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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:

FW0827102

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:

FW0827101

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?"
"Yes."
"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.

Conclusions

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.

References

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.

August 30, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View


Paul Krugman: It’s Witch-Hunt Season

Posted: 30 Aug 2010 12:33 AM PDT

"This is going to be very, very ugly":

It's Witch-Hunt Season, by Paul Krugman, Commentary, NY Times: The last time a Democrat sat in the White House, he faced a nonstop witch hunt by his political opponents. Prominent figures on the right accused Bill and Hillary Clinton of everything from drug smuggling to murder. And once Republicans took control of Congress, they subjected the Clinton administration to unrelenting harassment — at one point taking 140 hours of sworn testimony over accusations that the White House had misused its Christmas card list.
Now it's happening again — except that this time it's even worse. Let's turn the floor over to Rush Limbaugh: "Imam Hussein Obama," he recently declared, is "probably the best anti-American president we've ever had" ..., bear in mind that he's an utterly mainstream figure within the Republican Party; bear in mind, too, that unless something changes the political dynamics, Republicans will soon control at least one house of Congress. This is going to be very, very ugly. ...
What we learned from the Clinton years is that a significant number of Americans just don't consider government by liberals — even very moderate liberals — legitimate. Mr. Obama's election would have enraged those people even if he were white. Of course, the fact that he isn't, and has an alien-sounding name, adds to the rage.
By the way, I'm not talking about the rage of the excluded and the dispossessed: Tea Partiers are relatively affluent, and nobody is angrier these days than the very, very rich. Wall Street has turned on Mr. Obama with a vengeance:... And powerful forces are promoting ... this rage..., the superrich Koch brothers and their war against Mr. Obama has generated much-justified attention, but ... only the scale of their effort is new: billionaires like Richard Mellon Scaife waged a similar war against Bill Clinton.
Meanwhile, the right-wing media are replaying their greatest hits. ...Mr. Limbaugh used innuendo to feed anti-Clinton mythology, notably the insinuation that Hillary Clinton was complicit in the death of Vince Foster. Now ... he's doing his best to insinuate that Mr. Obama is a Muslim. ... [And] Mr. Limbaugh is ... tame compared with Glenn Beck.
And where, in all of this, are the responsible Republicans, leaders who will stand up and say that some partisans are going too far? Nowhere to be found. To take a prime example: the hysteria over the proposed Islamic center in lower Manhattan... On this issue, as on many others, the G.O.P. establishment is offering a nearly uniform profile in cowardice.
So what will happen if, as expected, Republicans win control of the House? ...Politico reports that they're gearing up for a repeat performance of the 1990s, with a "wave of committee investigations" — several ... over supposed scandals that we already know are completely phony. We can expect the G.O.P. to play chicken over the federal budget, too; I'd put even odds on a 1995-type government shutdown sometime over the next couple of years.
It will be an ugly scene, and it will be dangerous, too. The 1990s were a time of peace and prosperity; this ... time ... we're still suffering the after-effects of the worst economic crisis since the 1930s, and we can't afford to have a federal government paralyzed by an opposition with no interest in helping the president govern. But that's what we're likely to get.
If I were President Obama, I'd be doing all I could to head off this prospect, offering some major new initiatives on the economic front in particular, if only to shake up the political dynamic. But my guess is that the president will continue to play it safe, all the way into catastrophe.

Did I Hear that Right? You Want to Raise Interest Rates?

Posted: 30 Aug 2010 12:24 AM PDT

Let me explain, as simply as I can, the underlying reason for the strong reaction to Minnesota Fed president Narayana Kocherlakota's suggestion that raising interest rates would be helpful.

When a Federal Reserve president calls for an increase in interest rates while the economy is still struggling to recover, something that repeats the errors of 1937-38, all of his buddies in academia should expect a reaction. It comes with the job. The fact that he can point to a model that failed to provide much help with the situation we're in to justify the statement isn't of much comfort, and there are serious questions about the validity of the claim in any case.

This isn't just a theoretical exercise where finding novel, counter-intuitive results that may or may not have real world applicability draws the admiration of peers, people's livelihoods are at stake. Real people in the real world are depending on the Fed to get this right, and suggestions that the Fed raise interest rates to help with the recession go against every intuitive bone I have in my body. More importantly, for those who think those bones might be broken, it goes against the existing empirical evidence. This is not a game, actual policy is at stake that will affect people's lives, and we cannot be careless in how we approach it.

If I reacted strongly, it's because I don't want us to repeat the mistakes we made in the past, mistakes that would hurt people who have suffered enough already. Do the advocates of this policy really believe, way down deep, that raising interest rates is the right thing to do in this situation? Perhaps, but I sure don't, and I can't let it pass without comment.

links for 2010-08-29

Posted: 29 Aug 2010 11:02 PM PDT

"America’s Leaders are Letting the Country Down"

Posted: 29 Aug 2010 04:24 PM PDT

Clive Crook:

It falls to the Fed to fuel recovery, by Clive Crook, Commentary, Financial Times: The US recovery is stalling. As a matter of economics the balance of risks strongly favors further fiscal and monetary stimulus. Politics appears to rule out the first, and a divided Federal Reserve is hesitating over the second. America's leaders are letting the country down. ...
Unlike most other advanced economies, the US could undertake further fiscal stimulus at acceptably low risk. Global appetite for its debt is undiminished. The risk, such as it is, could be all but eliminated if Congress could commit itself to stimulus now, restraint later – an easy thing, you might suppose, but evidently beyond its grasp. The administration could and should be pushing for just such a package, but it is not.
The political problem is that US voters ... have wrongly decided that the first stimulus was an expensive failure. The administration is partly to blame. It oversold the ... first package...
One cannot know how many jobs the stimulus saved, but it is absurd to see high unemployment as proof that it was ineffective. More likely this shows how powerful the recession's downward pull has been, and still is. Most economists think the stimulus helped a lot. Yet, as in other areas, President Barack Obama's defense of his policy has been strangely diffident. ...
Meanwhile, there is monetary policy. At the end of last week,... Ben Bernanke, Fed chief, acknowledged the faltering recovery, and reminded his audience that the central bank has untapped capacity for stimulus. ... Mr Bernanke and his colleagues are understandably nervous about extending the radical measures they have already taken. ... But the balance of risks has moved. They need to go further. ...

A Question for the Kansas City Fed

Posted: 29 Aug 2010 01:15 PM PDT

This has annoyed me for several years now. Why won't the Kansas City Fed make the papers for the Jackson Hole conference available until after the conference is over? What's the purpose of this? None that I can think of, other than making themselves special, but that's no way for a public agency to behave.

This is the opposite of transparency. I can understand waiting until the final versions are submitted, but at that point, why not post the papers so we can read them prior to the conference and give more informed commentary on the event? As it stands, I have to rely upon reporters to accurately tell me what's in the papers and, while I do trust some of them to mostly get things right (but not all), I'd like to be able to check the papers for myself. Sometimes participants will give a report after the event is over, but that's a bit late and even then I'd like to be able to come to my own conclusions, or at least verify the reports from reading the papers themselves. What's the point in locking them up? (As far as I can tell, the authors aren't even allowed to post the papers on their own sites.)

The pdfs will also be copy protected when they are posted, another step that places unnecessary hurdles in the way of commenting on the papers. Under the KC Fed's policy, which extends to speeches by the president of the KC Fed but isn't followed by other district banks, reproducing a graph or a few paragraphs then becomes tedious. The copy protection doesn't stop anyone who really wants to post a paragraph or two as you are permitted to do, it's simply harder and hence discouraging (and the speeches themselves are supposed to be in the public domain and hence fully reproducible). But why discourage conversation about these papers? Why make it so that we can't actually read the papers and comment on them until the conference is over and people have lost interest in the event. Why make it as hard as possible to even take small excerpts? How is that helpful?

Creating an exclusive event like this does give the people involved power, it makes them special, it gives them the power to include and exclude people, and so on. But their duty is to serve the public interests, not create a special little club that only some can participate in, and then dribble out the important information in a way that maintains their exclusivity and power.

I can live with the copy-protection, but the attempts to discourage access to the conference papers is puzzling when viewed through the Fed's mission to serve the public interest.

[Maybe I've missed something obvious, it certainly wouldn't be the first time that's happened, and there's a good reason for this policy. If someone at the KC Fed wants to explain why they can't do what most conferences do and make the papers available prior to or at the beginning of the conference, or at the very least at the time of or right after a session is over, I will post the explanation. It would be nice if the explanation also included the reasons for trying to lock up other documents such as Fed speeches, something no other Fed tries to do.]

Interest Rates and Inflation Once Again

Posted: 29 Aug 2010 01:09 PM PDT

The conversation with Stephen Williamson continues. See here and here (including comments).

Update: Brad DeLong responds to Williamson.

Update: Paul Krugman comments.

"Can Interest Rates Explain the US Housing Boom and Bust?"

Posted: 29 Aug 2010 10:06 AM PDT

Did low interest rates cause the financial crisis as John Taylor and others contend? (I've argued that the low interest rate policy contributed to the crisis, but by itself was not the major factor. That is roughly consistent with their conclusion, though their numbers on the degree to which interest rates mattered are lower than I would have predicted):

Can interest rates explain the US housing boom and bust?, by Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko: Between 2001 and the end of 2005, the Standard and Poor's/Case-Shiller 20 City Composite House Price Index rose by 46% in real terms. By the first quarter of 2009 the index had dropped by about one-third before stabilizing. The volatility of the Federal Housing Finance Agency (FHFA) repeat-sales price index was less extreme but still severe. That index rose by 53% in real terms between 1996 and 2006 and then fell by 10% between 2006 and 2008. As many financial institutions had invested in or financed housing-related assets, the price decline helped precipitate enormous financial turmoil.

Much academic and policy work has focused on the role of interest rates and other credit market conditions in this great boom-bust cycle.

  • One common explanation for the boom is that easily available credit, perhaps caused by a "global savings glut," led to low real interest rates that boosted housing demand (Himmelberg et al. 2005, Mayer and Sinai 2009, Taylor 2009).
  • Others have suggested that easy credit market terms, including low down payments and high mortgage approval rates, allowed many people to act at once and helped generate large, coordinated swings in housing markets (Khandani et al. 2009).

Those easy credit terms may have been a reflection of agency problems associated with mortgage securitization (Keys et al., 2009, 2010, Mian and Sufi, 2009 and 2010, Mian et al. 2008).

If correct, these theories would provide economists with comfort that we understood one of the great asset market gyrations of our time; they would also have potentially important implications for monetary and regulatory policy. But economists are far from reaching a consensus about the causes of the great housing market fluctuation. For example, Shiller (2003, 2006) long has argued that mass psychology is more important than any of the mechanisms suggested by the research cited above.

Re-evaluating the missing link

Motivated by this question, we re-evaluate the link between housing markets and credit market conditions, to determine if there are compelling conceptual or empirical reasons to believe that changes in credit conditions can explain the past decade's housing market experience.

For credit markets to be able to explain the large recent price movements, the impact of credit markets must be large and there must have been a substantial change in credit market conditions during the periods when housing prices were booming and busting. On the surface at least, both of these conditions appear to be met – the real long rate dropped substantially during the housing boom.

  • Between 1996 and 2006, the real ten-year Treasury yield fell by 120 basis points, and it declined by an even larger 190 basis points from 2000 to 2005, when housing prices boomed the most. In addition, the static version of Poterba's (1984) asset market approach to house valuation suggests that the impact of interest rates on house prices is quite large.
  • Recent research implies a semi-elasticity of housing prices with respect to real rates of over 20 (Himmelberg et al. 2005), meaning that a 100 basis point decline in rates should be associated with roughly a 20% increase in price1.

The combination of a nearly 200 basis-point decline in real interest rates and semi-elasticity of 20 implies that the changes in real rates can account for the bulk of the 50%-plus boom in prices experienced in the aggregate US data (Himmelberg et al. 2005, Mayer and Sinai 2005).

But there are two reasons to question this conclusion. Our own work amends the standard house price model of Poterba (1984) and identifies various reasons why interest rates can have a much smaller impact on house prices than the traditional calculations suggest (Glaeser et al. 2010). Particularly important factors are the combination of mean reversion in interest rates and normal household mobility.

If people expect to move in the future, low interest rates today will not lead them to bid up prices so much now because they realize they might have to sell later at a lower price when rates are higher. The option to prepay also weakens the link between current interest rates and house prices for the same reason. Rates also should have little or no impact on prices in elastically supplied markets as shown in Glaeser et al. (2008).

Finally, if people are credit-constrained, lower rates today need not lead to higher prices. After all, if the marginal buyer cannot take advantage of those lower rates, they should not affect the buyer's valuation of a home. Taken together, we show that these factors can reduce the predicted impact of interest rates on home prices by about two-thirds, bringing it down to 6 or 8 from previous conclusions of around 20.

History lessons

The second reason to question the conclusion that low real rates can explain the recent large housing market gyrations is that the historical data are consistent with a much weaker connection. The simple bivariate relationship between log house prices and the real long rate, as measured by the 10-year Treasury rate corrected for inflation expectations, is plotted in Figure 1. [Note: there is no figure 1 in the article.] These data imply that a 100-basis-point fall in rates is associated with barely a 7% increase in house prices, as measured by the FHFA index between 1980 and 2008. Larger price effects are found by restricting the sample to years after 1984, but they do not survive inclusion of a simple national time trend.

As theory suggests, we find that real rates have their strongest impact when rates are low and in markets where housing supply is relatively inelastic. Our results support the insight from Himmelberg et al. (2005) that price impacts should be stronger at lower initial rates of interest, but even when rates change from a low base, a 100-basis-point fall in real rates is associated with only an 8% rise in real house prices, independent of trend.

While there are good reasons to question the empirical authority of less than 30 years of time-series data, these results are quite in line with the predictions of our expanded model. Both theory and data suggest that lower real rates cannot account for more than one-fifth of the boom in house prices.

If we ever are going to understand the US housing boom and bust, we will have to turn to other factors to complement the role of interest rates. Other conditions certainly were changing in the mortgage markets. There was a massive surge in mortgage applications during the boom, but our preliminary investigation did not find a similarly large increase in approval rates or loan-to-value ratios. That these factors were not trending with house prices suggests they cannot explain the boom or its subsequent bust. However, it is very difficult to identify what was happening to the marginal borrower. It seems likely that less creditworthy people were able to become homeowners, and if so, that could help explain what happened. Yet there is much more speculation whizzing around academic and policy circles than there are hard data and convincing analyses. It is clear that more research is urgently needed in this area.

Conclusions

We doubt that any single or simple story can explain the movement in house prices, especially over the past decade. While our analysis indicates that one plausible explanation of that boom, easy credit conditions – and low interest rates alone – cannot account for most of what happened to prices, we are not able to offer a compelling alternative hypothesis. Low rates certainly could have combined with other credit market conditions, including overly optimistic expectations about prices by prospective buyers, to drive the boom. In particular, we suspect that Case and Shiller (2003) are correct and the over-optimism illustrated by their surveys of recent home buyers was critical, but this just pushes the puzzle back a step. Why were buyers so overly optimistic about prices? Why did that optimism show up during the early and middle years of the last decade, and why did it show up in some markets but not others? Irrational expectations are surely not exogenous, so what explains them?

Finally, our results should not be interpreted as a defense of monetary policy as being either wise or appropriate. Housing is only part of the economy, and monetary policy should be evaluated in a broader context. Even within the housing sector, it is possible that a sharp rise in the federal funds rate could have substantially limited price increases by interacting with buyers' expectations during the boom. But this speculation only highlights the need for more research on the broader issue of buyers' expectations.

References

Case, Karl E and Robert J Shiller (2003), "Is There a Bubble in the Housing Market?", Brookings Papers on Economic Activity, 2:299-342, Fall.

Glaeser, Edward L, Joshua D Gottlieb, and Joseph Gyourko (2010), "Can Cheap Credit Explain the Housing Bubble?", NBER Working Paper 16230, July.

Himmelberg, Charles, Christopher Mayer, and Todd Sinai (2005), "Assessing High House Prices: Bubbles, Fundamentals and Misperceptions", Journal of Economic Perspectives, 19(4):67-92.

Keys, Benjamin J, Tanmoy Mukherjee, Amit Seru, and Vikrant Vig (2009), "Financial Regulation and Securitization: Evidence from Subprime Mortgage Loans", Journal of Monetary Economics, 56(5):700-720, July.

Khandani, Amir, Andrew W Lo, and Robert C Merton (2009), "Systemic Risk and the Refinancing Ratchet Effect", NBER Working Paper 15362, September.

Mayer, Christopher and Todd Sinai (2005), "Bubble Trouble? Not Likely", Wall Street Journal editorial, 19 September.

Mian, Atif and Amir Sufi (2009), "The Consequences of Mortgage Credit Expansion: Evidence from the US Mortgage Default Crisis", Quarterly Journal of Economics, 122(4):1449-1496, November.

Mian, Atif and Amir Sufi (2010), "Household Leverage and the Recession of 2007 to 2009." NBER Working Paper 15892, April.

Mian, Atif, Amir Sufi, and Francisco Trebbi (2008), "The Political Economy of the US Mortgage Default Crisis", National Bureau of Economic Research Working Paper No. 14468, November.

Poterba, James (1984), "Tax Subsidies to Owner-Occupied Housing: An Asset-Market Approach", Quarterly Journal of Economics, 99(4):729-752, November.

Shiller, Robert J (2005), Irrational Exuberance, 2nd Edition, Princeton University Press.

Shiller, Robert J (2006), "Long-Term Perspectives on the Current Boom in Home Prices." The Economists' Voice, 3(4):4.

Taylor, John B (2009), Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, Hoover Institution Press.


1 The semi-elasticity is defined as the derivative of the logarithm of housing prices with respect to the real interest rate.