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August 31, 2010

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Fed Watch: No Clothes

Posted: 31 Aug 2010 12:42 AM PDT

Tim Duy is "anything but" reassured by Ben Bernanke's recent speech outlining the Fed's possible policy actions, and what it will take to put them into action:

No Clothes, by Tim Duy:

Unless every able American pitches in, Congress and I cannot do the job. Winning our fight against inflation and waste involves total mobilization of America's greatest resources—the brains, the skills, and the willpower of the American people. --- President Gerald Rudolph Ford, "Whip Inflation Now" Speech (October 8, 1974)

Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. --- Federal Reserve Chairman Ben Bernanke, "The Economic Outlook and Monetary Policy" Speech (August 27, 2010)

Rereading Federal Reserve Chairman Ben Bernanke's recent speech and measuring it against the incoming data leaves me with a pit in my stomach. I sense Bernanke reveals in this speech he is the proverbial emperor without clothes, short on policy options but long on hope. A last ditch attempt to persuade us that as long as we don't believe deflation will be a problem, it will not be a problem. But he faces the same challenge as did then President Gerald Ford. All hat and no cattle. You need to be ready to back up your talk with credible policy options. While Bernanke outlined possible policy options, reading between the lines makes clear he lacks conviction in the viability of any of those options. Simply put, Bernanke is not ready to embrace the paradigm shift bold action requires.

First, it is worth considering the economic context of the policy environment via the lens of July Personal Income and Outlays report. Real gains fells short of what I believe to be already diminished expectations, with a clearly suboptimal trend in place:


When Bernanke expresses concern for the near term pace of economic growth, he is concerned with failing to track the current path of economic activity, as illustrated by the path of consumption since July of last year. This already is a substantial lowering of the bar, and appears to be a resignation that previous trends are unattainable. That is a problem in many respects, the most important of which is that previous trends were consistent with full employment. The failure to acknowledge the importance of re-achieving the previous path is, in my opinion, an admission of the willingness to accept a protracted period of high unemployment. This, of course, has been essentially admitted by Bernanke:

Although output growth should be stronger next year, resource slack and unemployment seem likely to decline only slowly. The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.

As I have already commented, if unemployment is a concern, and there is no conflict between the Fed's dual mandate, then why is the Fed waiting for further evidence of disinflation before acting? Indeed, Scott Sumner saw a line in the sand in Bernanke's speech of a one percent inflation rate. The most recent PCE data suggests we are perilously close to testing that line already:


Unemployment hovering just south of double digits, while near term inflation is hovering around one percent. And if that wasn't enough, the threat of near term slowing is all too evident. The recent spate of regional surveys suggests the much vaunted manufacturing revival is about to end, with the ISM likely to drop below 50 in the next month or two. The July report on durable goods, which revealed a sharp eight percent drop in new orders for nonair, nondefense capital goods bolsters this prediction. Moreover, Intel sent up another red flag on the sustainability of consumer spending in the back half of this year. And I think we all realize that the government's efforts to prop up the housing market are falling short of Washington's expectations.

If short term interest rates were at five percent, or three percent, or even one percent, policymakers would be falling over themselves to ease further. Yet at this point the most we get is a commitment to hold policy steady, and even that only grudgingly accepted by some policymakers.

Why so little, despite Bernanke's pleads that he can do more? Because the Fed is now up against the zero bound, and the available options are of uncertain effectiveness and internally contentious.

Consider what is the most likely path Bernanke would choose, the expansion of the balance sheet via additional asset purchases:

I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions. However, the expected benefits of additional stimulus from further expanding the Fed's balance sheet would have to be weighed against potential risks and costs. One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions. In particular, the impact of securities purchases may depend to some extent on the state of financial markets and the economy; for example, such purchases seem likely to have their largest effects during periods of economic and financial stress, when markets are less liquid and term premiums are unusually high. The possibility that securities purchases would be most effective at times when they are most needed can be viewed as a positive feature of this tool. However, uncertainty about the quantitative effect of securities purchases increases the difficulty of calibrating and communicating policy responses.

Translation: Asset purchases are effective in times of crisis, but otherwise are fraught with uncertainties that limit theirpolicy viability. We simply have no idea how to implement policy via asset purchases. They are a last ditch effort, at best.

Moreover, to be effective, they likely need to be conducted on a massive scale, especially if the Fed sticks with Treasuries as their main course. Former Fed staffer Vincent Reinhart, via NPR:

GHARIB: Now just to bring up the subject of tools, Alan Binder as you know a former vice chair of the Fed, wrote an op-ed piece this week saying that the ammunition that the Fed has to fix the economy, they`re running out and what they do have is the weak stuff. Now, Bernanke disagrees. What do you think?
REINHART: OK, so I think Chairman Bernanke probably disagrees on two main counts. One is there`s still communication. The Fed could convey they`re going to keep interest rates low for a very long time. They`ve probably done as much as they can on that front. They maybe could do a little bit more. But that leads to one other option, which is buying stuff, buying Treasury securities. Now, Alan Binder I think, believes that that effect isn`t that great, but the way you get around that is to buy in very large volume. That`s probably also why the Fed is hesitant to act. It feels that when the time comes to do unconventional policy action, it will have to do very large purchases of Treasury securities.

So, the answer is volume. Interestingly, St. Louis Federal Reserve President James Bullard made some comments on that point. From Bloomberg:

The Federal Reserve may increase purchases of Treasuries if the U.S. economy weakens further, though any new program should be "disciplined," St. Louis Federal Reserve President James Bullard said.
"The committee gave a signal that we are ready to move if conditions deteriorate further, which was certainly in line with my thinking," Bullard said in an interview on CNBC Television today at the Fed's annual symposium in Jackson Hole, Wyoming. "I want a disciplined program." ...
..."If we could still target interest rates, we would make small moves to adjust to the data," Bullard said. "I think we should do the same with our quantitative easing program."

Note: A "disciplined" program with "small moves." And Bullard is one of the most willing policymakers to pursue additional quantitative easing, yet he offers what is at best a recipe for policy disaster. Small moves are almost certain to yield very small impact, and will only intensify the growing sense that the Fed is at the end of its rope.

Reinhart also mentions Bernanke's second option, communication, but also notes the Fed has already exhausted that avenue. Bernanke seems to agree:

A potential drawback of using the FOMC's post-meeting statement to influence market expectations is that, at least without a more comprehensive framework in place, it may be difficult to convey the Committee's policy intentions with sufficient precision and conditionality.

Translation: We don't have a comprehensive framework in place, and we won't as long as some policymakers believe that the appropriate course of action is to raise interest rates.

Bernanke then dismisses the option of reducing interest on reserves, and gives no ground to Bruce Barlett's suggestion that the Fed think outside the box and actually charge interest on reserves. The fourth option, that of raising inflation expectations, is simply unthinkable.

In sum, what Bernanke actually said is that yes, there is more that we can do, but really none of it is effective and we do not intend to go there unless things get really, really bad. How bad? Your guess is as good as his:

At this juncture, the Committee has not agreed on specific criteria or triggers for further action...

They haven't even agreed on current action. Yet we can trust them to counter deflation when they see it. Paul Krugman sees the current situation as a monumental failure of Bernanke to follow his own research:

The sad thing is that policy makers were supposed to know all this. The Fed had studied Japan extensively, and believed that the Bank of Japan could have averted the lost decade if it had reacted very aggressively early on. Larry Summers talked about a Powell doctrine of overwhelming force in the face of crisis. And yet what we actually got was an underpowered response on both the fiscal and the monetary fronts.
As I've said before, we — and particularly Summers-san and Bernanke-sama – owe the Japanese an apology.

I think that Bernanke believes that he did in fact follow his own research, and orchestrated what he believed was an overwhelming force. And that force did help bring the crisis to a close, but fell short of what was necessary to revitalize the economy. Now that force has been expended, and they have little left in the arsenal.

The conventional arsenal, that is. I believe the Fed fundamentally views monetary policy as operating via interest rates, and is loathe to break that view, despite being stuck at the zero bound. Bernanke on reducing interest on reserves:

Moreover, such an action could disrupt some key financial markets and institutions. Importantly for the Fed's purposes, a further reduction in very short-term interest rates could lead short-term money markets such as the federal funds market to become much less liquid, as near-zero returns might induce many participants and market-makers to exit. In normal times the Fed relies heavily on a well-functioning federal funds market to implement monetary policy, so we would want to be careful not to do permanent damage to that market.

Seriously, millions of people looking for work, for years, according to the Fed's own forecasts, and Bernanke is concerned about permanent damage to the federal funds market? He can't deal with that problem at full employment?

Finally, note that Bernanke fails to describe what is arguably the most potent weapon remaining. Buy foreign currency. Lots of it. Rather than target interest rates, target a steady, nondiscriminatory depreciation of the Dollar until we can lift rates far from the zero bound. Or target equity prices. Or just put cash in bank accounts. Bernanke thought outside the box when it came to alleviating the crisis on Wall Street. Time to think outside the box when dealing with Main Street.

Bottom Line: Bernanke's speech struck me as anything but reassuring. He made it clear that the Fed's remaining options were weak and/or less than palatable for policymakers. With such low ammunition, how can we take seriously his conviction that the Fed will aggressively defend against the threat of deflation that is already upon us? Simply wait around for the fiscal policy backstop? Don't hold your breath - this Administration is about to be on the run; they have already dropped the policy ball, and there will not be a second chance. We already had a lost decade, and another is upon us.

"I'm not talking about Medicare, I'm Talking about Socialized Medicine"

Posted: 31 Aug 2010 12:36 AM PDT

Maxine Udall is enlightened and discouraged by a conversation with an elderly relative:

...[T]he spectre of "socialized medicine" prevents us moving to single payer, where the incentives for prudent life cycle management of risk across all age and income groups would be better aligned. Why, when we already have what is in effect single payer for the elderly and the poor, do some believe that single payer is "socialized medicine" and why do they fear it so?
I gained some insight into this recently when an elderly relative started complaining about "Obamacare" and how it would lead to "socialized medicine." Knowing the person had heart surgery courtesy of Medicare and was receiving ongoing monitoring and care, I said, "I didn't realize you were so unhappy with Medicare." To which I received the reply: "I'm not talking about Medicare, I'm talking about socialized medicine."
"How is Medicare different from socialized medicine?" I asked.
"Medicare isn't socialized," came the reply. "I pay for it. I pay every month and when I've had surgery, I've had to pay some of it. Medicare is like any other insurance."
"Well," I said, "I know you're paying a premium for Part B and I know there are copayments and deductibles, but Medicare is a government run health insurance program."
To which the reply was: "But I'm talking about socialized medicine. You know that whenever the government gets involved in anything, it never does a good job."
"I had no idea you were having problems with Medicare." said I. "I always had the impression you were pretty satisfied with it. And with the VA, too. I know you've used the VA for some care recently. What problems have you had with Medicare or the VA?"
"Well, none with Medicare or the VA, but I'm not talking about Medicare. I'm talking about socialized medicine."
"So you're happy with Medicare?"
"Would you mind if your [adult] children could buy into it? Your son is unemployed. Would it be OK if he could buy into Medicare?"
"Well, sure. As long as he has to pay like I do."
You were all wondering how someone could say, "Keep your government hands off my Medicare?" Well, there you have it. Now that I've told you, I'm still not sure I understand it. It was one of the most frustrating and at the same time enlightening conversations I have had in a long time. The person with whom I was conversing is intelligent, educated, and not senile.
I'm just not sure how to use the above information. I was unable to persuade my elderly relative. I confess that since the conversation, I have despaired that the national conversation will ever be much better.

links for 2010-08-30

Posted: 30 Aug 2010 11:01 PM PDT

Robert Barro's Questionable Claim

Posted: 30 Aug 2010 07:00 PM PDT

Robert Reich is unhappy with Robert Barro:

The Obscenity of the Right-Wing Professoriat, by Robert Reich: ...Harvard Professor Robert Barro ... opined in today's Wall Street Journal that America's high rate of long-term unemployment is the consequence rather than the cause of today's extended unemployment insurance benefits. ...
In point of fact, most states provide unemployment benefits that are only a fraction of the wages and benefits people lost when their jobs disappeared. Indeed, fewer than 40 percent of the unemployed in most states are even eligible for benefits... So it's hard to make the case that many of the unemployed have chosen to remain jobless and collect unemployment benefits rather than work. Anyone who bothered to step into the real world would see the absurdity of Barro's position. ... Right now, there are roughly five applicants for every job opening in America. ...

Barro argues the rate of unemployment in this Great Jobs Recession is comparable to what it was in the 1981-82 recession, but the rate of long-term unemployed is nowhere as high. He concludes this is because unemployment benefits didn't last nearly as long in 1981 and 82 as it they do now.

He fails to see – or disclose – that the 81-82 recession was far more benign than this one, and over far sooner. It was caused by Paul Volcker and the Fed yanking up interest rates to break the back of inflation – and overshooting. When they pulled interest rates down again, the economy shot back to life. ...

A record number of Americans is unemployed for a record length of time. This is a national tragedy. It is to the nation's credit that many are receiving unemployment benefits. This is good not only for them and their families but also for the economy as a whole, because it allows them to spend and thereby keep others in jobs. That a noted professor would argue against this is obscene.

Alex Tabarrok is unimpressed with Barro's work:

Barro v. Barro, by Alex Tabarrok: Robert Barro today in the WSJ, The Folly of Subsidizing Unemployment, estimates that UI extensions have increased the unemployment rate by 2.7 percentage points.

To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then ... the unemployment rate would have been 6.8% rather than 9.5%.

It's not clear to me why we should assume that the share of long-term unemployment in this recession should equal that in 1983.

Barro also argues:

We have shifted toward a welfare program that resembles those in many Western European countries.

In contrast Josh Barro, son of Robert, in How much do UI Extensions Matter for Unemployment, concluded that 0.4% was probably on the high side:

...Two Fed studies suggest that [extensions of UI] may have contributed 0.4 to 1.7 percentage points to current unemployment. But a closer look at this research makes me skeptical that the effects have been so large.

...The incentive effects of UI extension must also be weighed against the stimulative effects of paying UI benefits. For some reason it's become almost taboo to note this on the Right, but UI recipients tend to be highly inclined to spend funds they receive immediately, meaning that more UI payments are likely to increase aggregate demand. UI extension also helps to avoid events like foreclosure, eviction and bankruptcy, which in addition to being personal disasters are also destructive of economic value.

As a result, I am inclined to favor further extension of UI benefits while the job market remains so weak. I am not concerned that this leads us down a slippery slope to permanent, indefinite unemployment benefits (which historically have been one of the drivers of high structural employment in continental Europe) as the United States has gone through many cycles of extending unemployment benefits in recession and then paring them back when the economy improves, under both Republican and Democratic leadership.

I call this one on both counts for Josh.   

Arnold Kling says that if incentive problems exist for unemployment -- and he's right to be skeptical of the claim -- there's more than one way to fix them:

...Robert Barro ... claims that the unemployment rate would be much lower now if Congress had not passed any extensions of unemployment benefits. I have not gone through his analysis, but I suspect that I, like Alex Tabarrok, would not find it persuasive. Nonetheless, I think there is a case to be made for allowing people to continue to collect unemployment benefits after they find a new job, until their benefits are scheduled to expire. We can argue about how generous the unemployment benefits should be overall, but for any level of benefits it is possible to reduce the disincentive to find work. 

One more:

Shoe Staring: Robert Barro Edition, by Karl Smith: Based on Cable News and a notable NYT column one might think that economists are perpetually at one another's throats. This is far from the truth. The hierarchical nature of the economics profession lends an ecclesiastical air to many of our interactions. Brilliant figures are treated with enormous reverence.

To wit, when an eminent figure like Robert Barro says something that strikes most of as inane the most common reaction is shoe staring. For example, Barro writes:

To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%.

Upon hearing this no one wants to make eye contact for fear of revealing that he sees that the emperor – or esteemed economist in this case – is without his clothes.

For better or worse the blogosphere has changed that. Economists of all stripes will descend upon Barro over the next 36 hours. If he replies, which I suspect he will not, this will be an interesting moment.

Calling Barro's claim questionable, as in the title, was probably too generous.

FRBSF Economic Letter: The Effect of Immigrants on U.S. Employment and Productivity

Posted: 30 Aug 2010 01:31 PM PDT

What effect does immigration have on U.S. job markets? "Data show that, on net, immigrants expand the U.S. economy's productive capacity, stimulate investment, and promote specialization that in the long run boosts productivity. Consistent with previous research, there is no evidence that these effects take place at the expense of jobs for workers born in the United States":

The Effect of Immigrants on U.S. Employment and Productivity, by  Giovanni Peri, FRBSF Economic Letter: Immigration in recent decades has significantly increased the presence of foreign-born workers in the United States. The impact of these immigrants on the U.S. economy is hotly debated. Some stories in the popular press suggest that immigrants diminish the job opportunities of workers born in the United States. Others portray immigrants as filling essential jobs that are shunned by other workers. Economists who have analyzed local labor markets have mostly failed to find large effects of immigrants on employment and wages of U.S.-born workers (see Borjas 2006; Card 2001, 2007, 2009; and Card and Lewis 2007).

This Economic Letter summarizes recent research by Peri (2009) and Peri and Sparber (2009) examining the impact of immigrants on the broader U.S. economy. These studies systematically analyze how immigrants affect total output, income per worker, and employment in the short and long run. Consistent with previous research, the analysis finds no significant effect of immigration on net job growth for U.S.-born workers in these time horizons. This suggests that the economy absorbs immigrants by expanding job opportunities rather than by displacing workers born in the United States. Second, at the state level, the presence of immigrants is associated with increased output per worker. This effect emerges in the medium to long run as businesses adjust their physical capital, that is, equipment and structures, to take advantage of the labor supplied by new immigrants. However, in the short run, when businesses have not fully adjusted their productive capacity, immigrants reduce the capital intensity of the economy. Finally, immigration is associated with an increase in average hours per worker and a reduction in skills per worker as measured by the share of college-educated workers in a state. These two effects have opposite and roughly equal effect on labor productivity.

The method

A major challenge to immigration research is the difficulty of identifying the effects of immigration on economic variables when we do not observe what would have happened if immigration levels had been different, all else being equal. To get around this problem, we take advantage of the fact that the increase in immigrants has been very uneven across states. For example, in California, one worker in three was foreign born in 2008, while in West Virginia the comparable proportion was only one in 100. By exploiting variations in the inflows of immigrants across states at 10-year intervals from 1960 to 2000, and annually from 1994 to 2008, we are able to estimate the short-run (one to two years), medium-run (four years), and long-run (seven to ten years) impact of immigrants on output, income, and employment.

To ensure that we are isolating the effects of immigrants rather than effects of other factors, we control for a range of variables that might contribute to differences in economic outcomes. These include sector specialization, research spending, openness to trade, technology adoption, and others. We then compare economic outcomes in states that experienced increases in immigrant inflows with states that did not experience significant increases.

As a further control for isolating the specific effects of immigration, we focus on variations in the flow of immigrants that are caused by geographical and historical factors and are not the result of state-specific economic conditions. For example, a state may experience rapid growth, which attracts a lot of immigrants and also affects output, income, and employment. In terms of geography, proximity to the Mexican border is associated with high net immigration because border states tend to get more immigrants. Historical migration patterns also are a factor because immigrants are drawn to areas with established immigrant communities. These geography and history-driven flows increase the presence of immigrants, but do not reflect state-specific economic conditions. Hence, economic outcomes associated with these flows are purer measures of the impact of immigrants on economic variables.

The short- and the long-run effects of immigrants

Figure 1 Employment and income

Employment and income

Immigration effects on employment, income, and productivity vary by occupation, job, and industry. Nonetheless, it is possible to total these effects to get an aggregate economic impact. Here we attempt to quantify the aggregate gains and losses for the U.S. economy from immigration. If the average impact on employment and income per worker is positive, this implies an aggregate "surplus" from immigration. In other words, the total gains accruing to some U.S.-born workers are larger than the total losses suffered by others.

Figures 1 and 2 show the response of key economic variables to an inflow of immigrants equal to 1% of employment. Figure 1 shows the impact on employment of U.S.-born workers and on average income per worker after one, two, four, seven, and ten years. Figure 2 shows the impact on the components of income per worker: physical capital intensity, as measured by capital per unit of output; skill intensity, as measured by human capital per worker; average hours worked; and total factor productivity, measuring productive efficiency and technological level. Some interesting patterns emerge.

Figure 2 Capital intensity, hours per worker, and total factor productivity

Communication/manual skills among less-educated U.S.-born workers

First, there is no evidence that immigrants crowd out U.S.-born workers in either the short or long run. Data on U.S.-born worker employment imply small effects, with estimates never statistically different from zero. The impact on hours per worker is similar. We observe insignificant effects in the short run and a small but significant positive effect in the long run. At the same time, immigration reduces somewhat the skill intensity of workers in the short and long run because immigrants have a slightly lower average education level than U.S.-born workers.

Second, the positive long-run effect on income per U.S.-born worker accrues over some time. In the short run, small insignificant effects are observed. Over the long run, however, a net inflow of immigrants equal to 1% of employment increases income per worker by 0.6% to 0.9%. This implies that total immigration to the United States from 1990 to 2007 was associated with a 6.6% to 9.9% increase in real income per worker. That equals an increase of about $5,100 in the yearly income of the average U.S. worker in constant 2005 dollars. Such a gain equals 20% to 25% of the total real increase in average yearly income per worker registered in the United States between 1990 and 2007.

The third result is that the long-run increase in income per worker associated with immigrants is mainly due to increases in the efficiency and productivity of state economies. This effect becomes apparent in the medium to long run. Such a gradual response of productivity is accompanied by a gradual response of capital intensity. While in the short run, physical capital per unit of output is decreased by net immigration, in the medium to long run, businesses expand their equipment and physical plant proportionally to their increase in production.

How can these patterns be explained?

The effects identified above can be explained by adjustments businesses make over time that allow them to take full advantage of the new immigrant labor supply. These adjustments, including upgrading and expanding capital stock, provide businesses with opportunities to expand in response to hiring immigrants.

This process can be analyzed at the state level (see Peri and Sparber 2009). The analysis begins with the well-documented phenomenon that U.S.-born workers and immigrants tend to take different occupations. Among less-educated workers, those born in the United States tend to have jobs in manufacturing or mining, while immigrants tend to have jobs in personal services and agriculture. Among more-educated workers, those born in the United States tend to work as managers, teachers, and nurses, while immigrants tend to work as engineers, scientists, and doctors. Second, within industries and specific businesses, immigrants and U.S.-born workers tend to specialize in different job tasks. Because those born in the United States have relatively better English language skills, they tend to specialize in communication tasks. Immigrants tend to specialize in other tasks, such as manual labor. Just as in the standard concept of comparative advantage, this results in specialization and improved production efficiency.

Figure 3 Communication/manual skills among less-educated U.S.-born workers
Communication/manual skills among less-educated U.S.-born workers

Note: The data on average communication/manual skills by state are from Peri and Sparber (2009), obtained from the manual and communication intensity of occupations, weighted according to the distributional occupation of U.S.-born workers.

If these patterns are driving the differences across states, then in states where immigration has been heavy, U.S.-born workers with less education should have shifted toward more communication-intensive jobs. Figure 3 shows exactly this. The share of immigrants among the less educated is strongly correlated with the extent of U.S.-born worker specialization in communication tasks. Each point in the graph represents a U.S. state in 2005. In states with a heavy concentration of less-educated immigrants, U.S.-born workers have migrated toward more communication-intensive occupations. Those jobs pay higher wages than manual jobs, so such a mechanism has stimulated the productivity of workers born in the United States and generated new employment opportunities.

To better understand this mechanism, it is useful to consider the following hypothetical illustration. As young immigrants with low schooling levels take manually intensive construction jobs, the construction companies that employ them have opportunities to expand. This increases the demand for construction supervisors, coordinators, designers, and so on. Those are occupations with greater communication intensity and are typically staffed by U.S.-born workers who have moved away from manual construction jobs. This complementary task specialization typically pushes U.S.-born workers toward better-paying jobs, enhances the efficiency of production, and creates jobs. This task specialization, however, may involve adoption of different techniques or managerial procedures and the renovation or replacement of capital equipment. Hence, it takes some years to be fully realized.


The U.S. economy is dynamic, shedding and creating hundreds of thousands of jobs every month. Businesses are in a continuous state of flux. The most accurate way to gauge the net impact of immigration on such an economy is to analyze the effects dynamically over time. Data show that, on net, immigrants expand the U.S. economy's productive capacity, stimulate investment, and promote specialization that in the long run boosts productivity. Consistent with previous research, there is no evidence that these effects take place at the expense of jobs for workers born in the United States.

Giovanni Peri is an associate professor at the University of California, Davis, and a visiting scholar at the Federal Reserve Bank of San Francisco.


Borjas, George J. 2006. "Native Internal Migration and the Labor Market Impact of Immigration." Journal of Human Resources 41(2), pp. 221–258.

Card, David. 2001. "Immigrant Inflows, Native Outflows, and the Local Labor Market Impacts of Higher Immigration." Journal of Labor Economics 19(1), pp. 22–64.

Card, David. 2007. "How Immigration Affects U.S. Cities." University College London, Centre for Research and Analysis of Migration Discussion Paper 11/07.

Card, David. 2009. "Immigration and Inequality." American Economic Review, Papers and Proceedings 99(2), pp. 1–21.

Card, David, and Ethan Lewis. 2007. "The Diffusion of Mexican Immigrants during the 1990s: Explanations and Impacts." In Mexican Immigration to the United States, ed. George J. Borjas. Chicago: The University of Chicago Press.

Peri, Giovanni, and Chad Sparber. 2009. "Task Specialization, Immigration, and Wages." American Economic Journal: Applied Economics 1(3), pp. 135–169.

Peri, Giovanni. 2009. "The Effect of Immigration on Productivity: Evidence from U.S. States." NBER Working Paper 15507.

"This is Pretty Weak Evidence"

Posted: 30 Aug 2010 10:05 AM PDT

Karl Whelan identifies the questionable assumptions used by Jean Claude Trichet to support his calls for austerity:

Trichet on Ricardian Equivalence, by Karl Whelan: Jean Claude Trichet's Jackson Hole speech is here. This bit caught my eye:

The economy, it is sometimes argued, is at present too fragile and thus consolidation efforts should be postponed or even new fiscal stimulus measures added. As I pointed out recently, I am sceptical about this line of argument. Indeed, the strict Ricardian view may provide a more reasonable central estimate of the likely effects of consolidation. For a given expenditure, a shift from borrowing to taxation should have no real demand effects as it simply replaces future tax burden with current one.

The written version of the speech cites two papers by Robert Barro as supporting evidence for this position.

I think it's worth noting that the Ricardian equivalence idea put forward by Barro—that consumers see deficits and taxes as basically the same thing—has been tested many many times. And the general consensus on this, as I understand it, is that there is very little evidence to support the idea.

Moreover, though the idea works in one very simplified model set up, there are lots of reasons why the proposition does not hold in reality (liquidity constraints, people having finite lives, people not having rational expectations, uncertainty about the path of government spending—see this extract from David Romer's textbook.)  Very few economists emerge from graduate schools believing in the Ricardian equivalence idea.

There are, of course, lots of arguments in favour of European governments setting out their long-term plans for the restoration of fiscal stability. However, it is a pity to see economic theories that are known to have little support regularly rolled out as arguments for fiscal austerity.

Trichet follows up on his Ricardian equivalence comments by arguing that expansionary fiscal contractions "are not just a theoretical curiosity" with the footnotes citing the old Giavazzi and Pagno paper with its two examples: Denmark in the mid-1980s and, of course, Ireland in the late 1980s. I've already said my bit about this, so I won't repeat it. Suffice to say, this is pretty weak evidence that Trichet is serving up.

Trichet must know that the evidence for Ricardian equivalence is pretty shaky, and he must know that one or two papers with questionable results hardly offsets the build of the evidence pointing in the other direction. Yet the best case he can build revolves around those points. That tells you what you need to know about the strength of his argument.

Let me also add this from the "said my bit" link above:

The Enduring Influence of Ireland's 1987 Adjustment, by Karl Whelan: When I was a junior economist in short trousers, the first research I ever did was inspired by Ireland's successful 1987-89 fiscal adjustment.  Many international researchers looked at Ireland and decided that our successful adjustment stemmed from consumers stepping into the breach filled by the government spending cuts. The story was that increased consumer confidence, fueled by expectations of lower future taxes, was the key to the recovery.
From the research I did on this topic (both on my own and with John Bradley) I came away fairly convinced that this was not what had happened. Rather, the 1987 boom seemed to be fueled more by strong exports to the UK thanks to Nigel Lawson's tax cutting exercise.
However, Ireland's 1987 experience continues to pop up in discussions of fiscal austerity. I have to admit that I've not been too impressed by Alberto Alesina's work (here and here) on how fiscal adjustment can be expansionary—work that has had a lot of influence this year. Well, sure enough, Paul Krugman now cites work from Arjun Jayadev and Mike Konczal showing that the only country that ever cut its way to growth in a slump was, you guessed it, Ireland in 1987. The power of this datapoint endures.

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