This site has moved to
The posts below are backup copies from the new site.

July 9, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: Pity the Poor C.E.O.’s

Posted: 09 Jul 2010 12:42 AM PDT

Why are businesses so reluctant to invest? Is it because of an antibusiness climate? Yes, but the climate wasn't created by the Obama administration. The people who directly or indirectly blew up the financial system -- something that happened before Obama took office -- are the ones responsible for the discouraging climate that is making firms so unwilling to expand their operations. There is a political attempt to place the blame for the lack of investment on the administration, but there's nothing of substance to support -- and plenty to refute -- the claims being made by the lobbyists behind this effort:

Pity the Poor C.E.O.'s, by Paul Krugman, Commentary, NY Times: Job creation has been disappointing, but first-quarter corporate profits were up 44 percent from a year earlier. Consumers are nervous, but the Dow, which was below 8,000 on the day President Obama was inaugurated, is now over 10,000. In a rational universe, American business would be very happy with Mr. Obama.
But no. All the buzz lately is that the Obama administration is "antibusiness." And there are widespread claims that fears about taxes, regulation and budget deficits are holding down business spending and blocking economic recovery.
How much truth is there to these claims? None. Business spending is indeed low, but no lower than one would have expected given widespread overcapacity and weak consumer spending. ... After all, why should businesses expand ... when they're not selling enough to use the capacity they already have? And in case you haven't noticed, we still have a deeply depressed economy.
Historically, there has been a close relationship between ... business investment and the "output gap"... — ... there's nothing surprising about low investment now, given ... that the output gap is hugely negative. If anything, it's surprising how well business investment has been holding up.
Alternatively, we can look directly at measures of unused business capacity. Capacity utilization ... is ... still far below historical norms. Vacancy rates at industrial and retail properties are at historic highs. Again, given that businesses have plenty of idle structures and machines, why should they be building or buying even more? ...
The ... Obama's-socialist-policies-are-wrecking-the-economy chorus isn't coming from businesses; it's coming from business lobbyists... Read the report on the U.S. Chamber of Commerce in the latest Washington Monthly: peddling scare stories about ... Democrats ... is a large part of what organizations like the chamber do for a living.
Or read through the latest survey of small business trends by the National Federation for Independent Business, an advocacy group. The commentary at the front of the report is largely a diatribe against government — "Washington is applying leeches and performing blood-letting as a cure" — and you might naïvely imagine that this diatribe reflects what the surveyed businesses said. But while a few businesses declared that the political climate was deterring expansion, they were vastly outnumbered by those citing a poor economy.
The charts at the back of the report ... are even more revealing. It turns out that business is less concerned about taxes and regulation than during the 1990s, an era of booming investment. Concerns about poor sales, on the other hand, have surged. The weak economy, not fear about government actions, is what's holding investment down.
So why are we hearing so much about the alleged harm being inflicted by an antibusiness climate? For the most part it's the same old, same old: lobbyists trying to bully Washington into cutting taxes and dismantling regulations, while extracting bigger fees from their clients along the way.
Beyond that, business leaders are ... feeling unloved: the financial crisis, health insurance scandals, and the catastrophe in the Gulf of Mexico have taken a toll on their reputation. Somehow, however, rather than blaming their peers for bad behavior, C.E.O.'s blame Mr. Obama for "demonizing" business — by which they apparently mean speaking frankly about the culpability of the guilty parties.
Well, C.E.O.'s are people, too — but soothing their hurt feelings isn't a priority right now, and it has nothing at all to do with promoting economic recovery. If we want stronger business spending, we need to give businesses a reason to spend. And to do that, the government needs to start doing more, not less, to promote overall economic recovery.

Fed Watch: What is the Threshold For More Fed Action?

Posted: 09 Jul 2010 12:33 AM PDT

Tim Duy says the Fed talks a lot, but the threshold for action is pretty high:

What is the Threshold For More Fed Action?, by Tim Duy: Yesterday's Washington Post article suggesting the Fed was moving closer to additional policy action left me somewhat puzzled. It left out a critical piece. What is the threshold for additional action? Particularly any action of significance? Recent Fedspeak suggests the threshold is pretty high - financial crisis high. Otherwise, any action is likely to be more window dressing than anything else.

Neil Irwin at the Post claims:

Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.

Note the rhetorical claim suggesting this article is sourced by "top Fed officials." But the only officials cited are St. Louis Fed President James Bullard and Boston Fed President Eric Rosengren. No one from the Board, interestingly. To be sure, Bullard is an intellectual heavy hitter. But Bullard can be difficult to read. He talks. A lot. But with Bullard, the Post reduces his quotes to pretty pedestrian stuff:

"If the economic situation changes, policy should react," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. "You shouldn't sit on your hands. . . . I think there's plenty more we could do if we had to."

Surprising. I have to imagine that Bullard provided a lot of good quotes. And Irwin doesn't appear to challenge Bullard to explain how much the economic situation needs to change to prompt a policy change. But, luckily, Bullard gave an interview to Reuters at the end of June, and reporter Mark Felsenthal gave us a little more to work with. Yes, this is not new news. Just new for the Post.

For me, the Reuters piece had three main takeaways. First, Bullard and his colleagues underestimated the likelihood of a jobless recovery:

"We just started getting our job growth going three months ago, and then all of sudden we get a kind of a weaker number," said Bullard, who is a voter this year on the Fed's policy-setting panel. Nonfarm payrolls added a disappointing 41,000 private sector jobs in May, denting hopes for a speedy recovery.

Second, and related, the Fed actually believes we are experiencing a typical post-war recession in which output rapidly returns to trend:

Setting aside worries raised by softer economic indicators and Europe, the Fed continues to envision a moderate recovery, Bullard said.

"We would expect ... at some point start to gradually withdraw the accommodation and then things would continue to recover, and then eventually we would get back to normal," he said.

Does the Fed really fail to realize that the only reason the US economy returned to "normal" after the last recession was attributable to a housing bubble that was unsustainable? A topic for another time. Finally, the threshold for meaningful additional action is very, very high:

However, if the economy takes a decisive turn for the worse, the Fed would have to consider further stimulus, probably buying more Treasury securities to ease financial conditions, Bullard said.

"If things got really bad in some dimension and we were back in crisis mode, I think the FOMC wouldn't hesitate to do more if we had to, but I don't really think that that's the situation we're in right now," he said.

Note: "back in crisis mode." Note: "ease financial conditions." Nothing like "to ease the pain of unemployment." Did Bullard say the same thing to Irwin? We don't know, because Irwin falls back on plain vanilla quotes.

Putting the pieces together, it appears the Fed is beginning to realize that economic activity will not bounce back rapidly, but there is little meaningful they are willing to do unless they are in crisis mode. And that analysis is based largely on interviews with a single Fed official. Other Fed officials appear even less likely to act. From Bloomberg over the weekend:

Two Federal Reserve policy makers differed on the strength of the U.S. consumer in Nikkei newspaper interviews, amid evidence that the recovery in the world's largest economy is slowing.

Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said consumer spending is "moderately strong" and along with business investment will help sustain the recovery, the Japanese newspaper quoted him as saying. Richard Fisher, president of the Dallas Fed, cited "cautious" households as a reason for a growth to cool in the second half.

The remarks reflect debate on the durability of the economy after reports last week showed private-sector payrolls rose less than forecast in June, consumer confidence slumped and manufacturing growth slowed. Fed officials last month retained a pledge to keep record-low interest rates for an "extended period" and signaled Europe's debt crisis may harm growth.

Lacker said he was comfortable with the current level of interest rates, according to Nikkei. Later this year it will be a "legitimate question" whether to drop the 'extended period' language and "think about raising rates," the newspaper reported him as saying.

Fisher said any tightening of monetary policy "depends on the course of the economy," according to the report. He said on June 4 that while it's not time for central bankers to tighten policy, they may be "getting closer" as the economy further expands this year.

Goodness, over the weekend, both Richmond Fed President Jeffrey Lacker and Dallas Fed President Richard Fisher were still looking forward to tightening policy. Of course, Fisher, similar to Bullard, likes to talk. Indeed, Fisher looks closer to Kansas City Fed President Thomas Hoenig:

Hoenig, 63, has been the sole policy maker to dissent this year from decisions of the Federal Open Market Committee, objecting four times to its pledge to keep interest rates at a record low for an "extended period."

He also said the central bank should dispose of assets accumulated while fighting the crisis "as reasonably as we can, as quickly as we can." While he has proposed raising the target for overnight loans among banks to 1 percent by September, Hoenig said in the interview that the timing "can be debated."

Fisher indicated there's little more the Fed can do after cutting interest rates to a record low in December 2008 and pumping more than $1 trillion into the financial system through asset purchases.

"We ought to be very careful about not going too far," he said. "Interest rates are zero. It's not the cost of money that's the issue."

One can only imagine what kind of crisis would prompt Hoenig for additional action. Something that would rapidly deteriorate to the guns and gold portfolio. Still waiting for someone from the Board to speak. Wait, yes they did. Fed Governor Kevin Warsh gave a rousing speech:

The Federal Reserve should be wary of the short-term allure of further asset purchases, said Fed governor Kevin Warsh on Monday. In a speech in Atlanta, Warsh set a high bar for his support of further asset purchases, saying he would need to be convinced the benefits of the purchases would outweigh the costs of "erosion of market functioning, perceptions of monetizing indebtedness, crowding-out of private buyers, or loss of central bank credibility."

Which gets to the crux of the issue. Realistically, to generate significant impacts at the zero bound, the Fed is going to have to commit to policies that look a lot like debt monetization. We are nowhere near that stage. Indeed, after two decades, the Bank of Japan is not there. Sure, maybe the Fed commits to a long term ZIRP (pretty much there already), buys mortgage backed assets to offset maturing securities, or, as a temporary response to a fresh crisis, expands the balance sheet a bit. But commit to a higher inflation target? Target long bond rates? Those actions likely require sustained, massive purchases of US Treasuries - a bridge too far to cross for policymakers who view central bank credibility as a one sided game. The only real policy error is inflation. Anything else is interesting, but not important.

A Response to Arnold Kling

Posted: 09 Jul 2010 12:24 AM PDT

Arnold Kling:

An Assignment for Mark Thoma: I would like for Mark or for Paul Krugman to write an essay on the topic of what would happen if tomorrow the Fed stopped paying interest on reserves. ... I would like for Mark or for Paul Krugman to write an essay on the topic of what would happen if tomorrow the Fed stopped paying interest on reserves.

I don't know if I can get a whole essay out of this. This is something the Fed is considering, but I don't think it would have a very large impact on economic activity. The reason is that I don't think the lack of investment activity, or loan activity more generally (a new report says consumer credit fell again), is due to a problem on the supply side. Banks have tightened up a bit as the economic outlook has deteriorated, but I believe the main problem is lack of loan demand. Here's one reason I hold this view:

How "discouraged" are small businesses? Insights from an Atlanta Fed small business lending survey, macroblog: ..[T]here is congressional debate going on about how to best aid small businesses and promote job growth. Many people have noted the decline in small business lending during the recession, and some have suggested proposals to give incentives to banks to increase their small business portfolios. But is a lack of willingness to lend to small businesses really what's behind the decline in small business lending? ...
We at the Federal Reserve Bank of Atlanta have ... noted the paucity of data in this area and have begun a series of small business credit surveys. ... [T]he results of our April 2010 survey suggest that demand-side factors may be the driving force behind lower levels of small business credit. ...

Based upon this and other indications that this is primarily a demand side problem, I am not convinced that lowering the interest rate on reserves from one quarter of a percent to zero will have much of an effect on investment activity. What we need is a reason for firms to want to invest, and that will require a much improved outlook for the economy, something that could be aided by the government providing additional stimulus to aggregate demand.

links for 2010-07-08

Posted: 08 Jul 2010 11:01 PM PDT

Don’t Expect Miracles from Monetary Policy

Posted: 08 Jul 2010 12:09 PM PDT

I have a new post at MoneyWatch:

Don't Expect Miracles from Monetary Policy

It responds, briefly, to today's report on new claims for unemployment insurance, but the main discussion follows up on a post from Paul Krugman and looks at how effective further monetary policy initiatives might be.

The "Obama Shock" Hypothesis "Seems Ridiculous"

Posted: 08 Jul 2010 11:07 AM PDT

What has happened to Ed Prescott?:

Stephen Williamson: ...Ed Prescott did pathbreaking work in the economics profession, and his Nobel prize is well-deserved. His work with Finn Kydland made macroeonomists more quantitatively disciplined, and serves as a benchmark for most of the work done in macro in the last 30 years, including New Keynesian economics, models with financial frictions, and incomplete markets models. However, I doubt that there were any people in the room yesterday who took Ed seriously. Ed's key points were: 1. Monetary policy does not matter. 2. Financial factors are the symptoms, not the causes, of the recent downturn. 3. The recession was due to an Obama shock, i.e. labor supply fell because US workers anticipate higher future taxes. Bob Hall suggested that this would require a Frisch labor supply elasticity of about 27, which seems ridiculous. However, Ed stuck to his guns and thus seemed - well, ridiculous. As a basic framework, the real business cycle model is obviously useful - you can't argue with a basic framework of preferences, endowments, technology, and optimal choice. I think we know by now, though, that financial factors have a lot to do with what we are measuring as TFP (total factor productivity). We certainly should not be listening to suggestions that central banks are irrelevant - these institutions can clearly reallocate resources in a big way when they want to.

Prescott isn't alone in pushing the "Obama shock" idea. The claim is that the recession is due to a labor supply shock where workers collective decide to work less due to one government program or another, or some type of technology shock. So good to see there's some pushback against the silly claims being made by adherents to the RBC model.

But there are also those who think the New Keynesian model is, well, silly. On this topic, see David Andolfato's criticism of the New Keynesian model and Nick Rowe's response.

One of the points David Andolfatto raises is the evidence for the sticky price assumption, but the discussion of the evidence for and against the sticky price assumption is a bit slim. I haven't had time to write up a response to David and Nick due to deadline pressure, but let me try to add to the discussion by repeating a summary of some of the evidence from a post from 2007 (this is also very far from an exhaustive accounting of the work on this issue, but hopefully it's representative):

...[This is] from a paper I read not too long ago. According to this work, the degree of rigidity in prices depends upon the level of aggregation examined, the degree of monopoly power, and the type of shock hitting firms:

Sticky Prices and Monetary Policy: Evidence from Disaggregated U.S. Data, by Jean Boivin, Marc Giannoni, Ilian Mihov , NBER WP 12824, January 2007 [open linkAbstract This paper disentangles fluctuations in disaggregated prices due to macroeconomic and sectoral conditions using a factor-augmented vector autoregression estimated on a large data set. On the basis of this estimation, we establish eight facts: (1) Macroeconomic shocks explain only about 15% of sectoral inflation fluctuations; (2) The persistence of sectoral inflation is driven by macroeconomic factors; (3) While disaggregated prices respond quickly to sector-specific shocks, their responses to aggregate shocks are small on impact and larger thereafter; (4) Most prices respond with a significant delay to identified monetary policy shocks, and show little evidence of a "price puzzle," contrary to existing studies based on traditional VARs; (5) Categories in which consumer prices fall the most following a monetary policy shock tend to be those in which quantities consumed fall the least; (6) The observed dispersion in the reaction of producer prices is relatively well explained by the degree of market power; (7) Prices in sectors with volatile idiosyncratic shocks react rapidly to aggregate monetary policy shocks; (8) The sector-specific components of prices and quantities move in opposite directions.

The main contribution of the paper is to divide shocks into two types, economy-wide shocks that hit all sectors, and sector specific shocks that hit individual sectors, and to do so in an econometrically defensible manner.

In previous results, when shocks were not disentangled to separate economy-wide and sector specific shocks, empirical results tended to find a large degree of price stickiness at both the aggregate and sectoral levels lending support to sluggish-price, menu-cost* type models.

This paper follows in the path of previous work showing that individual prices, or at least highly disaggregated prices, are far more volatile, i.e. flexible, than typically assumed in sluggish price models.

Restating the results, when the authors separate shocks into aggregate and sector specific shocks, they find that:

1. Most of the price volatility at the sectoral level is due to sectoral shocks, not aggregate shocks.

2. Differences in price-setting behavior across sectors are mostly due to differences in the response to sector-specific shocks, most sectors respond similarly to aggregate shocks.

3. There is persistence (stickiness) in the response of disaggregated prices, but this is due to the response to aggregate shocks. There is little persistence in the response of disaggregated prices to sector specific shocks. In addition, the response of disaggregated prices to sector specific shocks is more immediate than the response to aggregate shocks.

4. The differences in the responses across sectors is explained by differences in market power. More monopoly power implies more stickiness.

5. There is no longer a price puzzle (the annoying tendency for prices to rise after the Fed tightens in empirical models used for policy analysis).

Overall, then, what this paper finds is that firms exhibit considerable flexibility in responding to sector specific shocks - there is not much price stickiness on display - but a much more sluggish response to aggregate shocks.

One thing that is needed is to explain these results theoretically. The paper outlines some recent attempts in this direction, but there is much more work needed on both the empirical evidence about price stickiness and on the supporting theoretical models.

The sluggish price to aggregate shocks is still present, so this doesn't rule out aggregate fluctuations driven by aggregate shocks. That is, I don't think the evidence against the sticky price hypothesis is quite as strong as David implies (though he is very careful to note that there is evidence for the assumption). That is from:

See also

Finally, this is a different topic, but since the wonkiness door is open, Paul Krugman posted a discussion of monetary policy earlier today:

I discuss Krugman's here, in particular why we shouldn't place too much faith in the Fed's ability to stimulate the economy through further reductions in long-term interest rates.

Update: Paul krugman comments on Prescott and RBC models.

No comments: