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July 31, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

"The Great Divergence, the Other Way Around"

Posted: 31 Jul 2011 12:06 AM PDT

Dani Rodrik:

The great divergence, the other way around, by Dani Dodrik: As rich economies' prospects dim under their crushing debt burdens and political paralyses, the world's hope for economic dynamism rests with developing nations. These countries had an exceptionally good decade before the global financial crisis struck. And most among them have recovered quickly.
Check out this picture, which I find quite interesting:

For the first time ever, developing countries as a group grew have been growing faster than industrial countries. Not only that, as the figure makes clear, the growth differential between the two groups has been widening in favor of the poor countries.
And it isn't just China, India, and a few countries that have been doing well. For a change, Africa and Latin America actually experienced some convergence with rich countries over the last decade.
Many analysts have projected these trends forward and predict rapid global growth, largely off the back of emerging and developing nations. In the words of a Citigroup report, "this time will be different."
I am not sure that it will. Growth in Latin America and Africa is fragile; much of it is making up for lost time rather than real convergence. Asia, I am more optimistic about. But growth in Asia has required unconventional policies (undervalued currencies, industrial policies) that will be difficult to rely on in a world where rich countries are facing economic crises.
More on these points later...

Here's the follow-up: Will the divergence in growth result in eventual convergence in incomes?

links for 2011-07-30

Posted: 30 Jul 2011 11:01 PM PDT

A Spending-Only Trigger?

Posted: 30 Jul 2011 09:45 AM PDT

The negotiations over the debt ceiling and the deficit appear to be stuck on the issue of triggers. Specifically:

Look closely at the Reid and Boehner bills. The first round of cuts are pretty much the same. The joint congressional committee charged with recommending further deficit reduction is pretty much the same. The difference is that Boehner's bill forces them to act. He ties a future increase in the debt-ceiling to the successful passage of their proposal. Reid's bill has no such trigger. ...
Most think the likely compromise is a trigger that would impose automatic, across-the-board cuts in spending if the committee fails in its mission. But Senate Democratic leadership isn't so sure. They worry that a spending-cuts only trigger is heads, Republicans win; tails, Democrats lose. ...
The White House proposed a balanced trigger in April: It would have automatically raised taxes and cut spending if America wasn't on a path to balanced budgets by 2014. ...

But at this point there's no way to be sure that the White House will hold firm on their insistence that any trigger be balanced:

But privately, they're less concerned about a spending-only trigger, which was seriously considered during their negotiations with Boehner.

If the Democrats want any claim whatsoever that this deal was not completely one-sided, there has to be at least has some weight on the other side of the scale. That is, tax increases must to be part of the agreement. (Using the word balance when the weight on the scale is so uneven, perhaps even piled entirely on one side, doesn't seem correct. The final deal won't be balanced in any case).

It's pretty discouraging to see Democrats trying to sell such a large defeat as a victory (we only lost half the farm!).

[I'm about to head to the land of no internet connections for awhile today, and it will be good to get away from the frustrating news for a few hours.]

July 30, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

Brad DeLong: America’s Locust Years

Posted: 30 Jul 2011 12:42 AM PDT

Brad DeLong:

America's Locust Years, by J. Bradford DeLong, Commentary, NY Times: It is hard right now to write about American political economy. Nobody knows whether the debt-ceiling tripwire will be evaded; if so, how; or what will happen if it is not. ...
So, rather than talking about the US debt ceiling, let us think instead about all of the things that the debt-ceiling impasse has prevented the US government from doing during the past six months...
The risks imposed by global warming, for example, have not gone away. ... The employment-to-population ratio in the US remains flat... America faces ... decaying infrastructure, weakening educational systems, and a dysfunctional health-care system that produces sub-standard outcomes at twice the cost of any other industrial country. ... Six months ... have been lost.
During the run-up to World War II, Winston Churchill ... lamented "the years that the locusts hath eaten" – the period during which preparatory action to face the great crisis of his day (the rise of Continental fascism) could have been taken, but was not. ...
My view is that the problem would fix itself easily if only the Republican Party of Dwight D. Eisenhower could stage a comeback (though without Richard Nixon and Joseph McCarthy).
It is becoming increasingly clear, however, that the problem is one not only for the US, but for the rest of the world as well. Since December 7, 1941, the world has in large part been able to rely on global governance by a somewhat-competent hyperpower. That America may be gone for good. If it is, the world needs to develop other institutions for global management – and quickly.

Blinder: Forget Debt, the Emergency is Unemployment

Posted: 30 Jul 2011 12:33 AM PDT


links for 2011-07-29

Posted: 29 Jul 2011 11:01 PM PDT

The Moral Consequences of Economic Growth

Posted: 29 Jul 2011 01:08 PM PDT

In response to the post What's the Point of Economic Growth, a former colleague, Paul Johnson, reminds me of Benjamin Friedman's "The Moral Consequences of Economic Growth":

The moral consequences of economic growth, Benjamin M. Friedman Interviewed by Romesh Vaitilingam, April 2009 [Transcription of an VoxEU audio interview]: Romesh Vaitilingam: Welcome to Vox Talks, a series of interviews with leading economists from around the world. Today's interview is with Benjamin Friedman, Professor of Political Economy at Harvard University. Ben and I ... spoke about his recently published book, "The Moral Consequences of Economic Growth." I began by asking him why he had chosen this striking title.

Ben Friedman: I wanted to convey that what I think economic growth is all about, ultimately, is not just the material aspect of how people live and how that improves, but rather how economic growth, or importantly today, the absence of economic growth affects societies more broadly.
The more I think about the subject, the more I thought about the subject when I was designing the book, the more I realized that I was exactly along the lines that many of the key thinkers of the Enlightenment Period, the late 18th Century, had in mind - especially Smith, Turgeau, but others as well – and that what they thought of themselves doing was not economics. They didn't even have the word economics at the time. They thought of themselves as doing moral philosophy.
And so, what I wanted to do was write about and think through the broad societal implications of whether we have economic growth, or not. And I wanted to do it in a way that connected very self-consciously with this moral philosophical approach to thinking about individuals and societies that was at the centre of the Enlightenment enterprise.

Romesh: So, what are the moral consequences to economic growth? What are the kinds of issues that you look at?
Ben: I look at four or five quite specific issues. One is opportunity. A key issue for any society is whether the young people who are given an opportunity to get ahead are simply the sons and daughters, and nieces and nephews of people who are already at the very top, or whether opportunities are made available more broadly.
I argue in the book on the basis – not just of theory, but also lots of social and political evidence for the U.S. and Western Europe and other countries – that when the broad bulk of the citizenry is moving forward in its living standard and has a sense of optimism that that forward progress will continue, then not only is the society better able to afford to make opportunity available more broadly, but people are more likely to support it.
A second issue is tolerance. Tolerance with respect to what? As an American, I would immediately think of race relations. As an American, I would immediately think of attitudes towards immigrants. But, I also have in mind things like religious tolerance, or discrimination, ethnic prejudice, and the like.
A third issue that I have in mind is generosity toward the poor. It's all very well to provide opportunities, but everybody knows that for one reason or another, lots of people are not going to be able to take advantage of the opportunities that are provided.
In economics, we talk often about people's individual endowments. We have this marvellous phrase called "labour market luck." Well, some people are not well endowed and others have bad luck, and then what? What are we going to do?
Once again, the idea that I advance in the book is that when the broad bulk of the society's population has this sense of forward progress in their material living standard, then people are also prepared to be tolerant in each of these ways.
And then finally, the fourth one that I'll mention is democracy, by which I mean creation of new democratic political institutions in societies around the world that are not yet functioning democracies, but even for a society like ours that already is one, the strengthening and nurturing of the democratic institutions that we already have.
Now, in each of these four cases, and in a few others besides, my argument is that sustained economic growth broadly distributed across the population leads to forward progress also in these moral dimensions, to call it that using the 18th century sense of the word.
And conversely, when people have a sense of stagnation – which frankly I'm afraid they're going to if they don't already now - then not only does the record show that no further forward progress is made, but often there's a period of rigidification, retrenchment, retreat, often with very unfortunate circumstances.
Romesh: What about the potentially negative consequences of economic growth? I mean, people talk about that perhaps rising incomes don't make us any happier. People talk about damage to the environment. And people talk about rising inequality. I mean, these are all kinds of issues that are in some ways linked to economic growth.

Ben: These are three separate issues that are all quite relevant. So, you're being very insightful here. Let me deal with them in turn.
First, on the question of whether growth makes us happier, the argument that I make on the basis of a model that I've developed in the book is that higher incomes don't make us happier. We're not necessarily any happier today than we were 30 years ago, or our ancestors were 300 years ago.
The argument I make is that the difference is not between one income level and another income level, but whether incomes are rising, or stagnant, or falling. And incidentally, this is a principle that goes right back to Adam Smith.
Smith articulated it very sharply in his writings so that the notion that thinking higher income levels don't make us happier is somehow inconsistent with neo-classical economics as we know it is fine if you don't want to consider Smith as having anything to do with neo-classical economics.
But for most of the economics profession, that likes to trace the roots of our discipline in its modern form to Smith, people ought to be aware that that's a very Smithian idea.
Second, you asked about the environment. This is a complicated issue. I have a lengthy chapter in the book about consequences of growth for the environment.
Crudely put, the issue is what are we supposed to think about a billion plus Chinese, and a billion plus Indians, coming up to a living standard over time that's going to look something like ours in the United States? What about all this?
I divide the environmental issue into three components. One is old-fashioned environmental concerns. That is clean air, clean water. I take a rather optimistic view on this. I'm quite persuaded by the evidence on the so-called environmental Kuznets curve that as countries become richer, they are willing to devote resources to cleaning up the air, and the water, and other elements of the environment.
Second issue is running out of things. Are we going to run out of oil? Are we going to run out of copper, or lead, or titanium, or any of these other key items. And this is exactly what the market is for.
The answer is that if and when we start to run out of oil for real, the price will go up. And when the price goes up, people will drive less or they will drive different types of cars. We saw a little of that when oil was at $140 a few months ago. But I think that will be back. And this is just what the market mechanism is meant to concern itself with.
And then, the third element is one on which I take much more negative, pessimistic view. And that's consequences for climate change, global warming, and the like. And here, the problem, frankly, is not an economic one, but a political one.
A standard principle of political economy is that you want to address externalities - because that's what we're talking about here - at a political level that is as coterminous as possible with the geographic scope of the externality, so that if you're dealing with people dropping refuse and empty coffee cups on the streets of a city, the city can deal with that.
And if you're dealing with utility plants in Michigan and Ohio that are putting stuff in the air that the air currents then blow downwind to New York, and Massachusetts, and Connecticut, you can't do that at a city level. And you can't deal with that even at a state level. You need it, at the least, at some kind of regional approach.
Well, global warming is just that. It's global. It doesn't make any difference whether the carbon goes into the air from Brazil, or China, or Mexico, or the United States. And so, it's necessary to deal with global warming and global climate change at a global level.
But, I think you'd have to be living in a closet not to understand that we have very imperfect global political institutions these days. And so, this is a real problem, but not for an economic reason, for a political reasons.
The final and third issue that you brought up is growth and equality. And here, I look at lots of evidence in the book. There was a time when people were quite persuaded by Simon Kuznets's view that after some point, economic growth inevitably led to narrowing inequality.
I think people are less persuaded of that than they were 20 years ago, and with good reason. The evidence has not been supportive of that part of the Kuznets idea.
But, I think it's not right to say either that economic growth inevitably leads to perpetually increasing equality. We don't want to replace the Kuznets's idea with the upside-down Kuznets's idea. That would be wrong too. So, I think this is a very complicated issue.
There's lots of good thinking being done by lots of good people, many of whose work I talk about in the book. And I think one should not be complacent. But at the same time, one should not despair.
The issue is there are kinds of growth, and kinds of growth. And the issue is what economic policy - which is an important part of the book - has to do with making sure that the growth is, after all, widely distributed. Because, to go back to where I started, the kind of growth that I argue leads to these positive moral outcomes is growth that's broadly distributed.
This is not a consequence of what happens when the GDP accounts change. This is a story that flows from the attitudes and impressions and ideas, and sensibilities of ordinary people who, over time, are smart enough to know whether they are getting ahead or not.
And if the economy is growing at some modest rate, but that growth is all accruing to a few people who were already at the top end of the scale - which frankly is a description of what's been happening in the United States in our decade - then, that does not deliver the kind of moral benefit that I describe in the book.
Romesh: Final question. We're entering a recession, potentially longer term stagnation, depression even. What do you think the potential consequence is of no, or very low, or even negative economic growth over a period of time might be?

Ben: For all the reasons that we've been talking about, I think the prospects of yet further stagnation in the incomes of ordinary citizens in the developed world as well as the developing world are very serious.
In the United States today, for just the reasons that we were talking about a moment ago, the median family income has barely changed at all over the entire decade.
Last year, the last year for which we have data, 2007, the median family income in the United States was $61,400. In the year 2000, when the decade began, it was $61,100. So, that's an increase of only about a half a percent over an entire seven years, not a half a percent per annum, a half a percent total over seven years.
Now, that's already stagnation for the majority of American families. And as you point out, we're now already in an NBER recession. Many people think it's going to be the largest recession, certainly since the 1981- 82 recession, possibly worse than that, and possibly the worse recession that we will have had since the post-World War II period began.
If that's true, then we are looking at ordinary citizens, the majority of them, going through an entire decade, maybe a decade an a half, of completely stagnant incomes, and living standards.
The historical record shows that this is the circumstance under which not good things happen. There are some dimensions of our political, social, moral lives that are unlikely to go backwards.
So, to cite the obvious thing, nobody is going to take away the vote from women. Nobody is going to repeal the 15th Amendment so that blacks are not able to vote. So, there must be some kind of ratchet effect at work. I leave that to the political scientist. But there certainly are examples, and plenty of them, that I talk about historically in the book in which there's an ebb and flow and progress made can be undone.
So, attitudes towards immigrants come and go in the United States. Religious prejudice wanes but then it comes back in many countries. Many countries, including our own, have gone through periods in which people put a lot of effort and resources into making opportunities available broadly for young people.
But then, there are other periods in which this isn't much emphasized, and very few resources are devoted. Another example is generosity toward the poor. We all have seen within our own lifetimes, periods when providing for the disadvantaged is a major public policy priority, and times when it's not.
And of course, when you refer to the possibility of a Great Depression – not in the United States interestingly, but in Europe - we have to remind ourselves that sometimes the adverse consequences of economic stagnation and decline can be really catastrophic.
So, I think that on just the grounds that you are pointing to, there was already ground for concern because of the stagnation of income for the majority of our country's families, even before the recession began. And now, the fact of a recession and prospect that it could be either deep, or long, or both, raises real concerns.

Romesh: Ben Friedman. Thank you very much.

Ben: Thank you.

Advance Estimate Shows Weak Second Quarter GDP Growth

Posted: 29 Jul 2011 08:37 AM PDT

The advance estimate of GDP growth for the second quarter of this year is 1.3 percent:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.3 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.4 percent.

And, if that news isn't discouraging enough, previous estimates were revised downward. For example, growth in the first quarter is now estimated to be just .4 percent, and GDP growth in the fourth quarter of 2008, i.e. at the worst part of the recession, was revised downward from -6.8 to -8.9 percent.

Why are we talking about cutting the deficit immediately and running the risk of making this even worse? It's time for Congress to wake up and realize that this problem, particularly troubled labor markets, should be their first priority?

[Note: I may not have internet access until much later today. There's one post scheduled for later, will do more if I can.]

July 29, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: The Centrist Cop-Out

Posted: 29 Jul 2011 12:42 AM PDT

Why won't members of the media "acknowledge the one-sided role of Republican extremists in making our system dysfunctional"?:

The Centrist Cop-Out, by Paul Krugman, Commentary, NY Times: The facts of the crisis over the debt ceiling aren't complicated. Republicans have, in effect, taken America hostage, threatening to undermine the economy and disrupt the essential business of government unless they get policy concessions they would never have been able to enact through legislation. And Democrats — who would have been justified in rejecting this extortion altogether — have, in fact, gone a long way toward meeting those Republican demands.
As I said, it's not complicated. Yet many people in the news media ... portray the parties as equally intransigent; pundits fantasize about some kind of "centrist" uprising, as if the problem was too much partisanship on both sides.
Some of us have long complained about the cult of "balance," the insistence on portraying both parties as equally ... at fault on any issue... The cult of balance has played an important role in bringing us to the edge of disaster. For ... there is no penalty for extremism. Voters won't punish you for outrageous behavior if all they ever hear is that both sides are at fault.
Let me give you an example... As you may know, President Obama initially tried to strike a "Grand Bargain"... To do so, he ... offered extraordinary concessions on Democratic priorities: an increase in the age of Medicare eligibility, sharp spending cuts and only small revenue increases. ...
But Republicans rejected the deal. So what was the headline on an Associated Press analysis of that breakdown in negotiations? "Obama, Republicans Trapped by Inflexible Rhetoric." A Democratic president ... who leans so far to the right that he's in danger of falling over ... is treated as being just the same as his utterly intransigent opponents. Balance!
Which brings me to those "centrist" fantasies..., what's with the buzz about a centrist uprising? As I see it, it's coming from people who recognize the dysfunctional nature of modern American politics, but refuse, for whatever reason, to acknowledge the one-sided role of Republican extremists in making our system dysfunctional. And it's not hard to guess at their motivation. After all, pointing out the obvious truth gets you labeled as a shrill partisan, not just from the right, but from the ranks of self-proclaimed centrists.
But making nebulous calls for centrism, like writing news reports that always place equal blame on both parties, is a big cop-out — a cop-out that only encourages more bad behavior. The problem with American politics right now is Republican extremism, and if you're not willing to say that, you're helping make that problem worse.

From Outside the Beltway

Posted: 29 Jul 2011 12:24 AM PDT

Tim Duy:

From Outside the Beltway, by Tim Duy: Tracking the debt ceiling debate has been something of a monumental task - there are simply too many pieces in motion at any given time. Perhaps even more of a challenge given that it is an insider's game, and I am well removed from that game Indeed, from my perch the only thing that looks certain is that whatever happens will be unambiguously bad for the economy. We are simply looking at degrees of bad – fiscal contraction in the range from mild to severe. The latter – a severe contraction – will almost certainly result if federal spending needs to be slashed beginning next month to maintain servicing the debt, thus preventing defaults to one group of creditors while defaulting on promises to another – the general US public.

One view is that the consequences of failure are so severe that failure is not an option. Thus, we are simply watching a political spectacle unfold that will ultimately be resolved. In other words, you can sleep peaceful dreams throughout the weekend.

I wish I could be that confident.

Here is my view from the other side of the continent: My fear is that this optimistic assessment fails to sufficiently acknowledge there are two battles. One between Democrats and Republicans, and the other within the Republican party itself. And any outcome that is acceptable to Democrats is internally corrosive to Republicans. So internally corrosive that compromise with Democrats is a monumental if not impossible challenge.

Consider Paul Krugman's analysis:

There's actually a simple way to resolve the debt ceiling crisis: non-crazy Republican leaders could support something like the Reid plan — which is, let's be clear, a huge victory for the right and defeat for progressives — and pass it with limited GOP support and overwhelming Democratic support. Situation resolved.

This would, however, probably be the end of these Republicans' political careers. And the answer is, so?

If you believe that default will quite possibly be a catastrophe — and leading Republicans probably do believe that — their unwillingness to take the action I've just described means that they are risking America's future rather than pay a price in their personal political careers. That's cowardice on an epic scale, even if it's the kind of behavior we take for granted nowadays.

On the surface, the Reid plan looks like an overwhelming defeat for progressives, but a look deeper suggests that it arguably puts the Democrats in a much stronger position in 2012. Ezra Klein:

Democrats are going to lose this one. Whatever deal emerges to raise the debt ceiling, we can be pretty sure it won't include revenue, it won't include stimulus, and it will let Republicans pocket a trillion dollars or more in cuts without offering anything to Democrats in return.

It's difficult to see how it could end otherwise. Virtually no Democrats are willing to go past Aug. 2 without raising the debt ceiling. Plenty of Republicans are prepared to blow through the deadline. That's not a dynamic that lends itself to a deal. That's a dynamic that lends itself to a ransom.

Yet Democrats will have their turn. On Dec. 31, 2012, three weeks before the end of President Barack Obama's current term in office, the Bush tax cuts expire. Income tax rates will return to their Clinton-era levels. That amounts to a $3.6 trillion tax increase over 10 years, three or four times the $800 billion to $1.2 trillion in revenue increases that Obama and Speaker John Boehner were kicking around. And all Democrats need to do to secure that deal is -- nothing.

The Reid plan raises the debt ceiling by enough to clear the next election, sufficient to take it off the plate next year. Which leaves the Administration holding the leverage – that's a nice little tax break you have there, you wouldn't want something to happen to it, would you?

If the Republicans are able to keep the debt-ceiling debate alive, however, they at least have some hope of holding onto some leverage in 2012, keeping the debt-ceiling/revenue/spending dynamic in play. After all, as Klein noted, a greater proportion of Democrats believe the debt ceiling is meaningful – which provides the Republicans with leverage. If the Republicans give up the debt ceiling now, they lose that leverage when it comes to the election year tax debate.

In other words, if the Republicans cave and give the Administration enough rope to raise the debt ceiling either all in one swoop or piecemeal over the next 20 months, continuing the Bush-era tax cuts becomes a more difficult game, as they simply expire without the signature of President Obama.

And, if the Republicans do cave, the internal politics become unbearable. As Krugman noted, some political careers may end. But it is worse than that – I think it throws the party into turmoil as the Tea Party contingent digs in their heels and forces the party to move much, much farther to the right ahead of the 2012 election, while Obama gets to move to the center. All of those "pledges" not to raise taxes or raise the debt ceiling come back to haunt the party all next year.

In the meantime, the Administration can't cave and make a deal that brings the debt-ceiling debate back to life before the elections. Why? I suspect the Administration is mollifying Congressional Democrats with the promise that tax revenues will take a front seat next year, once the leverage of the debt-ceiling is removed. If the Administration caves, the election-year debate is not as favorable for the Democrats and, perhaps worse, gives the Republicans time to regroup. The whole fight was for nothing – Congressional Democrats will be enraged.

It seems that, although there is a lot of griping that the Administration and/or Congressional Democrats have messed up big time, the Democrats are really squeezing the Republicans hard. Perhaps too hard, some might say, as a non-trivial contingent of Republicans are just that sort of crazy that makes them think not raising the debt ceiling won't be that bad (the relative calm in financial markets only further bolsters such faith). And they will viciously attack any Republican who sides with a Democrat plan. Leaving it a real possibility that Congress can't pull together a solution unless Democrats cave on the timeline. Which they can't do - which means they, or the Administration, must be willing to put the US economy at risk.

And this is where is gets even more interesting – how many eggs is Obama willing to break to make this omelet?

Brad DeLong, for instance, wonders why the Administration can't use technical fixes to ignore the debt ceiling limitation. Or why not just invoke the 14th Amendment? I think the answer is that Obama believes he can manage the pain – make it clear that he will abide by the wishes of a Republican-controlled House and not breach the debt ceiling, but the country will have to live with the consequences.

The trick here is to ensure the blame for the ensuing slowdown falls relatively harder on Republicans And the survey data suggests this is exactly what is happening. By this mechanism, the Republican party is torn apart by public opinion.

So, it seems to me the Administration has the Republicans in a heads I win, tails you lose situation. They will have to eat something that tastes very, very bad, and as a consequence, bear tremendous pressure from either the inside and the outside. Either way, Obama ends up looking like the reasonable centrist who can keep his party in line. To pull it off, Obama just has to be willing to endure the pain of a further economic slowdown, hoping to make it up on the other side. And note this – it seems this Administration is willing to bear a remarkable amount of pain. Notice the unemployment rate lately?

All of which leaves me thinking there is a very nontrivial chance the debt-ceiling question does not get resolved by August 2. But I admit that this is just my West coast, outsider view that has emerged from studying the news stream of East coast insiders, and will be happy to see the expected compromise emerge over the weekend.

links for 2011-07-29

Posted: 29 Jul 2011 12:05 AM PDT

Are We There Yet?

Posted: 28 Jul 2011 01:22 PM PDT

David Altig says there's a lot of ground to cover before things get back to normal:

Lots of ground to cover, by David Altig: In my last post I noted that the pace of the recovery, now two years old, is in broad terms similar to that of the first two years of the previous two recoveries. The set-up included this observation:

"Though we have grown used to thinking of the rebound from the most recent recession as being spectacularly substandard, that impression (which I share) is driven more by the depth of the downturn than the actual speed of the recovery."

The context of the depth of the downturn is not, of course, irrelevant. One way of quantifying that context is to look at measures of the "output gap," that is, the difference between the level of real gross domestic product (GDP) and the economy's "potential." An informal way to think about whether or not a recovery is complete is to mark the time when the output gap returns to zero, or when the level of GDP returns to its potential.

There are several ways to estimate potential GDP, but for my money the one constructed by the Congressional Budget Office (CBO) is as good as any. And it does not tell a pretty story:

Real GDP-Real Potential GDP

It is worth noting that the CBO's measure is not a just a simple extrapolation of a constant trend, but a calculation based on historical relationships among labor hours, productivity growth, unemployment, and inflation. Their trend in potential GDP growth rates implied by this methodology, described here, is anything but linear:

Real Potential GDP

Note that the output gaps in the first chart are at historical lows (by a lot) despite the fact that potential GDP growth is at historical lows as well.

These estimates provide one way to assess the pace of the recovery. For example, the midpoints of the Federal Open Market Committee's (FOMC) most recent consensus forecasts for GDP growth are 2.8 percent (2011), 3.5 percent (2012), and 3.85 percent (2013). If those forecasts come to pass, approximately 60 percent of the CBO-implied gap will be closed. This would still leave, in real terms, more resource slack than existed at the lowest point in the past two recessions.

Put another way, if the economy grows at 4 percent from 2012 forward, the output gap won't be closed until sometime in 2015. At a growth rate of 3.5 percent—the lower end of FOMC participants' projections for the next two years—the "full recovery" date gets pushed back to 2016. If, however, the FOMC projections are too optimistic and the economy can only manage to grow at an annual pace of 3 percent (which is currently the consensus view of private forecasters for 2012) output gaps persist until 2020.

The conventional view of the macroeconomy that motivates the CBO estimates of potential GDP (and hence output gaps) at least implicitly embeds the assumption that time heals all wound. But the healing won't necessarily be fast.

Unskilled Labor

Posted: 28 Jul 2011 09:09 AM PDT

David Frum:

I used to write editorials for the Wall Street Journal... So I'm well aware of the challenge faced by those assigned to compose these documents. The strict demands of the paper's ideology do not always lie smoothly over the rocky outcroppings of reality. It can take considerable skill to match the two together.

Unfortunately, many of the writers aren't that skilled.

He goes on:

In that regard, this morning's lead editorial about the debt-ceiling crisis is a true masterpiece.
If you were to write a story about government debt, you'd probably be inclined to write about the two sets of government decisions that produce deficits or surpluses: decisions about expenditure and decisions about revenue. You'd want to do that not only as a matter of fairness, but also as a matter of math.
And that's why, my friend, you would wash out as a WSJ editorialist. They wrote this editorial without any reference to revenues whatsoever. Boom! Gone! Don't deny reality. Defy reality. ...
One of the many traps and impediments facing a Journal editorialist writing about debt is that up until 2009, the US debt burden rose most under the two presidents the Journal most ardently supported: Ronald Reagan and George W. Bush. The debt burden declined most under the presidents the Journal most despises – Dwight Eisenhower, Bill Clinton and Jimmy Carter.
It must have taken some hunting, but the Journal managed to find a chart that did just the opposite: federal payments to individuals as a percentage of federal outlays. What's so great about this chart is that it excludes two of three biggest federal spending programs: Medicare and Medicaid, both of whose costs rose faster in the Bush 2000s than in the Clinton 1990s. ...

Better News on Labor Markets, But Will It Continue?

Posted: 28 Jul 2011 09:01 AM PDT

I  have some comments at MoneyWatch on today's news that new claims for unemployment insurance fell below 400,000:

Better News on Labor Markets, But Will It Continue?

Update: The post includes a graph from Macroadvisors giving their forecast of how the Boehner and Reid plans will slow economic growth. Brad DeLong describes their forecast:

Congress Debates Making the Economy Weaker: Macro Advisers:

Macroadvisers: Dueling Debt Proposals: How Much Fiscal Drag?: The House and the Senate have advanced separate but dueling plans to cut federal spending as a way to break the current impasse over raising the debt ceiling. Both plans would initially limit spending through 2021 with caps on discretionary budget authority while promising to convene commissions to identify more savings later…. CBO has now scored both of these plans relative to its March adjusted baseline…. The cuts in primary spending (that is, excluding interest payments) in the House (or Boehner) plan cumulate to just $715 billion ($851 billion including interest). The cuts in primary spending in the Senate (or Reid) plan cumulate to $1.8 trillion ($2.2 trillion including interest). The cuts in the Senate plan are so much larger because that plan quickly cuts budget authority for the wars….

We estimate that the Reid plan would slow GDP growth (again, statically) by about ¼ percentage point on average from fiscal year (FY) 2012 through FY 2015, with the peak effect being almost ½ percentage point in FY 2013.

We estimate that the Boehner plan would slow GDP growth by only about 0.1 percentage point on average over the same period, with the peak effect being a little over 0.2 percentage point in FY 2014.

Can't anybody play this game?

July 28, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

SF Fed: Residential Construction Won't Fully Recover Until 2014

Posted: 28 Jul 2011 12:42 AM PDT

There's a new paper from the San Francisco Fed discussing how long it will take for residential construction to rebound to normal levels. Here's the abstract:

When Will Residential Construction Rebound?, by William Hedberg and John Krainer, FRBSF Economic Letter: Over the past several years, U.S. housing starts have dropped to around 400,000 units at an annualized rate, the lowest level in decades. A simple model of housing supply that takes into account residential mortgage foreclosures suggests that housing starts will return to their long-run average by about 2014 if house prices first stabilize and then begin appreciating, and the bloated inventory of foreclosed properties declines.

The paper notes that price adjustment alone is not enough, "a significant easing of the drag on housing stemming from the inventory of foreclosed homes is also needed." For example, in this graph showing the predicted path for housing starts, the red line assumes a 50,000 per quarter decline in the inventory of foreclosed homes starting in 2012, which as the paper notes is an optimistic assumption. The black line assumes no decline at all. When foreclosures decline as assumed for the red line, the recovery time improves substantially (but note that the prediction of a recovery by 2014 depends upon the optimistic assumption about how fast foreclosures will drop):

An implication of this research is that polices that help homeowners escape foreclosure would speed the recovery of the housing market.

More Division on the Divide

Posted: 28 Jul 2011 12:33 AM PDT

"A Golden Opportunity to Please Conservatives and Liberals Alike"

Posted: 28 Jul 2011 12:24 AM PDT

Robert Stavins:

A Golden Opportunity to Please Conservatives and Liberals Alike, by Robert Stavins: ...It's too soon to forget that a year ago the Senate abandoned its attempt to pass climate legislation that would limit CO2 emissions. In the process, conservative Republicans dubbed cap-and-trade "cap-and-tax.'' But, as I've said before, regardless of what they think about climate change, conservatives should resist demonizing market-based approaches to environmental protection and reverting to pre-1980s thinking that saddled business and consumers with needless costs.
Market-based approaches to environmental protection should be lauded, not condemned, by political leaders, no matter what their party affiliation.  Otherwise, there will be severe and perverse long-term consequences for the economy, for business, and for consumers.

links for 2011-07-27

Posted: 27 Jul 2011 10:01 PM PDT

Low End Job Growth

Posted: 27 Jul 2011 02:07 PM PDT

 Quick one before getting back on the road:

Where the Job Growth Is: At the Low End, by Steven Greenhouse, NY Times: There's more unhappy news for the millions of Americans hoping for a surge in the number of good, high-paying jobs — a new report concludes that the great bulk of new jobs created since the economic recovery began are in lower-wage occupations, paying $13.52 or less an hour.
The report by the National Employment Law Project, a liberal research and advocacy group, found that while 60 percent of the jobs lost during the downturn were in midwage occupations, 73 percent of the jobs added since the recession ended had been in lower-wage occupations, like cashier, stocking clerk or food preparation worker.
According to the report, "The Good Jobs Deficit," the number of jobs in midwage and high-wage occupations remains significantly below the prerecession peak, while the number of jobs in lower-wage occupations has climbed back close to its former peak. ...
The report gives additional ammunition to those who argue, like David Autor, an economics professor at M.I.T., that there is a distinct hollowing out of the middle. ..."We should emphasize that it is too early in the recovery to predict whether these trends will continue," the report said. ...

Net Change in Occupational Employment During and after the Great Recession
Net change in occupational employment during and after the Great Recession.
Source: National Employment Law Project analysis of Current Population Survey

"A Perfect Case Study of Flawed Incentives"

Posted: 27 Jul 2011 06:48 AM PDT

Ratings agencies shouldn't have so much influence:

The Biggest Driver in the Deficit Battle: Standard & Poor's, by Robert Reich: ...All of America's big credit-rating agencies — Moody's, Fitch, and Standard & Poor's — have warned they might cut America's credit rating if a deal isn't reached soon to raise the debt ceiling. ... But Standard & Poor's has gone a step further: It... insists any deal must also ... reduce the nation's long-term budget deficit by $4 trillion — something neither Harry Reid's nor John Boehner's plans do.
If Standard & Poor's downgrades America's debt, the other two big credit-raters are likely to follow. The result: You'll be paying higher interest on ... every ... penny you borrow. ... In other words, Standard & Poor's is threatening that if the ten-year budget deficit isn't cut by $4 trillion..., you'll pay more – even if the debt ceiling is lifted next week.
With Republicans in the majority in the House, there's no way to lop $4 trillion of the budget without harming Social Security, Medicare, and Medicaid, as well as education, Pell grants, healthcare, highways and bridges, and everything else the middle class and poor rely on.
And you thought Republicans were the only extortionists around.
Who is Standard & Poor's to tell America how much debt it has to shed in order to keep its credit rating?
Standard & Poor's didn't exactly distinguish itself prior to Wall Street's financial meltdown... Had they done their job and warned investors how much risk Wall Street was taking on,... taxpayers wouldn't have had to bail out Wall Street; millions ... would ... be working now instead of collecting unemployment insurance; the government wouldn't have had to inject the economy with a massive stimulus...; and far more tax revenue would now be pouring into the Treasury... In other words, had Standard & Poor's done its job, today's budget deficit would be far smaller.
And where was Standard & Poor's (and the two others) during the George W. Bush administration – when W. turned a ... budget surplus ... into a gaping deficit? Standard & Poor didn't object to Bush's giant tax cuts for the wealthy. Nor did it raise a warning about his huge Medicare drug benefit (i.e., corporate welfare for Big Pharma), or his decision to fight two expensive wars without paying for them. ...
So why has Standard & Poor's decided now's the time to crack down on the federal budget — when it gave free passes to Wall Street's risky securities and George W. Bush's giant tax cuts ... thereby contributing to the very crisis it's now demanding be addressed?
Could it have anything to do with the fact that the Street pays Standard & Poor's bills?

Is there any evidence that ratings agencies are influenced by the fact that Wall Street pays their bills?:

Did Rating Agencies Give Preference to Big Banks?, by Matthew Philips: At the heart of the financial crisis was the market for mortgage-backed securities (MBS). These are the "toxic assets" that larded up bank balance sheets and all but froze the credit markets in the fall of 2008 ... thanks to the AAA ratings they received from the rating agencies Moody's, S&P, and Fitch. These firms that allowed so much junk to be passed off as gold were essentially the enablers of the financial crisis.

The relationship between the rating agencies and banks is a perfect case study of flawed incentives. With banks paying them to rate their investment products, and so much money pouring in at the height of the mortgage-boom..., Moody's, S&P, and Fitch had a strong incentive to play along.

A new study adds more fodder to the argument that these agencies were unduly influenced by the institutions whose products they were grading. It basically posits that the more MBS an institution issued, the better rating their stuff received. Here's the abstract:

We examine whether rating agencies (Moody's, S&P, and Fitch) reward large issuers of mortgage-backed securities, who bring substantial business, by granting them unduly favorable ratings. The initial yield on both AAA-rated and non-AAA rated tranches sold by large issuers is higher than that on similar tranches sold by small issuers during the market boom years of 2004-2006. ... We conclude that large issuers receive more favorable ratings...

July 27, 2011

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Latest Posts from Economist's View

Division over the Divide

Posted: 27 Jul 2011 05:04 AM PDT

As I get ready to hit the road for a couple of weeks away from Eugene, here are a few responses to my post yesterday at Reuters:

Brief replies:

I focused on the relationship between academic and other economists, but I should have at least mentioned the sociology within the profession as well. There were a few academic economists who called the housing bubble, but they were dismissed in much the same way as those outside of academia.

I am for specialization, of course, but being overly insular can cause specialists to deviate from the socially optimal set of research questions.

In at least one case it's easy to detect the attitude I was talking about.

When I say we should listen, I also mean that people should think about what they hear and consider the motivations of the person doing the talking, not blindly accept what, say, housing economists are saying.

Fed Watch: Is Structural Change the Primary Challenge?

Posted: 27 Jul 2011 12:24 AM PDT

Tim Duy:

Is Structural Change the Primary Challenge?, by Tim Duy: Given that thoughts of high structural unemployment continue to emerge in Fed thinking, the topic bears ongoing scrutiny. Especially so for me personally, as I have long seen the need for structural shifts that address the US current account deficit - but should such adjustments require persistently high unemployment rates? Some affirmation of my general story comes via David Altig, who recently posted this chart:


Note the shift in relative growth patterns – less consumption, more investment, and net exports at least a less negative drag. This seems consistent with a shift away from the externally supported pattern of household consumption so evident in the past decade. And in discussing the general disappointment with the strength of the recovery, Altig says:

The undeniable (and relevant) human toll aside, the current recovery seems so disappointing because we expect the pace of the recovery to bear some relationship to the depth of the downturn. That expectation, in turn, comes from a view of the world in which potential output proceeds in a more or less linear fashion, up and to the right. But what if that view is wrong and our potential is a sequence of more or less permanent "jumps" up and down, some of which are small and some of which are big?

The implication is that perhaps we are closer to potential output than is widely believed. Now, before you roll your eyes, as I am inclined to do, note the CBO estimate of potential output is not the only estimate. Menzie Chinn reminds us of the variety of estimates of potential output, some of which suggest that, at the moment, the output gap is actually positive.

Why might we believe that potential output has suffered some sizable, negative downward shock? Altig did not provide an explanation, but one can find the same idea in the most recent FOMC minutes:

Others, however, saw the recent configuration of slower growth and higher inflation as suggesting that there might be less slack in labor and product markets than had been thought. Several participants observed that the necessity of reallocating labor across sectors as the recovery proceeds, as well as the loss of skills caused by high levels of long-term unemployment and permanent separations, may have temporarily reduced the economy's level of potential output (italics added). In that case, the withdrawal of monetary accommodation may need to begin sooner than currently anticipated in financial markets.

"Several" means a nontrivial contingent. Notice the two, distinct explanations. One is a structural change story – the economy needs more IT workers, and less retail staff, but the latter cannot easily become the former. I cannot entirely dismiss this concern, as it is consistent with my own thoughts of how the US economy should evolve.

The second point is also not easily dismissible, at least in its entirety. Left leaning economists have worried that a protracted period of high cyclical unemployment could induce an increase in structural unemployment – that those workers out of the labor market for two years become essentially unemployable at anything remotely like their previous wages. Maybe not even two years of unemployment, perhaps just a day. See Ryan Avent here.

The standard argument against the structural change story is to turn to the data itself and recognize that job losses have been widespread throughout the economy. Thus, while some structural change is happening in the background, the primary issue at hand is really a demand shortfall. See Brad DeLong here. Moreover, one should expect increasing wage differentials. But Federal Reserve staffers have had trouble identifying such effects. From a good overview on Bloomberg:

Mary Daly holds up two charts containing 33 bars that all point down. They show eight industries getting hit equally hard after the 18-month recession ended in June 2009, suggesting that much of the past two years' high unemployment is broad-based and should dissipate as the economy improves.

Daly is among researchers throughout the Federal Reserve system -- from San Francisco to Philadelphia and the board in Washington -- who are scouring data, examining models and gleaning anecdotes to determine why the jobless rate has remained stuck around 9 percent or more since April 2009. Most are reaching the conclusion that any long-term, structural shifts in the labor market aren't significant enough to keep the U.S. from returning to a pre-crisis unemployment level of 5 percent to 6 percent by about 2016.

"If we were mis-measuring the natural rate of unemployment, I would expect to see rapid wage growth in some sectors offset by wage declines in others," said Daly, 48, who heads the Federal Reserve Bank of San Francisco's applied microeconomic research department. "I don't see that. I see pretty uniform patterns across all sectors."

I don't quite see why if the structural shifts are not significant that is should take until 2016 to get unemployment back down to a normal range, but we will put that aside for the moment. The main point to the story, however, is that it is challenging to find the impacts of very large structural change in employment or wage data. Not that there are no effects:

The availability of extended unemployment benefits may have increased joblessness by as much as 0.8 percentage point and should have only a transitory effect as they expire and economic conditions improve, according to a January paper by Daly and San Francisco Fed researchers Bart Hobijn and Robert Valletta. Daly puts the natural rate at 6.25 percent and predicts it will fall to as low as 5.5 percent in five or more years.

Let's give the benefit of the doubt to the structural change side of the story, and say the natural rate is at 7 percent. That still leaves over 2 percentage points of unemployment, and, currently, that number is moving in the wrong direction. Hence, this is why overall wage growth remains weak (another factor suggesting fears that we are close to potential output are overblown).

Also arguing for a largely demand side explanation to the current weak employment numbers is what looks like a pretty obvious link between asset bubbles and full employment over the last decade. As long as households had a mechanism to support demand, achieving full employment was not a problem. If not households, then why can't another form of demand fill the gap?

If I were to look for a sign that potential output has been breached, I would turn my attention to the trade deficit, which very much suggests domestic absorption exceeds domestic capacity. The challenge, however, is that a significant trade deficit still exists along with high unemployment. I would be happier if the trade deficit only coincided with low unemployment, which would suggest strains in satisfying domestic absorption with internal resources. In my opinion, this curious state of affairs is the consequence of allowing foreign central banks to manipulate the value of the Dollar to obtain a trade advantage, which in turn has created significant imbalances in global patterns of production and consumption (I wouldn't fool myself with the belief this has anything to do with seeking greater investment returns). This, though, brings us back full circle – we should expect patterns of activity to shift to further support export and import competing industries, which almost certainly entails a reduced contribution from consumption and an increased contribution from net exports. We have the former, but I believe the impact of the latter has so far been insufficient to push the structural change along. As to why that is not occurring more quickly, I will hand the microphone over to Michael Pettis.

The interesting footnote here is the role of the fiscal deficit. Additional fiscal spending could reduce unemployment, but would it come with a wider trade deficit? I think it would – meaning that a portion of additional stimulus would bleed out overseas. And this, I think, is one reason the Administration is comfortable with risking the consequences of additional fiscal contraction. Instead, they look for fiscal policy to support the rebalancing story, and thus maintain the confidence of foreign investors. (That and I get the sense they are trying to recreate the mid-90's, which seems unlikely given that it was a very different economy.)

All of which leaves me with these thoughts: While not discounting the probability that some structural factors are at play, the primary challenge facing the US economy is insufficient demand. Optimally, I think the best solution to this challenge is that demand emerges from the external sector – and here I mean NET exports, export and import competing industries. This source of demand would support needed structural change, ultimately for the good of the US and global economies. This adjustment requires a relatively complicated expenditure-switching story on a global basis. I don't know how to avoid such a story. Barring this outcome, one falls back on fiscal policy, which can surely do the job, but risks maintaining the current pattern of global imbalances. And perhaps such concerns are overblown; after all, so far the fears of a Dollar/current account crisis have not emerged. Indeed, despite the ongoing debate in Washington regarding the debt ceiling, it looks like foreigners (central banks?) continue to acquire US Treasuries.

In the end, I take something of a middle road. I don't think we need sudden withdrawal of fiscal stimulus, although that appears to be what is happening. More appropriate would be near term expansion of fiscal stimulus sufficient at least to support the social safety net while allowing for an expenditure-switching story to build. But perhaps there are just too many moving pieces in such a plan to allow it to actually come to fruition. My fallback then is that we should not allow the reality of economic pain to take precedence over only imagined externally generated crisis.

links for 2011-07-26

Posted: 26 Jul 2011 10:01 PM PDT

Summers: Why the Stimulus Package Was Too Small

Posted: 26 Jul 2011 01:08 PM PDT

Larry Summers on whether the stimulus should have and could have been larger (from a longer interview):

Ezra Klein: Overall, could we have done more?
Larry Summers: There are multiple aspects of this question. First, the administration proposed considerably more than Congress was willing to enact. Taking account of the addition of the AMT, the Administration's Recovery Act proposals were cut back by about 20% in the process of passing Congress by very narrow margins.
Second, the President's economic team advised that there was essentially no danger of excessive fiscal stimulus in 2009. I joked ... that worrying about overdoing fiscal policy was like my losing too much weight and becoming anorexic — a conceivable possibility, but very far from the dominant risk. The President's political advisers — rightly in my view — constrained the initial stimulus proposals to avoid sticker shock and rejection or great delay on Congress's part.
Third, politics aside there were difficulties in moving spending rapidly in 2009. So-called shovel-ready projects often were not in fact ready to go. ... Of course it would have been possible to increase the tax cuts or assistance to state and local governments, but there were severe political limits in both those areas.
Fourth, we believed in the winter of 2009 that if, as seemed likely, more stimulus would ultimately be required, it could be passed through the Congress using the unemployment insurance extension for 2010 as a vehicle. This view proved incorrect. The administration proposed and the House passed in the fall of 2009 a substantial further program... Unfortunately it did not pass the Senate and the focus has shifted very much towards deficit reduction rather than job creation. It is fortunate that the President was able last fall to lead an effort to pair extended tax cuts with payroll tax reductions — without that stimulus we might be looking at a double dip today

This doesn't explain the rosy baseline forecast for the economy that the White House put out, a forecast that has been a thorn in the side of the stimulus package ever since. Given the forecast, it didn't look like the fiscal package did anything. Had the baseline forecast been more realistic (i.e. lower), the stimulus package would have looked better, and the case for more stimulus would have been much stronger.

Note also that it only seemed "likely" they would need more stimulus, they thought it might be enough. They'd wait and see and ask for more if it was needed. But it was nowhere near enough. Thus, politics or not, they appear to have underestimated the degree of the problem, and hence the size of the response that would be required. Summers seems to say they knew how much was needed, but couldn't get it. I'm not so sure that they fully recognized the size of the problem they faced.

The "Great Divide" in Economics

Posted: 26 Jul 2011 08:10 AM PDT

When I was trying to figure out if there was a housing bubble or not, the academic economists I had come to trust said no, the fundamentals explain this. Sometimes this was backed by econometric analysis. But many people outside of academics, or at least a few, said there was a bubble. This was often backed by logic, intuition, and simple charts rather than sophisticated econometrics based upon theoretical constructs. For the most part, I dismissed the people I should have listened to, especially if it contradicted what the academics were saying. Most of all, I relied too much on the experts in the academic community instead of listening to all the evidence and then thinking for myself.

One of the reasons I didn't listen is that until I started blogging, I was pretty arrogant about academic economists. As far as I was concerned, pretty much, academic economists knew more about everything related to economics than anyone else. But one thing I've learned from the wide array of voices in the blogosphere is that I was wrong. Academic economists have a lot to learn if they are willing to listen.

This column at Reuters is, in part, a mea culpa:

The Great Divide in Economics

It's also a more explanation of why we need increased interaction between researchers and practitioners.

Update: Paul Krugman comments: Listening to Others.
: Dean Baker weighs in.
Update: More from Dean Baker: There's Zero Accountability in Economics.
Update: Paul Smalera: Krugman says Thoma's right, except when he's wrong.
Update: Larry Summers responds: Economic specialization is a feature, not a bug.
Update: Richard Green responds to Larry Summers.