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November 29, 2007

Economist's View - 5 new articles

Nicholas Stern: Climate Change, Ethics and the Economics of the Global Deal

Sir Nicholas Stern says "targets and trading must be at the heart of a global agreement to reduce greenhouse gas emissions." This is from his public lecture before the Royal Economic Society in anticipation of next week's world summit on climate change in Bali:

Climate Change, ethics and the economics of the global deal, by Sir Nicholas Stern, Vox EU: The problem of climate change involves a fundamental failure of markets: those who damage others by emitting greenhouse gases generally do not pay. Climate change is a result of the greatest market failure the world has seen. The evidence on the seriousness of the risks from inaction or delayed action is now overwhelming. We risk damages on a scale larger than the two world wars of the last century. The problem is global and the response must be a collaboration on a global scale.

Rich countries must lead the way in taking action. That means adopting ambitious emissions reduction targets; encouraging effective market mechanisms; supporting programmes to combat deforestation; promoting rapid technological progress to mitigate the effects of climate change; and honouring their aid commitments to the developing world.

Next week the world gathers at Bali for the meeting of the Conference of the Parties of the United Nations Framework Convention on Climate Change. In thinking about global action to reduce greenhouse gas emissions, we must invoke three basic criteria:

  • Effectiveness: the scale must be commensurate with the challenge – which means setting a stability target (or its equivalent in terms of an emissions reduction path) that can keep the risks at acceptable levels.
  • Efficiency: we must keep down the costs of emissions reduction, using prices or taxes wherever possible.
  • Equity: the problem is deeply inequitable with the rich countries having caused the bulk of current stocks of greenhouse gases and the poor countries being hit earliest and hardest – which means that the rich countries must take the lead.

What should the main elements of a global deal look like, what sort of a deal should it be, and how should it be built and sustained? My proposal is for a six-point programme with two groups of elements, the first three concerning targets and trading:

  • First, the overall targets of 50% reductions in global emissions by 2050 (relative to 1990) agreed at the G8/G5 summit in Heiligendamm in June this year are essential if we are to have a reasonable chance of keeping temperature increases below 2 or 3°C. While these targets involve strong action, they are not over-ambitious relative to the risks of failing to achieve them. Fixed quantity targets are crucial for the management of risk. Within these global targets, even a minimal view of equity demands that the rich countries' reductions (direct or purchased) should be at least 80%.
  • Second, there should be substantial trade between countries, including rich and poor countries, in greenhouse gas emissions. This will promote efficiency – in other words, the cheapest ways of achieving cost reductions. At the same time, the flow to poor countries will help them cover their costs of greenhouse gas reduction, thereby giving them an incentive to join a global deal. Trade in emissions reduction has a double benefit: efficiency and glue for a global deal.
  • Third, there should be a major reform of the Clean Development Mechanism, a Kyoto mechanism that allows developing countries to sell emission reductions, but does not penalise them for emissions themselves (a 'one-sided' trade mechanism). This is much too cumbersome for the scale required and omits key technologies. In the next stage, its successor should be based on sector and technological benchmarks against which reductions can be measured. In this way, it can move to 'wholesale' and build confidence in a flow of private sector finance to developing countries to help build low-carbon economies that can grow strongly. Demonstrating the viability of these flows is crucial to any acceptance, eventually, of overall targets by developing countries.

The second group of proposals for the global deal involves public funding:

  • Fourth, there should be a coherent, integrated international programme to combat deforestation, which contributes 15-20% of greenhouse gas emissions. For $10-15 billion per year, a programme could be constructed that could stop up to half the deforestation.
  • Fifth, there needs to be promotion of rapid technological advance for mitigation. The development of technologies must be accelerated and methods found to promote their sharing. Carbon capture and storage (CCS) for coal is particularly urgent since coal-fired electric power is currently the dominant technology round the world and emerging nations will be investing heavily in these technologies. For $5 billion a year, in terms of feed-in tariffs (which could be reduced as carbon prices rise), it should be possible to create 30 commercial scale coal-fired CCS stations within seven or eight years. Unless the rich world demonstrates, and quickly, that CCS works, developing countries cannot be expected to commit to this technology.
  • Sixth, rich countries should honour their commitments to 0.7% of GDP in aid by 2015. This would yield increases in flows of $150-200 billion per year. The extra costs developing countries face as a result of climate change are likely to be upwards of $80 billion per year and it is vital that extra resources are available for new initiatives. Adaptation to a changing climate is part of good development and is not separate from it.

This programme is one that can be built if rich countries take a lead in Bali on their targets, the promotion of trading mechanisms and funding for deforestation and technology.

Within different countries, there will be different choices of instruments – such as taxes, trading and standards – and different technological mixes. In all countries, there is scope for energy efficiency, which both reduces emissions and saves money. But trading must be a central part of the story because it can provide the international incentives for participation, and promote efficiency and equity, while controlling quantities of emissions.

With leadership and the right incentives on carbon finance and technologies, developing countries will join. The starting point is deeply inequitable, and developing countries feel this inequity very strongly. Poor countries will be hit earliest and hardest by climate change, but rich countries have created the bulk of past emissions and thus the stock of greenhouse gases. Currently US emissions are more than 20 tonnes of CO2 equivalent per annum, Europe 10-15 tonnes, China 5 or more tonnes, India around 1 and most of Africa much less than 1.

For a 50% reduction in global emissions by 2050, the world average per capita must drop from 7 tonnes to 2-3 tonnes. An 80% target for rich countries would bring equality of only the flow of emissions around the 2-3 tonnes per capita level. In fact, they will have consumed the big majority of the "available space in the atmosphere". Notwithstanding this great inequity, developing countries know they must be strongly involved in global action.

The building of the deal and its enforcement will come from the willing participation of countries driven by the understanding of the people that action is vital. It will not be a "wait-and-see" game as in World Trade Organisation talks, where nothing is done until everything is settled. The necessary commitments are increasingly being demonstrated by political action and elections around the world. A clear idea of where we are going as a world will make action at the individual, community and country level much easier and more coherent.

These commitments must, of course, be translated into action. There is a solution in our hands. It will not be easy to build. But the alternative is too destructive to accept. Bali is an opportunity to draw the outline of the common understanding or framework, which will both guide action now, and build towards the deal.

The last few years have seen a deepening understanding of:

  • Climate change and particularly the risks the world faces – see the fourth assessment report of the International Panel on Climate Change published this year, and summary document two weeks ago.
  • The challenges of adaptation that the developing world faces – see the United Nations Human Development Report published this week.
  • The scale of the response required in terms of reductions of greenhouse gas emissions and the economic and technological instruments that can support and drive these reductions – see the Stern Review on the economics of climate change.
  • Business too is becoming clear about what is necessary, as demonstrated in this week's publication on climate change from the UK's Confederation of British Industry.

This understanding is increasingly reflected in public demand for responsible action and in country after country, this is being demonstrated in the political and electoral processes. It is public demand that will promote and sustain action at the individual, community, national and international levels.

This is a problem that is global in its origins and global in its impacts. Action is urgent if we are to avoid the stocks of greenhouse gases building to levels that involve unacceptable risks. Because this is a flow-stock process – we can control only the flows of greenhouse gases and once the stocks are there, they are very difficult to remove – any delay will build up stocks making subsequent action to stabilise at acceptable levels much more costly.

Price mechanisms for greenhouse gases will be central to correcting the market failure, but the urgency and risk of the problem and inertia in behaviour imply that policy must go further. This means bringing forward technologies, deepening an understanding of what responsible behaviour means, overcoming other market failures that inhibit energy efficiency and innovation, and combating deforestation. We now have fairly clear idea of what to do and how to do it.

My six-point programme satisfies the requirements of effectiveness, efficiency and equity. It would allow all countries of the world to pursue their development aspirations via low-carbon growth. The necessary greenhouse gas reductions would cost around 1% of world GDP per annum over coming decades.

These costs are fairly modest relative to world wage differentials and medium-term exchange rate movements. For the most part, they do not raise serious issues of competitiveness; where they do they can be handled directly. On the other hand, new technologies can create great opportunities and provide impetus for new growth. Low-carbon growth is the growth strategy. Weak action will eventually stifle growth.

The costs of action are a small price to pay for the grave risks it would avert. The world would thereby greatly reduce the additional future expenditures necessary on adaptation, although substantial extra expenditure in both rich and poor countries would be unavoidable.

Update: HRH The Prince of Wales comments on the Bali conference.


With today's release of revised data showing that GDP grew faster than originally estimated in the third quarter of this year, Brian Blackstone of the WSJ Economics Blog reminds us that we can measure aggregate activity as GDP and as GDI (because income = expenditures), and notes the two measures are not telling the same story:

Gross Domestic Income Tells Different Story Than GDP, WSJ Economics Blog: According to the latest gross domestic product revision, the U.S. economy swelled at nearly a 5% clip last quarter, almost double the economy's noninflationary limit. Or did it?

Gross domestic income – a lesser-known gauge that the Fed has highlighted in the past as perhaps a better alternative — increased less than 2% last quarter, well below the economy's potential. The first estimate of GDI is released with the second GDP estimate because it incorporates data that isn't available earlier.

GDP counts economic activity based on expenditures, while GDI bases it on income. In theory, they should add up the same, though the often diverge — albeit not as much as they did last quarter.

Earlier this year when the Fed was trying to reconcile slower GDP growth with still-strong labor markets, it noted that GDI "might better capture the pace of activity." GDI was running hotter than GDP at the time. ...

The main difference between the two gauges last quarter was corporate profits, which GDI includes and GDP excludes. Corporate profits from current production fell last quarter. GDI also doesn't explicitly include net exports and inventories, as GDP does. GDI, in contrast, relies more heavily on employee compensation data.

But when there are differences, Fed officials may lean towards GDI, especially when it comes to signaling economic downturns. Fed economist Jeremy Nalewaik wrote in a March paper that GDI "has done a substantially better job recognizing the start of the last several recessions than has real-time GDP." ...

A penny saved... a penny workers don't earn:

Penny Foolish, by Eric Schlosser, Commentary, NY Times: The migrant farm workers who harvest tomatoes in South Florida have one of the nation's most backbreaking jobs. For 10 to 12 hours a day, they pick tomatoes by hand, earning a piece-rate of about 45 cents for every 32-pound bucket. During a typical day each migrant picks, carries and unloads two tons of tomatoes. For their efforts, this holiday season many of them are about to get a 40 percent pay cut.

Florida's tomato growers have long faced pressure to reduce operating costs; one way to do that is to keep migrant wages as low as possible. ...

In 2005, Florida tomato pickers gained their first significant pay raise since the late 1970s when Taco Bell ended a consumer boycott by agreeing to pay an extra penny per pound for its tomatoes, with the extra cent going directly to the farm workers. Last April, McDonald's agreed to a similar arrangement... But Burger King ... has adamantly refused to pay the extra penny — and its refusal has encouraged tomato growers to cancel the deals already struck with Taco Bell and McDonald's.

This month the Florida Tomato Growers Exchange, representing 90 percent of the state's growers, announced that it will not allow any of its members to collect the extra penny for farm workers. Reggie Brown, the executive vice president of the group, described the surcharge for poor migrants as "pretty much near un-American."

Migrant farm laborers have long been among America's most impoverished workers. Perhaps 80 percent of the migrants in Florida are illegal immigrants and thus especially vulnerable to abuse. During the past decade, the United States Justice Department has prosecuted half a dozen cases of slavery among farm workers in Florida. Migrants have been driven into debt, forced to work for nothing... The Coalition of Immokalee Workers — a farm worker alliance based in Immokalee, Fla. — has done a heroic job improving the lives of migrants in the state, investigating slavery cases and negotiating the penny-per-pound surcharge with fast food chains.

Now the Florida Tomato Growers Exchange has threatened a fine of $100,000 for any grower who accepts an extra penny per pound for migrant wages. ...

The prominent role that Burger King has played in rescinding the pay raise offers a spectacle of yuletide greed worthy of Charles Dickens. Burger King has justified its behavior by claiming that it has no control over the labor practices of its suppliers. "Florida growers have a right to run their businesses how they see fit," a Burger King spokesman told The St. Petersburg Times.

Yet the company has adopted a far more activist approach when the issue is the well-being of livestock. In March, Burger King announced strict new rules on how its meatpacking suppliers should treat chickens and hogs. As for human rights abuses, Burger King has suggested that if the poor farm workers of southern Florida need more money, they should apply for jobs at its restaurants.

Three private equity firms — Bain Capital, the Texas Pacific Group and Goldman Sachs Capital Partners — control most of Burger King's stock. ...

Telling Burger King to pay an extra penny for tomatoes and provide a decent wage to migrant workers would hardly bankrupt the company. Indeed, it would cost Burger King only $250,000 a year. At Goldman Sachs, that sort of money shouldn't be too hard to find. In 2006, the bonuses of the top 12 Goldman Sachs executives exceeded $200 million — more than twice as much money as all of the roughly 10,000 tomato pickers in southern Florida earned that year. Now Mr. Blankfein should find a way to share some of his company's good fortune with the workers at the bottom of the food chain.

"Marx's 'Das Kapital' Lives On"

An excerpt from a book on Karl Marx:

Marx's 'Das Kapital' Lives On in Capitalist Age, NPR [Listen Now]: ...Excerpt: 'Marx's Das Kapital: A Biography' by Francis Wheen: Chapter 1: Gestation ... Marx's earliest ambitions were literary. As a law student at the University of Berlin he wrote a book of poetry, a verse drama and even a novel, Scorpion and Felix, which was dashed off in a fit of intoxicated whimsy while under the spell of Laurence Sterne's Tristram Shandy. After these experiments, he admitted defeat: 'Suddenly, as if by a magic touch - oh, the touch was at first a shattering blow - I caught sight of the distant realm of true poetry like a distant fairy palace, and all my creations crumbled into nothing… A curtain had fallen, my holy of holies was rent asunder, and new gods had to be installed.' Suffering some kind of breakdown, he was ordered by his doctor to retreat to the countryside for a long rest - whereupon he at last succumbed to the siren voice of G. W. F. ...

After gaining his doctorate [Marx] thought of becoming a philosophy lecturer, but then decided that daily proximity to professors would be intolerable. 'Who would want to have to talk always with intellectual skunks, with people who study only for the purpose of finding new dead ends in every corner of the world!' Besides, since leaving university Marx had been turning his thoughts from idealism to materialism, from the abstract to the actual. 'Since every true philosophy is the intellectual quintessence of its time,' he wrote in 1842, 'the time must come when philosophy not only internally by its content, but also externally through its form, comes into contact and interaction with the real world of its day.' That spring he began writing for a new liberal newspaper in Cologne, the Rheinische Zeitung; within six months he had been appointed editor.

Marx's journalism is characterized by a reckless belligerence which explains why he spent most of his adult life in exile and political isolation. His very first article for the Rheinische Zeitung was a lacerating assault on both the intolerance of Prussian absolutism and the feeble-mindedness of its liberal opponents. Not content with making enemies of the government and opposition simultaneously, he turned against his own comrades as well, denouncing the Young Hegelians for 'rowdiness and blackguardism'. Only two months after Marx's assumption of editorial responsibility, the provincial governor asked the censorship ministers in Berlin to prosecute him for 'impudent and disrespectful criticism'.

No less a figure than Tsar Nicholas of Russia also begged the Prussian king to suppress the Rheinische Zeitung, having taken umbrage at an anti-Russian diatribe. The paper was duly closed in March 1843: at the age of twenty-four, Marx was already wielding a pen that could terrify and infuriate the crowned heads of Europe. ...

Marx was a pretty effective blogger. Here is a page from an archive of his posts, with more here.

Update: Andrew Leonard has more.

links for 2007-11-29

Economist's View - 4 new articles

The Ruth Marcus Obsession with the Social Security Crisis that Does not Exist

Ruth Marcus of the Washington Post is at it again, trying to portray Social Security as a system in need of immediate fixing. But, as these responses by Dean Baker, Kevin Drum, and Paul Krugman make clear, Marcus is doing her best to elevate a second-tier problem (if it's even that) to the crisis, first-tier level. It appears that having taken a position on Social Security that is wrong, i.e. that it is a system headed for "crisis," she is incapable of admitting her errors and instead continues to defend the indefensible. She says it's irresponsible not to attack the problem now in her guise as one of the "Very Serious People," but the irresponsibility is coming from those, like herself, who are promoting a crisis that doesn't exist.

Here's Dean Baker:

More Social Securty UFOs at the Post, by Dean Baker: Ruth Marcus is on the warpath again arguing that those who don't want to jump in line on the SS crisis train are being irresponsible. Read it and weep.

A couple of quick points are in order.

To claim unanimity of forecasts agree with SS trustees is simply false. The trustees assume that productivity growth will be markedly slower over the longterm horizon than its post-war average. They also assume that immigration will slow sharply from its rate over the last decade. Both assumptions make the projections for the program look considerably worse. One need only step over to the non-partisan Congressional Budget Office's website to find more positive projections on these variables.

The second key point to keep in mind is that the idea that taking steps earlier rather than later makes things easier means that it is better to either raise taxes on a cohort that has seen 30 years of wage stagnation or to cut their retirement benefits, even though most have accumulated little for retirement other than their SS. Even the trustees project that the typical worker will have a wage that is about 35 percent higher in 2040 than what workers earn today. Only the Post would argue that it's better to raise taxes and/or cut benefits on much poorer workers today than to risk the possibility that we may have to raise taxes or cut benefits on the much wealthier workers of the future in order to cover the greater cost of their own retirement (they are projected to live longer also -- that's the real problem. We're so cruel to our children.)

Kevin Drum next:

Social Security Again, by Kevin Drum: Why are Ruth Marcus and the Washington Post so obsessed with demanding that we all address Social Security's long-term problems right this instant? It's a mystery. Truly a mystery.

Here's what they need to think about. The most common solutions to Social Security's eventual shortfall are (a) a small tax increase, (b) a small reduction in the rate of growth of benefits, and (c) a small increase in the retirement age. Question: are there any advantages to implementing any of these solutions right now, rather than, say, ten years from now?

I'd say no. The advantage to waiting is obvious: projections of Social Security's solvency are uncertain, and waiting gives us more data. Why try to project 40 years in the future if you don't have to? Better to wait and see what direction the economy actually heads.

Balanced against that, there really aren't any advantages to acting sooner. Social Security is currently running a surplus, so increasing payroll taxes today does nothing except increase the size of the trust fund a meaningless exercise at best, and a positively harmful one at worst. We might need to raise taxes in the future once Social Security starts running a deficit, but raising them now does nothing at all to change either Social Security's future obligations or the source of its future funding.

As for ideas (b) and (c), what's the point of locking ourselves into them now? If we wait ten years, not only will we know more about the real shape of the future funding problem, but we'll still have 25 years or more to gradually introduce any changes we think we need. Do we really need to give beneficiaries more than 25 years notice that they might have to retire one year later than they think? Or that after they retire their benefits are going to increase at a slightly slower rate than the law currently requires? I don't see the point. 25 years is plenty of warning for changes as small as the ones we're talking about.

Bottom line: 2017 is a better time to deal with Social Security than 2007. Raising taxes now doesn't accomplish anything, and if it turns out that we need to reduce benefits we can do it in 2017 just as well as we can do it today. For now, we should put Social Security on the back burner and instead spend time worrying about healthcare costs, nuclear proliferation, and global warming. Those are problems that really do need to be addressed right away.

Krugman's turn:

The Social Security obsession, again, by Paul Krugman: By any reasonable standard, Social Security is at most a second-tier policy issue.

There are various ways to make this point. One is to compare the fiscal problems of Social Security, such as they are, with those of the rest of the federal government. The Social Security trustees estimate the 75-year financial shortfall of the program at 0.7% of GDP. That compares with a general fund deficit – the federal deficit outside of Social Security – of 3.3% of GDP last year (that is, not even taking into account future demands on Medicare and Medicaid.) Social Security, in other words, is in much better financial shape than the rest of the government.

Another illuminating comparison is to look at the sources of projected growth in entitlements spending. The last Congressional Budget Office long-term budget projection had Social Security spending rising from 4.2 percent of GDP now to 6.4 percent by 2050, a 2.2 percentage point increase – and Social Security, remember, is currently running a surplus to prepare for that eventuality. Meanwhile, Medicare and Medicaid spending are projected to rise from 4.5 percent of GDP to 12.6 percent, three times the Social Security increase – with negligible pre-funding.

As a result, Social Security fades to insignificance in any realistic discussion of entitlements problems. Medicare's unfunded liabilities, as estimated in the trustees' reports, are seven times those of Social Security. The unfunded liabilities of Medicare Part D alone are twice those of Social Security.

If you're seriously worried about America's long-run fiscal prospects, then, you should talk a lot about the general fund deficit and the problem of rising health care costs, and hardly at all about Social Security. But that's not how it works in DC these days.

How obsessed are Beltway types with what is really a minor problem? Here are two snapshots:

First, from commenter "Low-Tech Cyclist" at Brad DeLong's place:

The WaPo has a subset of its unsigned editorials where it comments on what it calls "the ideas primary."

Five of the last seven Ideas Primary editorials have been on the Social Security 'crisis.' There have been 15 editorials in this series. One has been on global warming - the greatest crisis of our era - and two have been on our greatest domestic crisis, the lack of universal health care and the upcoming crisis in the Medicare trust fund.

Second, from Jon Chait:

One of the oddities of the entitlement hysterics is that they are far more obsessed with the minor problems of Social Security than with the massive problems of Medicare. Indeed, if you look closely at their dire proclamations, they inevitably follow the same pattern: They begin with an ominous summation about entitlements–thus lumping together Medicare with Social Security–then swiftly proceed to demand that Social Security be shored up forthwith.

Russert's recent harangue at the Democratic presidential debate was a classic example. He began by warning of the crisis faced by "Social Security and Medicare" but proceeded to ask no fewer than 14 questions about Social Security, and zero about Medicare. It's as if he began fulminating against crime in the greater New York area and then immediately began demanding a large new police deployment in Chappaqua.

Look, I know this is very embarrassing to those who have been walking around thinking that hyping the Social Security issue makes them Very Serious People. But the facts are the facts – and the Beltway obsession with Social Security reflects ideology and fashion, not the real problems facing America.

Update: Brad DeLong comments:

This morning Ruth Marcus writes:

Social Security: Five Myths and a Slur: [The claim that] "Social Security is only a big deal to people who hate the program and want to see it destroyed -- or to their ignorant dupes"... is worse than a myth. It's a slur -- on responsible people, Democrats and Republicans, who may differ about the Social Security cure but agree on the diagnosis and on the need for treatment.

This reads like a lame reply to what Clive Crook wrote last week at the Atlantic:

On an important point, [Democrats] are right: no great fiscal crisis lies in wait for social security... tweaks will be enough to deal with it.... A fiscal crisis is indeed looming over the next few decades – but its cause is Medicare, not social security. For the US, the real fiscal enemy is not the ageing of the population, but the relentless rise in healthcare costs.... [Any exclusive] focus on social security reform [is] both ill-conceived and, no doubt, deliberately misleading...

Indeed, today Ruth Marcus gives a lot of ground, no longer hiding from her readers the fact that:

The [Social Security] shortfall is small, and it's a lot smaller than the Medicare shortfall.... Social Security isn't the biggest budgetary challenge...

Indeed, by my count Social Security needs to take a number and get in line, being only the fifth-most serious budgetary shortfall, behind:

  • Medicare hospitalization
  • Medicaid
  • Medicare drug benefit
  • The Bush 2001 and 2003 tax cuts

But ... Ruth Marcus lacks the ovaries to state that Social Security is only fifth in magnitude of our budgetary shortfalls...

Economic Security for Middle Class Families

How secure are middle class families? According to this report, not very:

2 out of 3 middle class American families on shaky financial ground, according to new report Landmark study based on new 'Middle Class Security Index' developed by Demos and Brandeis University, EurekAlert: Fewer than one in three middle-class families in America is financially secure, and the remaining majority are either borderline or at high risk of falling out of the middle class altogether, according to a new study published this week by Demos and the Institute for Assets and Social Policy (IASP) at Brandeis University.

By a Thread: The New Experience of America's Middle Class is the first comprehensive report to measure economic stability across the American middle class. Based on national government data, By a Thread is the first in a series of reports and briefing papers that will utilize the new "Middle Class Security Index" developed by the non-partisan policy center Demos and IASP/Brandeis.

This Index measures the financial security of the middle class by rating household stability across five core economic factors: assets, educational achievement, housing costs, budget and healthcare. Based on how a family ranked in each of these factors, they were defined as financially "secure", "borderline" or "at risk".

"Much like a common cholesterol test that shows whether someone's cardiovascular health is at risk, the Middle Class Security Index shows that financial health eludes the majority of the American middle class," said Thomas M. Shapiro, Director of the Institute on Assets and Social Policy at Brandeis and one of the co-authors of the report. " It also points to specific areas—like lack of assets—that inhibit financial security,"

The Middle Class Security Index shows worrying trends:

  • Only 31 percent of families who would be considered middle-class by income are financially secure.
  • One in four middle-class families match the profile for being at high risk of slipping out of the middle class altogether.
  • More than half of middle-class families have no net financial assets whatsoever.
  • Middle-class families have median debt of $3,500 and at least half of them have no assets.
  • Only 13 percent of middle-class families are secure in their asset levels—meaning that they have enough to cover most of their living expenses for nine months should their regular income cease; 79 percent are "at risk" in this category, meaning they could not cover the majority of their expenses for even three months. Another 9 percent are "borderline."
  • Twenty-one percent of middle-class families have less than $100 per week ($5,000 per year) remaining after meeting essential living expenses. These families are living from paycheck to paycheck with very little margin of security

The participants of a press conference to launch the report commented on these findings:

"If we look back at the public investments of the mid-twentieth century—the GI Bill, federal home loan guarantees, better funding for public education and college—we see that they were geared at two key benchmarks on the way to the middle-class: assets and education," said Henry Cisneros, Chairman of CityView and former U.S. Secretary of Housing and Urban Development. "But the Middle Class Security Index provides a real measurement of where we are after years of seeing those investments whittled away. American families are at risk of falling out of the middle class and never getting back in, and many of those who were excluded from the initial public investment—Latinos and African Americans—are among those with the greatest vulnerability. It's time for a new public investment to stabilize the household economy and build the future middle class."

"The By a Thread report findings mirror a reality of today's unstable economy: The nation's mortgage lending crisis is threatening the fabric of the urban communities that we revitalized by providing economic opportunity for more than 30 years. The ramifications of foreclosures on property values, municipal costs, crime, and consumer credit extends beyond the middle class and the neighborhoods most widely impacted by irresponsible lending practices," said Jean Pogge, Executive Vice President, Consumer and Community Banking for ShoreBank.

"Workers in America are suffering a now generation-long stagnation of wages and rising insecurity," said Ron Blackwell, Chief Economist at AFL-CIO. "By a Thread provides a unique metric for the resulting stress on middle class living standards and outlines bold policies to create an economy that works for all."

The Middle Class Security Index findings reported in By a Thread spotlight the strengths and vulnerabilities of the middle class by identifying barriers to financial security and offering solutions that would enable the broad majority of American families to enjoy a stable middle-class life. The report recommends a set of policies that will help open access to, and strengthen, America's middle class. Legislative proposals cover a range of important issues affecting American households, including asset building and debt reduction, making higher education more accessible and affordable, and addressing the healthcare crisis.

"The Index is the launching point for a range of new work that will examine economic stability in America's middle class," said Jennifer Wheary, Senior Fellow at Demos and report co-author. "In the coming months we'll be adding new reports that illuminate middle- class stability by age, race and income—several of the key demographic factors that will inform future public policy investments."

The Middle Class Security Index will be updated biennially, with accompanying reports, as new national data become available.

[Link to report]

Debate on Climate Change

Here is a debate on "how cutting emissions of greenhouse gases would affect the global economy" among Bjorn Lomberg, Gary Yohe, and Sir Nicholas Stern.

links for 2007-11-28

November 28, 2007

Economist's View - 8 new articles

NBER Recession Dating: Time for a Meeting?

Robert Hall says the NBER Business Cycle Dating Committee hasn't scheduled a meeting yet, but that could change. Justin Fox has the details:

Economist Robert Hall sees "dark clouds," but don't go expecting him to declare a recession anytime soon, Curious Capitalist: With all the recent talk of a looming recession, I figured I ought to check in with Stanford economist Robert Hall, chairman of the Business-Cycle Dating Committee of the National Bureau of Economic Research, the semi-official arbiter of when recessions start and end. I e-mailed:

When everybody starts talking recession, as is this case now, what do you folks on the Business-Cycle Dating Committee do? Schedule a meeting in Cancun? Set up a conference call? Start sending around lots of e-mails? Deputize somebody to keep an especially close eye on incoming economic data? (I just imagine there must be some form of heightened activity, and I'm curious as to what form it takes.)

He responded:

We all follow developments pretty closely. Now that Larry Summers has scooped us, all the more so. The process begins with emails. We don't usually have a conference call until we are quite convinced that a turning point has occurred. Thus the subject of the call is not whether the recession has begun or ended, but rather when that event occurred. Consequently, the call occurs long after it is generally recognized that a turning point has occurred. There is usually a period of 6 months or so when the financial press excoriates us for tardy action. We don't generally have a physical meeting, though we do if the time for action happens to coincide with the annual meetings of the American Economic Association at the beginning of January. So far there has been no suggestion of a meeting when that happens in 6 weeks, but things could change. I can certainly add as an individual member, now not speaking as chair, that I see some dark clouds. The high levels of consumption seen in the past decade may decline to something closer to normal. The relation of the consumption bulge to the house-price boom is still unclear, but it would not be a surprise to see the two variables return to normal together.

The Business-Cycle Dating Committee ... was set up by ... Marty Feldstein after he took over as president of the NBER in 1977. Before that, veteran NBER staffer Geoffrey H. Moore (he'd been there since 1939) had more or less singlehandedly determined what was a recession and what was not. Feldstein decided such work was better done by a committee. ...

Justin's post has a little more on the dating procedure, and there's even more here along with a set of FAQs . Here is the list of past recession dates.

Are we talking ourselves into a recession?

Reich: No Immunity for the Telecoms

Robert Reich does not favor immunity for the telecoms. I don't either:

Why the Telecoms Shouldn't Get Immunity, by Robert Reich: I'm old enough to remember J. Edgar Hoover's FBI and Nixon's CIA, and the Federal Intelligence Surveillance Act of 1978. But anyone who's even halfway sentient ought to know there's a Fourth Amendment to the Constitution. So you'd think that executives at the nation's biggest telecoms -- AT&T, Verizon, and so on -- would be alert to the possibility that government might illegally snoop on Americans. Yet these executives didn't blink an eye when the NSA came knocking. You want records of domestic phone calls? Sure, help yourself! Emails? Yeah, we got tons. They're yours!

When word of this leaked out and the companies got sued..., the telecoms went to Congress and complained... They deserved immunity from such lawsuits, they said, because they were only following orders. Now that Congress is back, it's about to decide whether the telecoms' argument makes sense. It doesn't.

Only following orders? ... Corporate executives have a duty to disobey government orders when they have reason to believe those orders are illegal or unconstitutional -- and make the government go to court to get what it wants. The duty to refuse is especially important when it comes to the nation's telecoms, whose technological reach is extending deeper and deeper into our private lives.

Sure, there's a delicate balance between fighting terrorism and protecting civil liberties. But that's for courts to decide – not spy agencies and not telecom executives. If in doubt, the telecoms can go to the special courts set up precisely to oversee this balance, and get a declaratory judgment. The only way to keep pressure on them to do this and not become agents of our spy agencies is to continue to allow Americans to sue them for violating their legal rights.

"Cyber Scholars"

PZ Meyers reports:

Cyber Scholars?, by PZ Meyers: Those sneaky alumni organizations — they've always got new angles on how to get to you. The alumni magazine for the University of Oregon has a writeup on me and a current member of the UO faculty, Mark Thoma. Apparently, we are Cyber Scholars, professors who use the blogosphere to teach the world. I think we need some new academic robes to go with that designation — preferably something in silver fabrics, and with a jetpack.

Here's the write-up. This kind of thing - the picture, the story, etc. - makes me self-conscious, so please feel free to scroll on by (I should note that one or two of the statistics are a bit off, but not by much, and that I wasn't going to post this until convinced to do so by others):

Cyber Scholars, by Katie Campbell, UO Quarterly: Mark Thoma compares the problem with the national deficit to dieting.

"People eat more in anticipation of a diet, which makes the diet that much harder once the time comes," the UO associate professor of economics explains. It's with that type of everyday language that Thoma reaches beyond the walls of academia to explain complex economic issues to average folks. That's what he does everyday—on his blog (short for web log).

Many view the blogosphere less as a scholarly realm and more as a perilous information wasteland where the average blowhard can present himself as an expert. But a growing number of people with Ph.D.s, such as Thoma, are using blogs to connect with colleagues beyond their university departments and with the greater nonacademic community.

Thoma compares the power of his blog to standing in the plaza of his hometown of Colusa, California, with its 5,800 residents gathered before him for a daily discussion of the economic issue of the day: the dangers of privatizing social security, the economic impact of immigration, or even a systematic analysis of supply-side economics. But in reality, his blog, called Economist's View, draws a worldwide audience.


An average of 10,000 Thoma fans check in every day—about fifty times the number of students he teaches each year. Because of Economist's View's informed content and widespread popularity, one web critic deemed it the "L.A. Times of econ blogs."

Standing out online today is a feat: there are already some 70 million blogs and about 120,000 more each day—that's 1.4 new blogs every second. But Thoma has attracted a dedicated and diverse following. One of his biggest fans is Princeton professor and noted New York Times columnist Paul Krugman, who said, "There's no blog I like better." Thoma's target audience, however, is less erudite. He hopes by reading Economist's View people like his mother, a woman without a college degree, enhance their comprehension of the economic issues at the core of today's public policy questions—issues such as whether the United States should adopt a national health care system or whether the Federal Reserve should adjust interest rates. He feeds his readers hearty servings of logic and information for their next dinner party debate.

"I come [to Economist's View] almost every day because of the consistently excellent explanations," wrote a Greek reader, commenting on one of Thoma's posts about how a free market isn't a panacea. Such praise keeps Thoma blogging— something he has done every day, without fail, since March 2005. "People presume that, because you're blogging, you're not doing serious academic work, but this is important. It's a way to connect with the real world," Thoma said. "There's a lot of clutter out there. Part of my job is to be a credible source."

For the reader wading through the blogosphere, knowing which sources to trust isn't always clear. Part of Deborah Carver's job as the UO's Phillip H. Knight Dean of Libraries is assessing the integrity of information online. In the past decade Carver has witnessed the surge of electronic communication and has been confronted with the question of what is worth trying to capture and preserve. Will we one day consider blog posts just as archive-worthy as the handwritten diaries of Oregon Trail pioneers? Although much of the material in the blogosphere could be considered nonsense, Carver says, "The format of a blog doesn't necessarily make the information invalid."

Online material should be scrutinized in the same way as printed work, she explains. Find out how up-to-date the information is, who is funding the report, and what the author's credentials are. By considering such information, the reader can determine if the material favors a certain bias.

Some blogs may even be more reliable than the mainstream media, according to professor Paul Zachary "PZ" Myers, Ph.D. '85, a science blogger known for his playful writings on evolutionary biology and neuroscience—including details of the arachnid sex life, complete with close-ups of spider genitalia.

"When you look at media coverage of the sciences, you find the majority of journalists don't know the science. They just go after the controversy," says Myers, who now teaches biology at the University of Minnesota in Morris.

The evolutionism-versus-creationism controversy riles Myers most and regularly sends him on a blogging tear. "(Media) stories usually present a scientist who represents 99 percent of intellectual thought facing off against some crank who wants to keep science out of schools," he said. The result, according to Myers, is that viewers end up seeing the debate as one to one, not one to ninetynine. He aims to set things straight on his blog.Named Pharyngula after his favorite embryonic stage of development, the blog has become so well liked that it receives between 35,000 and 40,000 visitors daily, making it the 162nd-most-read blog in the world. Nature magazine declared it the best blog by a scientist, and it earned the 2006 Weblog Award for best science blog.

Both Myers and Thoma have been praised for blogging, but not in the form of academic accolades. Publication in scholarly journals, not online web logs, still reigns as paramount in academia. But blogging has value, they contend. It's a public service: The twenty-first century's version of a civic debate.

"It's a way of communicating with the public daily. This form of mass communication should be a part of what we do as professors," Myers said. "Besides, it's good training to translate complicated research into words people can understand—it's exactly what we have to do in teaching freshmen."

"The Death of Distance Has been Greatly Exaggerated"

How much should service-sector workers in developed countries fear offshoring competition?:

Service offshoring: Same old trade with a new label?, by Keith Head, Thierry Mayer, and John Ries, Vox EU: Pundits regularly invoke the notion of a world economy that is either "shrinking" or becoming "flat." Explanations of this alleged flattening include technological innovations in transportation and communication that have enabled goods and ideas to flow more freely. The offshoring of service jobs, particularly call centers and computer software in India, has grabbed recent media attention. In his bestseller The World is Flat, New York Times columnist Thomas Friedman (2005) wrote of how he had "interviewed Indian entrepreneurs who wanted to prepare my taxes from Bangalore, read my X-rays from Bangalore, trace my lost luggage from Bangalore and write my new software from Bangalore."

Most economists, cognizant of the gains from trade, do not view a "flat" world as an alarming prospect. As the 2004 Economic Report of the President remarked sanguinely, "When a good or service is produced more cheaply abroad, it makes more sense to import it than to make or provide it domestically" (p. 229). In a press conference after the release of the report, the Chair of the Council of Economic Advisors at that time, Gregory Mankiw, elaborated on the remarks in the report saying, "Whether things of value, whether imports from abroad, come over the Internet or come on ships, the basic economic forces are the same." As Mankiw and Swagel (2006) describe in their insider account, these seemingly innocuous remarks about outsourcing managed to arouse a controversy. This was partly because of election-year sentiments but also because the threat of service offshoring raises serious concerns for many onlookers. How will we maintain our standard of living, people wonder, when we have to compete with highly skilled foreigners who are willing to do our jobs for a fraction of our wages?

Just as mainstream trade theory identifies gains from trade, it also shows that real wages of some workers tend to fall as a consequence of freer trade. Mankiw and Swagel (2006) respond to these concerns by arguing that the accumulated statistical evidence on the offshoring of services demonstrates that the magnitudes remain quite small compared to the size of the labour market. This case for complacency recalls a debate between Leamer and Krugman over whether rising imports from low-wage manufacturers were responsible for rising wage inequality in the US. Leamer (2000) pointed out that prices are determined on the margin and the volume of trade is irrelevant for wage determination. Krugman (2000) argued that, on the contrary, trade volumes were crucial evidence on the changes in factor prices that can be attributed to trade. However, if recent growth of service imports continues unabated, the current trickle of offshoring could turn into a flood. Mankiw and Swagel's argument would be more persuasive if there were strong reasons to believe that economic impediments to offshoring will curb its future growth.

Our research investigates whether geographic separation limits offshoring trade, thereby shielding domestic workers from direct competition with their foreign counterparts. We develop a model that envisions employers searching globally for the most suitable workers for any given task and posits that distance raises the costs of using foreign workers. These higher costs reflect travel, training, or translation time associated with using workers that reside far from where their services will be consumed. Firms choose workers that offer the lowest costs after adjusting wages for productivity and distance-based service delivery costs.

We use data on bilateral trade in services for a large sample of countries to infer the extent to which distance increases the relative costs of using remote workers. We focus on the service category called Other Commercial Services (OCS) that includes service categories that are subject to the offshoring debate—professional services and call centers. Distance effects are conventionally estimated by applying the "gravity equation" to bilateral trade. This method, which has been widely used to study goods trade, posits that exports from an origin country to a destination country are proportional to the economic sizes of each partner country and inversely related to the distance between them.

The scatter plot in Figure 1 of British imports of OCS (averaged over 2000–2004) provides intuition on how the gravity equation is used to estimate distance effects.

The vertical axis shows British imports as a share of origin-country GDP and the horizontal axis represents the distance from Britain. Origin countries are identified with standard codes and the data is plotted on a log scale. A symbol system (specified in the legend) indicates whether the origin country has linkages with Britain in terms of a colonial relationship, a common language, or a shared legal system. The figure shows a strong negative relationship between trade and distance, something that we would not observe if services could be delivered costlessly across space.

Figure 1 shows that the univariate regression line through this data has an absolute slope—what we call the "distance effect"—of 0.64. However, the figure also makes it clear that distance is not the only bilateral variable that influences trade. When the influence of colonial ties is taken into account, for example, the slope with respect to distance increases to 0.87. Our regressions control for all the linkages shown in the figure. They also control for time zone differences that are thought by many to be important considerations for offshoring. In keeping with recent theoretical developments and our own model, we include importer and exporter indicator variables.

Dist1 Figure 1: The impact of distance on British imports of Other Commercial Services (OCS), 2000–2004 averages

Figure 2 shows annual distance effects for OCS and goods estimated for the last decade of available data. Distance effects for OCS are initially higher than those for goods (for the same set of country pairs) but become lower in later years. In 2004, distance effects for OCS are 1.24, implying that a 10% increase in distance reduces bilateral trade by 12.4%.

Using theory and estimated distance effects, we are able to measure the extent to which geographic separation insulates local workers from foreign competition. The calculations reveal that, from the point of view of a London service purchaser, workers in Oxford can be paid 99% to 373% more than workers in Bangalore in productivity-adjusted wages and yet still be more attractive, once service-delivery costs are taken into account. This is because the Bangalore workers are 100 times more distant from London than the Oxford workers.

Dist2 Figure 2: Estimated distance effects for Other Commercial Services (OCS) and goods, 1995–2004

Those results indicate that geographic barriers offer high-wage workers substantial insulation from low-wage competitors based in remote countries. Distance has long acted as a serious impediment to international transactions. Unfortunately, most of what we know about the effects of distance on international transactions is based on studies of trade in goods. A consensus appears to be forming that freight costs cannot explain the strength and functional form of the distance effect for goods.[1] Instead, physical distance seems to be picking up some combination of the barriers imposed by cultural differences, the continued desire for face-to-face communication, and the geographically-biased structure of social and business networks. These factors apply to services as well as goods. Thus, there are two senses in which Mankiw is right to say it does not matter whether imports arrive by ship or by broadband. First, there will be potential gains from trade in either case. Second, there will be distance costs that limit the realisation of those gains.

How much should high-wage workers fear competition from much lower paid workers in India and China? Our findings suggest that distance still provides signification protection. Since these estimates reflect averages across a range of services, there are surely services where competition is especially acute. Moreover, service delivery costs associated with distance appear to have fallen over the last decade to a level that is slightly below the level estimated for goods. Unfortunately, the data do not clearly indicate whether distance costs for services will continue their downward trend or level off. We suspect that persistent cultural differences, as well as locally-biased social networks, will maintain distance costs at a high enough level to forestall the small, flat world envisioned by some journalistic accounts.

[This commentary is based on "How Remote is the Offshoring Threat?" by the same authors available as CEPR Discussion Paper No. 6542 at new-dps/dplist.asp?dpno=6542.]


Grossman, Gene M., 1998, Comment, in Frankel J.A. (ed), The Regionalization of the World Economy, NBER Project Report, The University of Chicago Press.

Leamer, Edward E., 2000, "What's the use of factor contents?," Journal of International Economics 50(1), 17–49.

Krugman, Paul R., 2000, "Technology, trade and factor prices," Journal of International Economics 50(1), 51–71.

Mankiw, N. Gregory and Phillip Swagel, 2006, "The politics and economics of offshore outsourcing," Journal of Monetary Economics 53(5), 1027–1056.


1 For an exposition of the reasoning, see Grossman (1998).

Globalization is "A Lot Less Important Than You Think"

Paul Krugman says international trade doesn't matter as much as you might think:

Cool the globalization rhetoric, Marketplace: ... Paul Krugman: I've been on the road a lot lately, talking to audiences about my hopes for a great revival of middle-class America, and I almost always get asked about whether such hopes make sense in an age of globalization. Is it really possible to make working Americans better off, when they have to compete with workers around the world?

Yes, it is. The truth, is that international trade is less important, for good or for evil, than most people suppose. [...continue reading...]

Measuring Pure Inflation

Here are Ricardo Reis and Mark Watson who will tell you what they have done and why it matters. This is interesting work:

Relative Goods' Prices and Pure Inflation, by Ricardo Reis and Mark W. Watson, NBER WP 13615, November 2007 [open link]: ABSTRACT This paper uses a dynamic factor model for the quarterly changes in consumption goods' prices to separate them into three components: idiosyncratic relative-price changes, aggregate relative-price changes, and changes in the unit of account. The model identifies a measure of "pure" inflation: the common component in goods' inflation rates that has an equiproportional effect on all prices and is uncorrelated with relative price changes at all dates. The estimates of pure inflation and of the aggregate relative-price components allow us to re-examine three classic macro-correlations. First, we find that pure inflation accounts for 15-20% of the variability in overall inflation, so that most changes in inflation are associated with changes in goods' relative prices. Second, we find that the Phillips correlation between inflation and measures of real activity essentially disappears once we control for goods' relative-price changes. Third, we find that, at business-cycle frequencies, the correlation between inflation and money is close to zero, while the correlation with nominal interest rates is around 0.5, confirming previous findings on the link between monetary policy and inflation.


6. What have we done and why does it matter? In this paper, we ... used different estimation techniques and specifications to robustly estimate pure inflation, and proposed a simple method to compute macroeconomic correlations while controlling for goods' relative price changes.

Our first finding was that pure inflation can differ markedly from other conventional measures of inflation, like the PCE deflator or its core version. It is smoother, less volatile, and in particular in the 1990s, its ups-and-downs are quite different from those in other measures of inflation. This should be useful to economic historians since it provides an alternative account of the movements in inflation in the last half-century. Relative to existing measure of inflation, pure inflation has the virtue of separating absolute from relative-price changes, which is a crucial distinction in economic theory. Moreover, pure inflation matches more closely the concept that many economists seem to have in mind when discussing aggregate movements in prices and monetary policy (typically based on intuition that comes from a one-good world).

Our second main finding was that pure inflation was quantitatively significant (it accounts for about 5% of individual price changes), but only accounts for 15-20% of the variability in inflation measured by conventional price indices, like the PCE deflator, the GDP deflator, or the CPI. This has at least two implications for the work of economic theorists building models to explain inflation. First, it shows that comparing the predictions of one-good models with common measures of inflation is flawed. The difference between these measures and pure inflation is large enough that it can easily lead to mistakenly accepting or rejecting models. Second, our estimates provide a new test statistic with which to test the pricing assumptions of models with many goods. An important ingredient (and topic of debate) in recent models of nominal rigidities is a model of pricing that implies slow adjustment of prices to monetary policy shocks together with frequent price changes. The fraction of the variability of cost-of-living inflation accounted for by pure inflation can be an important statistic to diagnose the success of these models at fitting the data.

Third, we found that, once we controlled for relative goods' prices, the Phillips correlation became quantitatively insignificant. Therefore, the correlation between real quantity variables and nominal inflation variables that we observe in the data can be accounted for by changes in relative prices. This implies that models that break the classical dichotomy via nominal rigidities in good's price adjustment are likely more promising than models that rely on money illusion on the part of agents.

Fourth, we found that pure inflation is partly related to monetary policy variables. The link to the growth rate in monetary aggregates is weak, but the correlation with nominal interest rates at business cycle frequencies is strong (approximately 0.5).

To conclude, economic theories have strong predictions on whether and when there should be pure inflation and what its effects would be, and discussions of monetary policy often revolve around its relation with pure inflation. However, observing pure inflation is naturally difficult, since the concept itself is more a fruit of thought experiments than something easily observed. As a result, there have been few systematic attempts to measure it in the data. The goal of this paper was to make some progress on measuring pure inflation and understanding its effects. Our estimates are certainly not perfect. We hope, however, that they are sufficiently accurate that future research can look deeper into the time-series and the moments that we provide, and that by stating the challenges and putting forward a benchmark, we can motivate future research to come up with better estimators. Likewise, we are sure that our findings will not settle the debates around the key macroeconomic correlations. Our more modest hope is that they offer a new perspective on how to bring data to bear on these long-standing questions.

"A Note on Economic Conditions in the United States"

From Michael Perelman at EconoSpeak, a quote from Keynes:

A note from a careful observer of US financial conditions, by Michael Perelman: [pg.] 569: "I fancy that the great New York (banking) institutions have more skeletons in their cupboards than anyone yet knows about for certain, and that their concealed anxieties cramp their action more than is admitted."

Keynes. 1930. "A Note on Economic Conditions in the United States: A Memorandum for the Economic Advisory Council." CW 20, pp. 561-94.

links for 2007-11-27

November 27, 2007

Economist's View - 5 new articles

"The Problem with Forecasting House Prices"

Richard Green, a professor of real estate, finance and economics at the George Washington University, explains the sensitivity of housing prices to assumptions about the rate of appreciation. Small changes in expected appreciation can bring about much larger swings in current housing prices:

The problem with forecasting house prices, by Richard Green: The value of a house should, in equilibrium, be its capitalized rents. Its capitalization rate is (roughly) the after-tax required rate of return, plus depreciation and expenses less expected appreciation. We may write this out as:

r + m - pi.

The r and the m are relatively easy to measure. Households in the conventional conforming market can borrow at an after-tax mortgage rate of about 5 percent right now, and with very little equity, they can borrow at around 6 percent (the cost of interest plus mortgage insurance). Let's add a risk premium and put the total around 7 percent (this is probably a bit high). Depreciation and expenses will run around 2 percent of house value. So the value of a house is the value of its rent divided by 9 percent less expected appreciation.

Now let's see what happens when we let expectations about future prices range from an increase of 5 percent in a year to a decrease of 5 percent in a year. If expected prices increase five percent, values are 25 times rent (rent/.04); if the decrease 5 percent in a year, values are about 7 times rent. So a ten percentage point decline in expectations could cause house prices to fall by two-thirds.

I think this is part of the current problem. On the one hand, after roughly 2002, prices in many markets shot up well past the 25 to 1 point (on a quality adjusted basis), in part because of very low interest rates, and in part because of unrealistic expectations. Now that prices are falling (as inevitably they would), expectations have reversed, although it is not yet clear by how much.

Some months ago, when others were writing that the bottom was coming, I wrote that I didn't know when the bottom of the housing market was coming, and neither did anyone else. I wish I had been wrong.

Also see Richard's follow up to this post, "Long run vs Short run," [update] and "Three principles for avoiding future subprime messes."

Social Security and UFOs

Having recently taken on an editorial on Social Security by Ruth Marcus, I was going to let the latest Washington Post "the sky is falling" piece on Social Security and how it is headed for crisis pass by without comment (other than in the title I gave it in the daily links of "The Washington Post Continues to Promote the Lie that Social Security is Headed for a Crisis"), but on second thought, let's review. Here's Brad DeLong:

Hoisted from Comments: Low-Tech Cyclist Writes:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: I know bringing up Fred Hiatt is like shooting fish in a barrel on this score, but the WaPo has a subset of its unsigned editorials where it comments on what it calls "the ideas primary."

Five of the last seven Ideas Primary editorials have been on the Social Security 'crisis.' There have been 15 editorials in this series. One has been on global warming - the greatest crisis of our era - and two have been on our greatest domestic crisis, the lack of universal health care and the upcoming crisis in the Medicare trust fund. None have been on Iraq and the power vacuum we've created in the center of the Middle East. Interesting set of priorities, huh?

The most recent piece in the Washington Post on the "crisis" isn't from their "Ideas Primary," but it's just as bad. Dean Baker has the description:

Main THE UFOs Are Back at the Post (literally), by Dean Baker: I praised the Post a couple of weeks ago for printing a coherent column by Robert Ball in support of protecting the current level of Social Security benefits. This was an extraordinary departure from its never-ending drumbeat of SS crisis news stories, columns, and editorials.

Since that day, the Post has run a strange column by Ruth Marcus, a former editor, that seemed to attack Paul Krugman for changing his mind on Social Security. In another forum, I quipped about this column that "the UFOs have landed," referring to a nutty effort to discredit Social Security by claiming that more young people believe in UFOs than they will receive a Social Security check.

Well, today the Post actually has the UFO story in its full glory. It appears in an oped column by Amity Shales which is apparently further payback for the Robert Ball column. It looks like we must pay a high price for this modest dissent from the Post's dogma on the SS crisis.

On the substance, I am not quite sure why the opponents of SS believe that the effectiveness of their lies is a basis for gutting the program. This would be comparable to claiming that tens of millions of people believe that Saddam was responsible for September 11th, therefore we should invade Iraq. The fact that the public has been so terribly misled on the financial condition of its most important social program (even if they don't actually believe in UFOs) is a strong argument for putting off any changes until the public can learn the true facts of the situation.

After all the basic issues about the SS program -- how much money it should provide in retirement, how much people should be taxed in their working years, and how late in life they should have to work -- are issues that should be decided democratically, not by people who control major media outlets. And the public cannot possibly make such decisions in an intelligent manner when they are being deliberately misinformed about the true financial status of the program.

Where did the misleading UFO story come from? Here's President Bush on February 10, 2005 giving what was a standard speech at the time:

THE PRESIDENT: ...Somebody was telling me the other day ... he read an interesting poll; he said that a lot of younger workers felt like they're more likely to see a UFO than get a Social Security check. (Laughter.) It's an interesting dynamic, isn't it, when you think about it? There are a lot of young people, when they analyze Social Security and think about it, that they just don't think the government can fulfill the promise, which is a powerful -- it's powerful leverage for members of Congress to listen to.

In other words, the dynamic has shifted. The reason people are comfortable about taking on the Social Security issue..., there's a lot of folks out there who are demanding change -- for their sake. They're saying, what are you going to do about saving the system for me? I'm coming up; I have a better chance of seeing a UFO than getting a check from the government. What are you and the government going to do to make sure I get my check? That's the dynamic that's happening.

And that's why I'm optimistic something is going to get done, because people are beginning to speak out. Younger Americans who understand the math and know the reality are beginning to say to those of us who have been elected, what are you going to do about it? You're up there in Washington, D.C. -- do more than just occupy the office, solve problems and do your job. (Applause.)

I think the last quote should be:

Younger Americans who understand the math and know the reality are beginning to say to those of us who have been elected, why are you lying to us about it? (Applause.)

Why is the Washington Post participating in this attempt to mislead people about the nature of the problem? Brad DeLong is right:

Without major personnel changes, I give the Washington Post five years.

Paul Krugman: Winter of Our Discontent

Why are people so unhappy with the economy?

Winter of Our Discontent, by Paul Krugman, Commentary, NY Times: "Americans' Economic Pessimism Reaches Record High." That's the headline on a recent Gallup report, which shows a nation deeply unhappy with the state of the economy. Right now, ... "an extraordinary 78% of Americans now say the economy is getting worse, while a scant 13% say it is getting better."

What's really remarkable about this dismal outlook is that the economy isn't (yet?) in recession, and consumers haven't yet felt the full effects of $98 oil (wait until they see this winter's heating bills) or the plunging dollar, which will raise the prices of imported goods.

The response of those who support the Bush administration's economic policies is to ... rattle off statistics... Many of these statistics are misleading or irrelevant, but it's true that the official unemployment rate is fairly low... So why are people so unhappy?

The answer from Bush supporters — who are, on this and other matters, a strikingly whiny bunch — is to blame the "liberal media" for failing to report the good news. But the real explanation ... is that whatever good economic news there is hasn't translated into gains for most working Americans.

One way to drive this point home is to compare the situation for workers today with that in the late 1990s, when the country's economic optimism was almost as remarkable as its pessimism today. ...

The unemployment rate in 1998 was only slightly lower than ... today. But for working Americans, everything else was different. Wages were rising, yet inflation was low, so the purchasing power of workers' take-home pay was steadily improving. So, too, were job benefits, including the availability of health insurance. And homeownership was rising steadily.

It was, in other words, a time when Americans felt they were sharing in the country's prosperity.

Today, by contrast, wage gains for most workers are being swallowed by inflation. ... Meanwhile, the percentage of Americans receiving health insurance from their employers ... is continuing its downward trend. And homeownership... — well, you know how that's going.

In short, working Americans have very good reason to feel unhappy about the state of the economy. But what will it take to make their situation better?

The leading Republican candidates for president don't even seem to realize that there's a problem. A few months ago Rudy Giuliani, denouncing Hillary Clinton's economic proposals, declared that "she wants to go back to the 1990s" — as if that would be a bad thing. ...

But simply putting another Clinton, or any Democrat, in the White House won't ensure that the good times will roll again. President Clinton was a good economic manager, but much of the good news during the 1990s reflected events that won't be repeated, including low oil prices and ... the temporary leveling off of health care spending ...

And there are good reasons to think that the negative effects of globalization on the wages of some Americans are larger than they were in the '90s. That's a hugely contentious issue within the progressive movement, with no easy resolution. ...

Despite these caveats, Democrats have every right to make a political issue out of the failure of the Bush economy to deliver gains to working Americans — especially because conservatives continue to insist that tax cuts for the affluent are the answer to all problems.

But Democrats shouldn't kid themselves into believing that this will be easy. The next president won't be able to deliver another era of good times unless he or she manages to tackle the longer-term trends that underlie today's economic disappointment: a collapsing health care system and inexorably rising inequality.

Fed Watch: Long Run Forecast vs. Short Run Reality

Will the Fed cut rates further, or pause at the next meeting?:

Long Run Forecast Vs. Short Run Reality, by Tim Duy: Recent Fedspeak has, in my opinion, been very clear – current policy is balanced and the bar for another rate cut in December is set high. Only evidence that growth will be substantially below already low expectations would prompt a rate cut. The minutes of the last meeting, however, present a puzzle. There was apparently lengthy discussion of downside risks, yet the final decision was supposedly a "close call." And despite these numerous downside risks, and a positive trajectory for inflation, the statement defined policy as roughly neutral. The mix of signals leaves perfectly reasonable people with completely opposing opinions about the Fed's intentions for future policy. One can read the minutes and find reason for pause, but also find a risk management motivation for another cut.

How can we resolve recent Fedspeak, the minutes, and the growth forecasts? Thinking on that question occupied a good part of the long holiday weekend. It appears that the Fed is preparing market participants for a pause in rate cuts before the economy has bottomed out. They would like December to be an opportunity for a pause. But assuming the continuing instability in financial markets, I suspect they will not be willing to risk a pause just yet.

One purpose of increasing transparency via the enhanced forecasts is to minimize the fluctuations of policy. I doubt anyone believes that wide swings in policy – such as the drop to 1% and the subsequent rise to 5.25% - are conducive to economic stability in the long-run. The long run forecast, both for growth and inflation, are intended to create a policy anchor from which the Fed can tie the economy with a short tether.

The Fed's long term forecast suggests they see the economy's potential growth rate near 2.5%. This reflects a combination of slower productivity and labor force growth. The inflation forecasts reveal an inflation target of 1.6% to 1.9%, with a midpoint of 1.75%. Combined, this suggests a range of the neutral fund funds rate at roughly 4.0% to 4.5%, with the current rate at the top end of this range. Hence, given this estimate of neutral, the Fed can reasonably conclude that current policy will "promote moderate growth over time" and that the risks to growth and inflation are equally balanced.

You might argue that given we are at that high end of the range, policy remains a tad bit tight relative to neutral. True enough, although the Fed might have cause to expect that ongoing high headline inflation deserves extra attention. From the minutes:

Participants were concerned that if headline inflation remained above core measures for a sustained period, then longer-term inflation expectations could move higher, a development that could lead to greater inflation pressures over the longer term and be costly to reverse.

Still, 25bp is not worth quibbling over – the point is that we are in the Fed's estimated neutral range, the range of policy intended to hit the Fed's long term goals. This, of course, has been the point of recent Fedspeak – their forecast implies a "rough patch" in the short run, but they are looking to the other side of that patch. They want us to look to the other side as well.

The Fed wants market participants to look to the other side because they do not want policy to stray too far from their neutral range. They do not want current policy to breed conditions that foster future instability, such as, for example, an extended period of ultra low interest rates that supports an asset price bubble. In order to keep current policy tethered to the long run anchor, the Fed needs to shift policy before the need is obviously evident. Which means doing something that might be surprising to market participants, such as pausing when inflation trends may still be on the uptrend (sound familiar?). Or, what is likely most challenging, pausing in an easing cycle when the economy remains weak.

Of course, it is the latter situation that the Fed is facing. Policymakers intend to pause at a time that may be somewhat "uncomfortable," when it is not clear the economy has reverted to its upward trend. Convincing market participants, however, that they are not going to cut rates until the skies are blue again is a challenge for a number of reasons:

1. The previous easing cycle was deep and prolonged, setting expectations for how an asset bubble burst should be managed.

2. The Fed came out of the gate with a 50bp cut in a high growth quarter, suggesting a willingness to cut deep.

3. The Fed consistently downplayed the risks of the housing bubble to the general economy, and now has some credibility issues when it comes to judging the extent of the downside risks.

Consequently, policymakers feel inclined to keep up the tough talk, reminding investors not to lose sight of the long term forecast. This creates the stage so that when the financial and economic conditions become conducive for a policy shift, expectations will swing in that direction.

There is, of course, some credibility risk for the Fed in repeatedly stating their benign forecast if they keep cutting rates. That is the current situation, as it appears that conditions are not conducive for a pause in December. That is what markets participants are saying by betting on continued rate cuts, effectively ignoring the steady stream of hawkish Fedspeak.

To be sure, the Fed could simply ignore market participants and surprise with a pause, but if financial markets keep deteriorating over the next two weeks, I don't think they will risk a surprise. From the minutes:

Participants generally viewed financial markets as still fragile and were concerned that an adverse shock—such as a sharp deterioration in credit quality or disclosure of unusually large and unanticipated losses—could further dent investor confidence and significantly increase the downside risks to the economy.

While the Fed would never say they were driven by market expectations, they also know that failing to meet the expectation of a rate cut is the same thing as an "adverse shock." There is a time and a place for a credibility building negative shock, but I doubt the Fed believes that that time is now. That is the risk management side of policy.

But that time will come – the Fed will continue to remind us of the long term forecast to keep us ready for that time. I believe the Fed intends to avoid a repeat of their response to tech bubble collapse, which means we are not on a runaway rate cut train. But the train is not ready to stop just yet.

Bottom Line: The conflict between the long term outlook and the short term risks leaves this once again a close call. Although the Fed would be happy to pause, recent deterioration in financials markets, including a flight to quality that threatens to push the 10 year rate below 4%, will make it difficult for the Fed to follow through on their hawkish rhetoric. But there is a point to the rhetoric – to keep us focused on the future, which the Fed can affect, not the present, which is already written in stone. The Fed will leap at the first opportunity to pause. For December to be that opportunity, markets need to stabilize and data need to conform to the Fed forecast.

links for 2007-11-26