are or will be vital to human health and survival. The press needs to do a better job of reporting on these cultural and political controversies which involve scientific understanding.

                                                                                                                                                                                                                                                                                    Jacob Kornbluth, New York: This “wimpy” media movement is an amazingly important problem. The only time the reporting of the news hasn't felt “scared” to me since 9/11 was during Hurricane Katrina. What happened to make the reporting of that disaster so much different than that of the Abramoff scandal? How did they fight through the partisan accusations, blogosphere noise and everything else, and just report the actual situation on the ground?

                                                                                                                                                                                                                                                                                    I have a feeling it's because the consequences of the wrong weren't an abstraction, that the pictures of real people experiencing real loss were unspinnable. During that tragedy, however, the reporting left me feeling more hopeful than I was before or have been since. ...

                                                                                                                                                                                                                                                                                    Gary Pace, St. Louis: ...I am struck by one consistent theme of today's administration practiced by the Republican Congress: abuse of power. Questionable actions are dismissed with backhanded comments, such as “We must stop terror”, or “We're at war!” Of course, President Bush has already announced victory in the Iraq war, so I'm not sure what war he refers to as he tries to justify his actions. Once a long-time Republican myself, I am appalled by what has taken place within the G.O.P. Moreoever, it's mind-boggling how many fellow conservatives rationalize the current misbehavior within the Republican party...

                                                                                                                                                                                                                                                                                    Bill Moore, Norwalk, Conn.: ...Many journalists ... apparently misunderstand what the words “balanced reporting” mean.

                                                                                                                                                                                                                                                                                    Paul Krugman: Let me expand a bit on what I said in the column. ... thinking of Jack Abramoff as a lobbyist in the conventional sense misses the whole point ... Mr. Abramoff didn't approach potential clients saying, “I know my way around Washington, and I can tell you who to support.” He came and said, in effect, “I've got powerful friends in Congress and the White House” - Republican friends, of course – “and, if you pay me, I can arrange for them to look kindly on your interests.” And there was, in the case of the Indian tribes, more than a bit of implied threat: "Nice gambling business you've got here. It would be a shame if anything happened to it."

                                                                                                                                                                                                                                                                                    And what did Mr. Abramoff do with the money he extracted? He took a big chunk for himself, of course. But he also used it to enrich and reward Republican loyalists. And money from his clients went to a variety of Republican causes, often with no relevance to the clients' interests. In effect, he was running a slush fund for the Republican machine.

                                                                                                                                                                                                                                                                                    That's why calling this a bipartisan scandal is such an outrage.

                                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Saturday, February 4, 2006 at 01:23 AM in Economics, Politics, Press

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                                                                                                                                                                                                                                                                                      The War on Science Continues...

                                                                                                                                                                                                                                                                                      The administration is up to its usual tricks on the science front, this time with health standards on soot and dust. Why worry about "thousands of more deaths" when mining and agricultural trade associations are opposed to the new rules?:

                                                                                                                                                                                                                                                                                      EPA Panel Advises Agency Chief to Think Again, by Janet Wilson, LA Times: In an unprecedented action, the Environmental Protection Agency's own scientific panel ... challenged the agency's proposed public health standards governing soot and dust. The Clean Air Scientific Advisory Committee, mandated by Congress to review such proposals, asserted Friday that the standards put forward by EPA Administrator Stephen L. Johnson ignored most of the committee's earlier recommendations and could lead to additional heart attacks, lung cancer and respiratory ailments. ...

                                                                                                                                                                                                                                                                                      In December, Johnson proposed to slightly tighten the health standards that state and local governments must meet in regulating industries and other sources of pollution. But those standards, governing the smallest and most hazardous particles of soot, were substantially weaker than the scientists' recommendations. Johnson also proposed to exempt rural areas and mining and agriculture industries from standards governing larger coarse particles, and he declined to adopt the panel's proposed haze reduction standards. ...

                                                                                                                                                                                                                                                                                      Some panel members called the administrator's actions "egregious" and said his proposals "twisted" or "misrepresented" their recommendations. ... It was the first time since the committee was established under the Clean Air Act nearly 30 years ago that the committee had asked the EPA to change course ... "We're in uncharted waters here," acknowledged committee Chairwoman Rogene Henderson, an inhalation toxicologist. She said their action was necessary because "the response of the administrator is unprecedented in that he did not take our advice. It's most unusual for him not to take the advice of his own science advisory body." ...

                                                                                                                                                                                                                                                                                      Cal/EPA's air pollution epidemiology chief, Bart Ostro, charged during the teleconference that the EPA had incorporated "last-minute opinions and edits" by the White House Office of Management and Budget that "circumvented the entire peer review process." ... In an interview later, Ostro said he was referring to marked-up drafts of Johnson's proposals that showed changes by the White House budget office and language that was "very close to some of the letters written by some of the trade associations."

                                                                                                                                                                                                                                                                                      He said the Clean Air Scientific Advisory Committee's seven-year review of data on health risks of particulate matter had been replaced with inaccurate conclusions about the science that could lead to "thousands more deaths," especially from fine particulates that lodge deep in the lungs. ... Sen. Barbara Boxer (D-Calif.) wrote to Johnson on Friday afternoon requesting that the EPA provide her with documents related to the EPA's ... contacts with ... representatives of the mining and agricultural industries. "These changes benefit mining and agricultural interests at the expense of public health," she wrote. ...

                                                                                                                                                                                                                                                                                        Posted by Mark Thoma on Saturday, February 4, 2006 at 12:59 AM in Economics, Environment, Politics

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                                                                                                                                                                                                                                                                                        February 03, 2006

                                                                                                                                                                                                                                                                                        Did the NRA Stop the FDIC Chair Nomination?

                                                                                                                                                                                                                                                                                        Okay, now I'm curious. Was it the NRA or not?:

                                                                                                                                                                                                                                                                                        F.D.I.C. Post Seems Unlikely for New York Banking Chief, by Jim Rutenberg and Raymond Hernandez, NY Times: This much is known: As of last week, it was assumed in Washington and on Wall Street that the White House would nominate Diana L. Taylor, the New York State banking supervisor — and companion of Mayor Michael R. Bloomberg — as the new chairwoman of the Federal Deposit Insurance Corporation.

                                                                                                                                                                                                                                                                                        Associates said she had told them the nomination to the F.D.I.C. was in the offing, the White House had signaled to some staff members on the Senate committee that approves such appointments that her nomination was being prepared, and F.B.I. background investigators were calling her friends and colleagues. This much is not known: What exactly changed in the last few days to scuttle the expected nomination, which now seems unlikely.

                                                                                                                                                                                                                                                                                        One senior aide on the Senate Banking Committee, who, citing the sensitivity of the matter, spoke on the condition of anonymity, pointed yesterday to the National Rifle Association. The mayor is singling out the group for criticism as he begins a new campaign for tougher national gun laws. "Our understanding is that the nomination was going to be sent to the Senate this week," the aide said. ... When it was not, the aide said, ... "The reason we were given is that the N.R.A. had a bee in its bonnet about Bloomberg's position on guns and wanted to try to send him a message," ...

                                                                                                                                                                                                                                                                                        But association officials denied it had anything to do with the matter. "We have checked internally, and no one from the National Rifle Association had any communication with either the White House or members of the committee on the nomination," said Andrew Arulanandam, a spokesman for the association...

                                                                                                                                                                                                                                                                                        The WSJs Washington Wire reports:

                                                                                                                                                                                                                                                                                        Administration scrambles for new FDIC chief after expected nomination fizzles for New York Banking Superintendent Diana Taylor, the companion of New York City Mayor Bloomberg. Speculation focuses on deputy Social Security commissioner James Lockhart.

                                                                                                                                                                                                                                                                                        And here's the latest from the NY Times:

                                                                                                                                                                                                                                                                                        Mayor's Companion Suggests 'Machinations' Cost Her a Job, by Diane Cardwell, NY Times: ...Diana L. Taylor, the New York State banking superintendent ... spoke publicly for the first time yesterday about her aborted nomination to head the Federal Deposit Insurance Corporation, saying she was mystified about why she was passed over. ... Ms. Taylor implied that political considerations may have killed her nomination. "You know as much as I do," she told board members about why she did not get the post, "whether you think it was the N.R.A. or the tobacco lobby or some cabal." ... Some suggested that the reason was pressure from the National Rifle Association, which denied any role, and the tobacco lobby, two interests with reason to be unhappy with Mr. Bloomberg. ... In an interview ..., she ...repeated that she had "no idea" what had gone on behind the scenes. "I know what I read in the papers," she said...

                                                                                                                                                                                                                                                                                          Posted by Mark Thoma on Friday, February 3, 2006 at 02:25 AM in Economics, Monetary Policy, Politics

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                                                                                                                                                                                                                                                                                          The Bigger the Oil Price Shock, the Harder We'll Fall

                                                                                                                                                                                                                                                                                          Martin Feldstein is worried that if oil prices go up again and depress economic activity, a falling saving rate won't to bail us out this time:

                                                                                                                                                                                                                                                                                          America will fall harder if oil prices rise, by Martin Feldstein, Commentary, Financial Times: The price of imported oil in the US doubled between summer 2003 and summer 2005, reducing consumers’ purchasing power by more than 1 per cent of gross domestic product. Nevertheless, the economic slowdown that was widely expected never occurred. Consumers kept spending and businesses kept investing. ... The continued strong growth contrasts sharply with the economic weakness that occurred after almost every previous significant rise in the oil price. How do we explain this remarkable difference? And what are the implications for the likely response to a future rise in oil prices?

                                                                                                                                                                                                                                                                                          The key to the economy’s strength in 2004 and 2005 was that household saving declined dramatically while the price of oil rose. ... This shift the annual rate of saving far outstripped the fall in income caused by the higher cost of oil. This fall in saving allowed households to raise consumption spending on non-oil goods and services while paying for the higher cost of imported oil. The primary cause of this dramatic shift was the fall in interest rates and the resulting rise in mortgage refinancing. Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumer durables, home improvements and the like. The lower monthly payments permitted a higher level of sustained spending on all non-durable categories. ...

                                                                                                                                                                                                                                                                                          The faster increase in consumer spending caused businesses to invest more and raised the rate of growth of GDP. Faster GDP growth caused an accelerated rise in employment and a fall in the rate of unemployment. Mortgage interest rates were falling because the Federal Reserve’s fear of deflation had caused it to lower the short-term federal funds rate ... to the extremely low level of 1.0 per cent in 2003 and to leave it there in the first half of 2004 before beginning a very gradual process of rate increases. ... The lower mortgage rates induced refinancing and the subsequent gradual rise in rates induced additional refinancing by homeowners who wanted to borrow before rates rose further.

                                                                                                                                                                                                                                                                                          The powerful effect of mortgage refinancing on consumer spending was a very happy coincidence for the American economy at a time when oil prices were depressing consumers’ real incomes. If oil prices were to rise again in 2006 or 2007, the adverse effect on consumers’ real incomes would not be offset by increased mortgage refinancing. Mortgage refinancing has now peaked and is declining. The Federal Reserve is raising interest rates again to counter the inflationary pressures that remain from the rise in energy costs. And individuals no longer have the large amounts of household equity against which to borrow.

                                                                                                                                                                                                                                                                                          A rise in the oil price could happen again at any time. There is little spare capacity in global oil production and oil demand is rising rapidly in China and other Asian countries. A shock that reduced the production or shipping of oil could drive its price sharply higher. Speculative forces could compound this problem. The US was lucky after 2003 to escape the contractionary effect of an oil price rise even without an explicit change in monetary or fiscal policy. It would not be so lucky if a big oil price increase happened again now.

                                                                                                                                                                                                                                                                                          I don't always agree with Feldstein, but I do here.

                                                                                                                                                                                                                                                                                            Posted by Mark Thoma on Friday, February 3, 2006 at 12:45 AM in Economics, Oil, Saving

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                                                                                                                                                                                                                                                                                            Paul Krugman: State of Delusion

                                                                                                                                                                                                                                                                                            Paul Krugman looks below the surface of the administration's policy announcements and finds little substance to back them up:

                                                                                                                                                                                                                                                                                            State of Delusion, by Paul Krugman, Commentary, NY Times: So President Bush's plan to reduce imports of Middle East oil turns out to be no more substantial than his plan — floated two years ago, then flushed down the memory hole — to send humans to Mars. But what did you expect? After five years in power, the Bush administration is still — perhaps more than ever — run by Mayberry Machiavellis, who don't take the business of governing seriously. ...

                                                                                                                                                                                                                                                                                            In the State of the Union address Mr. Bush suggested that "cutting-edge methods of producing ethanol" and other technologies would allow us "to replace more than 75 percent of our oil imports from the Middle East." But the next day, officials explained that he didn't really mean what he said. "This was purely an example," said Samuel Bodman, the energy secretary. And the administration has actually been scaling back the very research that Mr. Bush hyped Tuesday night...

                                                                                                                                                                                                                                                                                            Why announce impressive sounding goals when you have no plan to achieve them? The best guess is that the energy "plan" was hastily thrown together to give Mr. Bush something positive to say. For weeks administration sources told reporters that the State of the Union address would focus on health care. But at the last minute the White House might have realized that its health care proposals, based on the idea that Americans have too much insurance, would suffer the same political fate as its attempt to privatize Social Security. ("Congress," Mr. Bush said, "did not act last year on my proposal to save Social Security." Democrats responded with a standing ovation.)

                                                                                                                                                                                                                                                                                            So Mr. Bush's speechwriters were told to replace the health care proposals with fine words about energy independence, words not backed by any actual policy. What about the rest of the speech? The State of the Union is normally an occasion for boasting about an administration's achievements. But what's a speechwriter to do when there are no achievements?

                                                                                                                                                                                                                                                                                            One answer is to pretend that the bad stuff never happened. The Medicare drug benefit is Mr. Bush's largest domestic initiative to date. It's also a disaster ... So drugs went unmentioned in the State of the Union. Another answer is to rely on evasive language. In Iraq, said Mr. Bush, we've "changed our approach to reconstruction." In fact, reconstruction has failed. ... So now, having squandered billions ... America's would-be Marshall Plan in Iraq, reports The Los Angeles Times, "is drawing to a close this year with much of its promise unmet ..." I guess you can call that a change in approach.

                                                                                                                                                                                                                                                                                            There's a common theme underlying the botched reconstruction of Iraq, the botched response to Katrina (which Mr. Bush never mentioned), the botched drug program, and the nonexistent energy program. John DiIulio, the former White House head of faith-based policy, explained it more than three years ago. ... "There is no precedent in any modern White House for what is going on in this one: a complete lack of a policy apparatus. ... I heard many, many staff discussions but not three meaningful, substantive policy discussions. There were no actual policy white papers on domestic issues."

                                                                                                                                                                                                                                                                                            In other words, this administration is all politics and no policy. It knows how to attain power, but has no idea how to govern. That's why the administration was caught unaware when Katrina hit, and why it was totally unprepared for the predictable problems with its drug plan. It's why Mr. Bush announced an energy plan with no substance behind it. And it's why the state of the union — the thing itself, not the speech — is so grim.

                                                                                                                                                                                                                                                                                            Previous (1/29) column: Paul Krugman: A False Balance Next (2/5) column: Paul Krugman: The Effectiveness Thing

                                                                                                                                                                                                                                                                                              Posted by Mark Thoma on Friday, February 3, 2006 at 12:44 AM in Economics, Health Care, Iraq, Politics

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                                                                                                                                                                                                                                                                                              February 02, 2006

                                                                                                                                                                                                                                                                                              No, It's Not the Calvo One

                                                                                                                                                                                                                                                                                              Right now, I'm on a ferry crossing the Puget Sound. It's pretty cool.

                                                                                                                                                                                                                                                                                                Posted by Mark Thoma on Thursday, February 2, 2006 at 06:29 PM in Miscellaneous

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                                                                                                                                                                                                                                                                                                Greenspan's New Job

                                                                                                                                                                                                                                                                                                That didn't take long:

                                                                                                                                                                                                                                                                                                Sir Alan, Britain's Newest Economic Adviser, by Nell Henderson, Washington Post: Not bad for the first day on the job. As Alan Greenspan opened his new consulting firm yesterday, the British government's top economic official announced that he had retained the former U.S. Federal Reserve chairman as an unpaid adviser on economic issues. "I am delighted that Dr. Greenspan has agreed to be Honorary Adviser," Chancellor of the Exchequer Gordon Brown said in a written statement. "His advice on issues relating to global economic change will be much appreciated." ... The two men will confer "as issues of importance come up" said Charlotte Farrar, spokeswoman for the British treasury. ... Greenspan is so well regarded in Britain that Queen Elizabeth II awarded him an honorary knighthood in 2002 in recognition of "his outstanding contribution to global economic stability." ...

                                                                                                                                                                                                                                                                                                Greenspan's cachet "enables Brown to argue that whatever problems the British economy is having are related to the broader problems of the global economy and that the world's greatest central banker says Brown's is the best hand to have on the tiller," Forsyth said. That may benefit Brown -- if voters can understand what Greenspan is saying. ...

                                                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Thursday, February 2, 2006 at 08:46 AM in Economics, Monetary Policy

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                                                                                                                                                                                                                                                                                                  Wall Street might have to start drug testing traders:

                                                                                                                                                                                                                                                                                                  Brain Scans Show Link Between Lust for Sex and Money, Bloomberg: Late at night ... at Stanford University, Brian Knutson made a startling discovery: Our brains lust after money, just like they crave sex. ... The pleasure of orgasm, the high from cocaine, the rush of buying Google Inc. at $450 a share --- the same neural network governs all three... What's more, our primal pleasure circuits can, and often do, override our seat of reason, the brain's frontal cortex...

                                                                                                                                                                                                                                                                                                  Knutson ... knows how heretical his findings are. Wall Street is dedicated to the principle that when it comes to money, logic prevails... The idea is enshrined in the ... theory of rational expectations, for which Robert Lucas won the Nobel ... Prize in Economic Sciences in 1995. ... In practice, of course, investors do foolish things all the time. ... This controversial field, called neurofinance, may represent the next great frontier on Wall Street, says Daniel Kahneman, who won the 2002 Nobel Prize in economics for his pioneering work in behavioral finance, which fuses classical economic theory and studies of human psychology. "The brain scientists are the wave of the future in the financial world,'' Kahneman ...

                                                                                                                                                                                                                                                                                                  Neuroscientists may even develop psychoactive drugs, or neuroceuticals, that make people better, more-profitable traders, Knutson and other psychologists say. Look at Prozac. ... Prozac and other drugs have ... profoundly changed the way we view the mind. People recognize that chemistry drives their brains ... and that chemistry can change them. Similar drugs, ones that improve a trader's decision making by 20-30 percent, may be just a few years away ... If these neuroceuticals work, they could rock Wall Street...

                                                                                                                                                                                                                                                                                                  So far, the hopes and claims of neurofinance have far outpaced its science. Few investment professionals have even heard of the field. Many who have dismiss it as hokum. "It's the latest malarkey,'' says Richard Michaud, president of ... New Frontier Advisors LLC... Michaud ... says neurofinance and its forerunner, behavioral finance, have no place on Wall Street. ...

                                                                                                                                                                                                                                                                                                  Andrew Lo, a professor of finance and investment at the MIT Sloan School of Management, says ... "We can't answer any more questions by running another regression analysis. Now, we need to get inside the brain to understand why people make decisions.'' ...

                                                                                                                                                                                                                                                                                                  Not everyone says scientists should spend time and money plumbing the brains of traders and consumers. Neurofinance research ties up expensive medical equipment that should be used to heal people, says Gary Ruskin, ... "There's an opportunity cost of using these machines,'' Ruskin... says. ''I'd rather we use them to spot a tumor and save a life than earn an extra fraction of a percentage from stock trades.''...

                                                                                                                                                                                                                                                                                                  Is it true that this research crowds out medical care? I would have guessed that the imaging machines are only used when they would otherwise sit idle.

                                                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Thursday, February 2, 2006 at 12:41 AM in Economics, Health Care

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                                                                                                                                                                                                                                                                                                    Look Behind the Bush and You'll Find Lobbyists

                                                                                                                                                                                                                                                                                                    Here's a big surprise, lobbyists helped shape policy. Perhaps for the good, but still ...:

                                                                                                                                                                                                                                                                                                    Behind Bush's New Stress on Science, Lobbying by Republican Executives, by John Markoff, NY Times: President Bush's proposal to accelerate spending on basic scientific research came after technology industry executives made the case for such a move in a series of meetings with White House officials, executives involved said ... Computer scientists have expressed alarm that federal support for basic research is being eroded ...

                                                                                                                                                                                                                                                                                                    But in his speech, Mr. Bush pointed to work in supercomputing, nanotechnology and alternative energy sources — subjects that were favorites in the Clinton administration but had not been priorities for the current White House. What was different this year, according to a number of Capitol Hill lobbyists and Silicon Valley executives, was support on the issue by Republican corporate executives like Craig R. Barrett, the chairman of Intel, and John Chambers, the chief executive of Cisco Systems. Industry officials eager to see a greater government commitment to research held a series of discussions with administration officials ... in the Old Executive Office Building on Dec. 13. There, a group led by Mr. Barrett and Norman R. Augustine, a former Lockheed Martin chief executive, met with Vice President Dick Cheney...

                                                                                                                                                                                                                                                                                                    Peter A. Freeman, the National Science Foundation's assistant director for computer and information science and engineering, said the president's initiative would make a big difference. ... even those who had been publicly critical of the administration were enthusiastic. "This is really a huge deal and I'm very encouraged," said David A. Patterson, a computer scientist at the University of California, Berkeley ...

                                                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Thursday, February 2, 2006 at 12:35 AM in Economics, Politics, Science

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                                                                                                                                                                                                                                                                                                      The Growing Divide

                                                                                                                                                                                                                                                                                                      Some quotes:

                                                                                                                                                                                                                                                                                                      Sidney and Beatrice Webb (1923): "Nature still obstinately refuses to co-operate by making the rich people innately superior to the poor people."

                                                                                                                                                                                                                                                                                                      G. K. Chesterton (1874-1936): "The poor have sometimes objected to being governed badly. The rich have always objected to being governed at all."

                                                                                                                                                                                                                                                                                                      Walter Bagehot: "Poverty is an anomaly to rich people. It is very difficult to make out why people who want dinner do not ring the bell."

                                                                                                                                                                                                                                                                                                      John Ruskin (1819-1900): "The persons who remain poor are the entirely foolish, the entirely wise, the idle, the reckless, the humble, the thoughtful, the dull, the imaginative, the sensitive, the well-informed, the improvident, the irregularly and impulsively wicked, the clumsy knave, the open thief, and the entirely merciful, just, and godly person."

                                                                                                                                                                                                                                                                                                        Posted by Mark Thoma on Thursday, February 2, 2006 at 12:29 AM in Economics, Income Distribution

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                                                                                                                                                                                                                                                                                                        Do Futures Markets Have a Sporting Chance?

                                                                                                                                                                                                                                                                                                        Fledgling futures market for tickets to sporting events:

                                                                                                                                                                                                                                                                                                        Wait Till Next Year, but Lock In the Ticket Price Now, by Alan B. Krueger, Economic Scene, NY Times: Joe Kocott and Ian McKinley are both die-hard Pittsburgh Steelers fans. In the past week, Mr. McKinley urgently searched eBay, Craigslist, StubHub and other sources for a ticket to Super Bowl XL, eventually buying one for $2,500, while Mr. Kocott secured tickets for himself, his wife and seven children, and nine others in early January by paying an average of $350 for 18 futures contracts that promised him tickets if the Steelers made it to the championship game. ... Stephen K. Happel and Marianne M. Jennings of Arizona State University proposed a futures market for tickets to major events to reduce risk in 2002. Their idea is finally coming to fruition. ...

                                                                                                                                                                                                                                                                                                        If fans are risk-averse, then ticket futures add economic value. To see this, suppose that there is a 10 percent chance of a fan's team reaching the Super Bowl and that a futures contract costs $250 while a ticket could be purchased the week of the game for $2,500. At these terms, a risk-loving fan intent on going to the Super Bowl if his team plays would wait to buy a ticket for $2,500, and a risk-averse fan would buy a futures contract for $250.

                                                                                                                                                                                                                                                                                                        Indeed, a risk-averse fan would be willing to pay more than $250 for a futures contract in this situation. Like an insurance policy, ticket futures sell at a premium over their expected value because they help risk-averse buyers hedge against uncertainty.

                                                                                                                                                                                                                                                                                                        To gauge the size of the premium, note that a fan could guarantee a ticket to the Super Bowl by buying a futures contract for every team in a conference; one is bound to make it. Call this expenditure the sure-thing price of a ticket. If fans were risk-neutral, the sure-thing price would equal the price that tickets are expected to cost at game time — say $2,500 this year. The excess of the sure-thing price over $2,500 gives a rough indication of the market valuation of insuring against risk. The futures appear to have been priced reasonably. The premium for a sure-thing ticket from Yoonew ranged from about 35 percent to 60 percent during the season, not far from the markup in some lines of insurance. ...

                                                                                                                                                                                                                                                                                                        The emerging market for futures tickets remains thin, however, ... To survive, the futures market will require an influx of customers. ... Establishing a reputation for dependability is a prerequisite for a futures market in tickets to succeed. The sports leagues could help by distributing some tickets to fans through the futures market.

                                                                                                                                                                                                                                                                                                        Update: William Polley also comments.

                                                                                                                                                                                                                                                                                                          Posted by Mark Thoma on Thursday, February 2, 2006 at 12:15 AM in Economics

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                                                                                                                                                                                                                                                                                                          The Polarization of the U.S. Labor Market

                                                                                                                                                                                                                                                                                                          More evidence on growing wage inequality, a trend this paper finds is most severe in the upper half of the wage distribution. The results are consistent with an explanation based upon computerization:

                                                                                                                                                                                                                                                                                                          The Polarization of the U.S. Labor Market, by David H. Autor, Lawrence F. Katz, and Melissa S. Kearney, NBER WP 11986, January 2006: Abstract This paper analyzes a marked change in the evolution of the U.S. wage structure over the past fifteen years: divergent trends in upper-tail (90/50) and lower-tail (50/10) wage inequality. We document that wage inequality in the top half of the distribution has displayed an unchecked and rather smooth secular rise for the last 25 years... Wage inequality in the bottom half of the distribution also grew rapidly from 1979 to 1987, but it has ceased growing (and for some measures actually narrowed) since the late 1980s. ... We characterize these patterns as the “polarization” of the U.S. labor market, with employment polarizing into high-wage and low-wage jobs at the expense of middle-wage work. We show how a model of computerization in which computers most strongly complement the non-routine (abstract) cognitive tasks of high-wage jobs, directly substitute for the routine tasks found in many traditional middle-wage jobs, and may have little direct impact on non-routine manual tasks in relatively low-wage jobs can help explain the observed polarization of the U.S. labor market. [AEA Web version]

                                                                                                                                                                                                                                                                                                            Posted by Mark Thoma on Thursday, February 2, 2006 at 12:06 AM in Economics, Income Distribution, Technology

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                                                                                                                                                                                                                                                                                                            February 01, 2006

                                                                                                                                                                                                                                                                                                            Markets Can Fail? Really?

                                                                                                                                                                                                                                                                                                            Senators are discovering that free markets are not necessarily competitive markets and talk of anti-trust legislation is being heard from both sides of the aisle:

                                                                                                                                                                                                                                                                                                            US Senators in attack on oil industry mergers, by Stephanie Kirchgaessner, Financial Times: Washington lawmakers’ growing ire with the high price consumers are paying to heat their homes and fill their cars prompted new questions ... about the effects of consolidation in the oil industry, and whether it was time to re-think the nation’s anti-trust rules. Arlen Specter, the Republican chairman of the Senate judiciary committee, said the number of mergers in the oil industry had been “excessive”, and that record profits at giants like Exxon Mobil meant “it just may be time to legislate in this field”.

                                                                                                                                                                                                                                                                                                            Senator Herb Kohl, a Democrat from Wisconsin, went further by calling for a break-up of the world’s largest oil companies, citing an independent congressional report that found that the more than 2,600 mergers and acquisitions in the industry since the 1990s had contributed to higher oil and gas prices. “We need to ask the serious question as to whether our anti-trust laws are sufficient,” he said. Chuck Schumer, the New York Democrat, agreed ...

                                                                                                                                                                                                                                                                                                            The senators are worried about excessive profits, and they should be if they arise from market power. But in general high profits are not necessarily a bad thing. In a competitive market with free entry and exit, high profits are not a worry - high profits are the signal for more resources to flow into the industry. That's how the invisible hand works, but it's essential that the assumptions behind competitive markets are approximately satisfied for this mechanism to work properly.

                                                                                                                                                                                                                                                                                                            In any case, I can't see much anti-trust action happening under this administration's watch.

                                                                                                                                                                                                                                                                                                              Posted by Mark Thoma on Wednesday, February 1, 2006 at 03:40 PM in Economics, Market Failure, Oil

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                                                                                                                                                                                                                                                                                                              Ben's Comparative Advantage

                                                                                                                                                                                                                                                                                                              Will Bernanke speak out on trade issues like Greenspan did? If so, will he do a better job of selling its virtues and of promoting policies to reduce the transitional costs to displaced workers?

                                                                                                                                                                                                                                                                                                              How Bernanke Could Outshine Greenspan, by David Leonhardt, NY Times: ...Almost no one has talked about the things Mr. Bernanke may do better than Mr. Greenspan. But there are some, believe it or not, and he has already shown some real promise in one particular area. ... Mr. Greenspan made a ... case, again and again, ... for opening American borders. ... But as Mr. Greenspan exits, [trade] benefits are not the main thing on people's minds. The costs of the changes are. ... If Mr. Greenspan had one blind spot, it was that he never really figured out how to talk about those costs. Instead, like most economists, he called for a better-educated work force and repeated the idea that the long-term gains from trade easily outweigh the short-term costs...

                                                                                                                                                                                                                                                                                                              Many of us are torn. By a wide margin, Americans still say trade is good for the economy, but a solid and growing majority also wants restrictions to protect domestic industries. This is where Mr. Bernanke comes in. What the country is missing right now is a public figure who can bridge this gap, somebody who can point out that no nation has lifted living standards by shutting its borders but who can also talk eloquently about the downsides of open trade. And who might even help come up with some solutions.

                                                                                                                                                                                                                                                                                                              Almost two years ago, as a member of the Fed's board, Mr. Bernanke ... gave a speech that began with the standard argument for trade, complete with a mention of Ricardo. He finished, though, with words that are hard to imagine coming from Mr. Greenspan. Laid-off workers need help, Mr. Bernanke said. "Reducing the burdens borne by displaced workers is the right and fair thing to do," Mr. Bernanke said. "If workers are less fearful of change, less pressure will be exerted on politicians to erect trade barriers or to take other actions that would reduce the flexibility and dynamism of the U.S. economy."

                                                                                                                                                                                                                                                                                                              He did not take a position on specific ideas, but he mentioned a few possibilities. Laws could be changed so that pensions and health care did not disappear when a job did. Wage insurance could make up some of the difference between a lost job and a new one. The insurance benefits would be low enough that people still had incentive to find new work, but high enough to soften the blow.

                                                                                                                                                                                                                                                                                                              In the weeks leading to today's handover, some experts ... have urged Mr. Bernanke to have smaller ambitions than Mr. Greenspan did. Don't talk about big ideas, they say; stay focused on interest rates. So I put the question to Mr. Mankiw, the last high-profile economist to get himself in trouble by talking about trade. I began the conversation by pointing out the obvious, that selling people on trade is hard. Mr. Mankiw laughed.

                                                                                                                                                                                                                                                                                                              "I learned that the hard way," he said. So should Mr. Bernanke stick to platitudes? Absolutely not, Mr. Mankiw said. "Having a smart economist like Greenspan or Bernanke in a position where people will listen to him is too valuable," he said. "Bernanke comes from a background of being a teacher and a textbook writer. He may prove to be very good at boiling things down to their essence. He may prove to be a fantastic communicator." So speak up, Mr. Chairman.

                                                                                                                                                                                                                                                                                                              It's not an easy product to sell. A risk management approach would say, I think, to stay quiet on these issues and avoid learning "the hard way," at least until he is well established as Fed chair and the risks are small. The potential for uproar is great if the wrong words are uttered or the right words are misinterpreted, and the upside in terms of leading new legislation on trade issues, etc., isn't that large.

                                                                                                                                                                                                                                                                                                                Posted by Mark Thoma on Wednesday, February 1, 2006 at 01:08 AM in Economics, International Trade, Monetary Policy

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                                                                                                                                                                                                                                                                                                                What to Do with All Those Petrodollars?

                                                                                                                                                                                                                                                                                                                Oil producing nations are looking for ways to diversify their economies to insulate against the inevitable swings in oil prices and the troublesome changes in government revenues that price swings bring about. They are also learning to manage the revenue cycles and, instead of spending lavishly when revenues exceed trend, the money is finding its way into T-bills, equity markets, and other financial instruments to await less prosperous times in the future. If these nations decide the higher oil prices are permanent rather than temporary, and that seems possible, they may be willing to invest more of the money domestically rather than saving for future rainy days. If so, then some of the funds flowing into financial markets will dry up:

                                                                                                                                                                                                                                                                                                                New Money, New Ideas, by Jad Mouawad and Eduardo Porter, NY Times: ...Once again, oil producers ... are experiencing a boom. And just as they did in the 1970's and early 1980's, their coffers are spilling over with cash. Last time around, there was an abundance of outrageous projects, and judging from the extravagance on display in Dubai, lavish projects are finding financing once again. But this time around, the region's main oil producers, like Saudi Arabia, Kuwait, Qatar and the United Arab Emirates, have gotten wiser. Since the boom started three years ago, they have paid down their debt, saved more money than ever before and created more jobs in the private sector. And they are trying to diversify their economies away from oil and its increasingly volatile cycles.

                                                                                                                                                                                                                                                                                                                "People are asking where are all the petrodollars and why we have not seen anything like the spending of the 70's and 80's," said Bader al-Saad, who runs the Kuwait Investment Authority. "What has changed is the economic and political reforms in the region..." he said. "If we hadn't learned from our previous mistake, this would have been a big stupidity." After the 1973 oil shock, governments in the Middle East spent 80 percent of their increase in revenue. Between 2003 and 2005, by contrast, they spent less than 40 percent of their new revenue... Governments have also whittled down their debt to an average 20 percent of gross domestic product last year, from about 40 percent in 2004.

                                                                                                                                                                                                                                                                                                                Mohsin S. Khan, the director for the Middle East and Central Asia at the International Monetary Fund, said governments were still drawing up their budgets based on oil at $30 a barrel. ... Rachel Bronson, a specialist on Saudi Arabia at the Council on Foreign Relations... [says] "Unlike in the United States, where it feels like high prices are going to last forever, in the Middle East, the feeling is that it will not last..." Saudi Arabia, for example, tried to use its oil windfall of the 1970's and early 1980's to become an agricultural powerhouse. ... But then oil prices collapsed, and the Saudi government ran out of money. The costly effort to make the desert bloom then joined a list of financial follies...

                                                                                                                                                                                                                                                                                                                So it is not surprising that the region's finance ministries are still not convinced that oil prices will remain high for very long, even as they shape their oil policies to keep prices from falling. ... Much of the Arab world's new wealth that is invested abroad ... ends up in the United States, in Treasury bonds as well as corporate and other government debt instruments. Thus, the Arab world is helping to finance America's enormous trade deficit. ...

                                                                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Wednesday, February 1, 2006 at 12:57 AM in Economics, Oil

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                                                                                                                                                                                                                                                                                                                  Did Budget Deficits Cause Most Recent Employment Growth?

                                                                                                                                                                                                                                                                                                                  The Economic Policy Institute looks at how much of recent job growth is attributable to the traditional Keynesian deficit spending channel, and how much is from supply-side effects induced by tax cuts. The study concludes that "federal spending—not tax cuts—are responsible for the jobs created in the past five years."

                                                                                                                                                                                                                                                                                                                  Economic Snapshots, EPI, Sluggish private job growth indicates failure of tax cuts: Changes in tax law since 2001 reduced federal government revenue by $870 billion through September 2005. Supporters of these tax cuts have touted them as great contributors to growth in jobs and pay. But, in reality, ... a closer look at the new jobs created shows that federal spending—not tax cuts—are responsible for the jobs created in the past five years. If tax cuts have created jobs at all since 2001, it will have happened in the private sector. Assuming that job growth in 2006 matches the Bush Administration's projections, the economy will have added about 2.0 million jobs to the private sector from FY2001 through FY2006. But how many of these two million jobs actually can be attributed to tax cuts and how many to increased government spending—particularly increased defense spending—in this period?


                                                                                                                                                                                                                                                                                                                  Based on Defense Department estimates of the number of private-sector jobs created by its own spending, we project that additional defense spending will account for a 1.495 million gain in private sector jobs between FY2001 and FY2006. Furthermore, increases in non-defense discretionary spending since 2001 will have added yet another 1.325 million jobs in the private sector, for a total of 2.82 million jobs created by increased government spending. Increased mandatory government spending ... would account for even more job creation. The mere fact that the projected job growth resulting from increased defense and other government spending exceeds the actual number of jobs projected to be added to the economy through 2006 clearly indicates that the tax cuts hardly seem plausible as the engine of the modest job growth in the economy since 2001. MaxSpeak has more. [Note: Not the original figure].

                                                                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Wednesday, February 1, 2006 at 12:06 AM in Economics, Unemployment

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                                                                                                                                                                                                                                                                                                                    Blinder Says Bernanke Will Implement Explicit Inflation Targeting Relatively Quickly

                                                                                                                                                                                                                                                                                                                    Alan Blinder predicts that as soon as the Fed staff is worn down out from studying it to death, an explicit inflation target will be implemented:

                                                                                                                                                                                                                                                                                                                    Targeting Inflation, Washington Wire: Ex-Fed Vice Chairman Alan Blinder, holding forth on inflation targeting, a subject dear to the heart of Ben Bernanke, said ... reform ... will entail the Fed no longer playing games and coming out and saying "either "this is our target number, although we don't expect to hit it to the decimal, or this is our target range." He said he sees Bernanke moving on this front relatively quickly, though not precipitously. But Blinder also cautioned that "the Fed staff will insist on studying this to death." Indeed, he predicted the staff "will produce a telephone-book-size study." "When that is done and a consensus is reached--and he's a good consensus-builder on the FOMC -- they will enunciate an inflation target very clearly," added Blinder. "They will not play games anymore; there will be a very clear enunciation."

                                                                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Wednesday, February 1, 2006 at 12:03 AM in Economics, Monetary Policy

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