August 2009 Archives

Via Reuters:

OAK BLUFFS, Massachusetts (Reuters) - U.S. President Barack Obama will nominate Ben Bernanke to a second term as chairman of the Federal Reserve on Tuesday as the economy shows signs of recovery, a senior administration official said on Monday.

Bernanke, whose appointment as head of the U.S. central bank must be confirmed by the Senate, has led the Fed and the U.S. economy through its most tumultuous period since the Great Depression of the 1930s. Obama's Democrats control the Senate.

Read the whole article.

Give the president credit for understanding the importance of removing any uncertainty about the outcome of his decision.  I believe it was the right decision.

The temporary traffic signs pointing to the residence halls are up.  Suddenly I can't find a place to park like I could on Friday.  The cafe on the first floor is open again.  The only thing out of the ordinary is that it wasn't 90 degrees this weekend when the students moved in.

I know that some of my students check the blog once in a while, especially grad students, so to all of you I wish you a very sincere welcome.

After a semester off from teaching principles, I feel refreshed and ready get back into the groove.  Ask me tomorrow how that's going!

Sad news from the Friedman Foundation:

Rose Director Friedman passed away Tuesday, August 18, 2009, in her home in Davis, California, of heart failure. While the exact date of her birth is uncertain, she is believed to have been 98 years old.

She will be remembered both as a talented economist and an influential advocate of freedom. Her economic work helped to discredit the idea of government management of the economy, rolling back policies that were hindering wealth creation and thus helping extend the blessings of prosperity to millions around the world. And as a standard-bearer for human liberty, she contributed to the galvanizing of public opinion - especially in the 1980s - against the growing encroachments of intrusive government.

She will also be remembered as both the professional partner and beloved wife and friend of her late husband of 68 years, Milton Friedman.

Further down the obituary...

And, in addition to her many other accomplishments, Rose had the distinction of being the only person ever known to have won an argument against Milton Friedman.

They were indeed Two Lucky People.

(Thanks to Phil Miller, via Facebook, for alerting me to the news.)

From the Federal Reserve web site:

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

Summary/highlights:

• No change in the fed funds target
• Fed funds rate will likely remain low for an extended period
• Purchases of Treasury securities that has been announced and ongoing for several months will slow and come to an end by the end of October
• Economy to remain weak for some time, but gradually return to sustainable growth
• Commodity prices rising, but considerable slack suggests that inflation will remain subdued

Not too bad.  But even if (and it is a big "if") the worst is behind us, the recovery looks to be very gradual.

Edmunds.com:

Interest in the Cash for Clunkers program is slowing, and, if the current trend continues, vehicle sales could be back to pre-Cash for Clunkers levels by August 20, Edmunds.com calculates.

Edmunds.com's analysis of purchase intent on the car-shopping Web site shows sales activity tied to the government's Car Allowance Rebate System (CARS) remains well above the period leading up to its July 27 public launch.

However, activity is 15 percent below the peak of the Cash for Clunkers frenzy, which occurred the last week of July and specifically on July 29. Barring any intervention such as a major incentive program or a significant uptick in the economy, sales will be back to pre-clunker levels by next week. 

...

The funding for the original program was low relative to the size of the auto market, creating a Gold Rush mentality where consumers hurried to take advantage before funding ran out. In fact, it largely sopped up the pool of buyers who owned clunkers and had the ability to buy or finance a new vehicle. In addition, automakers are running extremely low on inventories of vehicles eligible and popular for clunker trades. 

With additional funding now approved, the sense of urgency to participate in the program is gone and the pool of eligible clunker owners who can buy a new vehicle has shrunk. Interest in the program is fading as fast as the first billion was used up. Quite possibly, some of the extra $2 billion will go untapped.

Despite this decline in clunker activity, however, Edmunds.com expects auto sales to be improved through the summer as the economy slowly improves and value-oriented consumers look for deals before the new 2010 models start arriving, said Jessica Caldwell, director of Industry and Pricing Analysis. "The real risk is this fall. Will the economy have picked up enough momentum to keep sales at these levels?"

Some of the extra $2 billion will go untapped?  I find that a little hard to believe.  But by the looks of it, CARS has already attracted the buyers who were on the fence and ready to jump.  It will get progressively harder to get additional buyers to take the plunge--simple marginal analysis in action there.  The low hanging fruit has been picked.

Remember also that the increase in sales at the end of the model year would have happened with or without CARS.  And remember that auto sales right now are so low (with or without CARS) that there is practically nowhere to go but up.  Look at the data (Econbrowser has some good charts).  We are down hundreds of thousands of units per month relative to the past few years.  And while the Big-Three's loss of market share means that some of that loss is permanent, a lot of it would have come back anyway.  If CARS uses all $3 billion, at $4,500 per car, that would mean a few hundred thousand unit sales.  According to this table, we're down about 30%, or just under 2 million unit sales YTD compared to 2008 (which was a really bad year as well).    By my back-of-the-envelope calculation, CARS cannot even come close to erasing the sales deficit experienced in the last 6 months.

And that means that any meaningful increase in production going forward would have happened anyway.  The increased sales from CARS could not possibly explain even a return of production to the levels of a year or two ago.  The sales declines have been too large, and the CARS program too small.

But I have to give the politicians credit for setting up the illusion that they made the recovery happen.  Sales (and production) will turn up eventually.  They have nowhere to go but up.  And when they do, CARS will get the credit, just you watch.

But make no mistake.  When and if production recovers, it won't be because of CARS.  The numbers just don't add up.

From the Bureau of Labor Statistics:

The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data--as measured by output per hour of all persons--for the second quarter of 2009. The seasonally adjusted annual rates of productivity change in the second quarter were:

6.3 percent in the business sector and 6.4 percent in the nonfarm business sector.

Productivity gains in both sectors were the largest since the third quarter of 2003, and were due to hours worked declining faster than output.

Brad DeLong says:

Wow. I knew this was coming, but even so... Wow!

Remember, folks, employment is a lagging indicator.  Productivity spikes like this and in 2003 are to be expected as GDP starts to turn back up before jobs.  Hence the title of DeLong's post "Let's give a warm welcome to the jobless recovery."

Things seem to be playing out as many expected.  Look for a recovery in GDP in the 2nd half, but unemployment probably hasn't peaked yet.  My own personal estimation is that this recession's drop in employment was more cyclical and less structural than in 2001, so the recovery in jobs should be somewhat more robust, but probably not much more so.

I'm working on a post or two on the labor market, but other duties will probably keep me busy for the rest of the day.

Mark Thoma makes a comment on his blog that is worth a response.

I've seen lots of objections to the Cash for Clunkers program based upon the fact that all the program does is shift consumption intertemporally, it doesn't actually create sales that wouldn't have occurred anyway.

But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy. When the economy is in recession, creating brand new things that wouldn't have existed otherwise to lift the economy back toward full employment is preferred, but generally there aren't enough opportunities along these lines to give the economy the help it needs. In the cases where we cannot create enough new output and consumption to bring the economy back to health, moving consumption from a time when the economy is overheated to a time when it is underperforming helps by bringing both time periods closer to the long-run trend.

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. But there is value in avoiding large cyclical swings in the economy, i.e. value in stability, and when we have the opportunity to shave the peak of housing and other booms - times when the overheating is dangerous as it could result in bubbles, inflation, and other problems - and then use the "shavings" to fill the troughs of recessions, we should do so.

Now, I don't think I was the only one to make the argument, but when you Google "cash for clunkers intertemporal substitution" I am at the top of the list.  So I guess I should respond.

Mark characterizes the intertemporal substitution argument thusly:  "it doesn't actually create sales that wouldn't have occurred anyway."

While that is certainly true, I took it a bit farther, particularly in my second post.  My point is that it might not even affect production much at all since the dealers were overstocked with inventory anyway.  The production took place before CARS, and it is unclear (unlikely in my estimation) that CARS will meaningfully stimulate production afterward.  The increase in consumption and the decrease in inventories create basically no effect on GDP.  In a world without CARS, the dealers would have had to slash prices at the end of the model year (which is fast approaching).  As I said before, the dealers benefit, but it is unclear if anyone else does.  (Ironically, the dealers are having problems getting paid, but that's a story for another day.)

Mark then says, "But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy."

I don't know.  If the program shifts consumption but not production, maybe it is a valid objection.  Don't you think?  Plus, there's the link in my first post that seems to have been overlooked.

I didn't quote from the article because I thought that people would read it, get the point, and see the connection.  But here it is in case you missed it.  The article is about the tech slowdown post Y2K, Internet boom, etc.

That has left many equipment and chip makers with much of the stuff they built in 2000. Motorola's Burgess figures that by and large, chip makers booked two years' worth of sales last year. The market for communications and networking chips grew 37% in 2000. But Burgess says "we got 12% last year that we shouldn't have had" because those sales were simply moved up from 2001. The result will be a decline in sales this year and continued slow growth next year. (emphasis mine)

The beauty of that article is that it was written after the fact, not speculating about what would happen.  Yes, I am speculating here, but I think I've got a pretty good script to work from.  I would not bet the farm on CARS providing a "stabilizing" force in the auto industry or beyond, and as noted in my second post, I don't think Detroit is either.

Again I ask, if the production has already occurred and would have occurred without CARS (and those workers were paid for that production before being laid off when demand slumped), then who benefits from the shift in consumption besides the dealers (who may have had to sell these cars at a huge discount without CARS)?  Remember, I don't dispute the fact that the dealers benefit.  And there is a (small) multiplier effect from that perhaps, but surely there are more effective ways to stimulate demand, aren't there?

Maybe Mark secretly agrees that there are better ways...

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. ...

I think Mark misses the point that effective stabilization policy does in fact intertermporally shift output--which should shift consumption as well because they are contemporaneously correlated.  And in fact, just about any policy is an attempt to intertemporally shift output.  Monetary policy surely is.  But an intertemporal shift in consumption and inventories alone (which this quote from Mark seems to acknowledge this is) really is of little value in the aggregate.

Of course, maybe Mark wasn't referring to my posts at all since there wasn't a link.

Just to be clear, my real issue with the "Cash for Clunkers" program is the same as the reasons that I oppose the income tax rebates brought to us by President Bush and the gas tax holidays embraced by politicians of all stripes.

These policies have almost no real stimulative impact.  Consumers don't benefit much from gas tax holidays.  And income tax rebates mostly get saved.  I will repeat what I said during the gas tax holiday debates:

My criteria for good public policy is that it be well out of the neighborhood of "pointless."

I apply this criteria without regard to the political party that advances the policy, and I encourage you to do the same.

Basically I get really irritated when any politician from any party tries to score points with a policy that is bound to be popular for obvious reasons even though it produces little or no real positive effect.  It irritates me that so many people can't see through the smoke and mirrors.  It irritates me that politically popular but nearly pointless policies crowd out other policies that are less politically popular but could produce far better results.

I've been irritated a lot in the last 10 years, and I don't see it getting better anytime soon--regardless of which party is in the big chair.

This NY Times op-ed by Eric Zencey makes all the usual points.  There's nothing in here that I haven't been teaching my classes for the last 15 years.

To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn't show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable -- and give G.D.P. a bit of a bump.

...

This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.

A similarly counterintuitive result comes from other kinds of defensive and remedial spending, like health care, pollution abatement, flood control and costs associated with population growth and increasing urbanization -- including crime prevention, highway construction, water treatment and school expansion. Expenditures on all of these increase gross domestic product, although mostly what we aim to buy isn't an improved standard of living but the restoration or protection of the quality of life we already had.

Yes, Hurricane Katrina is mentioned too.   (Although he doesn't mention the broken windows fallacy by name.)  So what should we do about this?  Fortunately he's got it all figured out.

Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)

Nature has aesthetic and moral value as well; some of us experience awe, wonder and humility in our encounters with it. But we don't have to go so far as to include such subjective intangibles in order to fix the national income accounts. As stressed ecosystems worldwide disappear, it will get easier and easier to assign a nonsubjective valuation to them; and value them we must if we are to keep them at all. No civilization can survive their loss.

Given the fundamental problems with G.D.P. as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop it altogether. We could keep the actual number, but rename it to make clearer what it represents; let's call it gross domestic transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.

Our use of total productivity as our main economic indicator isn't mandated by law, which is why it would be fairly easy for President Obama to convene a panel of economists and other experts to join the Bureau of Economic Analysis in creating a new, more accurate measure. Call it net economic welfare. On the benefit side would go such nonmarket goods as unpaid domestic work and ecosystem services; on the debit side would go defensive and remedial expenditures that don't improve our standard of living, along with the loss of ecosystem services, and the money we spend to try to replace them.

Not as easy as it sounds.  Let me speak for just a moment as a consumer of economic data.  Measuring what GDP measures is important--even if it is a terrible measure of national welfare. And consistency is paramount.  If it becomes a subjective matter of how much value to put on negative transactions, then trust me, those estimates are going to be a moving target, and probably (I am being characteristically charitable here) politically influenced.  Measuring economic activity is hard enough just concentrating on the market activity.  If we were to include these other things it would be useless for economic research.  The only value of his alternative measure would be to make the public feel good about reducing their carbon footprint or guilty for not doing so.  Guilt-tripping is not the point of economic statistics, and you know that's where this would end up.

Of course one response is to just teach this and all future generations of university students why GDP is useful for what it says and why it is limited by what it doesn't say.  We could engage students in discussion of this topic and make sure that they leave the university able to interpret economic news intelligently.  Just a thought.

I always discuss the limitations of GDP in my macro courses, and often I even bring this up as an example of attempts to do what Mr. Zencey suggests.  Old news.  But it keeps on coming up, so obviously we need to do a better job.

Thoughts?

It is quite fashionable at the moment to refer to the "cash for clunkers" program as an example of the "broken window fallacy".  See here, for example (Seeking Alpha).  Well, at least "cash for clunkers" is not mandatory.  A hurricane or a tsunami doesn't give you a choice about whether to participate in the destruction.  That is certainly an important difference.  But as the article from Seeking Alpha makes clear, the real similarity that matters is that it results in a net loss of value.  Let's explore this idea.

My last post on the subject made the observation that it just shifts the spending intertemporally, and therefore the auto industry will likely see a decrease in demand when it's all over.

Commenter "Lord" remarks that this is ok, even desirable.  It means a boost in production when you need it and a decline later that will reduce the threat of inflation.

First of all, it is unclear what effect this will have on production.  Sales have increased, and it is drawing down inventories.  But the automakers know that this might not be sustainable.  This article from Edmunds Auto Observer makes the point:

"If we can sustain this momentum in the industry, it will translate into having a very good ability - for the first time in a long time - to increase production," said Michael DiGiovanni, GM's executive director of global market analysis. "And that will help stem the rising tide of unemployment, and will feed on itself to revive the economy. Recoveries are usually fed by the auto sector."
 
But displaying appropriate caution, neither DiGiovanni nor any other auto company executives pledged immediately to boost production in the wake of CARS mania. LaNeve said that GM is "looking for ways to add production" during the third and fourth quarters, but he didn't make specific promises.

Read the rest of the article.  You will see that industry experts really don't know what will happen going forward after this rebate comes to an end.  Good for dealers?  Yes.  They get rid of inventory they've been unable to move.  Enough to save the Big-Three?  I don't see it.

If the argument is that this is a sort of Keynesian "pump-priming" that will get us out of a bad equilibrium (coordination failure, for all you grad students out there), then I admit to being skeptical.  I guess if 3rd quarter GDP is positive we can pretend it was CARS that did it (even though a lot of folks have been predicting that for a while anyway).

Commenter "Jake" concurs with "Lord" that it will end the recession faster and adds that the net effect of the program will be positive.  "Jake" doesn't go into detail about how he arrives at that conclusion.  So I'm left to try to fill in the blanks.  Luckily, people have made similar arguments about natural disasters (and committed the "broken windows fallacy").

One positive effect usually mentioned is the increased spending.  But as we've stated (and "Lord" would seem to agree), this is just intertemporal substitution.  If you don't buy the pump-priming argument, then this isn't a long-run benefit.  (Is a billion dollars really enough to prime the pump?  Seems like a drop in the bucket.)

The other positive effect is that we have exchanged--in aggregate--inefficient cars for more efficient ones.  We'll save energy and the environment.

Ok.  But as Mark Perry points out, with more fuel efficient cars people might drive more because it costs less.  I would stop short of saying that it would actually harm the environment without more information.  But it is perfectly reasonable economic logic to say that the environmental benefits will be less than advertised... especially in light of this.

But I'll be generous and say that there is some environmental benefit.

Now, those cars would have been taken off the road at some point anyway, right?  So the net present value of the environmental benefit would only be the reduced emissions that would have gone out from now until the time of that car's eventual disposal.

So again, it is less benefit than is being advertised.  But if the environment benefits at all, it's all good right?

Not necessarily.  There's no such thing as a free lunch.

It still cost the government something.  That's money that won't be spent on something else.  Granted, a lot of the praise for CARS is that it is a better way to spend money than bailing out banks and so on.  But a dollar of spending today equals a dollar of future taxes in present value terms.  No free lunches.  Are the environmental benefits worth the money being spent?  If not, then we're just breaking windows.

I don't know the answer to that question with certainty, nor do I think that Congress had enough information to answer that question.  The truth is that this program is easy to administer and easy to explain to people.  It's politically expedient, and that carries a lot more weight in Washington than its economic merits (or lack thereof).

As policies go, it's probably better than some ways to spend money and worse than others.  But to those who think it is undeniably a net benefit to the economy, then I would ask, why stop at cars?  Why not distort the prices of some other things that could be replaced with more energy efficient versions and let the government pick up part of the tab?  Why not tear down rodent and asbestos infested old inner-city school buildings and replace them with safer high-tech environmentally sound buildings?  Sure it would cost more upfront, but the energy savings and the environmental impact would be enormous.  And think of the jobs!

It's not about the environment or the jobs, is it?  It's about politics.

I'll keep this simple.

Consider a market for a good that most people purchase once every few years.  Suppose that the purchasing decisions of consumers is somewhat influenced by cyclical and seasonal swings in the overall economy, but that no other large external factors synchronize the buying habits of many people at once.

Now suppose that an external factor (such as a government policy) caused many people who would have purchased cars in the next few years to make those purchases now.

Intertemporal substitution, anyone?

And the implications for demand in that industry in the years that follow these synchronized purchases would be...?

Oh, right, this happened once before.

That is all.