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March 25, 2007

FRBSF: The Economic Outlook

Interesting graph from the San Francisco Fed on the relationship between unemployment and wage inflation:

Frbsf313079a

The accompanying write-up says:

Conventional wisdom holds that when the unemployment rate falls below the NAIRU, wage inflation increases, which eventually feeds through to price inflation. A key question for policymakers is whether this conventional wisdom remains relevant today.

There are a number of potentially mitigating factors that might temper the relevance of this historical relationship. Three factors that have received particular study of late are: (1) mismeasurement of available workers, (2) mismeasurement of the NAIRU, and (3) changes in the sensitivity of wage inflation to the unemployment rate owing to the rising importance and stability of inflation expectations.

Although the measured unemployment rate is quite low, some would argue that it does not fully capture the population available for work. Relative to the late 1990s, the labor force participation rate (LFP) and the employment-to-population ratio remain low, suggesting that there is some room for the total workforce to expand. On the other hand, the aging of the baby boom makes the return to past peaks in LFP or the employment-to-population ratio less than certain.

The NAIRU is difficult to measure and is affected by a number of demographic and institutional factors. There is a wide range of credible estimates of the current NAIRU—4.7 to 5.2—suggesting that labor markets may not be quite as tight as the consensus estimate would imply.

The sensitivity of wage inflation to the unemployment rate depends in part on the inflation expectations of workers. Despite elevated levels of price inflation of late, inflation expectations remain well-contained, likely tempering the magnitude of cost-of-living based wage increases demanded by workers.

The graph is part of the latest Economic Outlook from Mary C. Daly, vice president FRBSF. The entire report is on the continuation page:

Economic Outlook, by Mary C. Daly, Fed Views, FRBSF: Mary C. Daly, vice president at the Federal Reserve Bank of San Francisco, states her views on the current economy and the outlook:

Frbsf313071

As expected, real GDP growth for the fourth quarter of 2006 was revised down substantially from the advance release. GDP grew 2.2 percent in the fourth quarter of last year, well off the 3.5 percent pace reported in the advance estimate. GDP growth was restrained by declines in motor vehicle production and residential construction.

Turning to data for January, the news has been mixed but generally consistent with weaker momentum in the short term.

Frbsf313072

On the negative side, orders for durable goods posted large and broad-based declines in January. Manufacturing and industrial production also weakened and manufacturing capacity utilization fell. That said, the ISM survey of manufacturers rose above 50 in February, indicating expansion in the sector going forward.

On the positive side, consumer spending outside of autos and homes remains quite strong; real personal consumption expenditures rose a healthy 0.3 percent in January. Real disposable income growth also increased, suggesting that the consumer sector remains very healthy.

Recent readings on the housing market data have been mixed but, on balance, provide some tentative signs of a prospective stabilization. Sales of existing homes were up sharply in January. On the other hand, sales of new homes were weak. Housing starts were down and the value of overall construction put in place declined in January relative to December, but data on housing permits appear to have leveled off in recent months.

Frbsf313073

Turning to labor markets, job growth has edged down in recent months.

Frbsf313074

Still, labor markets remain relatively tight—unemployment in January was 4.6 percent and data on job openings point to future strength in hiring.

Frbsf313075

Turbulence in global and U.S. financial markets left equity markets down from recent highs. However, the declines have been modest relative to increases over the past 15 months, and values in equity markets remain high.

Incoming data suggest continued moderate growth in real GDP during the first half of this year. As the damping effects of weaker housing and domestic auto production wane, growth is projected to accelerate, reaching around 2-3/4 percent in the second half of this year.

Frbsf313076

In 2007, with real GDP expected to grow a little less than potential and with the unwinding of a variety of temporary factors that boosted inflationary pressures last year, the level of core inflation is expected to edge down during the course of the year. However, the low level of the unemployment rate remains an upside risk to this inflation projection.

Frbsf313078

Weakness in incoming data and turbulence in global and domestic financial markets have pushed down the expected path of the federal funds rate. About 50 percent of market participants expect a rate cut at the June FOMC meeting.

Frbsf313077

As noted, the low level of the unemployment rate is a noted upside risk to inflation. This concern arises from the historical relationship between the measured unemployment rate, the non-accelerating inflation rate of unemployment (NAIRU), and wage inflation.

Frbsf313079

Conventional wisdom holds that when the unemployment rate falls below the NAIRU, wage inflation increases, which eventually feeds through to price inflation. A key question for policymakers is whether this conventional wisdom remains relevant today.

There are a number of potentially mitigating factors that might temper the relevance of this historical relationship. Three factors that have received particular study of late are: (1) mismeasurement of available workers, (2) mismeasurement of the NAIRU, and (3) changes in the sensitivity of wage inflation to the unemployment rate owing to the rising importance and stability of inflation expectations.

Frbsf3130710

Although the measured unemployment rate is quite low, some would argue that it does not fully capture the population available for work. Relative to the late 1990s, the labor force participation rate (LFP) and the employment-to-population ratio remain low, suggesting that there is some room for the total workforce to expand. On the other hand, the aging of the baby boom makes the return to past peaks in LFP or the employment-to-population ratio less than certain.

The NAIRU is difficult to measure and is affected by a number of demographic and institutional factors. There is a wide range of credible estimates of the current NAIRU—4.7 to 5.2—suggesting that labor markets may not be quite as tight as the consensus estimate would imply.

The sensitivity of wage inflation to the unemployment rate depends in part on the inflation expectations of workers. Despite elevated levels of price inflation of late, inflation expectations remain well-contained, likely tempering the magnitude of cost-of-living based wage increases demanded by workers.

Students and Faculty Given Free Access to TimesSelect

Thought I'd pass this along:

'NYT' Opening TimesSelect to Students and Teachers for Free, by Jennifer Saba, Editor and Publisher: The New York Times is opening up access permanently to TimesSelect to all students and faculty who have .edu e-mail addresses beginning on March 13.

“It's part of our journalistic mission to get people talking on campuses,” says Vivian Schiller, senior vice president and general manager at NYTimes.com. “We wanted to open that up so that college students and professors can have a dialogue.” ...

Those students who are current subscribers will receive pro-rated funds for their paid subscriptions. Schiller explains that students and faculty will have to register for the service but that it’s self-regulatory. ... [via Freakonomics]

March 23, 2007

Brad DeLong on Milton Friedman

Here's the ending of Brad DeLong's review of a book on Milton Friedman appearing in Democracy Journal. This part discusses contradictions within Friedman's view of the proper role of government:

Right from the Start? What Milton Friedman can teach progressives, by J. Bradford Delong, Review of Milton Friedman: A Biography By Lanny Ebenstein, Democracy Journal [alternate link]: ...Friedman hated government–except when he didn’t. To be sure, the generation of libertarians to follow Friedman wanted to eliminate government completely. ... Friedman never went there. He had no problem with governments that declared and enforced property rights, that adjudicated contracts, that even, in certain specified situations, imposed extra taxes to counterbalance externalities or provided social insurance where transactions costs seemed to keep the requisite markets from existing. London Mayor Ken Livingstone’s congestion tax on cars in central London is Friedman’s idea. Friedman’s negative income tax is one of the parents of ... the Earned Income Tax Credit. Perhaps, you could get Friedman to say, in a first-best world you wouldn’t need a negative income tax, because people would sign up when relatively young for their own wage-insurance pools. But he would call that a sterile argument, given where we are now. Moreover, a negative income tax would be administratively cheap and effective, and it would remove the intrusive and offensive nanny-state overregulation of the lives of the poor that the existing welfare system imposes. Few liberals today would disagree.

Most importantly, in Friedman’s mind, the government has a very powerful and necessary role to play in keeping the monetary and banking system working smoothly through proper control of the money supply. If there was always sufficient liquidity in the economy–enough, but not too much–then you could trust the market system to do its job. If not, you got the Great Depression, or hyperinflation. Thus, it was Friedman’s belief that the government was required to undertake relatively narrow but crucially important strategic interventions in order to stabilize the macroeconomy–to keep production, employment, and prices on an even keel.

In this, Friedman was in the same chapter, if not on the same page, as John Maynard Keynes... The Great Depression had convinced Keynes that central bankers alone could not rescue and stabilize the market economy. To Keynes, stronger and more drastic strategic interventions were needed to boost or curb demand directly. Friedman and his coauthor Anna J. Schwartz argued in their Monetary History of the United States that this was a misreading of the lessons of the Great Depression, which in Friedman’s view was caused by monetary mismanagement (or perhaps could have been rapidly alleviated by skillful monetary management). Over the course of 40 years, his position carried the day: Federal Reserve Chair Ben Bernanke holds Friedman’s view, not Keynes’s.

Nevertheless, Friedman was not an advocate of a fully automatic system, such as a gold standard. Under a gold standard it is possible for the money supply to collapse. If people start to fear that the banks ... are shaky, they will go to the banks and–under a gold standard–demand that the banks give them their money back ... in gold. But with each dollar in gold that depositors withdraw, any banking system has to call in perhaps five or more dollars’ worth of loans... Fear on the part of depositors leads to a drying-up of capital and liquidity for businesses, and ultimately to economic depression.

It is here that Friedman and Schwartz felt the Fed had made its key mistake during the Great Depression. The stock market crash of late 1929, the recession that had already begun that June, the existing agricultural depression, and other news that shook confidence in the banking system led depositors to withdraw money from their bank accounts. The calling-in on loans that followed led to a steep fall in the money supply, in the liquidity of the economy. And the Federal Reserve stood by. It did not–as Friedman thought it should have–take every active step it could to keep the economy liquid. It did not furiously print currency. It did not frantically buy Treasury bonds for cash from all comers. Instead, it followed what it thought was a "neutral" monetary policy. And it was this neutrality that, in Friedman’s view–and in Bernanke’s, as well as my own–made the Great Depression so great. This is not exactly the same view as Keynes, but the differences are smaller than most people realize.

To be sure, Friedman always said that he favored a minimalist government, ... but a government nonetheless. Establish property rights. Enforce contracts. Prevent violence and theft. Defend the country. Keep the economy liquid by keeping the monetary aggregate M2 on a stable growth path. That, to him, was a minimalist government. But the last of these sticks out like a sore thumb: What is so special about the banking industry that the government must respond to a fall in demand for its services (for that is what going to the bank to pull out your deposit in gold constitutes) by providing it with a huge, immediate subsidy (for that is what buying up banks’ Treasury bonds for cash at their normal valuation constitutes)? And, if Friedman’s detailed study of the banking sector led him to make an exception from laissez-faire for this industry, who is he to say that a similarly detailed study of other industries would lead to similar conclusions about useful deviations from laissez-faire? And we have not mentioned that the ... state is itself a very powerful enterprise, able to make and enforce its own judgments about who owns what against not just against roving bandits, but local notables and even its own functionaries. Friedman’s minimal state is not so minimal, after all.

Friedman felt that his ideal state was the right one, but someone who reaches a different formulation can still agree with him on many of the same first principles. Indeed, it is by following through on these tensions in Friedman’s thought that I, at least, am able to feel the power of his arguments and yet retain my own uneasy combination of neoliberalism and social democracy.

This is not to say that Friedman’s legacy is all positive. Indeed, One of his closest ideological fellow travelers, Judge Richard Posner of the Seventh Circuit, worried about Friedman’s "dogmatic streak," which took his "belief in the superior efficiency of free markets to government as a means of resource allocation" as "an article of faith, and not … a hypothesis." Posner claims that Friedman found the ability of Scandinavian nations, particularly Sweden, to achieve and maintain very high levels of economic output despite very high rates of taxation almost to be a personal affront. And, in the long run, this faith crippled the intellectual movement of which he was the head. Sometimes government failures are greater than the market failures for which they purport to compensate. Sometimes they are not. We badly need a sophisticated, flexible, and reality-based intellectual toolkit to analyze different cases. We do not have one, in part because Friedman’s anti-government faith blocked his spear-carriers from helping to develop it.

But, perhaps more seriously, Friedman ducked the big questions regarding the relationship between economic freedom and political liberty, and he was completely incapable of seeing that political liberty is both a negative and a positive liberty: freedom from tyranny and oppression but also the freedom and power to decide on and accomplish our common purposes. These are the master questions of history and moral philosophy, and for all his brilliance and hard work, Friedman is of absolutely no help in answering them. As Posner says, Friedrich Hayek’s Road to Serfdom "flunks the test of accuracy of prediction … [The] view that socialism of the sort that Britain embraced under the old Labour Party was incompatible with democracy [is] extreme and inaccurate." Yet Friedman bought into that Hayekian view. And in so doing, he ultimately led his followers, and tried to lead the rest of us, down a false path.

The Changing Dynamics of Inflation

Federal Reserve governor Randall Krozner discusses the recent evidence on the changing dynamics between inflation and other macroeconomic aggregates, and how it might impact the conduct of monetary policy:

The Changing Dynamics of Inflation, by Randall S. Kroszner, FRB: ...My subject this afternoon will be inflation dynamics. Since the mid-1980s, we have seen important improvements in these dynamics--inflation is now much lower and more stable than it once was, and it appears to be less closely correlated with movements in other economic factors than it was during the 1960s and 1970s (see table). Moreover, we have seen these improvements not only in the United States but in other countries as well. Questions of intense interest to many of you as well as to us at the Federal Reserve are, What caused these changes in the inflation process? and What are their implications for monetary policy?

The Changing Dynamics of Inflation: Prominent Features Before and After the Mid-1980s

Feature 1960s to mid-1980s Mid-1980s to present
     
Inflation High and variable Low and stable
Inflation expectations High and variable Low and stable
Inflation persistence Inflation shocks long-lived Inflation shocks transitory
     
Sensitivity of core inflation
to selected factors
   
Unemployment rate Substantial Modest
Exchange rate movements Modest Diminished
Energy price movements Substantial Small

Having spent many years as a University of Chicago professor, my first reaction to these changes is to think “money.” As Milton Friedman famously said many years ago, “Inflation is always and everywhere a monetary phenomenon.” Unfortunately, given the lack of a stable relationship between money growth and inflation, the pure monetarist view has taken a beating since then. However, Friedman was right that inflation is, ultimately, something that central banks determine, at least on average, over time.

My second reaction is to think about another factor that Friedman emphasized--expectations. ...[I]n any model in which expectations are important, monetary policy will also be important. So monetary policy, if not money itself, remains a central determinant of inflation dynamics. Accordingly, one of my principal themes today will be that expectations are important in the inflation process and that the improved conduct of monetary policy, by influencing the formation of expectations in a favorable manner, may account for many of the changes in inflation dynamics that we observe. At the same time, I am wary of ascribing all of the changes in dynamics to monetary policy. We should not place too much faith in any one framework, and so we need to keep an open mind about other possible explanations for the recent changes in inflation dynamics....

The Expectational Approach to Thinking about Inflation Now almost forty years old, the expectational approach to inflation dynamics--developed simultaneously by Friedman and recent Nobel prize winner Edmund Phelps--is still the dominant framework for thinking about inflation. ...

In Friedman’s framework as expressed in his 1967 presidential address to the American Economics Association, inflation is related to inflation expectations as well as the level of resource utilization. Friedman explained that for a variety of real-world reasons, wages and prices might not always adjust immediately to changes in the money supply. If they did not so adjust, monetary policy could affect resource utilization. The reason that Friedman’s work, and that of Phelps, was so revolutionary was that it overturned the earlier belief that monetary policy could have a permanent influence on resource utilization in favor of a new view that monetary policy could affect real activity only temporarily. ...

Over the past thirty years, economists have taken these observations to heart in trying to explain the behavior of overall inflation. One standard approach starts with the notion that many wages and prices adjust only gradually to changes in costs and demand. ...

When wages and prices adjust only infrequently, expectations are important, because firms and households must take into account the demand and supply conditions that will prevail until they again reset their prices. All sorts of expectations will matter, but central among them are inflation expectations: If wages and prices in general are rising over time, then when firms have a chance to reset their prices, they will generally set them higher than they would if the overall price level was holding steady. ...

Moreover, some evidence indicates that empirical models based on this research do fairly well at forecasting. Of course, time will tell about their usefulness in the day-to-day operations of monetary policy. ...

Changes in Inflation Dynamics As I noted earlier, the inflation process seems to have changed in a number of ways in recent years, both in the United States and in other countries. I would like to review these changes and then consider what they may tell us about the underlying processes driving inflation.

One notable change is that movements in inflation now appear to tell us much less about future inflation than was the case, say, thirty years ago. Here I am talking about predictions of inflation using only information on past inflation, without taking into account any other information. The evidence suggests that, at the peak of U.S. inflation in the late 1970s and early 1980s, the best such “univariate” forecast of inflation--into the indefinite future--was a simple average of inflation over the past few quarters (Stock and Watson, 2007; Cecchetti and others, 2007). In that period, sharp increases in inflation were reversed only slowly.

By contrast, shocks to inflation since roughly the mid-1980s have tended to be short-lived, so that the best forecast of future inflation would be a very long average of past inflation. Thus, when inflation moves above its recent long-run average, most of the upswing will likely be quickly reversed, although this result is not guaranteed. That’s a remarkable change in the behavior of inflation. The international evidence indicates that the longevity of inflation shocks has been attenuated in many other countries as well (Cecchetti and others, 2007). Moreover, the timing of the switch from largely permanent to mostly transitory movements in inflation is remarkably similar across the United States and these other countries.

Another apparent change in the inflation process has been a reduction in the correlation between inflation and unemployment (Atkeson and Ohanian, 2001; Roberts 2006). Now, this relationship was always loose... Still, in the 1960s and 1970s, a reasonably strong empirical relationship between inflation and unemployment could be found for the United States, with inflation tending to rise in periods when unemployment was low and vice-versa. Starting in the 1980s, however, this correlation began to weaken noticeably. ... Again, similar shifts have been observed in other countries... (Borio and Filardo, 2006; Ihrig and others, forthcoming).

Next on the list of changes is the influence of energy prices. During the 1970s, fluctuations in energy prices appear to have had a significant influence on core inflation... But since the early 1980s, the inflationary effect of movements in prices for gasoline, natural gas, and other energy goods seems to have declined considerably, even after allowance is made for a secular decline in the energy intensity of the U.S. economy (Hooker, 1996). ...

Finally, one of the most striking changes in the U.S. economy in recent decades has been the reduction in the economy’s volatility. The standard deviation of quarterly growth of real ... gross domestic product for the United States since the mid-1980s has been about half that experienced during the 1960s and 1970s. The volatility of inflation has fallen to a similar degree; moreover, the reduction in volatility for both output and inflation is widespread across countries. ...

Expectations, Monetary Policy, and Changing Inflation Dynamics ...[C]an changes in the conduct of monetary policy in the United States (and elsewhere) help to account for the changes we’ve seen in inflation dynamics?

The strongest case for a link between monetary policy and changes in inflation dynamics is in the greater stability of inflation. Inflation is clearly under the long-run control of the Fed, and the relative stability of inflation clearly reflects the action of monetary policy. Thus, if the central bank wants to keep inflation low on average over time, it can surely do so. The case for monetary policy contributing to reduced volatility of inflation is also fairly straightforward: The central bank can stabilize inflation by raising and lowering interest rates to lean against inflationary disturbances.

Once we take account of the role of expectations, the stabilizing effects of monetary policy become even greater: If economic decision makers come to realize that the Fed is doing more to stabilize inflation, then shocks that push up inflation will lead to smaller increases in inflation expectations than in the past. Because current inflation is affected by inflation expectations, the smaller increase in expected inflation will lead to a smaller increase in actual inflation as well. And because many shocks that may lead to inflation, such as unexpected surges in spending, also cause movements in output and employment in the same direction, the maintenance of price stability promotes the stability of the real economy.

This experience of low and stable inflation, coupled with the Fed’s clear statements of commitment to maintaining this performance, has no doubt contributed to the stability of long-run inflation expectations in the past decade or so. ... [O]verall, the movements in the expectational indicators have been quite small.

Better monetary policy may also help explain the apparent decline in the sensitivity of inflation to resource utilization. We might interpret the reduced statistical correlation between unemployment and inflation as evidence of a decline in the direct effect of resource utilization on inflation. But given that the conduct of monetary policy was changing at the same time, it may be premature to draw such a conclusion. Consider the following thought experiment. Suppose that the Federal Reserve managed to stabilize inflation perfectly. That outcome would eliminate any empirical correlation between inflation and unemployment even if there really was an underlying relationship...[5] As this example illustrates, the correlation between unemployment and inflation may have no bearing on whether these variables are truly linked structurally. ...

From this perspective, the declining correlation of resource utilization with inflation may be an indication of the success of monetary policy in pursuing its dual mandate of price stability and maximum sustainable growth: Because the Fed is trying to stabilize both inflation and real activity, then, when faced by shocks that push these variables in the same direction, the Fed will want to try to offset both adverse developments to the extent that it can. Thus, I see the reduced correlation between inflation and unemployment as an indication of the success of monetary policy in this dimension.

Further evidence that better monetary policy and accompanying expectational effects have promoted a more stable economy is provided by the rather muted inflationary effects of the recent sharp increases in crude oil prices. In the 1970s, inflation moved up sharply with increases in crude oil prices. Moreover, ... inflation expectations moved up as well. In response to the resulting high inflation, the Fed was obliged to raise interest rates, and the economy weakened. The contrast with recent performance is quite stark....[The] pass-through was a mere ripple compared with the behavior of the 1970s. Similarly, when gasoline prices surge, surveys of household inflation expectations still move up, but not for long. ...

What can the international experience tell us about the likely sources of the changes in inflation dynamics? First, we need to acknowledge that many of the changes we have seen in U.S. inflation dynamics have also occurred in other countries. That fact suggests that at least some of the explanations of the change in inflation dynamics should be common across countries rather than country-specific. If monetary policy is central to these changes, it must be the case that many countries have made similar changes to monetary policy.

As I noted in a speech last fall, one possible reason for such common changes in monetary policy may have been greater currency competition (Kroszner, 2006). In broad terms, the idea is that increased globalization, deregulation, and innovation raised the returns to low inflation--and increased the penalties for high inflation--relative to results obtained twenty or thirty years ago. For example, deregulation has led to an opening of capital markets, and hence financial globalization, which has in turn boosted innovation and helped to increase global competition by shrinking barriers of time and distance. Accordingly, trade and financial linkages between countries have tightened tremendously in recent years. ...

As a result, deregulation, globalization, and innovation have made it easier for citizens to move their wealth out of nominal assets in their local currency and thereby avoid any inflation tax should their government show signs that it might resort to inflationary tactics to finance spending.[6] At the same time, .... Almost everywhere, public opinion eventually turned against allowing inflation to continue. This public pressure has reinforced the trend against inflationary policies.

Increased competition among currencies, driven by the confluence of factors that I just described, has limited the ability of governments and central banks to pursue high-inflation policies. ...

Many of these arguments will apply with greater force in developing economies, where the costs of poor policies have been demonstrated quite clearly. Nonetheless, I think that currency competition has played at least some role in disciplining policy in the United States and other developed countries.

Other Explanations for the Change in Inflation Dynamics Of course, monetary policy may not be the whole story, and we need to resist embracing any single explanation too wholeheartedly. ... For example, the reduced sensitivity of core inflation to oil and natural gas prices likely also reflects both the increased energy efficiency of the economy and the fact that shocks to the prices of these goods since the mid-1980s have, at least until the latest episode, been viewed as mostly temporary. In contrast, the rise in oil prices during the 1970s was probably seen at the time as largely reflecting a permanent shift in global demand/supply balances.

Another factor that might help to account for some of the changes in inflation dynamics is globalization. Because national markets have become more open to international trade, domestic firms and workers face more competition and have less market power than in the past. This development could help to account for any reduced sensitivity of U.S. inflation to domestic resource utilization. ...

Other factors may also be at work, such as the deregulation of the 1980s and the faster productivity growth we have seen over the past decade. But I think that even after we have given these factors their appropriate due, the evidence still suggests that better monetary policy explains much (albeit not all) of the changes in inflation dynamics that have occurred. ...

Policy Implications ...In today’s economy, it is very difficult to know whether any given change in output or employment will have inflationary consequences. One lesson that is fair to draw, however, is that resource utilization generally does not tell us much about the future course of inflation over the next year or two. Rather, the near-term inflation outlook is more likely to be dominated by cost factors, such as productivity growth and the price of raw materials, than by the tightness of labor and product markets. Furthermore, ... it is probably more difficult than ever to gauge the economy’s productive potential--and hence estimate so-called output gaps--especially in real time. In light of these uncertainties, prudent policymakers should take an eclectic approach and base their policy decisions on both a wide variety of indicators and views about how the economy may work and avoid a narrow focus on economic slack.

My earlier comments also underscored the central importance of expectations to the successful conduct of monetary policy. In particular, the Federal Reserve and many other central banks appear to have succeeded in anchoring long-run inflation expectations--an achievement that has contributed to macroeconomic stability and eased the task of monetary policy. However, bad luck or other factors could cause expectations to begin to drift again. If so, the Federal Reserve will need to respond appropriately. ...

The final lesson I draw is a cautionary note: The stability of inflation could lead to complacency. As long as inflation expectations are well anchored, actual inflation will have a natural tendency to revert to the anchor of long-run inflation expectations. Under such circumstances, policymakers may be tempted to relax their resolve in responding to potentially inflationary developments. Such relaxation could be costly... Inflation expectations have become well-anchored because the public has become confident that the Federal Reserve will do the right thing. But this belief will persist only as long as we on the Federal Open Market Committee continue to ratify the public’s expectations that inflation will remain low and stable. Thus, complacency would be a threat to the credibility that the Federal Reserve has worked so hard to acquire...

One message that I hope has been clear is that there is much we don’t know about the inflation process. Policymakers would of course like to be 100 percent confident that they have the right way of looking at the world. But I think we always need to be open to the possibility that other forces may be at work or that other interpretations better explain what we’ve observed. We need to approach our task with a certain degree of humility and an open mind.

Still, I think we can be fairly certain that low and stable inflation has been brought about by guarding against looming inflation risks, and continuing in this vein seems sensible to me. Above all, we must continue to conduct policy in such a way as to keep inflation low and stable--an approach that also promotes full employment and maximum sustainable real growth of the economy.


References

Atkeson, Andrew, and Lee H. Ohanian (2001). “Are Phillips Curves Useful for Forecasting Inflation?” Federal Reserve Bank of Minneapolis, Quarterly Review, vol. 25 (Winter), pp. 2-11.

Bernanke, Ben S. (2007). “Globalization and Monetary Policy,” speech delivered at the Fourth Economic Summit, Stanford Institute for Economic Policy Research, March 2.

Bils, Mark, and Peter J. Klenow (2004). “Some Evidence on the Importance of Sticky Prices,” Journal of Political Economy, vol. 112 (October), pp. 947-85.

Borio, Claudio, and Andrew Filardo (2006). “Globalization and Inflation: New Cross-Country Evidence on the Global Determinants of Domestic Inflation,” unpublished paper, Bank for International Settlements, March.

Cecchetti, Stephen G., Peter Hooper, Bruce C. Kasman, Kermit L. Schoenholtz, and Mark W. Watson (2007). “Understanding the Evolving Inflation Process,” paper prepared for the U.S. Monetary Policy Forum 2007 (February), http://research.chicagogsb.edu/gfm/events/conferences/index.aspx.

Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans (2005). “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy.” Journal of Political Economy, vol. 113 (February), pp. 1-45.

Hooker, Mark A. (1996). “What Happened to the Oil Price-Macroeconomy Relationship?” Journal of Monetary Economics, vol. 38, pp. 195-213.

Ihrig, Jane E., Steven B. Kamin, Deborah Lindner, and Jaime Marquez (forthcoming). “Some Simple Tests of the Globalization and Inflation Hypothesis,” International Finance Discussion Papers. Washington: Board of Governors of the Federal Reserve System.

Ihrig, Jane E., Mario Marazzi, and Alexander D. Rothenberg (2006). “Exchange-Rate Pass-Through in the G-7 Countries,” International Finance Discussion Papers 851. Washington: Board of Governors of the Federal Reserve System, January.

Kroszner, Randall S. (2006). “The Conquest of Worldwide Inflation: Currency Competition and Its Implications for Interest Rates and the Yield Curve,” speech delivered at the Cato Institute Monetary Policy Conference, Nov. 16, www.federalreserve.gov/boarddocs/speeches/2006/default.htm.

Roberts, John M. (2006). “Monetary Policy and Inflation Dynamics,” International Journal of Central Banking, vol. 2 (September), pp. 193-230.

Romer, Christina D., and David H. Romer (2002). “The Evolution of Economic Understanding and Postwar Stabilization Policy,” (439 KB PDF) in Rethinking Stabilization Policy, symposium sponsored by the Federal Reserve Bank of Kansas City, August 29-31. Kansas City: the Reserve Bank, pp. 11-78.

Stock, James H., and Mark W. Watson (2007). "Why Has U.S. Inflation Become Harder to Forecast?" Journal of Money, Credit, and Banking, supplement to vol. 39 (February), pp. 3-33.

Thomas, Charles P., and Jaime Marquez (2006). “Measurement Matters for Modeling U.S. Import Prices,” International Finance Discussion Papers 883. Washington: Board of Governors of the Federal Reserve System, December.

U.S. Department of the Treasury, Board of Governors of the Federal Reserve System, and U.S. Secret Service (2006). The Use and Counterfeiting of United States Currency Abroad, Part 3. Washington: Department of the Treasury, September, www.federalreserve.gov/boarddocs/press/other/2006/20061025/default.htm.

Woodford, Michael (2003). Interest and Prices. Princeton: Princeton University Press.


Footnotes

1. The academic literature refers to this new generation of macroeconomic models as dynamic stochastic general equilibrium models. Christiano, Eichenbaum, and Evans (2005) is one of the most prominent examples of this new approach.

2. Atkeson and Ohanian (2001) argue that the unemployment rate no longer has any ability to forecast inflation, while Roberts (2006) argues that the correlation has fallen but is still nonzero.

3. One area in which the pattern of smaller correlations with inflation does not hold is import prices. After adjusting for the rising share of imports in domestic price increases, we see little indication of a reduction in the effect of import prices on U.S. inflation. We have some evidence, however, of a reduced effect of exchange rates on import prices (Ihrig, Marazzi, and Rothenberg, 2006), although this result may be sensitive to specification (Thomas and Marquez, 2006).

4. One key element of the inflation process that I have not yet mentioned is labor costs. Recent developments in labor markets make it difficult to assess changes in the role of labor costs in the inflation process. For example, since the mid-1990s, incentive-based employee stock options have become an important form of compensation. This development has created measurement difficulties: The government’s principle measure of labor compensation accounts for such options at the time they are exercised (thereby conflating them with capital gains), rather than recording them at their expected value at the time of issuance. As a result, the published compensation data provide a distorted picture of labor costs.

5. Woodford (2003) includes results of this sort.

6. For emerging-market countries that had experienced high inflation, another aspect of globalization fostering currency competition is the large amount of physical dollars now present in these countries, which allows citizens to conduct transactions and store liquid wealth without holding the local currency. Over one recent period, the fraction of U.S. currency estimated to be held in foreign countries rose dramatically, from less than one-fifth in 1980 to as much as two-thirds in the late 1990s, and today the total nominal amount is in the neighborhood of $400 billion, or somewhat more than one-half (U.S. Department of the Treasury and others, 2006).

7. As noted in Bernanke (2007), Ihrig and others (forthcoming) find that these results are sensitive to details of specification.

Readings on (Mostly) Monetary Theory and Policy

A benefit of blogging is that you can harvest links for your classes as you look for things to blog about, and then post them as required or additional reading on a class blog or web page. In case anyone finds them useful, here are the additional readings and applications I've posted on the class blog for my Monetary Theory and Policy class so far this quarter (just short of 100 articles). I've been surprised at how many people in the class actually read these (I give short summaries of most of the articles posted as additional reading, so that probably helps encourage people to read more):

The Dark Side

Off and on, we've been discussing the progress economics has made as a discipline. In those discussions, we often hear what a sorry state economics is in, that the theoretical models don't predict well, that economics isn't a real science, and so on. A comparison to physics often comes up.

One response to this onslaught against economics is to point out that physicists also have a theory that doesn't predict well, in particular the motion of galaxies and the matter within them is at odds with theoretical predictions. Visible matter cannot account for the gravitational "stickiness" of clusters of matter.

The solution physicists have adopted is not to question the theory, at least not for the most part - see below, but instead to make stuff up - dark matter, dark energy, I expect there will be a "dark light" soon as well - whatever is needed to make the equations work must exist.

When I respond to attacks on economics by pointing out that these theories seem every bit as controversial and uncertain as ours, in fact perhaps more so with this "making stuff up" step that assumes the theory is correct and then assumes the matter needed to make the theory work is present in just the right invisible amounts to get motions to agree with theory, I get told it's because I don't understand (and let's not get into the vacuousness of string theory - when I say the absence of testable predictions makes string theory philosophy, not science, I guess I don't understand either).

I'm going to get myself in trouble again by not understanding one more time. This is an astrophysicist from a blog in the NY Times called Across the Universe:

Searching for the Dark Side, by Chris Lintott, Commentary, NY Times: ...The ... kind of matter we – and everything we can see directly – are made of accounts for only a sixth of the total mass in the universe. In the absence of knowledge, we label the rest as “dark matter” and look to detect it via its effects on what we can see.

We have long known that there is more to our universe than we can see. The great eccentric of American astronomy, Fritz Zwicky, realised in 1930 that the galaxies within galaxy clusters were moving more rapidly than they should be. The only explanation was to assume that there was more matter present than scientists had thought... A similar problem exists on the scale of individual galaxies; if only the visible disk of a galaxy such as the Milky Way existed, the galaxy would fly apart in just a few million years. The solution is the same; if the Milky Way is embedded in a halo of dark matter, then all is well.

What is this dark matter? We know very little about it... [M]ost cosmologists now believe that dark matter is composed of slow-moving exotic particles that have yet to be identified.

Such a situation is unsatisfactory to say the least. Although particle physicists are working on the problem, ... it is embarrassing not to know what the main component of the universe is. The alternative is to assume that there is something wrong with our knowledge of gravity, and that the work of Einstein needs revising. Theories that attempt to do just that have been somewhat successful. ...

[It will be] a stringent test for theorists attempting to dispose of dark matter, but I for one hope they succeed. It would be tidier, somehow, to lose the enigmatic dark matter, and exciting to discover a successor to Einstein’s relativity. As George Bernard Shaw said in 1930, “Ptolomy invented a universe and it lasted 2000 years. Newton invented a universe and it lasted 200 years. Now Dr. Einstein has invented a new universe, and no one knows how long this one is going to last.”

"[I]t is embarrassing not to know what the main component of the universe is." That's why economists should hang their heads in shame when real scientists enter the room.

Econoblog: Is Democracy the Best Setting For Strong Economic Growth?

This WSJ Econoblog features Ed Glaeser and Daron Acemoglu discussing the relationship between political freedom and economic growth. Here's the first of four rounds and an open link to the rest of the discussion:

Is Democracy the Best Setting For Strong Economic Growth?, WSJ Econoblog: Hoping to counterbalance the economic populism of Venezuela President Hugo Chavez, President Bush is on a weeklong tour of Latin America...

But what exactly do we know about the relationship between democracy and economic growth? Economies of less-than-democratic nations such as China have surged in recent years. Does a country's brightening economic picture boost the chance democracy may eventually blossom? Or is it the other way around? Are democratic institutions a key component of long-term economic growth? And what's the role of education?

WSJ.com asked economists Daron Acemoglu of the Massachusetts Institute of Technology and Ed Glaeser of Harvard University to discuss the delicate relationship between economic growth and broader political freedoms.

Ed Glaeser writes: Rich countries are stable democracies. Poor countries tend to be political basket cases, careening between brutal dictatorships and unstable semi-republics. The relationship between democracy and wealth might suggest democracy naturally leads to prosperity. This view is comforting and also gives us another reason to enthusiastically try to export democracy globally.

While I yield to no one in my passion for liberty, the view that democracy is a critical ingredient for economic growth is untenable. There is no robust statistical relationship to back it up, and Robert Barro actually found democracy reduces growth, once he statistically controls for the rule of law.

It is, however, true that growth rates vary much more under dictatorships than under democracies. Anti-development autocrats, such as Mobutu Sese Seko or Kim Jong Il, are about the worst thing for economic growth, other than civil war. But many of the best growth experiences have been in less-than-democratic regimes that invest in physical and human capital such as Lee Kwan Yew's Singapore or post-Mao China. Some dictators are even better than democrats at restraining the growth-killing practice of expropriating private wealth. I think the relationship between democracy and wealth reflects the power of human capital -- education -- to make countries both rich and democratic. If you put enough smart people together, they'll figure out how to govern themselves and gravitate towards democracy.

Daron Acemoglu writes: I agree with Ed on many points. In the postwar era, it's true that democracies haven't grown faster than autocratic regimes. Plus, there are clear examples of fast growth under dictatorships; see South Korea under Gen. Park Chung Hee. So, why haven't democracies been more successful? I believe the answer lies in recognizing two things. First, there are different kinds of democracies. And second, it's important to consider that economic growth and democracy have a very different relationship over the long term -- that is for periods as long as 100 years -- than over the short or medium term.

Many societies counted as "democratic" using standard measures are really "dysfunctional democracies" where traditional elites dominate politics through control of the party system, political influence, vote buying, intimidation and even assassination. Colombia, which has had regular democratic elections for the past 50 years, is a typical example. In others, democratic institutions survive, but there is significant in-fighting between ethnic groups, religious groups or social classes. The situation in Iraq would be the most extreme -- but not a unique -- example. Finally, many democracies suffer economically from populist and irresponsible macroeconomic policies, which are often adopted after transitions from repressive dictatorships and during periods when politics are turbulent and conflicts over wealth distribution are strong.

On the second point, it's true that autocratic regimes can generate growth for certain periods of time by providing secure property rights and good business conditions to firms aligned with political powers. But modern capitalist growth requires not only secure property rights, but also creative destruction, that is, the entry of new firms with new ideas and technologies that replace the successful firms of the past. Creative destruction requires a level playing field, which democracies are better at providing because they have more equal distributions of political power than autocracies or monarchies.

So, if we look beyond the past 60 years, we see that it was the U.S., with its democratic institutions, that created the environment for new businesses to enter, flourish and spur the industrial growth of the 19th century. There were many rich autocracies and repressive regimes in the 18th century, including places like Cuba, Haiti and Jamaica. But it was the U.S. that grew rapidly over the next two centuries while these autocratic regimes stagnated.The relationship between human capital and democracy that Ed raises is fascinating. But I will return to that in a little in the context of the causes of democracy.

[...continue reading...]

Ed Glaeser says in closing:

I have tried to articulate two views. First, democracy doesn't strongly predict economic growth. Second, education is an important factor that supports democracy.

Daron Acemoglu has the final word and sums up the discussion with:

There is a lot Ed and I agree on. Democracy doesn't strongly predict economic growth, at least not in the short run. Education is wonderful for many reasons. And democracy is not perfect as a political system, but it is the best we have. ... There are ... barriers to democracy's ability to flourish in many societies. And finally, exporting democracy is probably neither easy nor always feasible and we should be careful in such attempts. ...

However, there are still some areas where there is healthy disagreement between us. The main barrier to democracy is not low education but deep social and economic divides that create intense conflict. Democracy has failed in highly educated countries -- such as Germany before World War II or post-war Argentina. It has also been extremely successful in very low-education countries. Botswana provides a perfect example...

Felix Salmon: Is There a Looming Crisis in the Mortgage market?

I recently posted an article by Gretchen Morgenson of the New York Times on potential problems in the mortgage security market. The article gave a fairly pessimistic view of these markets, and talked of a looming crisis.

Felix Salmon has a follow-up post to the article giving more perspective and detail about how these markets work, and he questions whether there is evidence of a looming crisis as suggested in article:

Is there a looming crisis in the mortgage market?, by Felix Salmon: ...Gretchen Morgenson ... adduces no evidence whatsoever that any crisis is looming at all. For one thing, she doesn't seem to understand the difference between two entirely different types of investment: equity in subprime mortgage originators, on the one hand, and debt backed by pools of subprime mortgages, on the other. It's certainly true that originating subprime mortgages does not seem to have been a very good business ... over the past year or so. But Morgenson never connects the dots and explains why that means that the market in subprime MBSs is likely to implode.

Morgenson also talks at great length about the enormity of the market in MBSs, but never stops to point out that the vast majority of that market is in bonds issued by Fannie Mae and Freddie Mac, and that no one has any worries whatsoever about those securities crashing.

Here's a bit of typical overheated prose:

Wall Street firms and entrepreneurs made fortunes issuing questionable securities, in this case pools of home loans taken out by risky borrowers... Regulators stood by as the mania churned, fed by lax standards and anything-goes lending.

Issuance

But here is Morgenson's own graph, showing the practical effects of that churning mania: MBS issuance more than $1 trillion lower in 2006 than it was three years earlier. It's very hard to look at this graph and see any evidence of a bubble: rather, it seems that private-sector MBS issuance has been rising only to make up for a large drop in issuance from Fannie and Freddie.

Morgenson's most substantive problem is that there's a ticking bomb in the MBS market, in the form of investors failing to mark their securities to market. ...

Morgenson is missing two crucial points here. The first is that here simply isn't a market in most MBSs tranches – that's why so much of the recent activity has concentrated on MBS indices rather than the underlying securities. The liquid, mark-to-market activity ... is entirely in Fannie and Freddie bonds, not in individual tranches of securitized subprime mortgages. You can't mark subprime MBS tranches to market daily for the very good reason that most such tranches simply don't trade on a daily basis.

And the second point is that if you actually look at the prices for those subprime MBS tranches when they do trade, guess what? They haven't actually fallen much in price at all. ... As Josh Rosner told me, the problem is not that existing MBSs are likely to default or drop in price. ...

Anyway, here's my favorite bit from Morgenson's article. Before you read it, ask yourself what a scary loan-to-value ratio for subprime mortgages would be. 125%? 100%? 95%?

The rapid rise in the amount borrowed against a property’s value shows how willing lenders were to stretch. In 2000, according to Banc of America Securities, the average loan to a subprime lender was 48 percent of the value of the underlying property. By 2006, that figure reached 82 percent.

There you go: 82%, in the year universally considered to be the laxest year in the history of subprime mortgages. Now do you understand why investors aren't particularly worried about default?

Invidiously, Morgenson even hints darkly at nefarious conflicts of interest at the ratings agencies, saying that they might be soft-pedalling downgrades to save their own hides. I don't think they are. Mortgage pools are designed to be able to withstand a temporary drop in house prices or rise in default rates. I look at the tiny number of MBS downgrades and take comfort in it. I'm perfectly happy to concede that subprime mortgage originators who were active this time last year are going to be in a lot of trouble now. But I'm nowhere near convinced that there's any real problem in the market for the securities based on the mortgages they originated.

Update: NakedCapitalism has a detailed follow up on the NY Times article, Felix's comments, and related WSJ and Bloomberg articles: Reactions to New York Times Mortgage Market Story

Paul Krugman: Overblown Personnel Matters

In his last column, Paul Krugman highlighted research showing that Democrats have been investigated by federal prosecutors far more often than Republicans since the Bush administration came to power, an indication that political pressure may have been applied inappropriately. This column looks at the “overblown personnel matter” involving the recent firing of federal prosecutors, an action that again raises questions about the role politics played in the process, and whether the political pressure that was applied and exercised was proper:

Overblown Personnel Matters, by Paul Krugman, Commentary, NY Times: Nobody is surprised to learn that the Justice Department was lying when it claimed that recently fired federal prosecutors were dismissed for poor performance. Nor is anyone surprised to learn that White House political operatives were pulling the strings.

What is surprising is how fast the truth is emerging about what Alberto Gonzales, the attorney general, dismissed just five days ago as an “overblown personnel matter.”

Sources told Newsweek that the list of prosecutors to be fired was drawn up by Mr. Gonzales’s chief of staff, “with input from the White House.” And Allen Weh, the chairman of the New Mexico Republican Party, told McClatchy News that he twice sought Karl Rove’s help ... in getting David Iglesias, the state’s U.S. attorney, fired for failing to indict Democrats. “He’s gone,” he claims Mr. Rove said.

After that story hit the wires, Mr. Weh claimed that his conversation ... took place after the decision to fire Mr. Iglesias had already been taken. Even if that’s true, Mr. Rove should have told Mr. Weh that political interference in matters of justice is out of bounds...

And the thuggishness seems to have gone beyond firing prosecutors who didn’t deliver the goods for the G.O.P. One of the fired prosecutors was — as he saw it — threatened with retaliation by a senior Justice Department official if he discussed his dismissal in public. Another was rejected for a federal judgeship after administration officials, including then-White House counsel Harriet Miers, informed him that he had “mishandled” the 2004 governor’s race in Washington, won by a Democrat, by failing to pursue vote-fraud charges.

As I said, none of this is surprising. The Bush administration has been purging, politicizing and de-professionalizing federal agencies since the day it came to power. But in the past it was able to do its business with impunity; this time Democrats have subpoena power, and the old slime-and-defend strategy isn’t working. ...

Still, a lot of loose ends have yet to be pulled. We now know exactly why Mr. Iglesias was fired, but still have to speculate about some of the other cases — in particular, that of Carol Lam, the U.S. attorney for Southern California.

Ms. Lam had already successfully prosecuted Representative Randy Cunningham, a Republican. Just two days before leaving office she got a grand jury to indict Brent Wilkes, a defense contractor, and Kyle (Dusty) Foggo, the former third-ranking official at the C.I.A. ... And she was investigating Jerry Lewis, Republican of California, the former head of the House Appropriations Committee.

Was Ms. Lam dumped to protect corrupt Republicans? The administration says no, a denial that, in light of past experience, is worth precisely nothing. ...

What we really need — and it will take a lot of legwork — is a portrait of the actual behavior of prosecutors across the country. Did they launch spurious investigations of Democrats, as I suggested last week may have happened in New Jersey? Did they slow-walk investigations of Republican scandals, like the phone-jamming case in New Hampshire?

In other words, the truth about that “overblown personnel matter” has only begun to be told. The good news is that for the first time in six years, it’s possible to hope that all the facts about a Bush administration scandal will come out in Congressional hearings — or, if necessary, in the impeachment trial of Alberto Gonzales.

_________________________
Previous (3/9) column: Paul Krugman: Department of Injustice
Next (3/19) column: Paul Krugman: Don’t Cry for Reagan

How Productive Are We?

David Warsh writes about the development of productivity measures, what the measurements tell us about productivity in the past, and what we might expect in the future:

Fifty Years On, by David Warsh, Economic Principles: [In] 1957 ..., Robert Solow published “Technical Change and the Aggregate Production Function.” Ten years later, Dale Jorgenson and Zvi Griliches supplied theoretical foundations with “The Explanation of Productivity Change.”

Since then, growth accounting has turned into big business. ... The task ... is to understand the determinants of this elusive factor ­ perhaps even learn to quicken its pace. For the rate of increase of productivity is vital to our well-being. If it grows quickly, we will be rich, able to make all kinds of accommodations with demographic swings and climate change; if it grows slowly, the necessary adjustments will be much more painful. ...

Since the measurement business began in earnest, there have been three distinct eras of US productivity: the long boom from 1948 to 1973, when output per hour worked (labor productivity) grew at an annual average of 3.3 percent; the mysterious twenty-year slowdown after 1973, when the rate slowed to an average of slightly less than 1.5 percent per year; and the unexpected resurgence after 1995, when the annual rate jumped up to 2.5 percent or more.

The period of the slowdown was confusing... Economists advanced all kinds of explanations: the sharp increase in energy prices; the rise of a service economy; the growth of government; a decline in R&D spending in the 1960s; the limits to growth having been reached. Others argued that the slower rate of the ’70s was the normal rate, that the rapid productivity growth after World War II had been artificially high.

Thus the resumption of the earlier trend, after 1995, caught researchers totally by surprise. Recently, Northwestern University’s Robert Gordon recalled the mood that prevailed in January 1998, when the American Economic Association met in Chicago on the eve of another year of meteoric ascent in the stock market...:

Everybody, including Jack Triplett [of the Brookings Institution, a celebrated growth accountant], not to mention me, was still talking about the Solow paradox [“You can see the computer age everywhere these days but in the productivity statistics.”] Nobody was talking about the productivity growth revival….

Yet Business Week had seen it coming in late 1995 [with a celebrated “New Economy” cover story], not to mention Alan Greenspan’s wise remarks in 1996... As late as June 1998…, I was still trying to argue that “there is something wrong with the computers.”

These perceptions totally changed between mid-’98 and mid-’99. Since then, the debate has been an opera of contending voices seeking to explain the change. Stephen Oliner and Daniel Sichel, both of the Federal Reserve Board, touched off the debate, asking in an important paper in 2000, “Is Information Technology the Story?”

Indeed it was, replied Dale Jorgenson, of Harvard University, and Kevin Stiroh, of the Federal Reserve Bank of New York, in their 2002 paper, “Raising the Speed Limit: US Economic Growth in the Economic Age.” Some 60 percent of the gain in productivity stemmed directly from information technology, they calculated.

By 2004, however, Triplett and Barry Bosworth, also of the Brookings Institution, identified a different source. The service industries ­ airlines, broadcast, banking and the like -- had contributed much of the improvement, they argued.

All the while, Northwestern’s Gordon remained the leading techno-pessimist. The speedup was partly a cyclical phenomenon, he argued, partly a one-shot boost from improved Internet-computer communications. It would prove to be no more than a surge.

Last week, when many of the principals met in Cambridge at the National Bureau of Economic Research (NBER), there were more signs of convergence among those who looked to information technology and streamlined industrial structure to explain the productivity resurgence. Gordon, the pessimist, remained in the minority.

The stakes are high, of course. ... If Jorgenson and Stiroh are right, the US economy can grow at around 3 percent...; if Gordon is correct, the “speed-limit” of the economy is around 2.5 percent. ...

Meanwhile, attempts continue to decompose national income accounts and productivity calculations along different lines, in hopes of shedding more light on the issues. ...

"An Intellectual Gresham's Law in Action"

Brad DeLong makes an important point:

Un-Discourse Situations...: I was sitting on the right end of an nine-person panel at the New School Friday morning (webcast). Bob Solow was sitting on the left end--Solow, Shapiro, Schwartz, Rohatyn, Kudlow, Kerry, Kosterlitz, Hormats, DeLong. Bob Solow expressed concern and worry over the declines in the U.S. savings rate over the past generation. Larry Kudlow, in the middle of the panel, aggressively launched into a rant--about how the NIPA savings rate was wrong, about how the right savings rate was the change in household net worth, about how there was no potential problem with America saving too little, that the economy was strong, and that that day's employment report had been wonderful, and that Paul Krugman had predicted nine out of the last zero recessions, et cetera, et cetera, et cetera.

What is one to do? You watch a guy--Bob Solow--one of the smartest and most thoughtful people I know, having his intellectual impact neutralized by a guy--Kudlow--who really isn't in the intellectual inquiry business anymore. Kudlow clearly has not thought through the biases and gaps in the household net worth number: if he had, there is no way he could say what he is saying.

On paper, in print, on the screen, one can point out that the employment report was anemic--it was not a bloodletting by any means, but it was a bit disappointing. On paper, in print, on the screen, one can say that there is reason to worry about the decline in housing demand and the possibility that it might trigger a recession. On paper, in print, on the screen one can say that reasons (4), (5), and (6) pushing up measured household net worth are reasons to discount that statistic as misleading because they do not reflect any true increase in appropriately-defined wealth, that any increase in household net worth caused by (7) is a transitory phenomenon that tells us little about permanent saving and accumulation patterns, that (1) and (2) affect the level but not the trends of saving, and do not speak to Solow's worry about the savings-investment rate's decline, and thus that only reason (3)--the effects of the now decade-long computer-and-communications real investment boom on our total wealth--provides a reason to even begin to think about whether Bob Solow's worries about declining savings as measured by the NIPA are at all overblown.

But there are ninety minutes for a panel with nine people on it. To the audience it looks like two cocksure economists who disagree for incomprehensible reasons. And my ten minute share will come too late to try to referee Solow-Kudlow in any fair, balanced, and effective way.

It's an un-discourse situation: Kudlow doesn't acknowledge--may not know--the flaws in his chosen statistic. And I can't help wonder what Kudlow would be saying if a Democrat were president.

It's an intellectual Gresham's Law in action...

What can I do? I can blog about it.

And I can try to help as well. A big reason I started doing this was because I was tired of hearing about how tax cuts pay for themselves, hearing the kind of nonsense Brad is talking about and more just like it spouted on TV, in print, on the screen, and on the radio without any rebuttal. People who don't have a clue about the academic research on issues they are discussing or who are selling an ideological agenda are put side-by-side with and given equal time and weight to people like Bob Solow who is "one of the smartest and most thoughtful people" Brad knows, if they are rebutted at all. People watching, listening, or reading are left with the impression that there are schisms and disagreements in the profession that simply don't exist. I'm not sure what the answer is, how to stop people from being misled by sales jobs for agendas disguised as economic analysis, but speaking up is a start. [Update: The numbered items Brad refers to are in a part of the post I cut, but probably shouldn't have. added them in comments.]

Update: Bruce Bartlett, from Brad's comments:

When you saw that the organizers had stupidly put too many people on the panel, you should have refused to participate. You should have also asked who else was invited. When you saw that they had invited some whom you view as having insufficient stature to particpate, you should have refused to participate. If more scholars did this, conference organizers and talk show producers might improve the quality of such events.