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April 23, 2015

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Robert Hall: Secular Stagnation in the US

Posted: 23 Apr 2015 12:33 AM PDT

Robert Hall at Vox EU:

This column is a lead commentary in the VoxEU Debate "Secular Stagnation"
Secular Stagnation in the US, by Robert E. Hall: The disappointing post-crisis performance of the US economy and even more disappointing performance of continental Europe and Japan have revived interest in the possibility of secular stagnation. Under stagnation, real incomes fail to grow or even shrink, and the economy's output falls farther and farther below its earlier upward trend. Rising unemployment may also occur. Summers (2014) ignited interest in the possibility of secular stagnation.
One important factor in stagnations is the inability or reluctance of the central bank to lower interest rates as low as would seem to be appropriate, given the ability of low rates to stimulate output and employment. The Federal Reserve and the Bank of Japan have kept rates slightly positive since the crisis, while the ECB did the same until recently, when it pushed the rate just slightly negative. All three economies had combinations of high unemployment and substandard inflation that unambiguously called for lower rates, according to standard principles of modern monetary economics.
Extreme slack persists in continental Europe and Japan, but in the US, several labor-market indicators, such as low short-term unemployment and high levels of unfilled job openings, indicate the end of the period of slack that followed the crisis, while others, such as long-term unemployment and involuntary part-time work, still show slack but are declining and will probably reach normal levels in the coming year.1 Forecasters believe that the Fed will unpin the short-term interest rate in the middle of 2015 or a bit later in the year. Markets for forward rates agree.
European versus US secular stagnation: Demand versus supply factors
Thus a consensus is forming that inadequate demand will no longer be a factor in whatever US stagnation occurs in coming years. In Japan and Europe, on the other hand, the case for boosting demand is strong and inadequate demand is almost surely a main cause of the stagnation.
Despite the resumption of normal conditions in the US labor market and the consensus that slack is gone, the US economy is stagnated in the sense that the standard of living stopped growing around 2000. Family purchasing power today is just the same as in that year. Figure 1 shows that it grew briskly during the 1990s, slowed markedly prior to the crisis, dropped below its 2000 level as a result of the crisis, and grew slowly in recent years.

Figure 1.

Hall fig1 22 apr

Two episodes of low purchasing-power growth despite a growing economy appear in the figure. From 2002 through 2007 (recovery from the 2001 recession), and 2010 to 2013 (the recovery from the 2008-09 Great Recession). The unemployment rate reached 4.8% in 2007 – well below the long-run average rate of 5.8% and is right at that long-run rate today. The evidence is strong that inadequate demand is not behind the general stagnation of purchasing power, though it was a factor in the period immediately following the Crisis. As of 2014, the US has had a decade and a half of a new kind of secular stagnation, one associated with declining supply.
Causes of US secular supply stagnation
Four factors account for the stagnation of purchasing power in the US economy: 1) declining labor share; 2) depleted capital; 3) reduced productivity growth; and 4) declining labor-force participation. I will discuss indexes that capture each of these factors in turn using indices that all start at unity in 1989. An index of total purchasing power from earnings is the result of multiplying the four indexes together.
Labor's declining share of income.
Figure 2 shows an index of labor's share (including fringe benefits) of total US income. It tends to be level in recessions, fall during the first half of ensuing expansions, then rise back to a high level at the next recession. But superimposed on that pattern is a general decline that cumulates to about 10% over the period. Like the general declining trend in earnings, the decline in the share seems to have started around 2000. Economists have pursued multiple explanations of the decline, but no consensus has formed.

Figure 2.

Hall fig2 22 apr

Slow overall productivity growth.
Figure 3 shows that productivity grew rapidly from 1989 to 2007. The Great Recession caused a dip in productivity, as did past recessions (due mainly to idle facilities). Though productivity grew at normal rates during the recovery, it did not make up for the shock of the crisis, so the average growth since 2006 has been below par.2 Household earnings suffered proportionately. See Fernald (2014) for further discussion of productivity.

Figure 3.

Hall fig3 22 apr

Depleted capital per household.

Figure 4.

Hall fig4 22 apr

Figure 4 shows the third factor – the amount of capital available to equip the average worker. With more plant, equipment, and software, workers earn more. Capital per household rose rapidly during the 1990s, but more slowly after 2000. Capital per household actually fell during the Great Recession, and its more recent growth has not come close to placing capital per household where it would have been if the trend of the 1990s had continued.
Low labor-force participation.
Figure 5 displays the average household's involvement in the workplace as measured by an index of annual hours of work of household members. Hours per household grew rapidly until 2000, fell as usual during the recession of 2001, flattened but did not grow during the boom of 2002 through 2007, unlike previous booms, collapsed in the Great Recession, and have risen during the recovery that is still underway. The decline in hours since 2000 is the single biggest factor in the decline in household earnings.3 Recent growth in hours per household offers some hope for the return of earnings growth in coming years.

Figure 5.

Hall fig5 22 apr

Why hours worked declined
Because declining hours account for the biggest part of the stagnation of earnings, I will dig deeper, by breaking them down into three components: Labor-market participants per household; fraction of participants working; and hours per worker.
Figure 6 shows an index of participants per household.

Figure 6.

Hall fig6 22 apr

As the chart illustrates, participation rose during the 1990s, especially in the second half of the decade, but has fallen since. The Great Recession depressed participation only slightly and does not appear to have been an important determinant of the overall decline in involvement in the labor market. Of course, the recession was a time when fewer participants were actually working and more were looking for work.
Economists have been working hard on trying to understand the surprising decline in participation, which exceeds forecasts that were made in earlier years. Most research agrees that the slack labor market had a relatively small discouraging effect. Another suspect that has been found to have at most a small role is changes in the composition of the working-age population – the negative effect of aging of the population on participation just offsets the positive effect of higher educational attainment. A large increase in the fraction of households subject to taxes imposed on families benefiting from food stamps, disability, and other safety-net programs may be a factor.
Figure 7 shows an index of the fraction of participants who were actually working – the remainder were unemployed and actively looking for work.
This factor was flat on average, falling in recessions and rising in the ensuing recoveries. It has risen recently, as unemployment has fallen to the upper-five-percent range. It is not an important element of the stagnation of earnings as of today.

Figure 7.

Hall fig7 22 apr

Figure 8 tracks hours of work per week for the average household.
It was quite constant over most of the period, but fell sharply during the Great Recession and recovered only about half of the decline since. It is too early to judge whether hours per worker will return soon to its earlier level or remain as an element of the stagnation of earnings.

Figure 8.

Hall fig8 22 apr

Work versus other time uses
Some indication about the changing balance between work and other uses of time comes from the American Time Use Survey, which began in 2003. Table 1 shows the change in weekly hours between 2003 and 2013 in a variety of activities.

Table 1.

For men, the biggest change by far is the decline of 2.5 hours per week at work, a big drop relative to a normal 40- hour work week.
A small part of the decline is attributable to higher unemployment—the unemployment rate was 6.0% in 2003 and 7.4% in 2013.
The decline for women is much smaller, at 0.8 hours per week.
For both sexes, the big increases were in personal care (including sleep) and leisure (mainly video-related activities). Essentially no change occurred in time spent in education. Women cut time spent on housework.
Is there hope for a return to normal growth of household purchasing power?
Capital seems likely to continue to return to its historical growth path, as Figure 4 suggests. For the three other major categories, forecasting is a challenge. There has been no sign of a reversal of the decline in labor's share of total income and no body of research that supports the idea that it will. Productivity growth is definitely under way, at rates similar to those in the 1970s and 1980s, but well below the rates of the 1950s, 1960s, and 1990s. In particular, there is no sign that a burst of productivity growth will make up for the complete stall in productivity growth around the crisis, as Figure 3 shows.
Most importantly, there is no sign suggesting a departure from the decline in labor-force participation shown in Figure 6. Some commentators have declared a turnaround in participation based on recent monthly data, but Figure 9 suggests this is wishful thinking. Participation has declined along a straight line during the period of improving conditions in the labor market, suggesting a complete disconnect between participation and the state of the labor market.

Figure 9

Hall fig9 22 apr

One possibility for growth in purchasing power is that unemployment may dip below 5.5% -- the level that some believe defines full employment. The unemployment rate reached 3.8% in 2000 and 4.4% in 2007, in both cases at the ends of long expansions, without triggering inflation much above the Fed's target of around 2%.
I reiterate that these conclusions apply to the United States. In continental Europe, the case is strong that demand has far from recovered. In Japan, unemployment is at low levels but the performance of the economy is substandard.
References
Fernald, John (2014). "Productivity and Potential Output Before, During, and After the Great Recession", NBER Macro Annual, 2014, forthcoming.
Lawrence H. Summers, "U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound" Business Economics Vol. 49, No. 2  National Association for Business Economics
Footnotes
1 Complete backup for all of the calculations is available from my website, stanford.edu/~rehall
2 See Fernald (2014) for a discussion of the evidence.
3 See Foote and Ryan (2015).

'Mediamacro Myth: 2010 Britain Faced a Financial Crisis'

Posted: 23 Apr 2015 12:24 AM PDT

Simon Wren-Lewis is attempting to debunk a series of "mediamacro myths". This is the first in the series:

Mediamacro myth 1: 2010 Britain faced a financial crisis: The idea that the Coalition rescued Britain from a crisis is routinely put forward as fact by both the Conservatives and Nick Clegg. Every time the media let such statements pass (as they invariably do), the language seems to get more florid: Clegg's latest is that the coalition was born in the "midst of an economic firestorm". [1]
The facts say this is pure nonsense. The economy had begun to recover from the recession, and this recovery might have continued if it had not been hit on the head by domestic and Eurozone austerity. As Larry Elliott makes clear (see also here), there was no sign of any market panic, either in the markets for Sterling or government debt. ...
So where is the half-truth that gives the 'firestorm' myth some credence? It is of course the Eurozone crisis, and the idea that the UK could suffer a similar fate to the Eurozone periphery. But academic macroeconomists understand that the situation of a country with its own central bank, like the UK, is quite different from a country without, because the central bank can (and in the UK will) act as a lender of last resort, so the government will never 'run out of money'. That simple fact is sufficient to prevent any crisis happening for an economy like the UK. ...
Why is it so important to keep up the pretence that in 2010 the UK economy was 'on the brink' of a financial crisis? Because only then can the pain of the subsequent few years be excused. The truth is that the failure to recover until 2013 was not the inevitable cost of rescuing the economy from crisis, but an avoidable choice by the Coalition government. The delayed recovery, and the damage that did to living standards, was at least in part a direct consequence of attempts to reduce the deficit far too early, and there was no impending crisis that forced the government's hand. [3]

Links for 04-23-15

Posted: 23 Apr 2015 12:06 AM PDT

'Airbrushing Austerity'

Posted: 22 Apr 2015 06:51 AM PDT

Paul Krugman:

Airbrushing Austerity: Ken Rogoff weighs in on the secular stagnation debate, arguing basically that it's Minsky, not Hansen — that we're suffering from a painful but temporary era of deleveraging, and that normal policy will resume in a few years.
As far as I can tell, however, Rogoff doesn't address the key point that Larry Summers and others, myself included, have made — that even during the era of rapid credit expansion, the economy wasn't in an inflationary boom and real interest rates were low and trending downward — suggesting that we're turning into an economy that "needs" bubbles to achieve anything like full employment.
But what I really want to do right now is note something else, which is visible in the Rogoff piece and in many other things one reads lately — a backward-looking view of the austerity fever that swept policymaking circles in 2010 and airbrushes out the reality of intellectual folly. You see this sort of thing when people who predicted soaring interest rates from crowding out right away now claim that they were only talking about long-term solvency; when people who issued dire warnings about runaway inflation say that they were only suggesting a risk, or maybe talking about financial stability; and so on down the line.
So, in Rogoff's version of austerity fever all that was really going on was that policymakers were excessively optimistic, counting on a V-shaped recovery; all would have been well if they had read their Reinhart-Rogoff on slow recoveries following financial crises.
Sorry, but no — that's not how it happened. ...

'Spoofing in an Algorithmic Ecosystem'

Posted: 22 Apr 2015 06:48 AM PDT

Rajiv Sethi comments on the charge that Navinder Singh Sarao manipulated prices through "spoofing":

Spoofing in an Algorithmic Ecosystem: A London trader recently charged with price manipulation appears to have been using a strategy designed to trigger high-frequency trading algorithms. Whether he used an algorithm himself is beside the point: he made money because the market is dominated by computer programs responding rapidly to incoming market data, and he understood the basic logic of their structure.

Specifically, Navinder Singh Sarao is accused of having posted large sell orders that created the impression of substantial fundamental supply in the S&P E-mini futures contract:

The authorities said he used a variety of trading techniques designed to push prices sharply in one direction and then profit from other investors following the pattern or exiting the market.

The DoJ said by allegedly placing multiple, simultaneous, large-volume sell orders at different price points — a technique known as "layering"— Mr Sarao created the appearance of substantial supply in the market.
Layering is a type of spoofing, a strategy of entering bids or offers with the intent to cancel them before completion.

Who are these "other investors" that followed the pattern or exited the market? Surely not the fundamental buyers and sellers placing orders based on an analysis of information about the companies of which the index is composed. Such investors would not generally be sensitive to the kind of order book details that Sarao was trying to manipulate (though they may buy or sell using algorithms sensitive to trading volume in order to limit market impact). Furthermore, as Andrei Kirilenko and his co-authors found in a transaction level analysis, fundamental buyers and sellers account for a very small portion of daily volume in this contract.

As far as I can tell, the strategies that Sarao was trying to trigger were high-frequency trading programs that combine passive market making with aggressive order anticipation based on privileged access and rapid responses to incoming market data. Such strategies correspond to just one percent of accounts on this exchange, but are responsible for almost half of all trading volume and appear on one or both sides of almost three-quarters of traded contracts.

The most sophisticated algorithms would have detected Sarao's spoofing and may even have tried to profit from it, but less nimble ones would have fallen prey. In this manner he was able to syphon off a modest portion of HFT profits, amounting to about four million dollars over four years.

What is strange about this case is the fact that spoofing of this kind is, to quote one market observer, as common as oxygen. It is frequently used and defended against within the high frequency trading community. So why was Sarao singled out for prosecution? I suspect that it was because his was a relatively small account, using a simple and fairly transparent strategy. Larger firms that combine multiple strategies with continually evolving algorithms will not display so clear a signature. 

It's important to distinguish Sarao's strategy from the ecology within which it was able to thrive. A key feature of this ecology is the widespread use of information extracting strategies, the proliferation of which makes direct investments in the acquisition and analysis of fundamental information less profitable, and makes extreme events such as the flash crash practically inevitable.

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