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August 7, 2012

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 11 Jul 2012 12:06 AM PDT
Posted: 10 Jul 2012 12:42 PM PDT
Tim Duy:
Careful With That HP Filter, by Tim Duy: Brad DeLong reads Marcus Nunes' review of Stephen Williamson and concludes:
Marcus Nunes, I think properly, concludes that Williamson's graph is wrong, because Williamson ignores the fact that there was a rising trend of NGDP during the 1970s, while during the Great Moderation, NGDP was stationary... Furthermore, Scott Sumner questions whether the application of the Hodrick-Prescott filter to the entire 1947-2011 period was appropriate, given the collapse of NGDP after 2008, thereby distorting estimates of the trend…
Williamson is here, Sumner's reply is here. DeLong jogged my memory that this topic is trapped in my computer, and this seems a good time to get it out of there.
First off, I am very cautious about mixing pre- and post-1985 data because of the impact of the Great Moderation on business cylce dynamics. This applies to Jim Hamilton's reply to my thoughts about the positive impact from housing. Hamilton points out that prior to the Great Moderation, housing would make significant contributions to GDP growth as the economy jumped back to trend. True enough; Hamilton might prove correct. But I would add that large contributions prior to 1985 would typically come in the early stages of the business cycle. I don't think the same kinds of cycles are currently at play, and that it is a little late to be expecting a V-shaped boost from housing.
As to the issue of the HP filter, this was on my radar because St. Louis Federal Reserve President James Bullard likes to rely on this technique to support his claim that the US economy is operating near potential. As he said today:
The housing bubble and the ensuing financial crisis probably did some lasting damage to the economy, suggesting that the output gap in the U.S. is not as large as commonly believed and that the growth rate of potential output is modest. This helps explain why U.S. growth continues to be sluggish, why U.S. inflation has remained close to target instead of dropping precipitously and why U.S. unemployment has fallen over the last year—from a level of 9.1 percent in June 2011 to 8.2 percent in June 2012.
I think there is more wrong than right in these two sentences. I don't see how a slower rate of potential growth necessarily implies lower actual growth in the short run. Clearly we have many instances of both above and below trend growth over the years. The failure of inflation to fall further can easily be explained by nominal wage rigidities. And the drop in the unemployment rate, in itself not impressive, should be taken in context with the stagnation of the labor force participation rate.
Bullard likes to rely on this chart as support:
For some reason, Bullard rejects entirely CBO estimates of potential output, which would reveal a smaller output gap then his linear trend decomposition. My version of this chart:
To deal with the endpoint problem, I used a GDP forecast from an ARIMA(1,1,1) model to extend the data beyond 2012:1. If you don't deal with the endpoint problem, you get this:
I believe most people would believe this result (that output is solidly above potential) to be a nonsensical. By itself, the issue of dealing with the endpoint problem should raise red flags about using the HP filter to draw policy conclusions about recent economic dynamics.
Relatedly, notice that the HP filter reveals a period of substantial above trend growth through the middle of 2008. This should be a red flag for Bullard. If he wants to argue that steady inflation now implies that growth is close to potential, he needs to explain why inflation wasn't skyrocketing in 2005. Or 2006. Or 2007. Most importantly, we should have seen the rise in headline inflation confirmed by core-inflation. The record:
Core-inflation remained remarkably well-behave for an economy operating so far above potential, don't you think?
At issue is the tendency of the HP filter to generate revisionist history. Consider the view of the world using data through 2007:4:
Suddenly, the output gap disappears almost entirely in 2005. And 2006. And 2007. Which is much more consistent with the inflation story during that period.
Bottom Line: Use the HP filter with great caution, especially around large shocks. Such shocks will distort your estimates of the underlying trends, both before and after the shock.
Posted: 10 Jul 2012 10:17 AM PDT
This Economic Policy Paper is from the June 2012 issue of the Minneapolis Fed's The Region. It examines how inequality changed during the Great Recession, and illustrates the value of government intervention (i.e. social insurance) to households in the bottom 20% of the income distribution (though keep this in mind):
Inequality and Redistribution during the Great Recession, by Fabrizio Perri - Consultant, and Joe Steinberg - Research Analyst: Introduction Although there is little doubt that the Great Recession constituted a watershed for overall business cycle dynamics in the United States, the jury is still out on its distributional consequences. Did economic inequality change significantly during the recession? If so, which dimensions—income earnings, wealth and consumption—saw the largest changes? And what impact did government policies, such as taxes and transfer programs, have over this time period on both inequality and economic well-being?
Analyses focused on the first two years of the downturn seem to find no increase in economic inequality; indeed, some report a decline. For example, a recent comprehensive volume (Jenkins et al. 2011) that analyzes income distribution in 21 Organisation for Economic Co-operation and Development (OECD) countries (including the United States) across the Great Recession sees "little change in household income distributions in the two years following the downturn." Heathcote et al. (2010b) and Petev et al. (2011) study inequality in consumption expenditures in the United States up until 2009 and also find little change (if anything, they find a decline).
A longer-term view, however, suggests that high levels of unemployment and the large drop in housing prices, both of which started during the Great Recession but persisted well after, might have had longer-term adverse distributional consequences. In particular, the recession may have left a significant fraction of the U.S. population with very little wealth (due to the fall in asset prices) and poor labor market prospects (due to high unemployment).
The goal of this paper is to paint a more complete picture of the distributional impact of the Great Recession, including more recent data from 2010 and part of 2011. Most importantly, this paper considers inequality in a wide array of variables, such as earnings, disposable income, consumption expenditures and wealth, and looks at inequality for all of these variables at different sections of the economic distribution.
Our first finding is that during and after the Great Recession, the bottom of the U.S. earnings distribution has fallen dramatically. This is the result of historically high unemployment and nonparticipation. In terms of earnings, the bottom 20 percent of the U.S. population has never done so poorly, relative to the median, during the whole postwar period. We also show that this group experienced rapidly declining wealth.
Despite this, we find that inequality in disposable income and consumption did not increase at either the top or bottom of the distribution, confirming the findings of other studies. In other words, the same bottom 20 percent of the earnings distribution that fared so poorly during the Great Recession in terms of earnings and wealth is in pretty much the same relative position in terms of disposable income and consumption in 2010, after the recession officially ended, as it was in 2006, before the start of the recession.
Such a divergence of trends in earnings and disposable income at the bottom of the distribution is unprecedented in U.S. history, and we show that it is mainly due to government transfers and taxes, as opposed to private components of unearned income.
We conclude our study using panel analysis (i.e., following a specific set of households through time) to better assess the role of government taxes and transfers. This allows us to distinguish between the experience of a given section of the income distribution (e.g., the bottom 20 percent of the distribution, whose members change each period) and the experience of a fixed group of households (e.g., those households that were at the bottom 20 percent of the distribution in 2006 but whose position may have changed by 2010. If the "Smiths," say, were in the bottom fifth in 2006, we use panel analysis to understand where the Smiths ended up later on).
Our main finding is that although the bottom 20 percent of the earnings distribution experienced constant disposable income or consumption expenditures despite earnings losses, individual households that face earnings losses and enter the bottom 20 percent group do suffer significant losses in disposable income and small losses in consumption.
Our main substantive conclusion is that government redistribution in the Great Recession was at historical highs and partially shielded households from experiencing large declines in disposable income and consumption expenditures. The same households, though, have experienced losses in net wealth, and this might make them more vulnerable to further or more persistent earnings declines in the future.
We believe our analysis provides useful data to inform the policy debate about whether or not, looking forward, the government should take a more aggressive role in providing assistance for households that experience earnings losses. ...
Posted: 10 Jul 2012 08:46 AM PDT
Bruce Bartlett:
In Lost Opportunity of 1932, Are There Lessons for Today?, by Bruce Bartlett, Commentary, NY Times: By the summer of 1932, the Great Depression was three years old with no end in sight. The Hoover administration, like Republicans today, was adamant that economic stimulus was wrongheaded, that the big problem was business confidence, which would be restored by keeping the budget under control, and that under no circumstances should the Federal Reserve adopt policies that would ignite inflation.
However, it was painfully clear to farmers and business people that deflation – falling prices – was the root of the economy's problem. ... By early 1932, a growing number of prominent economists were openly advocating "reflation" – just enough inflation to get the price level back to where it was in 1929...
In a May 1932 article in The Atlantic Monthly, John Maynard Keynes agreed that deflation was the core economic problem and that cheap money was the necessary cure. But he warned that the economy's downward momentum may have gone too far for conventional monetary policies to work... Keynes warned that there might be "no means of escape from prolonged and perhaps interminable depression except by direct state intervention to promote and subsidize new investment." ...
On May 5, President Hoover ... argued that the nation's true problem was not monetary, but fiscal. Balancing the budget by drastically cutting spending and raising revenue was what the economy needed. "Nothing will put more heart into the country," Hoover said.
In testimony before the Senate Banking Committee on May 13, Fisher strenuously disagreed. He noted that the economy was showing some signs of life because of an expansion of the money supply that the Fed had adopted in the spring. But businesses had no assurance that it would continue, which was their prime source of uncertainty. ... He was prescient. In July, the Fed halted its policy of quantitative easing and the recovery was quickly aborted. ...
 Meaningful action to end the Great Depression would have to wait until after the election and the inauguration of Franklin D. Roosevelt in 1933.
We need both monetary and fiscal policymakers to attack the unemployment problem aggressively. The Fed has done better than Congress, but neither has gone far enough (e.g. on the Fed, see here).
Posted: 10 Jul 2012 05:40 AM PDT
While I was traveling, I meant to post the introduction and a link to this (relatively long) essay on crisis and renewal in economics -- I was interested to see what comments you might have -- but something went wrong (I pushed the wrong button) and it never appeared:
Economics and the Public Sphere: The Rise of Esoteric Knowledge, Refeudalization, Crisis and Renewal, by Erik S. Reinert, Tallinn University of Technology, Estonia: After receiving the National Bank of Sweden's 1973 'Nobel' Prize in economics – shared with development economist Gunnar Myrdal – Friedrich von Hayek (1899-1992) held an unusual dinner speech where he quite explicitly criticized the prestigious prize he had just received: "…if I had been consulted whether to establish a Nobel Prize in economics, I should have decidedly advised against it. One reason was that I feared that such a prize … would tend to accentuate the swings of scientific fashion." Hayek believed that economics was different than other sciences, and his 1973 speech shows a degree of humility towards the complexities of economics which, in my view, differs profoundly from today's professional attitudes.[1] An insight from a 1952 book by Hayek strengthens the argument: "Never will man penetrate deeper into error than when he is continuing on a road which has led him to great success."[2] In other words: when being right and successful, mankind will 'overshoot' into error.
The origins of what colleague Mark Thoma refers to as the "Great Disconnect" between professional economics and the public sphere can be better understood by taking a closer look at Hayek's propositions. Observing the economics profession over time, it indeed appears to be subject to cycles of fashion as Hayek suggests: apparent theoretical success overshoots the scientific fashion into error and irrelevance.
Other economists have contributed, from different angles, to describing this 'overshooting' phenomenon. Norwegian-American economist Thorstein Veblen (1857-1929) suggests that knowledge exists on two different levels. Highly abstract and esoteric knowledge, like that of high priests, carries much prestige, but is – in practice – often fairly useless. On the other hand there is exoteric knowledge – useful knowledge – based on facts and experience, that carries little prestige. Using Veblen's terminology, we can argue that Hayek's overshooting of scientific fashion corresponds to Veblen's idea that irrelevant education may contaminate healthy instincts of useful and exoteric knowledge.
In this paper I shall provide examples of historical instances where esoteric knowledge has created crises, and how these crises were only solved by resurrecting alternative, sometimes near-defunct, paradigms of knowledge. The paper identifies four different periods (1848, 1890s, 1930s – and neoliberalism today) where the same tendencies recur: a rise of academic monoculture (of esoteric knowledge), refeudalization (tendencies towards a Plutocracy), crisis and renewal. These sequences and their recurrence define the changing relationship between economics and the public sphere, and it is only through activities in the public sphere that any renewal will take place. ...[continue reading]...

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