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October 2, 2009

Economist's View - 6 new articles

Do Regulators Have Distorted Incentives?: Beatrice Weder di Mauro Roundtable at Free Exchange

I'm participating in a roundtable discussion at Free Exchange. The lead article by Beatrice Weder di Mauro argues that regulators need better incentives:

Here's my response:

Here are other responses:


"Another Bad Employment Report"

Brad DeLong on the discouraging employment report released today. As the three posts that follow this one attest, this was not a surprise. But as Brad notes, even though we could see this coming, we do not have the plans in place that are needed to respond to the continuing weakness in labor markets:

Another Bad Employment Report (I-Wish-We-Had-a-Ripcord-to-Pull Department), by Brad DeLong: The adult civilian employment-to-population ratio drops below 59% to 58.8%, down from a December 2006 peak of 63.4% (and am April 2000 peak of 64.7%) [graph]...

God! I really wish that I were not so smart!

Brad DeLong, March 25, 2009:

The Stimulus Package Looks a Lot Smaller Now...: We are going to need a bigger one in September, which means it has to be put into the budget resolution now...

Well, we didn't. And now when it would be very nice to have a very large state aid program ready to be dropped into the fall reconciliation bill--and when it would be very nice to have a government-paid health corps starting up now as part of health care reform--we don't. ...

More commentary:

What Larry Mishel said:

The... employment decline, down 263,000, is still far below the awful hemorrhaging in the winter months.... The revisions announced to last March's employment level—payroll employment was an astounding 824,000... shows the huge hole we have been thrown into. That, of course, can't be blamed on Obama!...

[T]he drop in the labor force of 571,000 is the only reason that unemployment didn't exceed 10.0% [last] month.... Also amazing is that the nation's labor force—those employed or seeking work-declined by 615,000, or 0.4% over the last twelve months when normally we would expect it to rise by at least 1%...

What Dean Baker said:

The loss of 263,000 payroll jobs, coupled with a 0.1 hour decline in the average workweek, pushed the index of aggregate hours to 98.5, slightly below the 98.6 level in December of 1998. Hours worked have now declined by 8.6 percent from the pre-recession peak. In the 1981-81 recession the decline from peak to trough was 5.8 percent. The loss of jobs also pushed the unemployment rate to 9.8 percent....

The government sector lost 53,000 jobs in September... at the state and local level... 47,000... lost jobs.... The construction sector continued its rapid pace of job loss, shedding 64,000 jobs in September.... Manufacturing lost another 51,000 jobs.... Wage growth continues to weaken with wages rising at just a 1.7 percent nominal rate over the last quarter, almost certainly less than the rate of inflation.

The Bureau of Labor Statistics (BLS) reported its preliminary benchmark revisions to the establishment survey data... employment in March of 2009 was 824,000 lower than originally reported with private sector employment 855,000 lower. This extraordinarily large downward revision is not surprising... the imputation for new firms not included in the survey was consistently larger than the imputation from the prior year when the economy was still growing.... [T]he economy has lost 8,029,000 [payroll] jobs in the downturn....

[A] turnaround in the labor market is not imminent. Continuing losses of jobs and declines in hours, coupled with stagnant or declining real wages, means that workers' purchasing power is still falling. There are no further tax breaks scheduled to boost demand and state and local governments are cutting back and raising taxes to address budget shortfalls. The future is not good.

Kristin Winkler Krapja:

New orders for manufactured goods declined 0.8% in August...

Alan Rappeport:

US unemployment rate hits 9.8%: The US unemployment rate climbed to a fresh 26-year high of 9.8 per cent in September, as the pain of recession continues to linger on the shoulders of American workers in spite of aggressive measures to stimulate the economy. Official figures on Friday showed that non-farm payrolls dropped by 263,000, making it the 21st consecutive month that the US economy has shed jobs. The data were worse than even the most grim expectations, as economists predicted a 175,000 drop in payrolls, and followed a decline of a revised 201,000 jobs in August when the unemployment rate was 9.7 per cent. "It is clear that the labour market is still very weak," said Paul Dales, US economist at Capital Economics. "The last time one in ten members of the labour force were out of work was in 1983."...

The US unemployment rate has more than doubled in the past two years and the number of people without jobs has risen by 7.6m to 15.1m since the recession began in December 2007.... In September, hourly earnings ticked up by a penny to $18.67, but the average work week, a closely watched measure that signals future hiring, slid back to 33 hours. This remains close to a record low and economists suggest that an expansion in working hours will have to come before new hiring begins. "Hourly earnings are soft, reinforcing a view that the short term problem is disinflation not inflation, and does not support a consumer spending rebound," said Alan Ruskin, a strategist at RBS Greenwich Capital.

The labour department figures come as analysts project that the US economy grew at an adjusted annual rate of 3 per cent in the just completed third quarter. Fears abound, however, over a "jobless recovery", where companies that have become acclimated to operating with fewer workers are slow to begin rehiring and where employment lags the rest of the economy. Ben Bernanke, chairman of the Federal Reserve, said on Thursday that even if the economy expands at a rate of 3 per cent, that will not be enough to chip away at the unemployment rate, which is expected to rise above 10 per cent before falling back next year. Mr Bernanke has pointed to rising levels of long-term unemployment – of six months or more – as another looming risk to the labour force, as workers begin to see their skills erode. In September, 5.4m Americans had been unemployed for more than six months, representing 35.6 per cent of those who were unemployed....

Other indicators have added to the argument that unemployment will remain stubbornly high. New jobless claims have been mounting at a clip of around 500,000 a week, the rebound in manufacturing activity appears to be sputtering and the latest Conference Board survey found that more people feel like jobs are hard to get...

The U-6 underemployment rate--"total unemployed, plus all marginally-attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally-attached workers--is 17.0%.

See also Record Drop in Education Jobs, by Michael Mandel; Employment Report, by spencer; Employment Report, by Calculated Risk; Unemployment Numbers Still Point to Partial Recovery, by Edward Harrison ; An Upside Down Employment Report, by Andrew Samwick; The Job Numbers for September, by Robert Reich


Paul Krugman: Mission Not Accomplished

If we don't do more to promote recovery, the human and economic costs will be large:

Mission Not Accomplished, by Paul Krugman, Commentary, NY Times: Stocks are up. Ben Bernanke says that the recession is over. And I sense a growing willingness among movers and shakers to declare "Mission Accomplished" when it comes to fighting the slump. It's time, I keep hearing, to shift our focus from economic stimulus to the budget deficit.
No, it isn't. ... Yes, the Federal Reserve and the Obama administration have pulled us "back from the brink" — the title of a new paper by Christina Romer, who ... argues convincingly that expansionary policy saved us from a possible replay of the Great Depression.
But while not having another depression is a good thing, all indications are that unless the government does much more than is currently planned..., the job market ... will remain terrible for years to come. Indeed, the administration's own economic projection ... is that the unemployment rate ... will average 9.8 percent in 2010, 8.6 percent in 2011, and 7.7 percent in 2012.
This should not be considered an acceptable outlook. For one thing, it implies an enormous amount of suffering over the next few years. ... John Irons of the Economic Policy Institute ... points out that sustained unemployment on the scale now being predicted would lead to a huge rise in child poverty — and that there's overwhelming evidence that children who grow up in poverty are alarmingly likely to lead blighted lives.
These human costs should be our main concern, but the dollars and cents implications are also dire. Projections by the Congressional Budget Office, for example, imply that over the period from 2010 to 2013 — that is, not counting the losses we've already suffered — the ... difference between the amount the economy could have produced and the amount it actually produces, will be more than $2 trillion. That's trillions of dollars of productive potential going to waste.
Wait. It gets worse. A new report from the International Monetary Fund shows that the kind of recession we've had, a recession caused by a financial crisis, often leads to long-term damage to a country's growth prospects. ...
The same report, however, suggests that ... a temporary increase in government spending — "is significantly associated with smaller medium-term output losses."
So we should be doing much more than we are to promote economic recovery, not just because it would reduce our current pain, but also because it would improve our long-run prospects.
But can we afford to do more...? Yes, we can.
The conventional wisdom is that trying to help the economy now produces short-term gain at the expense of long-term pain. But as I've just pointed out,... that's not at all how it works. The slump is doing long-term damage to our economy and society, and mitigating that slump will lead to a better future.
What is true is that spending more on recovery ... would worsen the government's own fiscal position. But even there, conventional wisdom greatly overstates the case. The true fiscal costs of supporting the economy are surprisingly small.
You see, spending money now means a stronger economy, both in the short run and in the long run. And a stronger economy means more revenues... Back-of-the-envelope calculations suggest that the offset falls short of 100 percent, so that fiscal stimulus isn't a complete free lunch. But it costs far less than you'd think from listening to what passes for informed discussion.
Look, I know more stimulus is a hard sell politically. But it's urgently needed. The question shouldn't be whether we can afford to do more to promote recovery. It should be whether we can afford not to. And the answer is no.


"The Truth About Jobs"

Robert Reich joins the call for the government to do more to promote recovery:

The Truth About Jobs That No One Wants To Tell You, by Robert Reich: Unemployment will almost certainly in double-digits next year -- and may remain there for some time. And for every person who shows up as unemployed in the Bureau of Labor Statistics' household survey, you can bet there's another either too discouraged to look for work or working part time who'd rather have a full-time job or else taking home less pay than before... And there's yet another person who's more fearful that he or she will be next to lose a job.
In other words, ten percent unemployment really means twenty percent underemployment or anxious employment. All of which translates directly into late payments on mortgages, credit cards, auto and student loans, and loss of health insurance. It also means sleeplessness for tens of millions of Americans. And, of course, fewer purchases...
Which brings us to the obvious question: Who's going to buy the stuff we make or the services we provide, and therefore bring jobs back? There's only one buyer left: The government. Let me say this as clearly and forcefully as I can: The federal government should be spending even more than it already is on roads and bridges and schools and parks and everything else we need. It should make up for cutbacks at the state level, and then some. This is the only way to put Americans back to work. We did it during the Depression. It was called the WPA. Yes, I know. Our government is already deep in debt. But let me tell you something: When one out of six Americans is unemployed or underemployed, this is no time to worry about the debt. When I was a small boy my father told me that I and my kids and my grand-kids would be paying down the debt created by Franklin D. Roosevelt during the Depression and World War II. ... My father was right about a lot of things, but he was wrong about this. America paid down FDR's debt in the 1950s, when Americans went back to work, when the economy was growing again... We paid taxes, and in a few years that FDR debt had shrunk to almost nothing. You see? The most important thing right now is getting the jobs back, and getting the economy growing again. People who now obsess about government debt have it backwards. The problem isn't the debt. The problem is just the opposite. It's that at a time like this, when consumers and businesses and exports can't do it, government has to spend more to get Americans back to work and recharge the economy. Then – after people are working and the economy is growing – we can pay down that debt. But if government doesn't spend more right now and get Americans back to work, we could be out of work for years. And the debt will be with us even longer. And politics could get much uglier.


Fed Watch: Hawkishness Dominates

Continuing with the same theme, but with monetary rather than fiscal policy, Tim Duy is worried about unwarranted hawkishness:

Hawkishness Dominates, by Tim Duy: As I await the employment report, I am reflecting on the flow of information over the past week and find myself somewhat dismayed by the apparent policy implications. The spate of FedSpeak in recent days leaves one with the uneasy feeling that monetary policymakers are more willing to use unconventional monetary policy to support Wall Street than Main Street. The most hawkish appear eager to normalize policy at the earliest opportunity possible, and even the dovish, grasping onto green shoots, appear to think they have done enough to support recovery. It is as if the FOMC has concluded that the risks are now entirely one-sided toward inflation. To be sure, Bernanke & Co. have shifted direction often during the past two years. But the FOMC looks to be developing something of a blind spot with regard to downside risks to the economy, suggesting that even if the economy stagnates in a jobless recovery, the bar to further easing is very high.
Governor Kevin Warsh fired the shot across the bow last week, first with a Wall Street Journal op-ed, followed by a speech that included the key paragraphs:
Ultimately, when the decision is made to remove policy accommodation further, prudent risk management may prescribe that it be accomplished with greater swiftness than is modern central bank custom. The Federal Reserve acted preemptively in providing monetary stimulus, especially in early 2008 when the economy appeared on an uneven, uncertain trajectory. If the economy were to turn up smartly and durably, policy might need to be unwound with the resolve equal to that in the accommodation phase. That is, the speed and force of the action ahead may bear some corresponding symmetry to the path that preceded it. Of course, if the economy remains mired in weak economic conditions, and inflation and inflation expectation measures are firmly anchored, then policy could remain highly accommodative.
"Whatever it takes" is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If "whatever it takes" was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Fed's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.
While Warsh does note that weak economic conditions would defer tightening, the message is clear: we are looking to tighten, and will do so aggressively when economic activity firms. Moreover, we will do so preemptively, which means we are looking for opportunities prior to the emergence of very solid data.
Note one of the concerns identified by Warsh:
In my view, if policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal--and the economy has returned to self-sustaining trend growth--they will almost certainly have waited too long. A complication is the large volume of banking system reserves created by the nontraditional policy responses. There is a risk, of much debated magnitude, that the unusually high level of reserves, along with substantial liquid assets of the banking system, could fuel an unanticipated, excessive surge in lending. Predicting the conversion of excess reserves into credit is more difficult to judge due to the changes in the credit channel.
Are we really worried about a lending explosion by itself, or that the regulatory environment remains so weak that financial institutions will quickly repeat the experience of this decade's debt bubble? Considering the question always draws me back to this chart, which for me epitomizes the difference between the 1990s and the 2000s:
The 1990s saw a remarkable period of sustained, high levels of investment in equipment and software. In contrast, a sustained period of very low interest rates during this decade was barely able to coerce firms to invest in the high single digits. That, in my mind, is a critical problem, reflecting low expected returns to capital investment. In effect, the policy error might not have been low rates. Indeed, rates do not look to have been low enough to stimulate sufficient investment demand to absorb the productive capacity of the nation, the classic Keynesian problem:
This analysis supplies us with an explanation of the paradox of poverty in the midst of plenty. For the mere existence of an insufficiency of effective demand may, and often will, bring the increase of employment to a standstill before a level of full employment has been reached. The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.
Moreover the richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then, in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.
But worse still. Not only is the marginal propensity to consume weaker in a wealthy community, but, owing to its accumulation of capital being already larger, the opportunities for further investment are less attractive unless the rate of interest falls at a sufficiently rapid rate....
With the primary build out of the internet backbone complete, the US appeared to experience a dearth of traditional investment opportunities (I suspect that the need to expand production domestically was made moot by an international financial arrangement that favored the establishment of productive capacity overseas), and, like water flowing downhill, capital was thus allocated this decade to residential investment, which, we now know was more about consumption than investment, and the resulting economic activity was anemic by historical standards.
This line of argument leads one to believe that withdrawing monetary stimulus would be a significant policy error, especially if investment growth remains constrained as we saw this decade. In fact, it would lend additional credence to reports that the Fed needs to do much, much more - a massive, unsterilized expansion of the balance sheet - should they even hope to stimulate sufficient investment demand to absorb underutilized labor. Instead, FOMC members appear to be concerned that stimulative policy will be the root cause of the next financial crisis. That, however, appears to me to confuse monetary with regulatory policy. The former should speak to inducement to invest, while the latter speaks to protecting against significant misallocations of capital.
Following the Warsh speech, Vice Chair Donald Kohn looked to tamp down expectations of an imminent rise in rates:
Although economic conditions have apparently begun to improve--partly in response to the extraordinary steps the Federal Reserve and other authorities have taken--resource utilization is quite low, inflation is subdued, and continuing restraints on credit are likely to constrain the speed of recovery. For that reason, as the FOMC stated last week, exceptionally low interest rates are likely to be warranted for an extended period. Given the highly unusual economic and financial circumstances, judging when the time is appropriate to remove policy accommodation, and then calibrating that removal, will be challenging. Still, we need to be ready to take the necessary actions when the time comes, and we will be.
Still, like Warsh, Kohn looks determined to find an opportunity to remove accommodation. This despite expected high rates of unemployment. From Bloomberg:
Federal Reserve Chairman Ben S. Bernanke said U.S. economic growth next year probably won't be strong enough to "substantially" bring down the jobless rate, which may remain above 9 percent at the end of 2010.
"Most forecasters including the Fed are currently looking at growth in 2010, but not growth so rapid as to substantially lower the unemployment rate," Bernanke said in response to questions at a House Financial Services Committee hearing today in Washington. Growth of 3 percent means the rate would "still probably be above 9 percent by the end of 2010," Bernanke said.
Interesting how the Fed is encouraging expectations of policy withdrawal even though unemployment rates will remain unacceptably high through 2010. And, if above 9 percent at the end of next year, certainly unacceptably high during 2011 as well. Richmond Federal Reserve President Jeffrey Lacker even goes one step further in a Bloomberg interview:
The Federal Reserve will need to raise interest rates when the economic recovery is "firmly" in place, even if unemployment lingers near 10 percent, Federal Reserve Bank of Richmond President Jeffrey Lacker said.
"I am going to be looking for when growth reestablishes itself firmly enough that it is clear real interest rates need to rise," Lacker said today in a Bloomberg Radio interview. "I think the growth outlook, particularly the consumer spending outlook, are more fundamental than labor-market conditions."
Seriously, raising rates even if unemployment is 10%? LACKER SAYS THIS ON THE DAY WE GET CORE PCE INFLATION SLIDING TO 1.3% Y-O-Y! This redefines the term "hawk."
From where does this fear of inflation emanate? That brings us to perma-hawk Philadelphia Fed President Charles Plosser:
Unfortunately, slack was poorly measured and turned out to be not as significant as first estimated. Thus, the Fed's monetary expansion led to rising inflation for the balance of the 1970s. One lesson learned during this episode is that inflation expectations can matter a great deal, and if they become unanchored — that is, if the public comes to believe that the Fed will not do what is necessary to preserve price stability — then inflation can rise quickly regardless of the amount of so-called slack in the economy. The price we paid to regain control of inflation and the Fed's credibility to do so came in the form of the 1981-82 recession and was a steep one.
Consequently, just as the Fed has taken aggressive steps in flooding the financial markets with liquidity during this crisis to reduce the possibility of a second Great Depression, it will also have to take the necessary steps to prevent a second Great Inflation. Our credibility depends on it. As the economy and financial markets improve, the Fed will need to exit from this period of extraordinarily low interest rates and large amounts of liquidity. We recognize the costs that significantly higher inflation and the ensuing loss of credibility will impose on the economy if we fail to act promptly, and perhaps aggressively, when the time comes to do so. The Fed will need courage because I believe we will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels. The issues of when and the pace at which we unwind the extraordinary measures taken during the financial crisis and recession are ones that are high on my list of priorities and are the subject of ongoing discussions within the Fed.
The experience of the 1970s is such a tired and faulted analogy. To generate a wage-price inflation spiral, you need to explain the mechanism by which rising inflation expectations (which don't exist anyway) get translated into high wages. I do not see that current institutional arrangements in the US allow this; nor do we see it in the data:
One could at least wait for significant - or any, for that matter - year over year gains in unit labor costs before declaring that we are at the doorstep of the 1970's. Moreover, the seeds of that inflation did not sprout overnight; the signs were evident but ignored in the late 1960's. Only in Plosser's mind exists the need for an imminent withdrawal of policy.
Bottom Line: The data this week has not been supportive of a rapid exit from accommodative policy. Indeed, the opposite could very well be the case. Despite this, Fed officials, albeit to varying degrees, are uniformly signaling that the actions to expand the balance sheet are only temporary and will be reversed absolutely as soon as possible, which only undermines the stimulative potential of those actions. This is definitely not quantitative easing, and uncomfortably harkens back to the fear of inflation that constrained policy at the Bank of Japan. It is interesting that Fed Chairman Ben Bernanke has worked so hard to avoid a repeat of that experience yet appears ready to risk repeating it nonetheless.


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