Creative Destruction

Will the recovery be "jobless"?

noreply@blogger.com (Maynard) — Thu, 12 Nov 2009 02:17:00 +0000

A lot of economists are worried that the recovery from the 2007-09 recession, like those following the 1990-91 and 2001 recessions, will be "jobless." Mark Thoma, for example, writes

Historically, a good rule of thumb has been that the peak in unemployment lags the trough in economic output by a quarter. Thus, if output begins recovering in the second quarter of the year, unemployment would not begin to decline until the third quarter... But as shown in these graphs of the unemployment rate and NBER-dated recessions, this changed with the 1990-91 and 2001 recessions... in the most recent recessions, the peak in the unemployment rate came a year or more after the trough in GDP... An important question is whether this new relationship between unemployment and output observed in the last two recessions will also be present in this recession. All indications are that it will.

I don't think there's any mystery here. The reason that unemployment was slower to fall after the last two recessions than in previous recoveries was that GDP growth was anemic. The average growth rate in the first four quarters of the recovery following the 1974-75 recession was 6 percent and after 1981-82 it was 5.5 percent. By contrast, in the first year of recovery following the 1990-91 recession GDP growth averaged 2.6 percent, and after 2001 it was 2.2 percent. Okun's Law says that the unemployment rate falls when growth exceeds its average rate, which from 1973-2009 was about 2.7%. If you think growth will be higher than this for the next year, you should expect to see unemployment begin to fall; if you think unemployment will continue to rise, you must believe GDP growth will be lower than 2.7%.

The graphs below demonstrate that the recoveries from the 1990-91 and 2001 recessions were not unusual. Suppose that in the recoveries following each of the last four major recession we wanted to predict the path of the unemployment rate based on GDP growth. A version of Okun's Law should do the trick: the change in the unemployment rate this quarter should equal one half the difference between last quarter's GDP growth rate and the post-1973 average growth rate (2.7%). (Note: because we're dealing with quarterly data here, we need to divide the annual growth rates by four before applying Okun's Law).

The graphs below show that Okun's Law does a great job predicting the path of the unemployment rate following the 1974-75 and 1981-82 recessions. After four quarters of growth beginning in 1975Q2, Okun's Law predicts an unemployment rate of 8.0%; the actual rate was 7.7%. After 12 quarters, Okun's Law predicts 6.2%, the actual rate was 6.3%. Same thing for the recovery beginning in 1982Q4. Four quarters in Okun's Law predicted an unemployment rate of 9.9%, actual was 9.4%; 12 quarters in Okun's Law predicted 7.0%, actual was 7.2%.

Was the pattern any different following the most recent two recessions? Not really. When output began to grow in 1991Q2, the unemployment rate was 6.8%. For the next four quarters GDP grew by 2.6%. Okun's Law would predict a slight increase in the unemployment rate, and indeed the rate rose to 7.4%. Twelve quarters into the recovery, a period during which GDP grew at an average rate of 3.1%, Okun's Law predicts an unemployment rate of 6.4%; the actual rate was 6.6%. (There was a divergence in the second year of recovery, but it disappeared in the third.)

The same pattern held following the 2001 recession. When GDP began to grow again in 2001Q4, the unemployment rate was 5.5%. After four quarters during which GDP grew at an average rate of 2.2%, Okun's Law predicts the unemployment rate should have increased to 5.6%; the actual figure was 5.7%.
In the first 12 months of recovery GDP growth was 2.7%. Okun's Law predicts that the unemployment rate should have ended up exactly where it had started, at 5.5%; the actual rate was 5.4%.

Despite all the structural changes that have occurred in the economy in the last few decades, Okun's Law remains a remarkably stable relationship. Until I hear convincing stories explaining why Okun's Law has suddenly broken down after all these years, I'm going to assume that the pace of decline in the unemployment rate for the next few years will be dictated by the strength of growth in GDP.

For reasons I have given in a number of posts below, I believe GDP growth is going to be about 4 percent over the next year. We've already had one quarter of 3.5% growth. Okun's Law predicts that 2009Q4 unemployment will be 0.5*(3.5-2.7)/4 = 0.1% below the level of 2009Q3, or 9.5%. If growth is 4% from 2009Q3-2010Q2, by 2010Q3 the unemployment rate should be down to 8.9% and down to 8.7% by Q4. Now these numbers are probably optimistic given that unemployment rose to 10.2% in October. If we assume unemployment peaks at 10.2% in 2009Q4, then four quarters of 4% growth from 2009Q4 to 2010Q3 brings us down to 9.5% by 2010Q4. Let's split the difference between optimistic and pessimistic scenarios: unemployment will be 9.1% by 2010Q4.

That's a grim unemployment forecast however you slice it. It calls for some more aid to states, extension of unemployment insurance, and so on. But it doesn't mean that there's been a dramatic change in the laws of economics.

Governance reform proposal

noreply@blogger.com (Maynard) — Tue, 10 Nov 2009 22:17:00 +0000

No one should be allowed to serve on APPC if he has expressed any interest in serving on APPC.

If current trends continue...

noreply@blogger.com (Maynard) — Fri, 06 Nov 2009 12:37:00 +0000

... job growth will turn positive in January. An employment change number today in the -200,000 range is consistent with that trend.

But job growth needs to be around +140,000 for the unemployment rate to fall (usually); that won't happen until around April.

Employment growth (percent)

Bob says that "at business cycle turning points, revisions are in the direction of the inflection." So when the jobs numbers are revised next year we may find that job losses were smaller last summer and this fall than we think they are now, and the period of job growth would come earlier.

** Update **

Today's employment situation report says 190,000 jobs lost in October: right on target. Furthermore, job losses were revised substantially downward (fewer losses than earlier estimated) in August and September. Unemployment up to 10.2% - very bad, but it doesn't change my story.

Still pretty damn awful

noreply@blogger.com (Maynard) — Thu, 05 Nov 2009 15:58:00 +0000

I think we're headed into a healthy recovery. That's not to say economic conditions right now aren't pretty dismal. Calculated Risk has a lot of great information. Here's a frightening graph. Note what a huge outlier the 2001 "jobless recovery" was. If the current recovery takes that shape there will be rioting in the streets. The best we can probably hope for is something like the post 1982 recovery (magenta I believe). Note that there was a 4-5 month period at the trough of that employment series where it was easy to believe that, while the job losses had ended, the economy wasn't going anywhere fast. I hope we'll reach that point by early next year, with pretty healthy job growth and declining unemployment beginning in summer.

This recession is different, but not in the way you think

noreply@blogger.com (Maynard) — Thu, 05 Nov 2009 01:41:00 +0000

First we have the article mentioned below in which David Leonhardt argues that we might be a bit too pessimistic about the possibility of recovery - after all, everyone was pessimistic in 1982, and soon thereafter the economy went on a tear.

Calculated Risk responds that things are different this time (ignoring Leonhardt's point that things are always different this time):

Second, most recessions have followed interest rate increases from the Fed to fight inflation, and after the recession starts, the Fed lowers interest rates. There is research suggesting the Fed would have to push the Fed funds rate negative to achieve the same monetary stimulus as following previous recessions (see San Francisco Fed Letter by Glenn Rudebusch The Fed's Monetary Policy Response to the Current Crisis). Welcome to ZIRP! (Note: Professor Taylor disagrees on the size of the negative Fed funds rate).

Paul Krugman's response to Leonhardt echoes that of Calculated Risk:

OK, although I’m with Calculated Risk: we’re really in a liquidity trap now, which means that it’s much harder for the Fed to turn things around.

What CR and Krugman are talking about is the graph below. The graph shows the federal funds rate from six months before the trough of the last five recessions to 12 months after, normalized to zero in the month of the trough. (I'm assuming the 2007-09 recession ended in July and show the fed funds rate for the following three months.)

The blue and red lines are the recoveries following the two big recessions of 1974-75 and 1981-82. In each case, beginning 6 months before the trough the Fed drastically cut the federal funds rate (by 6 percentage points, give or take), then let rates drift down some more after the trough. The drop in rates was smaller but still noticeable - 2 percentage points - in the 1990-91 and 2001 recessions; in the 2001 recession the fed funds rate continued to fall for a year into the recovery. But in this recession, the Fed used up all its ammunition in the first year of the recession. By last spring the fed funds rate was already zero, so it did not fall at all during the six months leading up to the recovery, and is not going to fall in the months to come. Leonhardt and Krugman conclude that we're in worse shape now: because we're hard up against the zero bound, monetary policy won't bail us out of this one.

But wait. The interest rates that are most important as determinants of aggregate demand are things like corporate bond rates and mortgage rates (and we're interested in the real rates, not nominal). The federal funds rate is important only to the extent that changes in the fed funds rate affect these other interest rates. The Fed has been trying to change real long-term risky interest rates through unconventional means: providing liquidity to the banking system, intervening in credit markets, and buying long-term Treasury bonds, agency debt, and mortgage-backed securities. A more meaningful measure of the stance of monetary policy today and in recoveries past is how real long-term risky interest rates behaved. So let's look at the real yield on Baa corporate bonds:

What we see is that the amount of monetary stimulus we've been getting in the last nine months stacks up pretty well against the record of previous recessions. In the six months leading up to the recovery that began in 1982 the real Baa rate fell by about 2 percentage points; for the recovery that began in 1975 it fell about half a percentage point; and for this recovery it fell by about 1 percentage point. The real Baa rate has continued to fall since July, by more than it did in the months following the 1982 recovery. After the recovery that began in 1975 the real Baa rate shot up rather than falling. So by this measure we've got more stimulus than in 1975 and almost as much as in 1982; and a lot more than in 1991 and 2001.

On the other hand, it may be the level of the real Baa rate, not the change, that is important. When the recovery began in 1975 the real Baa rate was an incredibly low 0.48 percent versus 5.69 percent today - with interest rates that low it's a wonder everyone didn't start borrowing (and I think everyone did!). But the real Baa rate is not as high now as it was at the start of the 1982 recovery. It's also lower than it was in 1991 and 2001. Again - there's more monetary stimulus in our economy today than there was in four of the last five recessions.

There may be many things that are different about this recovery than previous strong recoveries, but lack of monetary stimulus is not one of them.

Commentators are always pessimistic in the early stages of recovery

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 22:38:00 +0000

I was going to post something like this a few days ago but didn't have the time. David Leonhardt gives basically the argument I was going to make (and quotes my friend Bob Barbera, some of whose thinking I have absorbed osmosistically in the past couple of years, along the way).

In the fall of 1982, with a long recession ending but the unemployment rate heading toward 10 percent, The New York Times ran an article titled “The Recovery That Won’t Start.”

It quoted prominent economists who worried that “the recovery may amount to nothing more than a few quarters of paltry growth — and possibly not even that.” The economists, the article noted, had “growing doubts about whether the mechanisms of economic recovery will — or can — operate as they have in other postwar business cycles.”

Over the next two years, the American economy grew at a blistering annual rate of more than 6 percent.

These days, as in the aftermath of every recession, you are again hearing a version of those early 1980s worries: this time, things are different. Consumers are tapped out. Business executives are skittish. Banks remain reluctant to lend...

“Of course, there is a long list of things to worry about,” says Robert Barbera, an economist and the author of a recent book on the financial crisis. “But it’s ever thus. If that were the reason you didn’t have a genuine recovery, you would never have a genuine recovery.”

Jobless recovery or not?

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 12:46:00 +0000

I've been telling anyone who will listen (there aren't too many of them out there) that the economy is going to grow more strongly coming out of this recession than the conventional wisdom holds. My argument is basically that deep recessions are followed by strong recoveries: GDP growth for the year coming out of the 74-75 and 81-82 recessions was in the 5-6 percent range while growth coming out of the 1990-91 and 2001 recessions was in the 1-2 percent range. I think this economy is more like the 74-75 and 81-82 recessions.

There are two things standing in the way of strong recovery: (1) consumer spending is going to be slow for awhile as households deleverage from their excessive debt levels of the 2000s. (2) the economy recovered strongly in earlier recessions because the Fed moved to an expansionary policy, but in the current recession the Fed has already spent its ammunition.

Number (1) is an important factor that I think should shave a percentage point or more off growth. Number (2) turns out not to be true. True, the Fed has used its conventional ammunition already (the fed funds rate is near zero), so it can't be as expansionary on that dimension as it was in 1975 and 1982. But it has been free and easy with unconventional monetary policy. As a result, interest rates that really matter for the economy like the real Baa corporate bond rate have been falling by more leading up to the current recovery than in 1974-75 and 1981-82, and there's room for a continued decline in the next year. And fiscal policy is extraordinarily expansionary this time around. So I conclude that growth is likely to average around 4 percent this time around - not extraordinary, but enough for us to avoid a jobless recovery.

One problem with this story is that there seems to be no support for it from the labor market. Now comes along an analysis in Grant's Interest Rate Observer relayed by Noam Scheiber at the New Republic. Grant and his colleague Dan Gertner say that the behavior of unemployment in this recession looks more like it did following the 74-75 and 81-82 recessions than in the last two "jobless recoveries." The report is not online, but I reconstructed the data. Here's what I find:

Grant and Gertner's story is that in the typical strong recovery, the number of people unemployed for short durations (<5>

I guess the economic story here has to be that as the recession goes on, people who have been unemployed for short periods of time transition into the ranks of people who have been unemployed long term because there aren't enough new job opportunities. So long-term unemployment rises, while new layoffs and the shortage of job opportunities continually replenish the ranks of the short-term unemployed. When the labor market begins to recover, there is still a lot of transition from short-term to long-term, but the ranks of short-term unemployed are no longer replenished - the numbers in those categories start to turn down, eventually bringing overall unemployment with them.

I wish we had more to go on than the tea-leaf readings I've been relying on, but I find this new piece of analysis somewhat encouraging.

A comforting graphic

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 12:16:00 +0000

Awhile ago I posted a very scary figure showing that world industrial production during this recession was following closely the path of industrial production during the Great Depression. Here's the latest version of that graph from Economix (period 1 is April 2008):

Bernanke! Obama! Hu!

Bank breakups on the way?

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 11:40:00 +0000

The American Banker points to European regulators' decision to break up ING and Britain's decision to force Royal Bank of Scotland and Lloyds to divest some big units as the beginning of a trend that may hit the US as well. Paul Volcker and even former Citicorp CEO John Reed have called for moving back to a Glass-Steagal style division between commercial banking and other financial services.

This seems like a good trend, but it's not a standalone solution to financial instability. The firms that took the biggest risks during the housing boom were investment banks like Lehman Brothers that were not affected by the repeal of Glass Steagal in 1999. But interesting nonetheless.

Krugman v. Keynes

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 01:34:00 +0000

Paul Krugman takes Ned Phelps to task for mischaracterizing what Keynesians think:

Phelps:

Keynesian economics, which had been nearly forgotten inside the macro field, has found new voices from outside. They take the position that fiscal “stimulus” of all kinds is effective against slumps of all causes.

Krugman:

Nobody, and I mean nobody, holds that alleged position. The position held by Keynesians — by the way, if Keynesian economics has been “nearly forgotten inside the macro field”, someone should tell Greg Mankiw that he’s an unperson — is that fiscal stimulus is necessary only under certain special conditions. Namely, when you’re up against the zero lower bound, and conventional monetary policy is useless, fiscal stimulus may be your best option.

And we are at the zero lower bound right now, for the first time in 70 years. That’s why fiscal stimulus is on the agenda — not because Keynesians believe that deficit spending is always and everywhere the best policy.

Phelps' argument is nonsense. But Krugman's "defense" of fiscal policy is pretty pathetic. I think it's probably true that many people like Krugman who consider themselves Keynesians do believe that fiscal policy is only useful at the zero bound. But this is a pretty constipated version of Keynesianism. Keynes himself thought fiscal policy was an important policy tool in general, not just at the zero bound. His macroeconomic policy program during WWII was heavy on the fiscal policy.

I think if the profession put its minds to it, we could make a good argument for using fiscal policy on a more regular basis.

- Monetary policy affects some sectors of the economy (housing, small business) more heavily than others - why should those sectors be the ones to bear the burden of stabilization?

- We probably need to use monetary policy to prick asset market bubbles from time to time, but why sacrifice the productive sectors of the economy for the sake of financial stability; why not when faced with bubbles that need pricking execute an increase in interest rates coupled with fiscal expansion?

Fiscal policy is fraught with practical difficulties - delays in passing the necessary legislation, capture by parochial interests, complications posed by environmental and labor regulations, etc. But if we spent half the effort ironing out those infrastructural details as we have greasing the skids for monetary policy (I'm thinking of the ingenious ways that the Fed has come up with to issue and withdraw reserves and manage interest rates), fiscal policy would be a much more powerful tool.

New Jersey governor's race

noreply@blogger.com (Maynard) — Wed, 04 Nov 2009 01:29:00 +0000

Bruce Larson's analysis of the New Jersey governor's race:

NJ is a mess. The state's fiscal situation is dire, unemployment is worse than in surrounding states, and local property taxes are out of control. What's more, NJ Democrats are corrupt (and this is coming from a true-blue Democrat!), although corruption is probably worse at the local level than at the state level.

Given the context, NJ would seem to be a prime opportunity for Republicans to pick up a statehouse. But astonishingly, Corzine may well win a close one today. The problem is that incumbent failure by itself is insufficient to produce a challenger victory; voters also need an acceptable alternative. And it's far from clear that voters see Christie as such.

Republicans face difficult political terrain in NJ. Registered Democrats substantially outnumber registered Republicans in the state. To win statewide, therefore, Republicans need to win a sizable majority of NJ's large bloc of independent voters. But Christie, by many assessments, has been a disappointment. He has offered nothing specific about how to fix the state's fiscal mess, and the Corzine campaign has attacked him ruthlessly. Polls show him winning only about half (at best) of the state's independent voters.

Christie's chances are also hurt by independent candidate Chris Daggett, who has been polling roughly 8 percent of likely voters. This is a problem for the GOP because Daggett's numbers are strongest among independent voters--the very group that Christie needs to win in order to oust Corzine. His presence in the race may well have the effect of dividing the anti-Corzine vote--leaving Corzine victorious.

If I were a betting man, I'd PROBABLY put my money on a slim Corzine victory. This is only because I've seen a similar scenario (truly bad Democratic incumbent; even worse Republican challenger) play out in NJ again and again. NJ Republicans have not won a statewide race in NJ since 1997 (when Christie Todd Whitman won reelection as governor), and it may well be that the state's Democratic political terrain is simply insurmountable for Republicans.

But I may well be wrong about a slim Corzine victory. (How's that for hedging?) Many New Jerseyans dislike Corzine intensely, and in all my years of watching NJ politics, I've never seen NJ voters so gloomy about the state's future. Voters may be so fed up that they decide it's worth it to take a chance on Christie. In any case, it will be interesting to see what happens in the state today.

(As an aside, local property taxes in NJ will never come down until the state pushes for municipal reform/consolidation. Where I lived in NJ, there were at least five towns in a 25-mile radius from my house--each with its own school system, police department, fire station, etc. New Jerseyans don't seem to want to give up the benefits of these services, but they don't want to pay for them, either.)

My analysis:

Maybe only Republicans named Christie can win statewide elections in NJ.

Pre-emptive election spinning

noreply@blogger.com (Maynard) — Tue, 03 Nov 2009 15:53:00 +0000

Nate Silver sez the vote for governor has no predictive power for the presidential vote:

Still, if Republicans sweep the Virginia, NJ and NY House elections, it's a sign (as if any was needed) that there's an awful lot of discontent out there that the Democrats need to address - and be seen as addressing - by this time next year.

H1N1 in Gettysburg

noreply@blogger.com (Maynard) — Tue, 03 Nov 2009 13:51:00 +0000

A five year old boy who used to go to my kids' day care died yesterday of complications associated with H1N1. Get your children vaccinated!

Gettysburg Times front page story that day: "Horse Shot, Killed in Tyrone." Nice.

Sometimes the conventional wisdom is right!

noreply@blogger.com (Maynard) — Tue, 03 Nov 2009 00:53:00 +0000

William Sterling, "Looking Back at Lehman: An Empirical Analysis of the Financial Shock and the Effectiveness of Countermeasures."

My summary: John Taylor, John Cochrane, and Luigi Zingales say the Lehman Brothers catastrophe didn't cause the financial crisis of fall 2008 after all - instead, they say, it was Hank Paulsen saying there was a financial crisis, and that the government needed $750 billion to deal with it, and we can't tell you what we're going to use the money for. Their evidence is that LIBOR rates didn't move much after Lehman went under, spiking when Paulsen made his request. Sterling says - you dumb clucks, LIBOR data is drawn from surveys of how much banks say they charge each other for loans, not the observed rates on actual loans. In the days after the Lehman bankruptcy banks weren't lending to each other at all, hence LIBOR is meaningless. He reports the movements of the Bloomberg Financial Conditions Index, and lo and behold - well, just look at the graphs.

Paul Krugman makes an excellent point

noreply@blogger.com (Maynard) — Tue, 03 Nov 2009 00:00:00 +0000

He writes: If Fannie Mae, Freddie Mac, and the Community Reinvestment Act were responsible for the explosion of subprime lending, then why are 55 percent of the commercial mortgage loans coming due before 2014 underwater?

Apparently banks don't need government inducements to make boatloads of irresponsible mortgage loans.

New book on macroeconomic theory and pedagogy

noreply@blogger.com (Maynard) — Sun, 01 Nov 2009 14:20:00 +0000

Where's my copy of this book? I'm pretty sure I've got a chapter in there.

Inventories

noreply@blogger.com (Maynard) — Sat, 31 Oct 2009 22:26:00 +0000

The ratio of real inventory investment to real GDP averages 0.4 percent over the postwar period. The inventory ratio now is -1 percent, on the way up from a record low. When inventories recover, they shoot up very strongly, very quickly: following the 2001 recession it took two quarters from the trough of the recession for the inventory-GDP ratio to go from -0.8 percent to +0.12 percent.

Moving from an inventory-GDP ratio of -1 percent to zero adds one percent to annual GDP growth. If it happens over four quarters it adds one percent to the annualized growth rate in each quarter; if in two quarters, two percent each quarter. So inventory investment should be a powerful driving force for growth in the next few quarters.

I like the Financial Times too, but..

noreply@blogger.com (Maynard) — Sat, 31 Oct 2009 01:46:00 +0000

Brad DeLong's going all gaga about the Financial Times' economics coverage versus that of, say, the Washington Post. But the article he cites has an atrocious piece of nonsense in it:

With motor vehicles excluded, output grew by only 1.9 per cent. Up to half of that in turn consisted of businesses rebuilding depleted inventories – a sign of optimism, but also, like cash-for-clunkers, a one-off boost to output that will not persist.

Explain to me how inventory investment can continue to be -$130 billion quarter after quarter after quarter. Mathematically speaking, inventory investment has to be on average over the long haul a small positive number if inventories-sales or inventories-GDP is going to be constant. So inventory investment simply has to rise from its current levels. And as I noted in my previous post, the string of negative inventory investment we've seen is unprecedented. When inventory investment starts to rise, it's going to have a major impact on GDP. It already has!

There's room for improvement in economics coverage all around I'd say.

GDP is up at last!

noreply@blogger.com (Maynard) — Thu, 29 Oct 2009 17:49:00 +0000

The Bureau of Economic Analysis reports GDP growth was 3.5% in 2009Q3, considerably higher than the consensus forecasts. Lots of commentary here.

My take, which is largely informed by conversations with Bob Barbera, is that people are being far too pessimistic about the strength of the recovery. For example, here's Bruce Kasman and Jan Hatzius debating whether growth in 2010 is going to be slow at 2%, falling to 1.5% by year's end (Hatzius), or fast at 3.5% (Kasman). If growth is even as slow as 3.5%, that would be very surprising given how fast the economy recovered from the last two deep recessions: in the first five quarters of the recovery from the 1974-75 recession GDP growth averaged 5.4%; in the first five quarters of the recovery from the 1981-82 recession it averaged 6.0%. Forecasters are thinking we're going to have a recovery more like those of 1990-91 and 2000-01 (2.9% and 1.8% respectively), but I don't know why that would be the case. Yes, there are impediments to strong growth in the current recession that didn't exist in the 1974-75 and 1981-82 recession - notably, households have to work through a big debt overhang and the financial sector is still very weak. But there are also forces that should accelerate growth, among them extraordinarily stimulative monetary and fiscal policy. Once growth begins, I would anticipate that all of the accelerator effects that made the downturn so scary - low growth --> problems in housing sector --> problems in financial sector --> credit crunch --> low growth - will begin to work in the opposite direction. The financial sector that looks so weak today won't be looking weak at all a year from now. The threat of massive foreclosures and a crumbling commercial real estate market will recede as growth solidifies. I think it would be prudent to have another round of fiscal stimulus focusing on aid to states, but I don't see grounds for pessimism overall.

As for 2009Q3 GDP, Bob has an interesting take. He says (I'm paraphrasing here) that the inventory numbers the BEA computed are almost certainly too low. They have inventory investment at -$130 billion in Q3 versus -$160 billion in Q2. Bob says - and he's right, I've looked at the numbers - that the US economy has never had such a string of large inventory reductions as the BEA is reporting. And these numbers are essentially a guess anyway - at this point, BEA has the inventory numbers for July, partial numbers for August, and nothing for September.

A more realistic estimate of inventory investment is that rather than improving from -160 to -130 (a +$30 billion addition to GDP in Q3), the improvement was 2 to 3 times that (so inventory investment should be between -100 and -70). Eventually inventory investment has to be positive; this will take a few quarters, but the process has to move faster than the BEA is proposing.

The implications for our estimate of Q3 growth: the $30 billion improvement added 0.94 percent to growth in Q3. Doubling or tripling that gives us an additional 0.94-1.88 boost to growth. Now about a third of the higher inventories, if it occurred, would be due to higher imports, so you have to reduce it proportionately. This would give us a net impact of 0.63-1.25%. That is, Q3 GDP growth should have been between 4.1% and 4.75%.

If Bob's right about the inventory numbers, then when Q3 GDP is revised next month it will be revised substantially upward. If he's wrong about the inventory numbers for Q3, that just means that we're headed for a stronger inventory adjustment in the next quarter or two - we could see 4%+ growth in 2009Q4 and 2010Q1.

After that, it's kind of a race between the momentum of the recovery versus the headwinds in the form of state and local spending, financial stress, etc. I'm betting on the momentum of the recovery.

A difference of opinion

noreply@blogger.com (Maynard) — Tue, 27 Oct 2009 12:31:00 +0000

Garry Howard:

This is pretty simple, Green Bay fans:

When Brett Favre, aka No. 4, enters Lambeau Field late Sunday afternoon in his white Minnesota Vikings uniform - intent on working his magic for the purple-helmeted enemy - this is what you should do, please.

Stand up in front of your seat, put your hands together and clap. And whistle. And then clap some more. Forcefully. And cheer. Loud. Louder. The loudest you have ever screamed in your life.

That's right. . . .

Show him the love and affection he has certainly earned by leading this franchise back to respectability and its rightful place as "Titletown."

Empower yourselves by showing off your obvious class with this rousing ovation.
Make him cry huge teardrops (he may just do that, mind you) all over his graying beard.
And then, after four strong minutes of this lovefest, hope that your boys, the Packers, kick his Hall of Fame (expletive deleted).

Leroy Butler:

The reaction should be 100% about Aaron Rodgers. When Aaron Rodgers comes out there you should give Aaron Rodgers a standing ovation because he’s our guy for the next 10 years. When Brett comes out you do like any other opposing quarterback, you boo him. If you don’t want to boo him, don’t say anything. But if you’re going to stand up wearing Packer clothing or a Packer uniform and cheer when Brett Favre comes out, you should bring a bag and put it over your head. You don’t cheer for somebody to beat your team, I don’t care who it is. You don’t cheer for another quarterback. If you want to cheer Brett, just bring a bag, put it over your head and you can cheer, and no one will hear you and that’s fine. This is Aaron Rodgers’ show. Don’t let somebody come into your back yard and cheer against you. You don’t cheer for another guy to beat your team. I hope I’m crystal clear with these fans who say they love to see Brett Favre. Well, Brett Favre is gone. It’s Aaron Rodgers’ show. He’s the No. 1-rated quarterback in the NFC, including Brett Favre. I’m happy we’ll be good for the next 10 years. I hope they’ll cheer Aaron and boo Brett. If they don’t want to boo him, that’s their right. But any other quarterback they’d boo, what makes him so special? I mean, wait until he has his number retired, you can cheer him then. You can applaud him all you want. You can’t do that the day of the game, and want your team to win. That’s standing on the fence. You’re either a Packer fan or a Brett fan. If you’re a Brett fan, go buy some purple and wear purple. I have a strong feeling on this, this is my team. I played 12 years for this team. Anybody who comes into that stadium, I want them to lose. If it were me coming back, I wouldn’t expect anyone to cheer for me when I’m going to destroy your team. Of course not.

One more on geoengineering, then I'm done

noreply@blogger.com (Maynard) — Tue, 27 Oct 2009 12:17:00 +0000

Economists, especially those of Steven Levitt's ilk, are very much aware of the limits of government's ability to intervene in markets. Economies are complex systems whose workings we barely understand. Beware the law of unintended consequences. The subtle ways in which government interventions can backfire by changing incentives in a way that undermines the government's objectives are a staple of economic analysis. Tread lightly, son, respect the market!

So it's odd to see someone like Levitt argue that because of the unintended consequences of trying to reduce carbon emissions through cap'n trade or carbon taxes, what we really ought to do is massively alter the earth's carbon cycle to produce the climate we desire. Launch a giant parasol in earth's orbit to absorb and refract the sun's rays! Dump iron oxide into the oceans to stimulate plankton growth! Create vast algae blooms in lakes and oceans! Have thousands of ships sail the oceans burning sulphur to increase cloud cover!

Yeah, that's the ticket, what could possibly go wrong?

Geoengineering

noreply@blogger.com (Maynard) — Fri, 23 Oct 2009 12:49:00 +0000

Jeff Goodall quotes Ken Caldeira (via Brad DeLong):

“Thinking of geoengineering as a substitute for emissions reduction is analogous to saying, ‘Now that I’ve got the seatbelts on, I can just take my hands off the wheel and turn around and talk to people in the back seat.’ It’s crazy.”

Here's another analogy: geoengineering is like Nixon's price controls of the early 1970s. A sensible approach to galloping inflation is a monetary contraction in conjunction with temporary price controls. But imposing price controls without the monetary contraction gives you an explosion of inflation when the price controls are ultimately lifted.

Down with Freakonomics

noreply@blogger.com (Maynard) — Fri, 23 Oct 2009 12:40:00 +0000

I thought Freakonomics was a clever little book when it first came out. I've since been convinced that the Freakonomics approach to economics is destroying my profession. The argument against Freakonomics, in a nutshell, is: how about we think about important economic issues for awhile rather than spending so much time and energy showing each other how clever we are?

Sady Doyle has an excellent definition of Freakonomics:

Freakonomics, of course, is the science of choosing an appropriately wacky or controversial subject (sumo wrestlers, abortion), applying a little economic analysis to it and coming up with a shocking conclusion that will make people blog about you.

The takedowns in blogotopia of Levitt and Dubner's new book, Superfreakonomics, have become very tiresome. But the lesson we should learn from all this is simple: don't buy Superfreakonomics. Buy The Cost of Capitalism instead.

A simpler health care reform

noreply@blogger.com (Friedrich) — Thu, 22 Oct 2009 23:00:00 +0000

Maynard and I exchanged a couple words last week about a very clever idea he had to increase competition in health care markets. Turns out there me be a much simpler way. I did not know until reading today's Washington Post that health insurance has an anti-trust exemption !That could certainly retard competion...

I should note we both confessed that we were not health economists.

The car czars

noreply@blogger.com (Maynard) — Thu, 22 Oct 2009 01:02:00 +0000

I suspect that one day the Obama Administration's handling of the GM and Chrysler bankruptcies will be recognized as an economic policy triumph - a model of good practical policymaking and stunning efficiency. Here's the Car Czar himself, Steven Rattner, giving his perspective. Some highlights (my headers):

What a mess:

And so I closed my eyes and jumped. Among the surprises along the way: We were shocked, even beyond our low expectations, by the poor state of both GM and Chrysler. Looking just at the condition of GM's finances and Chrysler's new-car pipeline, the case for a bailout was weak.

But on the other hand, as we surveyed the interconnected web of finance companies, suppliers, and related businesses, the potential impact of the likely alternative -- liquidation -- stunned us. We imagined that the collapse of the automakers could devastate the Midwest beyond imagination. We were determined not to fail. But as we started down the road, we saw mainly obstacles...

Of course, the Bush Administration was no help:

When the Obama administration took office on Jan. 20, it inherited nothing in the auto area: no staff, no stacks of analyses, no plans of any kind. The Bush administration had decided in late December that GM and Chrysler were not going to go bankrupt on its watch and had shoveled $17.4 billion of TARP money into the companies to keep them afloat, but without any meaningful stab at restructuring them...

Everyone wants a handout:

Moving simultaneously down multiple paths, we began meeting with all the interested parties: labor, lenders, legislators, and suppliers. We naively assumed that stakeholders eager to see a rescue of the two companies would come with a set of "gives"; I was startled that each stakeholder meeting invariably included a set of "asks" from the government.

Case in point: parts supplier Delphi, which hoped for government assistance even though nearly 90% of its workforce was outside the U.S. An important part of our job was going to be to convince the stakeholders that the government wasn't going to be everyone's piggy bank...

GM's "stunningly poor management":

Everyone knew Detroit's reputation for insular, slow-moving cultures. Even by that low standard, I was shocked by the stunningly poor management that we found, particularly at GM, where we encountered, among other things, perhaps the weakest finance operation any of us had ever seen in a major company.

For example, under the previous administration's loan agreements, Treasury was to approve every GM transaction of more than $100 million that was outside of the normal course. From my first day at Treasury, PowerPoint decks would arrive from GM (we quickly concluded that no decision seemed to be made at GM without one) requesting approvals. We were appalled by the absence of sound analysis provided to justify these expenditures.

The cultural deficiencies were equally stunning. At GM's Renaissance Center headquarters, the top brass were sequestered on the uppermost floor, behind locked and guarded glass doors. Executives housed on that floor had elevator cards that allowed them to descend to their private garage without stopping at any of the intervening floors (no mixing with the drones).

In my relatively few interactions with chairman and CEO Rick Wagoner, I found him to be likable, dedicated, and generally knowledgeable. But Rick set a tone of "friendly arrogance" that seemed to permeate the organization.

Certainly Rick and his team seemed to believe that virtually all of their problems could be laid at the feet of some combination of the financial crisis, oil prices, the yen-dollar exchange rate, and the UAW.

It seemed completely obvious to us that any management team that had burned through $21 billion of cash in a year and another $13 billion in the first quarter of 2009 could not be allowed to continue. Equally important, GM's February viability plan was more "business as usual" and not the aggressive new approach that we felt was essential...

Meanwhile, if ever a board of directors needed shuffling, it was GM's, which had been utterly docile in the face of mounting evidence of looming disaster. We decided to recommend to Tim, Larry, and ultimately the President a package that would include replacing Rick with Fritz as interim CEO, changing at least half of the board, and making an outside director chairman (which should be universal)...

Obama's style:

The question for us -- and ultimately, the President -- was whether any restructuring could save Chrysler.

Back and forth the debate went in Larry's small office in the West Wing. Our working team was joined by Diana and other administration economists. Gene Sperling, a Michigan native, argued eloquently and passionately for standing by America's heartland.

Austan Goolsbee, a fearless former University of Chicago economist who had been with Obama since the beginning of his campaign, led the charge against Chrysler, marshaling strong factual arguments. One was that letting Chrysler go would give a needed boost to GM (and also to Ford), since most buyers of Chrysler's strongest products -- trucks, minivans, and Jeeps -- probably would turn instead to the other Detroit automakers.

Harry maintained that a Chrysler liquidation could potentially add billions of dollars a year to GM's operating income in a normal sales environment, vastly increasing the value of the company.

The group was torn (at one point the vote was four to four) and so were Tim, Larry, and I. We intuited that from a theoretical point of view, the correct decision could well be to let Chrysler go. But this was not an academic exercise.

Repeatedly, Larry asked us for probabilities -- what did we think the chances would be of Chrysler making it for two years? For five years? Indefinitely? Pressed by Larry, I came down 51-49 in favor of helping. Comfortable that Chrysler could survive, Larry asked us to recast Austan's analysis into an assessment of the employment effects of a Chrysler liquidation.

We were all shocked to realize that when the collateral damage of a Chrysler shutdown was factored in (like lost jobs at dealers and suppliers), the short-term effect of a Chrysler shutdown could be 300,000 more unemployed, similar to what was lost across the entire economy in the month of July. And with the memory of Lehman's collapse still fresh, we imagined the potential for other systemic risk. That cemented matters for Larry and me...

In our meeting in the Oval Office on March 26, Larry began to lay out the issues, only to be interrupted after a few minutes by the President, who said "Larry, I've read the memo," signaling that he wanted to dive into the decision items. Quickly, the question of whether to save Chrysler dominated the discussion.

As we went back and forth over Chrysler, the President himself seemed as torn as Larry and I had been. Suddenly, he realized that Austan Goolsbee, unofficial spokesman for the opposition, was not in the room. "Where's Goolsbee?" the President asked. A few minutes later, Austan joined the conversation. But the President had only about 20 minutes available before his assistant, Katie Johnson, came in with a note urging him to move on to his next appointment. "This is too important to try to decide in a rush," the President told us. "We need to get together again later."

For that early-evening session, we convened in the windowless Roosevelt Room, the only real conference room in the West Wing. Larry asked me to begin by summarizing the consequences of refusing aid to Chrysler, and from there the conversation took off. The group was sobered by my assessment that given the early stage of the Fiat discussions, there was only a fifty-fifty chance of reaching an acceptable agreement.

The President's political advisers were as torn as his task force: Polls universally showed the public strongly opposed to the auto bailouts. At the same time, the advisers recognized the severe economic and political consequences of a Chrysler shutdown across broad swaths of the industrial Midwest. We were dazzled that chief of staff Rahm Emanuel -- a former congressional leader -- could identify from memory the representatives in whose districts the large Chrysler facilities lay.

After about an hour, the President asked for any final comments and then said, "I've decided. I'm prepared to support Chrysler if we can get the Fiat alliance done on terms that make sense to us." And we were thrilled when the President said, "I want you to be tough, and I want you to be commercial."

With that, the meeting dispersed. The recommendation to ask GM's Rick Wagoner to step aside had received barely a mention. New to business meetings with Presidents, I found Obama's style consistent with his "No drama Obama" image and on a par with the best CEOs I had spent time with. He was cordial without being effusive and decisive when his advisers were divided...

Obama plays hardball:

The President's announcement that he was prepared for bankruptcy dramatically changed the nature of the discussions we were having with the stakeholders, none so much as those with Chrysler's 45 senior lenders.

Led by Jimmy Lee, J.P. Morgan's top banker and a long-standing business friend of mine, the banks had been insisting that, as secured lenders, they were entitled to repayment of their entire $6.9 billion. "And not a penny less," Jimmy said to me on more than one occasion.

From the outset that had struck us as ridiculous. The debt was trading at about 15¢ on the dollar, and according to Chrysler's analysis, the liquidation value of the company was around $1 billion. Clearly the banks didn't believe that the government would push back and let the lenders take over the company, if necessary. Until they heard the President speak on Monday morning. Almost immediately afterward, Jimmy called with a new message: "We need to talk."...

Hmm, I'd thought this was intentional:

We had not anticipated one benefit of putting Chrysler on a faster track than GM. The successful completion of Chrysler's restructuring established a clear precedent and signaled to GM's stakeholders that we had leverage. That was helpful because, with hindsight, some form of GM bankruptcy was inevitable from the start. Unlike Chrysler, with its 45 lenders, GM had thousands and thousands of bondholders, many of them individuals. There was no way that we were ever going to corral enough of them to avoid at least a quick-rinse bankruptcy...

Damn Congressmen:

Because we were operating under TARP, we encountered relatively little congressional intrusion -- until the two automakers virtually simultaneously announced their dealer-reduction plans. Our dentistry had finally struck a nationwide nerve.

Every congressional district had dealers, many of whom were leading figures in their communities. We were inundated with an avalanche of calls, letters, and demands. We patiently worked through each grievance and explained hundreds of times that the companies -- not the government -- made the decisions about which dealers to close.

But the episode left an indelible impression on me: If we hadn't had TARP money available and had had to seek congressional approval, I am convinced that one or both of our two automakers would have been forced to liquidate...

The prognosis:

Like any patient that undergoes major surgery, a successful recovery is far from assured. For Chrysler, the biggest challenges are its need to regenerate its product line and manage a significantly leveraged balance sheet. In the case of GM, the overarching question is whether, without an infusion of new blood, its management team can implement the massive cultural change that is essential. But by dramatically lowering the break-even point for both companies, we believed we were creating a healthy margin for error.