November 2005 Archives

Is 4.3% growth of real GDP just ok, or is it _______ (use whatever superlative you like)? One of my frequent commenters, spencer, writes in response to my earlier post that since WWII real GDP growth has exceeded 5% almost a third of the time. Against that record, today's news sounds quite average.

But of course the volatility of real GDP has declined significantly since WWII. Here's the picture:

The words "structural break" come to mind.

Chang-Jin Kim and Charles Nelson were thinking along those lines when they wrote their paper "Has the U.S. Economy Become More Stable? A Bayesian Approach Based on a Markov-Switching Model of the Business Cycle" in the 1999 Review of Economics and Statistics. Drawing on work done by fellow blogger James Hamilton (1989 Econometrica), they find a break at 1984Q1. (Links are to the appropriate papers on JSTOR for those who have access.)

Bottom line: If you want to grade the current economy on a curve, don't use the 1950s to construct the grading scale (or anything before 1984, for that matter).

Interestingly, David Tufte (VoluntaryXchange) constructs a grading scale for GDP based on post 1983 data. I would contend that "eyeball econometrics" should lead you to believe that the relevant data to use to construct your grading scale is somewhere between 1983 and 1985. Kim and Nelson's result happens to fall right smack in the middle of that range, so I'm ok with that.

So the next step is to look at a histogram of the data from 1984 onward. Here you go:

This does not include today's data release, but you can see where it would go. Grading on a curve, it's a solid "B". Tufte concurs. Tufte's scale using 1983 as a starting point indicates that the last quarter falls in at the 69th percentile. Using Kim and Nelson's 1984 break point makes things look a little better. The last quarter comes in at the 73rd percentile of GDP growth since 1984.

Of course, the structural break model is just that, a model. The variance of GDP may change more than once. We haven't even addressed what might be causing the change. In general, I'm reluctant to grade a time series on a "curve" like this if there is heteroskedasticity (changing variance) such as this.

That said, I am very sympathetic to the reason why you might want to make the comparison. Thus, I am quite happy to give this report a solid "B" as long as everyone understands that a nice long string of "B"s and "C"s without any "F"s is a pretty good achievement indeed. Stable, sustainable growth gets a "B" or a "C" on this scale, but stable and sustainable growth is exactly what we want.

UPDATE: See the comments for an addendum about per capita GDP.

UPDATE: David Tufte responds by calculating presidential GPAs. For fun, try to guess Clinton's and Bush's GPAs before clicking over!

Tyler Cowen and Max Sawicky debate in the latest Econoblog. It ends up being largely about the appropriate tax rate on capital. Enjoy!

The Beige Book is out. Follow the link to read the details. Yes, the news is mostly good, but if you read closely, it's not unambiguously so. Conditions are not uniformly good throughout the country, but that might be hard to achieve in the best of times. But where there are soft spots, they are for a specific reason. Case in point,

The Dallas District provided the only indication of lower wage pressures--for the airline industry.

On prices,

Consumer prices remained stable or experienced generally modest increases, but most Districts reported increasing input prices, particularly of energy-related products, construction and raw materials, and transportation. Fuel surcharges have become common in many Districts. In response to higher input prices, some businesses in the New York, Philadelphia, and Richmond Districts were able to pass along a portion of increased costs to consumers. Retail prices in the Boston District remained stable but had risen modestly in the Cleveland, Richmond, Chicago, and Kansas City Districts. Competitive pressures in the Atlanta and Dallas Districts have limited the ability to increase selling prices. Some manufacturers in the Dallas and Minneapolis Districts, however, plan to raise prices in 2006.

On Manufacturing,

Manufacturing activity increased in all Federal Reserve Districts except St. Louis, where activity was mixed.

Real estate is moderating, and labor markets are improving. But the auto sector is not as hot.

With all that good news, all eyes will be on the employment report. If it doesn't hit 200,000 we'll all be scratching our heads over the weekend trying to figure out what to believe.

From the Wall Street Journal:

The Commerce Department reported Wednesday that gross domestic product, the broadest measure of U.S. economic activity, grew at a seasonally adjusted annual rate of 4.3% in July through September. That was stronger than the 3.8% rate of growth seen in an earlier estimate of GDP issued a month ago, and was the best showing since an identical 4.3% gain in the first quarter of 2004.

Also,

Real final sales of domestic product, which is GDP less the change in private inventories, advanced at a 4.7% annual rate in the third quarter, above the originally estimated rate of 4.4% while below the second-quarter's 5.6% growth.

Read the report from the BEA.

Consumer and business spending was higher than originally estimated. The PCE and GDP deflator were revised down a tenth of a percent each (and that's including food and energy, in case you're interested).

Bloomberg also has the story. Here's a sampling:

``The economy is booming,'' said Mike Englund, chief economist at Action Economics LLC in Boulder, Colorado. Englund correctly forecast third-quarter growth. ``As much as people may have been concerned about gas prices, consumers took the hit and now gas prices are falling.''

and...

Manufacturing in the Chicago area expanded for a third straight month in November, the National Association of Purchasing Management-Chicago said today. The group's index, based on a survey of executives in the region, fell to 61.7 from October's 62.9. Readings higher than 50 signal growth and the November figure exceeded the 60.5 average for this year. A measure of orders backlogs was the highest since July 1994.

Hard to put a dismal face on that data.

Treasury Secretary John Snow heralded the GDP report as ``very good news for American workers and those looking for jobs,'' even as a recent poll showed many Americans still perceive the economy as weak. A survey released Nov. 28 by the Manchester, New Hampshire-based American Research Group found that 43 percent of those questioned said the economy was in a recession, while 44 percent said it wasn't.

OK. Believe me. Despite my usual attempts to be optimistic, I'm aware of all of the reasons to be pessimistic. The yield curve is flat and job growth has been sluggish, and so on. But 43% of people thinking the economy is in recession? Half of those surveyed who have an opinion at all? Seems a little high, don't you think?

If yesterday's news was "pretty good", today's news is "quite good," I would say.

UPDATE: James Hamilton (Econbrowser) notices improvement in the economy and says,

Putting it all together, what are this month's data telling us? Overall, the numbers are better than expected, so whatever your take on the economy was at the start of the month, you should be a little more optimistic about things now.

And he says it with "emoticons", so be sure to check it out.

UPDATE 2: General Glut is back! He laments the sorry state of personal savings in his post.

UPDATE 3: I said the report is "quite good," others say it's "perfect." Let's not get carried away.

Plenty of good headlines, but does the good news run deeper? From the NY Times:

Sales of new homes surged to a record in October, the government reported today, bucking recent reports of a slowdown in the roaring housing market.

New home sales jumped 13 percent last month, to an annual pace of 1.42 million, and selling prices increased modestly, the Commerce Department said. The report comes a day after the National Association of Realtors said existing home sales fell 2.7 percent last month and inventories rose to their highest levels in more than two years.

Calculated Risk, as always, has even more on the housing picture. Let's just say he is encouraged. Back to the Times article:

New home sales, which account for about 15 percent of the overall housing market, tend to increase and decrease more erratically from month to month than the far bigger base of existing home sales. Also, the Commerce Department records sales when contracts are signed, rather than when transactions are closed as the Realtors association does for existing home sales.

...

In other economic news, the Conference Board said that its consumer confidence index surged by 13.7 points, to 98.8, after falling for the previous two months. It credited an improving job outlook and falling gasoline prices, which at an average of $2.16 a gallon are below where they were before Hurricane Katrina struck New Orleans.

"While the index remains below its pre-Katrina levels, the shock of the hurricanes and subsequent leap in gas prices has begun wearing off just in time for the holiday season," Lynn Franco, the board's director of consumer research, said in a statement.

Good news, but hard to interpret. Katrina made mincemeat out of consumer confidence. It had to come up, but predicting how much and when is probably best left to a roll of the dice. Give me a couple more data points post-Katrina, then we'll talk.

American manufacturers, particularly aircraft makers, also appear to be in better spirits.

The Commerce Department said today that orders for durable goods - or products that last for more than three years - surged by 3.4 percent last month after falling by 2 percent in September. Economists had been expecting an increase of 1.6 percent, according to a survey by Bloomberg News.

Orders for defense aircraft and parts more than doubled to $7 billion in October, after falling by 2.7 percent in September. Commercial plane orders saw a dramatic 50.4 percent increase, to $11 billion, after dropping by 41.5 percent the month before. Some of the rise was related to the end of a machinists' strike, which hurt production at Boeing in September.

Excluding the transportation sector, however, orders rose just 0.3 percent, far slower than the 1 percent increase forecast by analysts. Orders excluding transportation dropped 0.2 percent in September, a figure the Commerce Department revised today from the 1 percent decline it had reported earlier.

So the slow 0.3% gain may not be as bad in light of the revision of the September data.

All in all, there's nothing that makes me jump up and down, but nothing to make me hang my head either.

UPDATE: Barry Ritholtz is not impressed by the new home sales data. To be fair, the article did point out that new home sales make up a smaller percentage of the real estate market and are notoriously variable. When looking for quotes to pull from the article, I wanted to make sure that I got that in. What the article did say was enough to make me a little skeptical (hence, my opening sentence). But Ritholtz really digs in. Go read what he has to say.

Too much activity around the holiday set me behind on blogging. Time to get back into it.

I thought I'd start by informing you of a rather interesting situation north of the border. Canada's minority Liberal government is expected to get a no-confidence vote as early as tonight. That would mean federal elections in Canada, probably in January. Conservative whip Rob Nicholson tells the Globe and Mail,

"I think there is a little less suspense about the outcome of this but it is historic nonetheless. And you feel the buzz, you feel the excitement in Ottawa today. That something historic is going to happen, that this government is going to be taken down and the Canadians will get an opportunity to change that government. So there is quite a bit of excitement in the air."

If you aren't familiar with the parliamentary system, click on the link to learn more. One of the advantages is the flexibility to call elections at any time through the use of a no-confidence vote. Though our American sensibilities are so accustomed to the 4 year (2 year for Congress) cycle that the thought of having to ramp up the election machinery over the Christmas holiday would seem to be a disadvantage. There are other features of the system that may be positive or negative depending on your perspective as well.

Why does this deserve attention on an economics blog? Because in reading about the coming vote, I noticed some interesting things going on in Canadian fiscal policy. Namely, a lot of spending going on. The Toronto Sun writes,

Let's get a federal election under way before this government of ours has the whole country in the poor house.

The feds are spending money like drunken sailors as they attempt to shore up support and convince Canadians to give them another term in office.

And the Globe and Mail reports the new spending proposals of the last few days. It's a long list.

While I don't follow Canadian politics terribly closely on a daily basis, I try to keep up with the major stories when I can. (More than most Americans, I am quite sure!) It is an intersesting development. Not that different from our own experience. We're all familiar with politicians trying to push spending policies to generate votes. But there does seem to be a different dynamic in the parliamentary system, especially when the ruling Prime Minister does not have a majority.

If indeed the imminent collapse of the government causes a rush of spending, it is worth noting. Just doing a quick search on the political economy of parliamentary systems yields some good papers. One particularly intriguing that I might want to read is titled "The Size and Scope of Government: Comparative Politics with Rational Politicians" by Persson and Tabellini. It is NBER working paper 6848 and published in the European Economic Review in 1999. Comments are open for other papers you might suggest.

UPDATE: Mr. Martin's Liberal government fell in a 171 to 133 vote. Tomorrow, Prime Minister Martin will officially call for elections, most likely to be held on January 23. More from the Globe and Mail. I watched the Liberal and Conservative speeches on C-Span tonight. It's going to be quite a campaign up there.

Alan Bjerga reports:

BEIJING -- "Excuse me for my frankness," said Andy Wei, pouring another cup of tea in his top-level Beijing office, "but American media report little about China."

"Whenever someone comes to visit from the U.S. or Europe, they always see things that are different from what the media tells them, if they're told anything at all. People will ask me if Deng Xiaoping is president. They don't know Hu Jintao. They know about bird flu, SARS. They don't know China."

Andy Wei knows China. He heads the Beijing office of Goodrich, a supplier for Boeing and other companies that has something on nearly every airplane made today. Wei's been at Goodrich and predecessor, pre-merger companies since shortly after he left the Chinese Air Force for 18 years in 1991. He started in the Air Force as a translator, and he still translates -- China to his bosses in America, America to his employees in China.

...

Outsourcing is global reality everywhere, he said. "Singapore used to be strong in shipbuilding. Now that's shifted to South Korea and China. Singapore concentrates on IT and services. If they compete in shipbuilding, they fail. Americans and Europeans must also adapt to change."

But he said he wonders if they will -- if they're informed enough about economics to understand the basics of global development. And that brought him to his original point.

"I don't think Americans are informed about what's happening here, the good that's happening here. This country is underdeveloped, and it needs growth," he said. "This is fair competition, and you can't stop that."

Bjerga has been traveling China for the last month or so reporting on the aviation industry.

The discontinuance of M3 has been getting attention, notably from The Prudent Investor and The Big Picture. Mark Thoma and David Altig also mentioned it. Altig, for his part, is not too worried. He looks at the percentage changes in M1, M2, and M3 together.

Let's probe further. Here's a chart, similar to Altig's, but showing only M2 and M3 (M1 behaves a lot differently) just over the last 20 years (a period in which the two series have varied in a fairly stable manner).

Yep. They move together. Now, there looks like there could be a lead/lag relationship that asserts itself from time to time. Might be worth looking at. There is also a small gap that appears to be opening up. That bears watching.

But it would be useful to see if any particular non-M2 component of M3 is driving things. Consider the following chart:

Large time deposits are red "ltd" and repurchase agreements are in black "rp". Eurodollars are in blue. Money market mutual funds in M3 are in green.

First of all, note that some of these components are pretty small, and most are quite volatile. Raw data is from H.6 historical tables from the Fed.

Repurchase agreements jumped in 2002 and 2003, but that coincides with falling M2 and M3. It is possible, of course, that policy lags come into play. However, at the moment, it appears that if there is a divergence in M2 and M3, it's large time deposits causing the divergence in the data. Interesting, but not sinister.

I'm never really happy to see a data series disappear. Continuity of data is important to researchers. But at the same time, I see no evidence that they are covering up something going on with repurchase agreements. After all, system open market holdings, as well as temporary and permanent operations are available on a daily and a historical basis from the New York Fed. RPs along with other factors affecting reserve balances are also published weekly in the H.4.1 release. Nothing says that this will change, so I am under the impression that you will still be able to find the data there.

UPDATE: A commenter asks why I think they are discontinuing M3 (a question I did not address directly above). The truth is, of course, I don't know. As I said above, I'm pretty sure that it's not to try to hide anything, particularly anything nefarious going on with repurchase agreements. If I had to speculate, I'd say it was probably determined that the value of that particular formulation of a monetary aggregate to the Fed was no longer was worth the cost of producing it on a monthly basis and benchmarking it annually.

This has happened before, you know.

I offer the dedicated reader three papers that describe the monetary aggregates from a historical perspective. These papers detail, among other things, the old monetary aggregates (M4, M5, ...) that are no longer reported. As a research point, I think it would be interesting to see some investigation into the behavior of the non-M2 M3 components as I described above. If there is anything useful in there, let's focus on it, and then the world will little remember the precise definition of M3, just like we no longer remember what was in M4 or M5.

The papers:

Anderson, Richard and Kavajecz, Kenneth. A Historical Perspective on the Federal Reserve’s Monetary Aggregates: Definition, Construction and Targeting, St. Louis Fed Review, March/April 1994.

Walter, John. Monetary Aggregates: A User's Guide, Richmond Fed Economic Review, Jan/Feb 1989.

Broddus, Alfred. Aggregating the Monetary Aggregates: Concepts and Issues, Richmond Fed Economic Review, Nov/Dec 1975.

One from the 70's, one from the '80s, and one from the '90s. Read them together and you get a very nice historical overview of the evolution of the aggregates we have today. Maybe the time is right for one from the '00s to explain why M3 is no longer worth publishing. I, for one, would read such a paper with interest.

As I write tonight, I'm listening to the Bernanke confirmation hearings via the C-Span website. It's going as I expected. Sen. Sarbanes held up a chart showing how our unemployement rate is so much lower than Europe's...and of course he reminded us that the European Central Bank has an inflation target.

Mr. Bernanke's response: "Senator, it was below that rate 20 years ago before the ECB was even created. I believe there are other factors that contribute to that difference."

Indeed it was.

Anyway, it's good stuff to have on in the background while blogging.

Barry Ritholtz has been posting about the recent announcement from the Fed that the publication of M3 is going to be discontinued. A comment on Ritholtz's blog (The Big Picture) says that the silence on the econ blogs is deafening.

I've been grading one set of exams and writing another. I promise a post on it later.

Yeah, I like college soccer. WIU plays Notre Dame in the first round. The winner has the pleasure of playing #3 Indiana. Maryland has the top seed. Good luck, Leathernecks!

NCAA D-I Men's Soccer Bracket

Tim Duy wants to avoid being complacent, but feels like he's stuck in a rut.

Little has come to my attention in the past couple of weeks to change my underlying outlook – the Fed will continue to raise rates until they see a clear shift in real activity. In this case, “clear” means “evident in the data,” not anecdotal evidence...

He and I are also on the same page regarding the housing bubble.

Elsewhere, Calculated Risk and Buttonwood are very worried that the Fed will overshoot. With the real fed funds rate still very low, I'm not in the overshooting camp... yet. But can I forsee scenarios that would cause me to switch camps? Yes. The 4th quarter numbers will go a long way in suggesting to me where we are with regard to the overshooting scenario.

But that's just it, isn't it? Waiting for the next data point, letting the inertia build. When I said that I had been more worried about policy error a several weeks ago, does that mean that I'm getting complacent now? Hopefully, raising the question will remind me not to become complacent in the coming weeks.

And so begins another week. Will it bring more of the same?

The "witch of November" is a term given for a fast moving, gale force storm that often signals the beginning of winter on the Great Lakes. Exactly 30 years ago this night, the a particularly brutal storm of this type was bearing down on Lake Superior.

The S.S. Edmund Fitzgerald left Superior, Wisconsin on the afternoon of November 9, 1975 bound for Detroit with 26,000 tons of iron ore. By 1:00am on November 10, the winds had picked up to 52 knots. By afternoon, the Fitzgerald lost her radars and was coping with waves crashing onto the deck. Sometime around 7:30pm, she sank beneath the waves with all hands.

In 1995, the bell--the symbolic heart of the ship--was recovered from the site of the wreck and the area was declared off limits to further exploration. Tonight, the bell, which resides at the Great Lakes Shipwreck Museum at Whitefish Point in Michigan, will be rung as part of a memorial service. The bell will ring 29 times. Once for each member of the crew. The bell will then be rung a 30th time for all who have been lost on the Great Lakes. The museum will have a webcast of the memorial at 7pm eastern tonight. Go here for more information about the ship and the wreck. This page was the source for the times given above.

The title of this post is from the Gordon Lightfoot song that memorializes the tragedy. Click the link for the lyrics.

UPDATE: Here's another link with a meteorological perspective.

If you've been following the debate over where the FOMC is heading and you want to know why it's so hard to know where the neutral rate is, you might want to read this short letter from the San Francisco Fed.

In other news, I'm not the only one who thinks that housing prices are not driving the Fed's agenda.

From Reuters:

ST LOUIS (Reuters) - The Federal Reserve will continue to raise interest rates amid strong U.S. growth and risks of higher inflation, with no hint that it is nearing a pause, Fed policy-makers made plain in comments on Wednesday.

"I think the inflation risks around the point estimate are skewed to the high side ... I would put a higher probability on an upside surprise," St Louis Federal Reserve President William Poole told reporters after delivering a speech to students.

"That calls for the Federal Reserve to make sure policy is risk-adverse with respect to that outlook," he said.

"We've been on a course of raising interest rates. The language in the last (Federal Open Market Committee) statement suggests that there was more to come...If we had wanted a different interpretation, we would have said something different," said Poole.

...

Markets bet this means three more consecutive quarter point rate hikes to 4.75 percent.

Unless anything drastic happens, I'd say that two more are a sure thing. The third is definitely a better than even chance. If forced to predict, I'd say yes. After that, I'm not ready to predict yet.

...the Berlin Wall was opened. In the days that followed, it was broken apart with sledgehammers.

There's a piece of the Berlin Wall at Eureka College, Ronald Reagan's alma mater, not far from here.

Whatever your political leaning, it is a sobering experience to walk around to the back side--the side without the graffiti--to touch the blank concrete.

Hat tip to Cold Spring Shops for reminding us of the day.

Apropos of our discussion on inflation and monetary policy, comes this via Reuters:

On Monday, U.S. crude touched an intraday low of $58.60 a barrel, the weakest level since late July, and prices had also fallen by more than a dollar on Friday.

"We started coming down at the end of August," said Christopher Bellew of Bache Financial in London. "So we've been coming down for about 10 weeks. Oil trends tend to go on for much longer than that, so we have got a continuation of the downward movement, whether on warm weather or on weak demand."

And yet natural gas prices are soaring. I just got my bill and the marginal rate is almost three two and a half times what it was a couple years ago. (UPDATE: To be exact, 48 cents/therm in Jan. 2002; $1.20/therm in Oct. 2005)I don't think there's any doubt that the price is going even higher. No matter what kind of winter we have.

My point? Even if oil prices head towards $40, a lot of us will feel "inflation" from higher energy prices. It's not trivial. It's going to be a rough winter for a lot of people. But there's not much that monetary policy can do about it.

I was remiss in not commenting on this last week. From Everyone's Illusion (a blog with the rather hawkish tagline: "Inflation: Everyone's Illusion of Wealth") comes this news:

Aside from GM being downgraded two notches to B1 today (something for another time but needless to say this company will not be around much longer), there was other bad news for the auto industry. Total auto sales plummeted in October as the end of “employee discounts” cause consumers to stay home. Sales fell from 16.4million to 14.7million which was the weakest pace since mid 1998. There are two interesting consequences from this, first consumers are unwilling to accept any inflation in auto prices, and perhaps fears about core-CPI increases are a little overblown. Second real PCE is likely to be negative in October.

If real PCE falls in October it will be the third straight month of real PCE shrinkage. The last time this happened was the 1991 recession....

...

With demand falling, how much longer will the Fed increase rates. As I said earlier today 4.50% seems like a lock, but it looks like that will be an overshoot as opposed to neutral.

File this away. We might want to come back to it later.

James Hamilton (Econbrowser) has more.

In the latest Econoblog at the Wall Street Journal Online, Tim Duy and I discuss what may be in store for monetary policy. We cover a range of topics from the Greenspan "conundrum" to the core vs. headline inflation debate. Here's a sample to whet your appetite. Early in the discussion, Tim remarks,

Still, even if Mr. Bernanke is immune from his critics' pressure, there remains a risk of policy error. As the federal-funds rate is pushed further into the 4% range, we will be closing in on the neutral point for monetary policy. A considerable amount of accommodation has been removed, and recent and expected rate hikes have yet to work their way into the economy. With the Fed seemingly locked on a higher rate trajectory, there will be a risk that past rate hikes will be slowing economic activity even as more tightening is implemented.

The Fed is cognizant of this risk and, I believe, will likely require a higher bar for rate hikes at some point early next year. The real trick for Mr. Bernanke might be the need to communicate the transition to a new policy direction at the same time the Fed is transitioning to new leadership.

For the rest of the discussion, go to the Econoblog page.

Some of my comments, and I think some of Tim's as well, were deliberately aimed at stimulating some blogosphere discussion. Consider this your invitation.

My appreciation goes out to the Wall Street Journal for running this feature. And of course many thanks to Tim Duy for his excellent comments and to Mark Thoma whose blog (Economist's View) is home to Tim's monetary policy commentary.

So says this NY Times article. It's a good read if you're just getting up to speed on the Bernanke nomination and the future of monetary policy. Go read the whole article. Here's a teaser...

"Inflation is clearly not right around the corner like it used to be," said Edward M. Gramlich, until recently a Fed governor and now interim provost at the University of Michigan. "The relationships are different, and Mr. Bernanke is going to have to figure them out."

Perhaps the biggest differences are the rise of global production, as well as much easier access to capital, particularly from abroad. Adding to the change is labor's weaker bargaining power. These factors have combined to greatly diminish the force of old-style inflation in which demand outran supply, pushing prices ever higher, and wages, too, until the Fed put the brakes on the economy.

Instead, a new style of inflation has emerged as one of the principal threats to the economy. It is evident in the stock market bubble of the late 1990's and in surging home prices in this decade. This asset price spiral, as it is called, has proved much more resistant to the Fed's standard interest rate tool than traditional inflation.

Mr. Bernanke, for his part, is known as an advocate of inflation targeting, a technique for adjusting interest rates with the aim of keeping traditional inflationary pressures within a limited range. He has also asserted, like Mr. Greenspan, that he does not intend to use interest rates prematurely to puncture an asset bubble. But he has signaled a readiness to use a different set of tools to fight the new inflation, and in this he departs from Mr. Greenspan.

Stephen Karlson (Cold Spring Shops) links to Phil Miller's (Market Power) post and mine on a common media mistake. Karlson adds this,

...the source of the confusion in many observers' minds might be in the terminology of introductory economics (and nowhere else in economics) itself.

Much of the discipline refers to the act of drawing a new demand or supply curve as a "change in demand (or supply)," sometimes calling that an "increase" or "decrease" in demand or supply. A new choice along the same demand or supply curve goes by the cumbersome locution "change in quantity demanded (or supplied.)" Bleah. I recommend the use of the term "shift" to describe the drawing of a new curve, and I'm continually reinforcing "left shift" and "right shift" as "increase" and "decrease" have the potential for mischief on the supply curve. A new choice along the same curve is a "movement along."

I agree. Bleah. He is absolutely right that this terminology is only an issue at the introductory level. Why, you ask? Long story. At more advanced levels, the mathematics forces you to keep track of what is going on without resorting to these labels. That's part of it. We (those of us who teach this) also just tend to obsess over making sure students shift the right curve. These labels, properly used, do force you to be clear about what you're doing. But I agree with Karlson that there has got to be a better way.

Personally, I make students equate the book's definition with exactly what Karlson said. I guess that will do until I write my own book.

The news comes from Reuters.

I guess my consumption of the stuff was not enough to bolster sales.

Arrgh.

According to the BLS, the economy added a net 56,000 jobs in October, well below the level needed to keep up with population growth. This only adds to the building puzzle over why job growth has been sluggish even as real GDP posts 10 consecutive quarters over 3%.

I'll add a graph later, but I'm trying to do about three things at once and wanted to get this story up with a couple of links right away.

See the NY Times story here. They note that:

The department revised its figures for August and September. It said that 148,000 jobs were created in August instead of 211,000 that it previously thought and that 8,000 jobs were lost in September instead of 35,000. As a result, the data shows 36,000 fewer jobs were created over the two months than the department previously estimated.

Kash (Angry Bear) notes that construction job growth has been strong while all other sectors have really fallen off in the last three months.

The household survey continues to show a different picture than the establishment survey. The unemployment rate fell to 5.0% and the labor force participation rate and employment to population ratios have been basically steady for the last three months or so.

The annual revisions in a few months might be interesting. Stay tuned.

UPDATE: PGL leaves a comment and has a post at Angry Bear

UPDATE 2: Here's the graph I've been meaning to make. It's not a pretty picture.

As Barry Ritholtz said today in a post entitled "Ignore the noise," meaning the noisy monthly payroll data.

...Considering that much of the noise comes from professional economists – who should know better – I find this to be disappointing.

...

The monthly jobs data is too noisy to focus on any one single point; That’s even more true post Katrina/Rita/Wilma. So why concoct all this happy talk?

And Ritholtz certainly doesn't want to focus on the household survey either. (I don't either--but I'm going to be interested in how the annual revisions shape up.)

Anyway, this graph eliminates some of the noise. Look at how the current downturn (the last three months have averaged about 65,000 jobs per month) in job growth looks similar to the drop in 1995, but the post-recession peak this time around was lower than in 1994. That observation is not discernable from the noisy monthly data.

And how bad is the bad news? Let's take the good news first. Via Reuters:

WASHINGTON (Reuters) - Business productivity surged in the third quarter, far outpacing Wall Street forecasts, and an unexpected decline in labor costs helped ease inflation worries.

Non-farm productivity, or worker output per hour, grew at a 4.1 percent annual rate from July to September and second-quarter gains were revised higher to 2.1 percent, the Labor Department said in a report on Thursday.

Wall Street had expected productivity to rise at a 2.5 percent pace after a previously estimated 1.8 percent second-quarter advance.

The gain in productivity "reinforces confidence that the underlying sustainable rate of increase in productivity is solidly 2.5 percent or more and that has been the premise of the Fed's willingness to raise rates in only a measured, moderate way," said Pierre Ellis, senior economist, Decision Economics in New York.

That's good news. If you look at the last few years of data, we've been averaging around 3 to 4% since the 2001 recession. This is on the high side of average, and that's a decent spot to be.

But there's more...

Unit labor costs -- a key profit pressure gauge -- also defied analyst expectations by declining at an annual rate of 0.5 percent in the third quarter.

Economists, which had forecast a 2 percent gain in unit labor costs, said the report could ease worries at the Federal Reserve about creeping inflation.

"Come the Fed meetings around April, May, June next year, this may have an impact," said Tim Mazanec, senior currency strategist at Investors Bank & Trust in Boston.

"If unit labor costs are not increasing as much as we initially expected, that would get the Fed to pause (rate hikes) sooner than expected," Mazanec said.

The Fed watches productivity data for signs of how companies cope with rising costs, including expensive energy. Rising productivity and low labor costs gives companies a chance to hold prices down.

So is this good news, bad news, or both? Both. The very slow growth of unit labor costs mentioned here is supporting evidence of the widely reported sluggish growth of real wages in this recovery. If you're new to the issue, start with this post by Brad DeLong. Back in June, DeLong said,

When real wages start rising faster than trend productivity growth, it's a sign that inflationary pressures are or are about to start building. It's a sign that--as long as the Fed wishes to maintain its credibility as the guardian of effective price stability--it isn't going to be able to let employment grow rapidly for much longer.

So if I were to cheer at receiving news of disappointing real wage performance, it would be because I thought it told me that the natural rate of unemployment was lower than I had thought, and that the economy had more room to boom than I had thought.

Of course, bond traders don't think that far: they cheer at falling real wages and rising unemployment because the Fed's response to them is to cut interest rates and so elevate bond prices, and they are long bonds.

My minor quibble with the semantics of that post is that in the present environment it's less about cutting interest rates and more about the timing of the peak. That is, does this news make it more likely that the Fed will pause or stop the rate hikes in January? March?

Well, in what can only be described as a fit of rationality, the bond market is (at 11:18CST) essentially unchanged, even down a bit. In other words, aside from a tiny little blip right after the report came out, the news probably didn't much change the bond market's assessment of where the Fed is going. I concur--at least for now. By that I mean that I don't think this one data point will change much. It will take a couple more before the Fed declares victory. Think spring.

In the meantime, wages continue to grow slowly, and lose ground quickly to rising (relative) prices in the energy, healthcare, and higher education markets. The Fed can't do much to fight rising relative prices, but they certainly don't want to accommodate them with easy money either. That would only compound our problems. The result is pretty much what we're getting--bad news with the good--a consequence of having more objectives than tools to attain those objectives.

UPDATE: It might not have been a "fit of rationality" in the bond market. They might have simply been responding to this. And of course you know when I say "fit of rationality" my tounge is firmly in my cheek! I find the small scale almost daily overreactions in the bond market amusing but mostly harmless.

True genius is seeing the ability to improve on something that we assume to be so simple that it can't be improved. Here's an invention that I can't wait to see in action. (NY Times)

The best way to see the future of New York elevators may be to visit the Marriott Marquis Hotel, the behemoth in Times Square.

Visitors who get into the elevators there, expecting to press a button for their floor, are stymied: there are no buttons in the elevators. Instead, there are keypads in the lobby. Punch in the floor you want, and a digital readout tells you which elevator to take (each car is identified by a letter). "I call it the express bus system," said the hotel's general manager, Michael J. Stengel.

Because it knows where people are going before they board, the computer controlling the elevators can sort passengers, eliminating a pet peeve of elevator riders: doors that open at floor after floor even though the car is full.

Already, Mr. Stengel said, a system installed in "the back of the house" - the service zone used by employees - has drastically cut average elevator waiting time.

Beautiful. Anything to make the high rise elevator experience better is an idea worth supporting.

Full statement here. Here are the important paragraphs:

Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. The cumulative rise in energy and other costs have the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.

The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

The vote was unanimous and all 12 banks submitted requests to increase the discount rate.

The 2nd paragraph is the same as usual. The first has some different wording in light of the hurricanes and rebuilding. They mention the negative impact of the hurricanes but note that planned rebuilding (read, investment) will pickup in coming months. It's a very concise version of what we've been hearing for the last several weeks. One sentence contains the most interesting new word, as I see it,

The cumulative rise in energy and other costs have the potential to add to inflation pressures

"The cumulative rise..." sounds like an acknowledgement that what we have experienced so far is not a one-off event and not something that can be ignored. I am guessing that this word was very carefully chosen to give the right tone to the message. It's as if they are saying that now is not the right time to let our guard down. It does, after all, take time for these changes to work through the economy. If pressure is building now, it may be a few months before it affects the headline CPI in a big way. The heating season is ahead. The rate hikes are not over.

UPDATE: Mark Thoma (Economist's View) has more.

We'll see in 45 minutes or so. CNN has this story on their web site:

With Greenspan's term set to end on January 31, there is rising hope that the Fed may finally be prepared to remove the statement about how it plans to raise interest rates at "a pace that is likely to be measured."

"I'm hoping that Greenspan will see it in his wisdom to say, 'Okay, I'm going to put the brakes on and let the new Fed digest this economic data'," said Andrew Corn, chief executive officer Clear Asset Management, a New York-based institutional money management firm. "Changing the 'measured' sentence would have the right effect."

Corn argues that despite recent increases in the prices of oil and food, consumers have yet to get hit hard by price increases of other types of goods.

I'm thinking "measured" will stay in the statement today, 50-50 odds on the next one, and probably gone by January. Whether the rate hikes continue in after that or not, there will, I think, be a need for new language by that time.

UPDATE: See below.

Division of Labour links to this Wall St. Journal article on President Bush's plan for tax reform. The way they treat the mortgage interest deduction seems like a sensible compromise.

The panel suggests turning the deduction into a tax credit equal to 15% of eligible mortgage interest, which means the tax break for interest on a $100,000 mortgage would be the same for every taxpayer, regardless of income. It suggests lowering the $1 million ceiling to the size of an average mortgage, using Federal Housing Administration regional data.

In today's real-estate market, the ceiling would range from $172,632 in rural areas to $312,895 in the urban corridors of New York City, Boston, Washington, D.C., and parts of California. The FHA says about 81% of its loans are close to the lower end and about 2.5% of loans are in the ceiling range.

The change would mostly affect only taxpayers in higher brackets with above-average mortgages. Under current interest-deduction rules, a taxpayer in the 35% income bracket with a $500,000 mortgage at 6% in the country's pricier urban corridors can reduce his or her taxes by just over $10,000. By contrast, under the new proposal, that same individual could claim a credit of roughly $2,800, according to Goldman Sachs.

The commission also recommends ending tax breaks for second homes and home-equity loans. In its proposal, current homeowners would be able to keep their original mortgage-interest deductions, which would change only if the homeowners refinanced or purchased a new home.

Seems like a good place to start. The effect at the low end is going to be small, and that's where there would likely be any adverse impact on home ownership. So I don't worry that it would change the home ownership numbers that much. There might be some impact on prices at the high end. Using the numbers in the article, the present value of the stream of tax savings on a $500,000 house with a discount rate of 6% amounts to a bit over a bit under $100,000 (Footnote: That's before factoring in any expected appreciation, and the rate of appreciation isn't likely to change much with this policy--we're looking at a level effect here. So think of it as $100,000 in today's housing purchasing power. Update: It's actually a bit less because the interest deduction falls over time, but most of the action is up-front. I haven't incorporated all the details in the proposal, so this is very "back-of-the-envelope" see below for an update that contains the details). I think that's significant enough to make you want to think carefully about how to phase this in over time, but that's not an insurmountable problem. Of course, some people will never be swayed. Read on...

Nevertheless, the housing industry was quick to criticize the proposal. "The tax deductibility of interest paid on mortgages is both a powerful incentive for homeownership and one of the simplest provisions in the tax code," said Al Mansell, president of the National Association of Realtors. "It should not be targeted for change."

I'm shocked... shocked! Note that they [the panel] are recommending an elimination of the tax deduction for state and local taxes. Actually I find it more difficult to argue for a tax on a tax than to argue for the interest deduction. But rent seeking is a powerful thing.

UPDATE: I calculated the actual total present value difference in the tax breaks under the current system and the new proposal. For a $500,000 home in the highest price areas, the actual present value increase in taxes due to the change will be about $66,000. In the lowest price areas, the present value of the change would be about $83,500. Assumptions: 30 year mortgage, 6% interest, 35% tax bracket. By my calculations, having a 5 year phase-in, as they recommend, would reduce the cost in the neighborhood of 10 to 20 thousand dollars in this example.

Read the report, especially the appendix for details.

Students make this mistake all the time. It's got to be one of the most common. It's also one of the more common errors in the media. Phil Miller (Market Power) finds today's example. Phil writes:

I turned on CNN Headline news this morning (Saturday) and watched a item on gas prices. The reporter, who's name I did not catch toed the party line by going after the greedy oilmen. But then he tried to use economic reasoning to make his point. To explain the rocketing gas prices, he said:

"A short supply increases demand...."

This statement is a rather bizarre version of the common error, namely to link changes in demand directly to changes in supply or vice versa (shortcutting the role of price).

How does one make such an egregious mistake? I'll give you one possibility. Supply disruptions in the gasoline production chain (such as those associated with the recent hurricanes) make people think about gas lines from the 1970s. Of course we know that a true shortage happens only when the price is below the market clearing price. In the '70s, this was due to price controls. But old memories die hard. For many the gut-level reaction is to think of gas lines.

The next step in their reasoning is that if gas shortages are on the horizon, then you'd better get in line now. Or, by the same token, if the price is expected to rise, you'd better buy your gas now. Either way, you arrive at the perfectly economically valid argument that an increase in the expected price (or an increase in the probability that the good will be unavailable in the future) causes an increase in demand now. I would be willing to bet that this sort of logic is what drives people to make a statement like that.

But if they are using that logic to explain the higher prices, their efforts are misplaced. The higher prices (as well as the expectation of higher prices in the future) are due to the decrease in supply itself! The fact that prices rise due to the decrease in supply is the reason why there are no true shortages (outside the hurricane's zone of devastation, at least).

So there you have it. Trying to explain higher prices by thinking about what happens in a shortage causes you to miss the real reason fo the higher prices. And I think that also goes to show what a profound impact those gas lines in the '70s had on the way we think about the market for gasoline. We're so mindful of queueing for gas that in the minds of many people the reason for higher prices must be because we are afraid of queues and we're all rushing out to stockpile gas. In reality, that effect, even to the extent that it does happen in a few cases, is small compared to the main reason for the price increase.

Of course, the panicking buyer afraid of shortages does play into the greedy Big Oil mythology a lot better. You don't think that has anything to do with it, do you?

As I said a while back, principles level is all I ask! The direct linkage of changes in supply to changes in demand is a common error, and it's a particularly bad mistake to make because it leaves out the role of price. Our experience with price controls notwithstanding, changes in price are what induces a response in buyers and sellers. Never forget that.