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May 13, 2013

FRBSF Economic Letter: Will Labor Force Participation Bounce Back?

This is related to the recent post from Gavyn Davies. Recall that he is worried about the unemployment rate giving misleading signals about the labor market. Many workers have dropped out of the labor force, and if those workers return to the labor force as the economy improves, then the measured unemployment rate will make conditions in the labor market look better than they actually are.
In this Economic Letter from the SF Fed, Leila Bengali, Mary Daly, and Rob Valletta argue that this is, in fact, something to worry about. They "find evidence, reinforcing other research, that the recent decline in participation likely has a substantial cyclical component" (i.e. their analysis concludes that exit from the labor market is temporary for a substantial number of people, and they will begin seeking work again when the economy improves):
Will Labor Force Participation Bounce Back?, by Leila Bengali, Mary Daly, and Rob Valletta, Economic Letter, FRBSF: The most recent U.S. recession and recovery have been accompanied by a sharp decline in the labor force participation rate. The largest declines have occurred in states with the largest job losses. This suggests that some of the recent drop in the national labor force participation rate could be cyclical. Past recoveries show evidence of a similar cyclical relationship between changes in employment and participation, which could portend a moderation or reversal of the participation decline as the current recovery continues.
Since the beginning of the recession in 2007, the U.S. labor force participation rate has dropped sharply. Some of this decline reflects long-term demographic trends and other factors that helped push down the participation rate before 2007. But the recent withdrawal of prime-age workers from the labor market is unprecedented and may reflect a cyclical component that could reverse as the labor market recovery solidifies. The return of these workers to the labor force would partially offset the longer-term demographic influences and potentially cause the participation rate to bounce back (Daly et al. 2012, Van Zandweghe 2012). Moreover, the increase in the number of active jobseekers in the labor force associated with higher participation could slow the decline in the unemployment rate.
Assessing the contribution of cyclical factors and the likelihood of a reversal or slower decline in labor force participation is difficult based on aggregate labor market data alone. Such data cannot perfectly distinguish between long-term trends and shorter-term cyclical factors, particularly given the severity of the labor market dislocation during the past recession. To assess the role of cyclical factors in the current recovery, we examine state-level variation in the relationship between changes in the labor force participation rate and changes in employment over several business cycles. ...
After a detailed analysis, they conclude that:
The U.S. labor force participation rate has declined sharply since 2007, intensifying a downward trend that has been evident since about 2000. Distinguishing between long-term influences on the participation rate, such as demographics, and short-term cyclical effects is important because it helps us understand and predict the future path of macroeconomic variables such as the unemployment rate. Using state-level evidence on the relationship between changes in employment and labor force participation across recessions and recoveries, we find evidence, reinforcing other research, that the recent decline in participation likely has a substantial cyclical component. States that saw larger declines in employment generally saw larger declines in participation. A similar positive relationship was evident in past recessions and recoveries. In the current recovery, it will probably take a few years before cyclical components put significant upward pressure on the participation rate because payroll employment is still well below its pre-recession peak.
Let me add, once again, that the costs of being wrong are not symmetric. If we are going to make a policy mistake, the bias ought to be toward keeping policy in place too long (and perhaps enduring a temporary bout of inflation) rather than putting the brakes on too quick (and ending up with an elevated unemployment rate and all of the short-run and long-run consequences that come with it).

Fed Watch: Fed Notes

Tim Duy:
Fed Notes, by Tim Duy: Gavyn Davies at the Financial Times questions the Federal Reserve's employment target:
On the wider issue of general monetary policy, the behaviour of inflation and unemployment remain the key drivers, and here the Fed has a headache. Its forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed.
I agree. Davies cites research indicating that recession-driven underemployment makes the unemployment rate a poor measure of resource utilization. The policy implications:
What does this imply for policy? It implies that the Fed will have a bias to keep policy aggressively easy long after the unemployment rate has fallen below 6.5 per cent, and even after it has fallen below the estimated natural rate of 5.25 to 6 per cent, provided that the inflation threshold is still intact. This is because the reserve army of disguised unemployed people will exert a downward force on inflation which will not be correctly picked up by the official unemployment statistics.
See my related piece on structural (or lack thereof) unemployment here. Davies raises a often-forgotten point: Even though the Federal Reserve is turning its attention to ending quantitative easing, the timing of the first rate hike is most likely much farther off in the future.
A challenge for the Fed is that asset purchases are at least in part a communications device that signals commitment to a given policy path. Thus, the Federal Reserve will need to take care to avoid the impression of imminent rate hikes as they scale back asset purchases. Indeed, I thought this was the most important takeaway from Friday's Jon Hilsenrath article in the Wall Street Journal:
Officials are focusing on clarifying the strategy so markets don't overreact about their next moves.
Overreaction can come in many forms:
For example, officials want to avoid creating expectations that their retreat will be a steady, uniform process like their approach from 2003 to 2006, when they raised short-term interest rates in a series of quarter-percentage-point increments over 17 straight policy meetings...An abrupt or surprising end to it could send stocks and bonds in the other direction, but a delayed end could allow markets to overheat. And some officials feel they've ended other programs too soon and don't want to repeat the mistake.
This sounds as if Fed officials are cognizant of this from Davies:
The more precise the forward guidance given, the more the Fed exaggerates the degree of knowledge which the central bank can possibly have about its own future actions, since these actions will depend on many factors which cannot be exactly predicted in advance.
Which also speaks to the inclusion of "increase or decrease" phrase in the last FOMC minutes. Back to Hilsenrath:
The Fed said in its postmeeting statement that it was "prepared to increase or reduce the pace of its purchases" as the economic outlook evolved.
The suggestion that the Fed might boost its bond buying was a change in the policy statement that seemed to some an acknowledgment that more aid for the economy might be needed...
...But many officials believe the recovery is on track and aren't yet concerned about the inflation slowdown. Instead, the most recent statement seems more aimed at signaling the Fed's broader flexibility in managing the programs.
Bottom Line: We need to be very careful in extrapolating the implications of the next policy move to future policy moves. The Fed has only a general strategy for exit, but policymakers lack enough certainty about the future to determine the exact nature of that exit. Still, even given that uncertainty, the current state of labor force utilization and inflation suggest that while the end of QE may occur this year, the first rate hike is not likely until some point well into the future.

Links for 05-13-2013

Fed Watch: What Does Japan Mean For The Rest of the World?

Tim Duy once again:
What Does Japan Mean For The Rest of the World?, by Tim Duy: Is Abenomics about boosting exports or domestic demand? I tend to agree with Lars Christensen on this issue:
There has been a lot of focus on the fact that USD/JPY has now broken above 100 and that the slide in the yen is going to have a positive impact on Japanese exports. In fact it seems like most commentators and economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”. I think this focus is completely wrong.
While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see is a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works.
In my view, Abenomics has been remarkably centered on the domestic economy. The impact on the Yen is almost an afterthought, whereas in the past policymakers would have turned to intervention to directly support the economy. This looks like policymakers finally realized that such a policy approach wasn't working and they need to change gears to a frontal-assault on domestic policy levers.
That said, a side-effect of Abenomics is currency depreciation, and this will have an impact on global trade. Investment Week has an interview with hedge fund manager Hugh Hendry:
"Japan's monetary pivot towards QE will not create economic growth out of nothing. Instead it seeks to redistribute global GDP in a manner that favours Japan versus the rest of the world. This is the last thing the global economy needs right now," he said.
So what's right and what's wrong with that quote? What's right is that there will be a trade impact. A story floating around right now is that Japanese exporters are not changing prices, but instead just allowing the impact of the weaker Yen to fall straight through to the bottom line. But they will soon turn their attention to leveraging the weaker Yen to cut prices and take market share. And they have Europe in their sights. They might not be able to compete with Chinese exporters, but they can with German ones.
What's wrong, however, is that this is exactly what the global economy needs right now. If Germany and by extension Europe experiences weaker growth, European policymakers will need to respond. And they are not likely to respond by buying Yen to hold its value up. They are likely to respond by stimulating their domestic economy directly via easier monetary policy and, hopefully, easier fiscal policy.
In other words, successful domestically-orientated policy in Japan will have second-round effects that will induce further policy easing Europe. And a good kick in the pants in Europe is exactly what we need right now. Rather than thinking about Japan's policy as triggering "competitive devaluations," think of it as triggering "coordinated global easing.
What's also wrong is Hendry's usual hedge-fund bias again monetary policy. By altering expectations to lower real interest rates, Japan's monetary policy is in a sense creating economic growth out of nothing. We frequently heard that "uncertainty" was holding back the recovery, but isn't this the same thing as creating a recession out of nothing? If you can create a recession out of nothing, then why not an expansion?

May 12, 2013

'The Fed Dials the Wrong Unemployment Number'

Gavyn Davies argues the Fed is targeting the wrong thing (unemployment instead of employment):
...the Fed has a headache. Its forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed. ...
The difficulty is that unemployment is declining towards the announced threshold in part because large numbers of people have left the labour force altogether as the recession has dragged on, and this probably means that the official unemployment rate is no longer acting as a consistent measuring rod for the amount of slack in the labour market.
The upshot is that the Fed will probably want to keep short rates at zero until unemployment has dropped a long way below 6.5 per cent...
[I]t is a distortion which the Fed cannot afford to ignore. Its mandate requires that it should aim for “maximum employment”, not “minimum unemployment on the official statistics”, which is what it risks doing under its current forward guidance. ...
If the Fed is going to make a mistake -- ease too long or tighten too soon -- you can probably guess which mistake I think is worse.

'Corporate Boards Are Still Failing'

Dean Baker:
Corporate Boards Are Still Failing: The median pay for a member of the board of a Fortune 500 company is almost $240,000 a year. This typically involves 4-8 meetings a year. One of the top priorities of the board is supposed to be ensuring that top management doesn't rip off the company. They have not been doing a very good job as Gretchen Morgenson points out in her column today. That raises the question of what exactly the get all this money for? ...
Gretchen Morgenson:
Directors Disappoint by What They Don’t Do: Directors of some high-profile public companies are coming under scrutiny this proxy season. Shareholder advocates say it’s about time.
The coming meeting of JPMorgan Chase shareholders, to be held in Tampa, Fla., on May 21, is a case in point. Directors on that board are under fire for not monitoring the bank’s risk management, a failure highlighted by last year’s $6 billion trading loss... Shareholder advisory firms have recommended voting against some of the directors on the risk policy committee and audit committee, so it will be interesting to see what kind of support those board members receive at the election.
The risk-management fiasco at JPMorgan was an obvious failing, but directors of public companies often let down their outside shareholders in ways that are more subtle, but equally important... Directors commonly neglect chief executive succession planning and inadequately analyze company performance as it relates to managers’ pay. ...
See also Lucian Bebchuk here (academic papers) and here (op-eds).

Links for 05-12-2013

RSS Feeds in the Sidebar are Fixed

Some of the RSS feeds in the sidebar stopped working for mysterious reasons (DeLong, Krugman, Econbrowser, Calculated Risk, Free Exchange, Environmental Economics, and a few more) -- I didn't change a thing -- and several of you have emailed/left comments wondering what happened.

United decided to delay yet another flight (grrr!!!), and it gave me some unexpected time so I fixed them. For now anyway. Let me know if the feedes stop working again.

(TypePad has a limit on how many RSS feeds you can have in the sidebar, but I found a way around it -- that may be the problem, don't know.)

May 11, 2013

'Moby Ben, or, The Washington Super-Whale'

Learn why hedge fund traders are so angry with Ben Bernanke, and why
There is a reason that the trade of shorting the bonds of a sovereign issuer of a global reserve currency in a depressed economy is called "the widowmaker".
See: Moby Ben, or, The Washington Super-Whale: Hedge Fundies, the Federal Reserve, and Bernanke-Hatred by Brad DeLong.

'In Praise of Econowonkery'

Paul Krugman:
In Praise of Econowonkery: ... I would say that in general the quality of economic discussion we’ve been having in recent years is the best I’ve ever seen. ...
Part of what he covers is
that we’re having a conversation in which issues get hashed over with a cycle time of months or even weeks, not the years characteristic of conventional academic discourse. ... events are moving fast, and the long lead times of conventional publication essentially guarantee that it will be irrelevant to current policy issues.
I've called this "real-time analysis" (this is from a much longer essay):
... Real-Time Analysis and Policy Prescriptions
Economic research is largely backward looking. After the fact – when all of the data has been collected and the revisions to the data are complete – economists examine data on, say, a financial crisis, and then figure out what caused the economy to become so sick. Once the cause has been determined, which may involve the construction of new theoretical frameworks, they tell us how to avoid it happening again, i.e. the particular set of policies that would have prevented or attenuated the damage.
But the internet and blogs are changing what we do, and to some extent we now act like emergency room physicians rather than pathologists who have the time to carefully examine data from tests, etc., determine what went wrong, and then recommend how to avoid problems in the future. When the financial crisis hit so unexpectedly, it was like a patient showed up at the emergency room very sick and in need of immediate diagnosis and care. We had to reach into our bag of macroeconomic models, choose the one that was correct for this question, and then use it to both diagnose the problems and prescribe policies to fix them. There was no time for a careful retrospective analysis that patiently determined the cause and then went to work on the potential policy responses.
That turned out to be much harder than expected. Our models and cures are not designed for that type of use. What data should we look at to make an immediate diagnosis? What tests should we conduct to give us data on what is wrong with the economy? If we aren’t sure what the cause is but immediate action is needed to save the economy from getting very sick, what is the equivalent of using broad spectrum antibiotics and other drugs to attack unknown problems? The development of blogs puts economists in real-time contact with the public, press, and policymakers, and when a crisis hits, traffic spikes as people come looking for answers.
Blogs are a start to solving the problem of real-time analysis, but we need to do a much better job than we are doing now at providing immediate answers when they are needed. If Lehman is failing and the financial sector is going down with it, or if Europe is in trouble, we need to know what to do right now, it won’t help to figure that out months from now and then publish the findings in a journal article. That means the discipline has to adjust from being backward looking pathologists with plenty of time to determine causes and cures to an emergency room mode where we can offer immediate advice. Blogs are an integral part of that process. ...

Links for 05-11-2013

May 10, 2013

'Markets Erode Moral Values'

Trying to figure out what to make of this:
Markets erode moral values, EurekAlert: Researchers from the Universities of Bamberg and Bonn present causal evidence on how markets affect moral values
Many people express objections against child labor, exploitation of the workforce or meat production involving cruelty against animals. At the same time, however, people ignore their own moral standards when acting as market participants, searching for the cheapest electronics, fashion or food. Thus, markets reduce moral concerns. This is the main result of an experiment conducted by economists from the Universities of Bonn and Bamberg. The results are presented in the latest issue of the renowned journal "Science".
Prof. Dr. Armin Falk from the University of Bonn and Prof. Dr. Nora Szech from the University of Bamberg, both economists, have shown in an experiment that markets erode moral concerns. In comparison to non-market decisions, moral standards are significantly lower if people participate in markets. ...
Details here.

Fed Watch: When Will The Divergence Between PCE and CPI Matter?

Tim Duy:
When Will The Divergence Between PCE and CPI Matter?, by Tim Duy: The divergence between PCE and CPI measures of inflation remains in the headlines. Pedro da Costa at Reuters sees a test of the Fed's credibility at hand:
With the inflation rate about half of the Federal Reserve's 2.0 percent target, the central bank is facing a major test and some experts wonder whether it will eventually need to ramp up its already aggressive bond buying program.
The challenge for policymakers is that they are clearly falling short of their dual mandate and that should open the door for additional asset purchases. But, but, but...I think that additional asset purchases is just about the last thing they want to do right now. We will see if their thinking evolved much at the last FOMC meeting, but the minutes of the March meeting clearly indicate that a large contingent of FOMC members are looking to end the asset purchase program by the end of this year. Take ongoing improvements in labor markets, add in concerns about financial stability, mix in some cost-benefit analysis about the efficacy of additional QE, and top-off with a dash of improving housing markets, bake at 350 for 40 minutes, and you get monetary policymakers hesitant to push the QE lever any further.
My sense is that policymakers will thus try to find reasons to dismiss falling PCE inflation as a non-issue. From an email exchange last week, today da Costa quotes me as saying:
"The Fed may view the divergence between the two measures as indicating that worries about deflation are premature," said Tim Duy, a professor of economics at the University of Oregon. "If core CPI was trending down as well, the Fed would be more likely to conclude that their inflation forecasts should be guided lower."
And also last week, Greg Ip at the Economist had this observation:
If CPI inflation were to converge to PCE inflation, that would be a concern. Goldman expects CPI inflation to drop to 1.8% in coming years and PCE inflation to rise to 1.5%. It would be preferable for both to converge to 2%; but so long as inflation expectations remain where they are, it is of little consequence for monetary policy – and a tangible plus for incomes and spending.
Yesterday, Philadelphia Federal Reserve President Charles Plosser had this to add, via the Wall Street Journal:
As of right now, “I’m not concerned” about inflation drifting too far under the central bank’s price target of 2%, Federal Reserve Bank of Philadelphia President Charles Plosser said in response to reporter’s questions at a conference here.
Inflation expectations “look pretty well anchored,” and it’s likely that price pressures as measured by the personal consumption expenditures price index will drift back up to 2% over time and reconverge with the consumer price index, he said.
Today, Chicago Federal Reserve President Charles Evans seemed resigned to low inflation. Again, from the Wall Street Journal:
“Inflation is low, and it’s lower than our long-run objective,” Mr. Evens said in an interview on Bloomberg Television, adding that he would like to see inflation closer to 2% but expects it to stay below 2% for several more years. Inflation, he said, “can be too low” when the central bank’s objective is 2%.
Asked if low inflation should prompt a policy response from the Fed, Mr. Evans said “I think it’s way too early to think like that.” In the debate over how the Fed might exit from the asset purchase program, Mr. Evans, a voting member of the policy-setting Federal Open Market Committee, said he remains “open minded [and] I’m listening to my colleagues.”
The general story seems to be that as long as inflation expectations remain anchored, and CPI inflation does not drift much below 2%, then the Fed will resist accelerating the pace of asset purchases.
Also note that the downward inflation drift is an underlying trend, or so concludes the Federal Reserve Bank of Atlanta's macroblog. The authors use a principle component model to estimate a common trend in the price data, and get these results:
Macroblog
The author's note that by this measure, the decline in PCE is not as ominous as it first seems, but it is clear that inflation by either measure is missing the Fed's target and currently trending away from that target. They conclude:
Does that mean we should ignore the recent disinflation being exhibited in the core PCE inflation measure? Well, let’s put it this way: If you’re a glass-half-full sort, we’d say that the recent disinflation trend exhibited by the PCE price index doesn’t seem to be “woven” into the detailed price data, and it certainly doesn’t look like what we saw in 2010. But to you glass-half-empty types, we’d also point out that getting the inflation trend up to 2 percent is proving to be a curiously difficult task.
Indeed, very curious given that we tend to think that at a minimum the monetary authority should be able to raise inflation rates. You are left with thinking that either the Federal Reserve still had more work to do or that monetary policy can do little more at this point than put a floor under the economy. If the latter, and if you want something more, you need to turn to fiscal policy.
Bottom Line: I suspect that at this point the Fed tends to think the costs of additional action still outweigh the benefits, and thus below-target inflation only induces pressure to maintain the current pace of QE longer than they currently anticipate rather than increase the pace of purchases.

Have Blog, Will Travel: Poverty, Inequality, and Social Policy

I am here today (I discuss inequality, poverty, and social policy quite a bit and thought this conference would be a good opportunity to hear some of the latest academic research on these issues):
NBER Universities' Research Conference
Poverty, Inequality, and Social Policy
Phillip B. Levine and Melissa Schettini Kearney, Organizers
May 10-11, 2013
Royal Sonesta Hotel
PROGRAM
Friday, May 10
1:30 pm Welcome and Introduction
1:40 pm
Hilary W. Hoynes, University of California at Davis and NBER
Marianne Bitler, University of California at Irvine and NBER
Elira Kuka, University of California at Davis
Do In-Work Tax Credits Serve as a Safety Net?

Discussant: Bruce Meyer, University of Chicago and NBER
2:30 pm
Bhashkar Mazumder, Federal Reserve Bank of Chicago
Sarah Miller, University of Michigan RWJ Scholar
The Effects of the Massachusetts Health Reform on Financial Well Being

Discussant: Robin McKnight, Wellesley College and NBER
3:20 pm Break
3:40 pm
Joanne Hsu, Federal Reserve Board
David Matsa, Northwestern University
Brian T. Melzer, Northwestern University
Unemployment Insurance and Consumer Credit

Discussant: Tal Gross, Columbia University and NBER Food Insecurity Roundtable
4:30 pm
Neeraj Kaushal, Columbia University and NBER
Jane Waldfogel, Columbia University
Vanessa Wight, Columbia University
Public Policy and Food Insecurity among Children

Patricia M. Anderson, Dartmouth College and NBER
Kristin Butcher, Wellesley College and NBER
Hilary W. Hoynes, University of California at Davis and NBER
Diane Whitmore Schanzenbach, Northwestern University and NBER
Understanding Food Insecurity During the Great Recession


Lucie Schmidt, Williams College
Lara Shore-Sheppard, Williams College and NBER
Tara Watson, Williams College and NBER
The Effect of Safety Net Programs on Food Insecurity
5:30 pm  Adjourn
6:00 pm Reception and Group Dinner
Saturday, May 11
8:00 am Continental Breakfast
8:30 am
Hannes Schwandt, Princeton University
Unlucky Cohorts: Income, Health Insurance and AIDS Mortality of Recession Graduates

Discussant: Ann Huff Stevens, University of California at Davis and NBER
9:20 am
Ariel Kalil, University of Chicago
Magne Mogstad, University College London
Mari Rege, Case Western Reserve University
Mark Votruba, Case Western Reserve University
Father Presence and the Intergenerational Transmission of Educational Attainment

Discussant: Elizabeth Ananat, Duke University and NBER
10:10 am Break
10:30 am
Phillip B. Levine, Wellesley College and NBER
Melissa Schettini Kearney, University of Maryland and NBER
Income Inequality and the Decision to Drop Out of High School

Discussant: David Deming, Harvard University and NBER
11:20 am
Anna Aizer, Brown University and NBER
Florencia Borrescio Higa, Brown University
Hernan Winkler, University of California at Los Angeles
Impact of Rising Inequality on Health at Birth
Discussant: Doug Almond, Columbia University and NBER
12:10 pm Lunch
1:10 pm
Adriana Lleras-Muney, University of California at Los Angeles and NBER
Anna Aizer, Brown University and NBER
Joseph P. Ferrie, Northwestern University and NBER
Shari Eli, University of Toronto
The Long Term Impact of Means-Tested Transfers: Evidence from the Mother's Pension Program
Discussant: Hoyt Bleakely, University of Chicago and NBER
2:00 pm
Sendhil Mullainathan, Harvard University and NBER
Eldar Shafir, Princeton University
The Psychology of Poverty (additional paper)
2:45 pm
David Ellwood, Harvard University and NBER
What Can We Possibly Do Now?  Reflections on Future Directions for Research and Policy in an Era of Rising Inequality
3:15 pm Adjourn

Paul Krugman: Bernanke, Blower of Bubbles?

Should we worry about bond and/or stock bubbles?
Bernanke, Blower of Bubbles?, by Paul Krugman, Commentary, NY Times: Bubbles can be bad for your financial health — and bad for the health of the economy, too. .... So when people talk about bubbles, you should ... evaluate their claims — not scornfully dismiss them, which was the way many self-proclaimed experts reacted to warnings about housing.
And there’s a lot of bubble talk out there right now. Much of it is about an alleged bond bubble.... But the rising Dow has raised fears of a stock bubble, too.
So do we have a major bond and/or stock bubble? On bonds, I’d say definitely not. On stocks, probably not, although I’m not as certain. ....
Why, then, all the talk of a bond bubble? Partly it reflects the correct observation that interest rates are very low by historical standards. What you need to bear in mind, however, is that the economy is also in especially terrible shape... The usual rules about what constitutes a reasonable level of interest rates don’t apply.
There’s also, one has to say, an element of wishful thinking here. For whatever reason, many people in the financial industry have developed a deep hatred for Ben Bernanke... As it turns out, however, dislike for bearded Princeton professors is not a good basis for investment strategy. ...
O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits ... are more than two-and-a-half times higher than they were when the 1990s bubble burst. Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.
All in all, the case for significant bubbles in stocks or, especially, bonds is weak. And that conclusion matters for policy as well as investment.
For one important subtext of all the recent bubble rhetoric is the demand that Mr. Bernanke and his colleagues stop trying to fight mass unemployment, that they must cease and desist their efforts to boost the economy or dire consequences will follow. In fact, however, there isn’t any case for believing that we face any broad bubble problem, let alone that worrying about hypothetical bubbles should take precedence over the task of getting Americans back to work. Mr. Bernanke should brush aside the babbling barons of bubbleism, and get on with doing his job.

Links for 05-10-2013

May 9, 2013

'Economists See Deficit Emphasis as Impeding Recovery'

Another travel day quickie:
Economists See Deficit Emphasis as Impeding Recovery, by Jackie Calmes and Jonathan Weisman: The nation’s unemployment rate would probably be nearly a point lower, roughly 6.5 percent, and economic growth almost two points higher this year if Washington had not cut spending and raised taxes as it has since 2011, according to private-sector and government
After two years in which President Obama and Republicans in Congress have fought to a draw over their clashing approaches to job creation and budget deficits, the consensus about the result is clear: Immediate deficit reduction is a drag on full economic recovery.
Hardly a day goes by when either government analysts or the macroeconomists and financial forecasters who advise investors and businesses do not report on the latest signs of economic growth — in housing, consumer spending, business investment. And then they add that things would be better but for the fiscal policy out of Washington. Tax increases and especially spending cuts, these critics say, take money from an economy that still needs some stimulus now, and is getting it only through the expansionary monetary policy of the Federal Reserve. ...
In all this time, the president has fought unsuccessfully to combine deficit reduction, including spending cuts and tax increases, with spending increases and targeted tax cuts for job-creation initiatives in areas like infrastructure, manufacturing, research and education. That is a formula closer to what the economists propose. But Republicans have insisted on spending cuts alone and smaller government as the key to economic growth. ...
And they keep insisting this is true despite the evidence to the contrary because it supports their ideological goals, and there is little political price for taking this position.

'Big Data Needs a Big Theory to Go with It'

Travel day, so some quick ones before heading out:
Big Data Needs a Big Theory to Go with It, by Geoffrey West: As the world becomes increasingly complex and interconnected, some of our biggest challenges have begun to seem intractable. What should we do about uncertainty in the financial markets? How can we predict energy supply and demand? How will climate change play out? ... To bring scientific rigor to the challenges of our time, we need to develop a deeper understanding of complexity itself.
What does this mean? Complexity comes into play when there are many parts that can interact in many different ways so that the whole takes on a life of its own: it adapts and evolves in response to changing conditions. It can be prone to sudden and seemingly unpredictable changes—a market crash is the classic example. One or more trends can reinforce other trends in a “positive feedback loop” until things swiftly spiral out of control and cross a tipping point...
The digital revolution is driving much of the increasing complexity..., but this technology also presents an opportunity..., enormous amounts of data. ... The trouble is, we don't have a unified, conceptual framework for addressing questions of complexity. ... “Big data” without a “big theory” to go with it loses much of its potency and usefulness...  We now need to ask if our age can produce universal laws of complexity...
We won't predict when the next financial crash will occur, but we ought to be able to assign a probability of one occurring in the next few years. The field is in the midst of a broad synthesis of scientific disciplines, helping reverse the trend toward fragmentation and specialization, and is groping toward a more unified, holistic framework for tackling society's big questions. The future of the human enterprise may well depend on it.

Links for 05-09-2013

May 8, 2013

'Let's Get Real About the Stock Market'

One thing I learned from the recent crisis is that despite my indifference to the day to day gyrations in asset markets, I need to pay more attention to them. For example, is there presently a bubble in stock market prices?
Antonio Fatás argues that it's a difficult to find evidence for this:
Let's get real about the stock market: As reported by the financial press, the stock market continues to hit fresh record-high levels in many advanced economies. The Dow Jones passed the 15,000 mark, the Nikkei just went over 14,000, and the DAX just went above its previous record. It seems to be the time to talk about bubbles in asset prices - an important issue given how these bubbles have dominated the last business cycles in these economies.

Except that we are looking at the wrong numbers. It is remarkable that the discussion on the value that these indices are reaching ignores two fundamental issues:
  1. These are nominal values and as we were told in the first economics lesson, we need to look at real variables and not nominal ones.
  2. Asset prices are not supposed to stay constant (in real terms). In many cases its appreciation will reflect real growth in the economy, earnings and/or the expected return that these assets should provide in equilibrium.
No need to look for data that provides a better benchmark than just nominal indices. Robert Shiller provides all the necessary data in his web site. Adjusting for inflation is easy and below is a chart with the real price of the S&P500 index where the CPI has been used to convert nominal into real variables.
After adjusting for inflation we can see that the index is far from its peak in 2000 and it is even below the peak in 2007. No sign of a record level yet.

Adjusting for inflation is not enough as the fundamentals (earnings) also grow because of real growth. The price-to-earnings ratio takes care of this adjustment (it also takes care of inflation because earnings are measures in nominal terms). Making this adjustment is more difficult but I will reply on Shiller's numbers again (his book and writings provide a lot of detailed analysis on his data).

Once we adjust for nominal as well as real growth, the current levels look even less impressive. Very low compared to the bubble built in the 90s and significantly lower than the ratio observed in most of the years during the 2002-2007 expansion. We are very far from record-high levels if we use this indicator.

Of course, to do a proper analysis we need to bring a lot of other factors: expected earnings growth, interest rates, risk appetite,.... And there will be room there to debate whether the current valuation of the stock market is reasonable, too high or too low. But starting the analysis with a statement of record-high levels when measured in nominal terms and ignoring real growth in earnings is clearly the wrong place to start the debate.
For more on stock prices, see Fernando Duarte and Carlo Rosa of the NY Fed: Are Stocks Cheap? A Review of the Evidence:
We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models? ...

Why is the equity premium so high right now? And why is it high at all horizons? There are two possible reasons: low discount rates (that is, low Treasury yields) and/or high current or future expected dividends. ... We find that the equity risk premium is high mainly due to exceptionally low Treasury yields at all foreseeable horizons. In contrast, the current level of dividends is roughly at its historical average and future dividends are expected to grow only modestly above average in the coming years. ...

About Those Inflation Fears

Via Cardiff Garcia at FT Alphaville, Inflation is falling everywhere:

(Charts via Capital Economics.)
... It’s probably worth noting that the wild fluctuations in the headline rate have had only a muted impact on core inflation in the past decade. Just something to keep in mind when you start hearing calls for policy action at the first hint of commodity price gyrations.
Capital Economics writes that there is divergence among some of the bigger emerging economies, with India and Brazil headed in opposite directions, but across the developed world the story is similar (though Japanese inflation expectations are heading higher, and are now above the eurozone’s, by one popular market measure):

What is Wrong (and Right) in Economics?

Dani Rodrik:
What is wrong (and right) in economics?, by Dani Rodrik: The World Economics Association recently interviewed me on the state of economics, inquiring about my views on pluralism in the profession. You can find the result on the WEA's newsletter here (the interview starts on page 9). I reproduce it below. ...

Fed Watch: 'Really? One Basis Point?' and 'Rising Structural Unemployment?"

Two from Tim Duy. Here's the first:
Really? One Basis Point?, by Tim Duy: Bloomberg has a story with an ominous opening paragraph:
Bank of Japan Governor Haruhiko Kuroda’s stimulus policies are backfiring in the housing market, where mortgage rates are rising even as the central bank floods the financial system with cash.
Lions, tigers, and bears, oh my! The next paragraph:
Fixed 35-year home-loan costs rose to 1.81 percent this month, the first increase since February and up from an all-time low of 1.8 percent in April, according to data compiled by the Japan Housing Finance Agency. Federal Reserve Chairman Ben S. Bernanke’s monetary easing almost halved 30-year U.S. mortgage rates since 2008 to 3.35 percent on May 2.
Seriously? The case against Kuroda is that after declining since February, mortgage rates climbed a whole basis point? And Kuroda is expected to accomplish in a few months what took Bernanke five years? And I thought I could be a harsh critic of central bankers!
Hopefully this is just a typo; I can't seem to locate a time series of the 35-year mortgage rate in Japan. Otherwise, one might be tempted to conclude that the reporters were biased against Abenomics.
And here's the second:
Rising Structural Unemployment?, by Tim Duy: This tweet from Andy Harless caught my eye:
HIres-to-openings ratio looking uglier & uglier bls.gov/news.release/j… Looks like rising structural unemployment
— Andy Harless (@AndyHarless) May 7, 2013
The chart:
0507RATIO1
The ratio of hires to openings fell to the low of the last cycle. Now compare the ratio to the unemployment rate:
0507RATIO2
Unemployment appears to be too high relative to the hires/openings ratio (caution is warranted, however, as the JOLTS data only extends back to 2001). One would normally associate such a low ratio with low unemployment as the number of hires would be relatively low because of the lack of available workers. In this case, however, the number of hires appears to be low despite a large pool of potential employees, consistent with the concern that available workers lack the skills firms seek. Structural unemployment, as Harless suggests.
That said, recall that Matthew O'Brien pointed us at research here and here suggesting that high unemployment is attributable not to structural factors, but instead to a bias against the long-term unemployed. O'Brien recognizes the insidious nature of this problem:
Circles don't get more vicious than this. The people who need work the most can't even get an interview, let alone a job. It's a cycle that could end with the long-term unemployed becoming unemployable. It's what economists call hysteresis, the idea being that a slump, left untreated, can make us permanently poorer by reducing our future ability to do and make things.
Bias against the long-term unemployed might explain why wage growth remains muted:
0507RATIO3
One would think that a low hires/openings ratio suggests that wage growth would be accelerating (as employers appear to face a relative shortage of workers), but that is not the case. Indeed, low wage growth is one reason to believe that excessive unemployment is cyclical in nature. How does this fit with the long-term unemployed story above? Perhaps that although firms have a bias against the long-term unemployed, those potential workers still place downward pressure on wages. The newly unemployed don't require higher wages despite demand for their skills because they know there is a large pool of people available with similar skills. If the newly unemployed demand too high wages, they may induce employers to take another look at the pool of long-term unemployed. Consequently, they do not seek higher wages.
Incidentally, this also explains the low quits rate. The consequences of becoming long-term unemployed are particularly severe, raising the expected cost of voluntarily leaving a job.
So I guess the "good" news would be this: If bias against the long-term is simply creating the illusion of structural unemployment, then we are not yet faced with the problem of hysteresis. If the pool of long-term unemployed can place downward pressure on wages, then they must have a valuable skill set. Otherwise, they would not represent a threat to the newly unemployed. Keep the demand up for employees long-enough, and firms will eventually give up their bias against the long-term unemployed (I assume this would be preferable to the alternative of prematurely escalating wages). Eventually, the pool of unemployed would decrease and then wage pressures increase.
Still, the longer we wait for this bias to diminish, the more likely it is that the unemployment does indeed become structural. Then we would expect rapidly rising wages despite elevated unemployment. Another argument for pulling on all the stimulus levers. Alas, that is not the case.
Update: And after I wrote all this, I saw this Harless tweet:
Likely part of the reason 4 low hires/opening is that most applicants r now long-term unemployed, who face a more rigorous screening process
— Andy Harless (@AndyHarless) May 8, 2013
Apparently on the same path.

Links for 05-08-2013

May 7, 2013

Seven Myths about Keynesian Economics

The recent blow-up surrounding Niall Ferguson's comments on Keynes' concern for long-run issues prompted my latest column:
Seven Myths about Keynesian Economics
The claim that Keynesians are indifferent to the long-run is one of many myths about Keynesian economics.

'Extended Benefits Didn’t Keep People From Taking Jobs'

We can be "kinder and gentler" without destroying (or even much affecting) the job market:
Extended Benefits Didn’t Keep People From Taking Jobs, by Amy Schatz, WSJ: Extended unemployment insurance benefits in the most recent recession prompted some people who would otherwise have dropped out of the workforce to stay in a little longer, but didn’t encourage people to reject jobs, according to new research recently released by the Federal Reserve Bank of San Francisco [by] Robert Valletta, a San Francisco Fed economist and Henry Farber, a Princeton University economist...