My Last Free Post

...is coming soon.

With Harvard having lost so much of its endowment lately, the university has asked me to stop providing this blog free of charge. Starting shortly, therefore, this blog will be available only to Harvard students and alumni and to others who subscribe via the new Harvard-bloggers program. All revenue from this program will be split between building the new Allston campus and providing students hot fudge sundaes on alternate Thursdays and every day during exam periods.

To obtain your subscription to this blog, please click here.

Update: Please, please, please, no more irate emails before you click on the link to check out the price.

Market-based Financial Regulation

An idea from Oliver Hart and Luigi Zingales.

Those on college wait lists: Stay cool

So says my Harvard colleague Al Roth.

The Mess that is GM

The take from David Brooks.

Haircuts as Tradables

Economists often use haircuts as a prototypical non-tradable good. But maybe we need to find a new example:

Dear Greg,

I am a professor of economics in Germany and a reader of your blog. I found this funny but true tidbit in a newspaper over here. It's about haircuts. Eastern Europe's financial troubles and the strong nominal depreciations have suddenly turned haircuts into tradable goods. Here is the original link.

I guess few people read German, so here are a few key facts from the article:

The financial crisis has hit Eastern Europe particularly hard, leading to strong depreciation pressure on exchange rates. As a result, traditional non-tradable goods have suddenly become tradable. The Polish village of Osinow Dolny at the Polish-German border has approx. 200 inhabitants, 100 of which are active hairdressers. Germans come from as far as Berlin (70 km) to take advantage of the zloty exchange rate, which went from 3.30 per euro in the summer of 2008 to well over 4 now. "Salon Teresa" at the end of main street charges 9 euros for ladies and 4 for men.

Best regards
Martin Klein

Thanks, Martin, for the story. It certainly demonstrates that people respond to incentives. And it illustrates the forces that tend to push exchange rates toward purchasing-power parity.

Majors at Harvard

The Case for Drug Legalization

From Harvard's Jeff Miron.

Top Young Economists

Here is the ranking. (For information about this ranking, click here.)

I am delighted to report that I was on the PhD dissertation committee for two out of the top three (Reis and Angeletos). That is one of the great things about being a faculty member at Harvard: You get to know the young stars before the rest of the world notices their brilliance.

For those aspiring to make this list someday who are now deciding where to attend graduate school, here is the most up-to-date ranking of economics departments.

The Youngest Member of the Pigou Club

When Maggie turned one, she got this t-shirt from her uncle, an econ grad student:

Forecasting as Futuristic Fiction

Robert Shiller's latest.

More Competition

Keith Hennessey, the former director of the National Economic Council, has a blog.

Menu Costs, Defeated

Thanks to the Harvard student who took this picture outside a Thai restaurant in London during spring break.

History Repeating Itself

2009:

President Obama's budget chief hinted Wednesday that the president's signature campaign issue -- a middle-class tax cut -- will not likely survive a budget battle with Democrats on Capitol Hill. On a conference call with reporters in advance of the president's trip to the Hill to speak before the Senate Democratic caucus, Office of Management and Budget Director Peter Orszag indicated that, while 98 percent of the budget mark-ups in the House and Senate are on par with the administration's budget blueprint, some campaign trail promises, like middle-class tax cuts, may get left on the cutting room floor.

1993:

Seeking to explain why he is backtracking on a campaign promise to cut taxes for the middle class, President-elect Bill Clinton said Thursday that the plan was never a major theme in his race for the White House. Mr. Clinton, speaking at a news conference a day after saying he would have to "revisit" his tax-cut plan, said Americans voted for him because of the "big things" he wanted to do.The middle-class tax cut, he said, was not among them....

Mr. Clinton spoke throughout the campaign of the need to redress declining middle-class incomes during the 1980s. He proposed a tax cut for the middle class nearly a year ago, in New Hampshire, and repeated the pledge frequently.

The Demand for Money

Click on graphic to enlarge.

Bhagwati on Card Check

Jagdish is, surprisingly, in favor of the so-called Employee Free Choice Act.

As I understand it, his argument is from the standpoint of the second best. Jagdish does not really like the bill itself ("And it is, indeed, hard to defend the denial of an automatic secret ballot"). But he thinks that strengthening unions will raise the wages of some workers and thereby diminish the populist push for trade restrictions, which he views as the more pernicious threat.

An alternative view is that unions are among the most anti-trade institutions out there, so strengthening them will advance the push for trade restrictions.

The Zimbabwe hyperinflation ends

The BBC reports:

Prices in Zimbabwe have begun to fall after years of galloping inflation, according to figures from the state Central Statistical Office (CSO).

Prices of goods bought in US dollars, Zimbabwe's new official currency, fell by up to 3% in January and February. They were the first official figures since the country's recent adoption of the US dollar.

So now it is up to Ben Bernanke to keep Zimbabwe inflation (and deflation) in check.

Sachs on the Geithner-Summers Plan

Jeff doesn't like it.

What the IMF is up to

My old friend Olivier Blanchard, now chief economist at the IMF, sends me an email:

In the last few months, it has become clear to us (the IMF) that we needed to be ready for a major slowdown of capital inflows in many emerging countries, as banks deleverage by repatriating funds, foreign direct investment is dropping, bond issuances and syndicated loans are dwindling. We decided to focus on creating anew lending window which could help, and on raising the funds we may need. Our board has just adopted this new window, called the FCL (for flexible credit line).It is very different from anything the Fund has offered in the past. It works on prequalification, with no conditionality. It allows qualified countries to draw a large amount if and when needed, and to repay within 3 to 5 years. I think it is a very important step, for the fund, but also probably for the world, and will help avoid major economic catastrophes in a number of emerging countries. What I am hoping for is that you help us advertise this new window, by talking about it in your (very influential) blog.

Okay, I just did. Click here to learn more.

Feldstein on the Charity Tax

One basic lesson of tax incidence (see Chapters 6 and 12 of my favorite textbook) is that the burden of a tax does not always stay where our political leaders try to put it. My Harvard colleague Martin Feldstein gives an example:

President Obama's proposal to limit the tax deductibility of charitable contributions would effectively transfer more than $7 billion a year from the nation's charitable institutions to the federal government. But the high-income taxpayers affected by the rule change are likely to cut their charitable giving by as much as the increase in their tax bills, which would, ironically, leave their remaining income and personal consumption unchanged.

Continue reading here.

Outraged over AIG Bonuses?

If so, read this.

Toxic Assets versus Toxic Liabilities

The Bulow-Klemperer plan to fix the banking system.

A Pessimistic Forecast

From Carmen Reinhart and Ken Rogoff:

The good news from our historical study of eight centuries of international financial crises is that, so far, they have all ended. And we confidently predict this one will end, too. We are just not quite so sure it will be nearly as soon as the chirpy forecasts coming from policymakers around the globe. The U.S. administration, for example, is now predicting that growth will renew in the latter part of this year and continue at a brisk pace of 4 percent for several years thereafter. Is this a fact-based forecast or wishful thinking?

A careful look at the international evidence on severe banking crises suggests a far more cautious assessment. The recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11–12 percent in 2011.

The Coming Slowdown in Potential Growth

Above are three alternative forecasts for GDP. The chart is from the CBO.

As part of the explanation for the CBO forecast, Director Doug Elmendorf makes this important observation:

Projected growth from 2015 to 2019 is also below historical average growth rates, a difference that is more than accounted for by slower growth in the labor force because of the retirement of the baby boom generation. Over the postwar period, the labor force grew at an average annual rate of 1.6 percent; by contrast, we project it to grow only 0.4 percent per year in the period from 2015 through 2019. As a result, potential GDP grew 3.4 percent per year on average in the postwar period, but CBO expects that it will grow by only 2.4 percent annually (allowing for a tad more productivity growth) in the 2015-2019 period.

And I did not even get a citation

A reader (and former staffer from my time at the CEA) emails me regarding the Treasury's plan to fix the financial system:

Props, my friend! I'm not familiar with the details of the latest Treasury proposal, but in broad outline it seems strikingly similar to the fund-matching proposal you made on your blog way back in *October*. (What took so long?)

Here is that old post of mine.

The basic idea of what Treasury is trying to do is to piggyback on the expertise of the market to try to ensure that taxpayers get a reasonable deal. In that sense, our proposals are similar. However, I was aiming at recapitalizing the banks, while Treasury is now aiming at removing toxic assets from their balance sheets. The issue of further recapitalization seems deferred until the results of the Treasury's "stress tests."

Moreover, some commentators have raised the concern that, because of the structure of the deal, the Treasury is providing its private partners a subsidy (which will, in part, be passed on to banks in the form of higher prices for those toxic assets). I don't know enough to judge how large this problem is, but it is reasonable to raise the question. Paul Krugman does a good job of explaining this point.

In other words, there are similarities between our proposals, but also differences. The devil is in the details. Or is God in the details? I can never figure out which it is, which is perhaps why this stuff is so damn confusing.

Time to Scramble

If you are a new econ PhD still looking for a job, click here immediately for an important message from Al Roth.

Is the NCAA evil?

Maybe so:

Top-level college sports is big business, but very little of this flows to the student-athletes. Ohio State, for example, receives about $110 million in revenue each year from ticket sales, television rights, concessions, parking, logo sales, etc. -- over one-fifth of what it receives in tuition revenue from its more than 50,000 students. And its basketball players are paid about $29,500 each.

In a competitive market, companies cannot exploit workers in this way for long, as rival firms will hire them away at higher salaries. In basketball, however, the NCAA cartel prevents that, dictating limits on pay (essentially college costs) and even penalizing transfers to other schools. Strict rules also prevent college athletes from signing lucrative endorsement deals or accepting gifts beyond a certain amount....

If all of that money from ticket sales and television rights isn't going to student-athletes, where does it end up? In 2006, salaries for coaches and administrators accounted for nearly 32% of total athletic-department expenses. Many head football coaches at top universities earn five times the salary of their university president. At a time when most schools are tightening their belts with salary freezes, staff layoffs and the like, the University of Tennessee just announced it was going to start paying two assistant football coaches $650,000 or more each (the head coach makes $2 million). Jim Calhoun, head coach of the University of Connecticut men's basketball team, recently made headlines when he launched into a tirade at a blogger who questioned his $1.6 million annual compensation. Those high salaries are financed from the talents of unpaid student-athletes. (Talk about income inequality.) So not only are the young being exploited, but the exploitation is being committed by their adult mentors....

Of course, for the students who go on to the pros, putting off their financial bonanza won't be a big deal. But most college athletes do not make the pros. They may not even end up with the basic skills necessary to succeed in other workplaces, since only a minority of student-athletes in major sports even graduate (25% in top-ranked University of Connecticut men's basketball, for example). Long practices and missed classes make it difficult to succeed academically. A recent study funded by the Andrew W. Mellon Foundation shows the academic performance of athletes is lower than non-athletes even at Division III schools.

Heckuva Job, Larry

Anyone who has followed the remarkable roller-coaster career of Larry Summers would have reason to expect his new White House job eventually to cause controversy. But this withering critique from Frank Rich is arriving far earlier than expected and is, in my view, unduly harsh.

I continue to believe that Larry and his talented staff (e.g., my former student Jason Furman and my Harvard colleague Jeremy Stein) remain beacons of hope for good policy in the new administration. I pray that when the populist hullabaloo over AIG bonuses is over, the good guys are left standing.

Teaching amidst a Crisis

A teacher emails me an excellent question:

I teach basic economics to seniors at a private high school in New York. I am a big fan of your blog and have been lobbying for your textbooks at my school. I have a question about teaching economics during the current financial climate.

Here it is:

Do you ever have the feeling that teaching the fundamentals to your students is somewhat difficult these days? I struggle most with the bail-outs and trying to explain how this kind of government intervention impacts the "free" market as well as areas such as supply and demand, prices, and inflation among others. Overall, I look at certain topics I am charged with teaching very impressionable high school seniors and I get an almost sinking feeling that what I am teaching flies in the face of what is going on; in that right now, ceteris paribus is clearly not the rule.

If you understand what I mean or am trying to say and could offer any advice I would greatly appreciate your insight and experience or any suggestions you maybe able to extend.

I think I understand the sense of unease this instructor feels. Introductory economics classes start with such topics as supply, demand, elasticity, comparative advantage, deadweight loss, externalities, etc., while the newspaper is filled with talk of banking crises and bailouts. In traditional econ classes, it is easy for students to feel that we econ profs are off on some irrelevant tangent.

I don't believe we are, however. Here is an analogy: Suppose that an 18-year-old student comes into a science classroom and says, "My grandmother is ill with a serious, rare, and hard-to-diagnose disease. I want to become a doctor to help figure out a cure." What should the student study? Probably not this specific disease, at least at first. The place to start is with basic biology, chemistry, and so on. Only after these fundamentals have been mastered can the student go to medical school, become a doctor, and be in a position to study the illness that motivated him in the first place. Much the same is true with the study of economics.

At Harvard, we have not instituted any radical reforms in the introductory economics curriculum in response to recent events. We have had some guest speakers, such as John Campbell and Andrei Shleifer, give excellent and well received lectures about the current crisis to assure students that, despite all the uncertainties, economists really are on the case and that the tools of economics are useful in trying to figure out what is going on. But nothing in the current situation makes the basic lessons of economics irrelevant. And the basic lessons are where education needs to begin.

In other words, whether you want to help an ailing grandmother or an ailing economy, you need start by mastering some first principles, which do not change in response to current events.

Sumner on Financial Regulation

One of the most thoughtful bloggers on the recent financial crisis and what policymakers might do about it is Scott Sumner, an econ prof at Bentley University. He tends toward longer posts than are common in the blogosphere, but if you have the patience, they are well worth the time. In a recent post defending the efficient-markets hypothesis (EMH), he includes this insight:

So the anti-EMH argument for regulation must be based on the following: bankers are irrational and make lots of foolish loans. Regulators are rational and can see that these loans are too risky, and can protect bankers from hurting themselves. At a theoretical level this doesn’t even pass the laugh test. But what happened in practice? What position did the “regulators” take in this crisis? First we need to define “regulators,” who are much more than just the low-paid Federal bureaucrats that oversee the banking industry. Regulators are the watchmen, those who watch the watchmen, and those who watch those who watch the watchmen. In other words:

1. The President

2. Congress

3. The Fed

4. The media

5. Most academics

6. Nouriel Roubini

Guess how many of these institutions warned us about the sub-prime crisis. Now guess how many were encouraging banks to behave even more recklessly than they did. Unless we plan on making Roubini dictator of the world, there is zero evidence from the sub-prime crisis that simply giving regulators more power would have helped. And how do we know that even Roubini wasn’t just lucky, and might miss the next fiasco?

Scott then goes on to discuss the relationship between his perspective and the views of Richard Rorty, my old philosophy professor. Great stuff.

The "Just Right" Major

Middlebury econ prof David Colander opines on why economics is so popular on college campuses.

What's wrong with this comic?

Click on the graphic to enlarge.

I think the writer probably had "balanced trade" in mind, rather than "a balanced budget." In a closed economy, both imports and exports are zero, so trade is necessarily balanced. But these three guys can certainly set up a government as a institution and then have the government tax, spend, and borrow money (clamshells?) from each of the three citizens. There is no reason the budget needs to be balanced.

On the other hand, without any women on the island, there won't be future generations to inherit the government debt. So there may be little point in running a budget deficit. Maybe what Silver-Lining Phil meant is, "Hey...at least we have an economy with Ricardian equivalence."

Interview with Gary Becker

Here.

Budget Deficit as a Percent of GDP

Source.

That is, according to the Congressional Budget Office, under President Obama's proposed policies, the budget deficit would never fall below 4 percent of GDP, and at the end of his second term, it would be about 5 percent of GDP and rising.

Update: The Washington Post covers the story.

The Direction of Policy

Alan Blinder is happy about it.
Gary Becker and Kevin Murphy not so much.

Reloading the Weapons of Monetary Policy

Some people are concerned that in the the fight against recession, the weapons of monetary policy are nearly out of ammunition. That is certainly the case for the standard monetary weapon--cuts in short-term interest rates. After all, short-term interest rates are already about zero, and the Fed cannot cut interest rates below zero.

Or can it? In a discussion at a Harvard seminar recently, a clever grad student proposed a solution to the zero-lower-bound problem.

Let's begin with the basics: Why can't the Fed cut interest rates to below zero? Why can't the Fed announce, for example, an interest rate of negative 2 percent? You borrow $100 today and repay $98 a year from now. A negative interest rate would certainly encourage people to borrow and spend, thereby expanding aggregate demand. And if negative 2 percent wasn't enough to get the economy going, we could try negative 3 percent. And so on.

The problem, you might reply, is that no one would lend money on those terms. Rather than lending at a negative interest rate, you could hold onto cash by, for example, stuffing it in your mattress. In other words, the interest rate on loanable funds cannot fall below zero because holding cash guarantees a rate of return of zero. If the Fed tried to cut interest rates below zero, money would dominate debt instruments as a portfolio investment.

With this background, I can now state the proposed solution: Reduce the return to holding money below zero. Imagine that the Fed were to announce that, one year from today, it would pick a digit from 0 to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 2 percent. Losing 2 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money by, for example, buying new car. But since expanding aggregate demand is precisely the goal of the interest rate cut, that incentive is not a bug but a feature!

Okay, I understand that this plan is not entirely practical. But you have to give the student credit for thinking out of the box. And his plan does address a fundamental problem facing the economy right now: Given the fall in wealth, increases in risk premiums, and problems in the banking system, the interest rate consistent with full employment might well be negative.

---
Update: Alan Taylor of UC Davis (and coauthor, incidentally, of an excellent international economics textbook) reminds me of earlier versions of this kind of idea:

The idea of using scrip to stimulate spending dates back to the 1890s, when Silvio Gesell wrote a series of books related to monetary system reform. He claimed that since money held its nominal value over time, there was little reason to be in a hurry to spend it. This encouraged people to hoard money during periods of financial stress. Gesell, following a suggestion made by Swiss merchant George Nordman, argued that a “carrying tax” on money could prevent hoarding.

Gesell suggested that a periodic tax placed on money could do the trick. By making it costly to hold money, he believed people would be encouraged to spend it. In a severe depression, the idea that spending could be stimulated by making money costly to hold seemed appealing. In fact, Gesell’s views received the stamp of approval of the renowned economist John Maynard Keynes in his General Theory. Keynes viewed stamp scrip as a possible solution to what has been referred to as a “liquidity trap”—a situation where interest rates are so low in an economy, that no one cares to hold interest-bearing assets. By establishing a carrying tax on money, the nominal rate of return on money could be lowered, creating an incentive for people to hold interest-bearing assets, which might stimulate greater production across the economy.

Thanks, Alan, for the pointer.

A Primer on Quantitative Easing

From the Financial Times.

New Editors at BPEA

The Brookings Papers on Economic Activity has a new team of editors: David Romer and Justin Wolfers. Both are old friends and former coauthors of mine. They are also both excellent economists. I am delighted to see BPEA in such capable hands.

You might ask, What happened to the last team of three editors? One went to the NEC, one went to the CBO, and one, optimally responding to expected incentives, is enjoying more leisure.

This Blog as a Teaching Tool

Economics textbooks are always a bit out of date, simply because the world is always changing. One goal of this blog is to help economics instructors and their students stay current. Toward that end, my publisher has put together a blog map, which shows how the posts on this blog are related to material in my principles textbook.

My publisher writes:

Ken McCormick and David Hakes have done a very nice job of updating this weekly -- providing topic and page references to each post in an organized manner so users of the fifth edition can easily locate/apply/assign your posts to text content. Your blog allows your text to remain the most current on the market. With this map it's now the most current -- and organized. We're very open to having customers provide us with feedback on the map -- positive or constructive.

The link to the blog map is above. If you have feedback, send it to Brian.Joyner@cengage.com. Please copy me as well.

Trivial Pursuit

The AIG bonuses now being debated in Congress and everywhere else represent about .001 percent of annual GDP. If a typical Congressman spent that fraction of a 2000 hour work year on the topic, it would consume only about 1 minute of his or her time.

Yes, I know, that calculation is silly in many ways, but here is my point: Regardless of how outraged you are about the AIG bonuses, it is probably not an optimal allocation of resources for our elected leaders to spend large amounts of time and energy on the topic. The economy has bigger problems right now, and it would be better to focus attention on those.

Unless, of course, you think that our elected leaders are more likely to make things worse than better. In that case, jabbering on about the AIG bonuses may be the perfect activity to keep them busy.

---

Updates from my readers: As evidence for my last conjecture, a reader recommends a research study that finds:

Stock returns are lower and volatility is higher when Congress is in session. This "Congressional Effect" can be quite large -- more than 90% of the capital gains over the life of the DJIA have come on days when Congress is out of session.

Another reader remarks that "the 'Congressional Effect' is merely a modern, attenuated version of John Randolph of Roanoke's famous observation that 'No man's life, liberty or property are safe whilst the legislature is in session.'"

This second reader also offers a good observation about how our leaders prioritize their efforts:

The phenomenon you describe in this post was identified by Norman Augustine in his book ("Augustine's Laws") as "inversion": the tendency for managers to spend disproportionate amounts of time and energy on the inconsequential. He attributed this behavior to the (in)ability of most managers to comprehend the larger issues. As an example, he described a board meeting in which it was proposed to spend several millions to build a large power plant (this was back in the 1960s), a proposal quickly and uncontroversially approved. The same group then spent a much longer time, with much more vigorous debate, on the proposed expenditure of a fraction of this sum on an ancillary building to house a maintenance facility. Augustine surmised this was because (1) no one had the slightest clue as to how much a power plant should cost, but (2) everyone had an idea of how much a tool shed should cost.

(A third reader claims the correct citation is Parkinson's Law of Triviality.)

Yes, indeed, that sounds like what is going on in the Washington right now. Our nation's leaders are focused on the tool shed.

The Wizard of Oz as a Monetary Allegory

The BBC gives some background for one of my favorite case studies in my favorite textbook (which here makes a brief photo appearance).

Jay Leno disses the free market

This is an amusing story, good for generating class discussion. As I understand it, here are the facts:

1. Comedian Jay Leno takes his show to Michigan to help "not just the autoworkers -- anybody out of work in Detroit."

2. He gives away tickets for free.

3. Someone tries to sell his ticket on eBay.

4. Mr Leno objects.

So I wonder: If a person down on his luck prefers the cash to the opportunity to watch Leno live, why would Leno object? Is it altruism that is really motivating Leno here? Is he really sure that the unemployed person in Detroit would be better off with an evening of laughs than $800 in his pocket? Or does Leno want to play to a live audience of unemployed workers so he will seem altruistic to his television audience?

Absent externalities, markets improve the allocation of resources. Both the buyer and the seller of the ticket must be better off: otherwise they would not engage in the transaction. The only significant negative externality that I can see here falls on Mr Leno himself. In other words, Leno's objection to the eBay sale is an understandable and fundamentally self-interested act in that the sale impedes his abilty to appear selfless.

---

Update: Via my email inbox comes a reader who claims specific knowledge of the situation:

While searching the internet I came across your article on the Leno-Palace tickets on ebay. Yes, I was the seller. While I never thought it would get to the point of what it's become, you are right. Being unemployed I would rather have the money from the tickets sold to help me. I do feel if Mr.Leno wanted to help the ones down on their luck, he shouldn't object to someone trying to help me. I just wanted to comment on your article, this whole situation just makes me chuckle.

I wish him luck in finding a buyer, despite Mr Leno's objection and eBay's ban.

Happy St Patrick's Day

The Leprechaun Bailout: Here.

They're baaack!

Price controls, that is:

Across the country, from Vermont to Alaska, state and municipal governments are doing what they can to ease the burden for Americans who are increasingly out of work and unable to pay their bills. One controversial solution being considered is a move back to price controls. The New York Legislature and the San Francisco City Council are considering expanding rent controls. Some politicians in Vermont are trying to limit the price of milk. And in Alaska, a bill to cap oil prices is pending in the state legislature.

The bad news: There will be more shortages and gross inefficiencies in the allocation of resources.

The good news: Chapter 6 of my favorite textbook will not become obsolete.

Larry Summers: A Hagiography

From The New Republic. An excerpt for the Pigou Club:

In the late '80s, an acquaintance introduced him to Robert Rubin, then a top executive at Goldman Sachs and a major Democratic donor. Rubin eventually helped pull Summers into the Dukakis campaign as an unpaid economic adviser. Summers was a well-intentioned flop. He sometimes pushed the kind of proposals academic economists love--say, raising gasoline taxes or eliminating the minimum wage for teenagers--and which drive political hands batty. But the experience did, for the first time, cast his worldview in a more overtly political light.

Team Obama on the Sanctity of Contracts

Regarding AIG bonuses:

"We're not a country where contracts just get abrogated willy nilly," [Larry] Summers, a former treasury secretary, said on CBS's "Face the Nation" program.

Regarding mortgage contracts:

The financial services industry and House Republicans are fighting back against a bill pushed by House Democrats that would empower bankruptcy judges to write down mortgage interest rates and principal....Since Monday evening, the financial industry and House Republicans have sent a flurry of letters to the administration and House members in strident opposition. The “cramdown” provision is sponsored principally by House Judiciary Committee Chairman John Conyers Jr. (D-Mich.) and is part of a combined bill backed by Conyers and House Financial Services Committee Chairman Barney Frank (D-Mass.)....President Obama offered support for cramdown generally in his housing proposal last week.

I wonder: Is Larry privately opposed to the cramdown proposal as an abrogation of contract? (Of course, even if he is, he is too much of a team player to say so explicitly.) Or perhaps he sees some principled reason why one kind of contract cannot be rewritten ex post while the other can. It would be a good question the next time some reporter talks to him.

Update: A reader brings to my attention this older article on the topic by private citizen Larry, which suggests some sympathy for cramdowns. The article does not, however, fully explain when (in Larry's view) changing the rules of the game ex post is justified and when it is not.

A Welcome Hypocrisy

The New York Times reports:

The Obama administration is signaling to Congress that the president could support taxing some employee health benefits, as several influential lawmakers and many economists favor, to help pay for overhauling the health care system.

The proposal is politically problematic for President Obama, however, since it is similar to one he denounced in the presidential campaign as “the largest middle-class tax increase in history.”...

In television advertisements last fall, Mr. Obama criticized his Republican rival for the presidency, Senator John McCain of Arizona, for proposing to tax all employer-provided health benefits. The benefits have long been tax-free, regardless of how generous they are or how much an employee earns. The advertisements did not point out that Mr. McCain, in exchange, wanted to give all families a tax credit to subsidize the purchase of coverage.

Kudos to President Obama! He is now doing exactly what I suggested back in November.

Update: The CEA chair is asked about this policy issue.

Visit msnbc.com for Breaking News, World News, and News about the Economy

Reading the Tea Leaves in the Budget

Click here to read my column in tomorrow's NY Times.

Healthcare and Competitiveness

NEC director Larry Summers and CBO director Doug Elmendorf are old friends of mine and great economists. On most things, they agree. But compare these passages regarding the economic impact of healthcare costs.

First, Larry from yesterday's talk at Brookings:

moving away from foreign debt-financed growth is only one component of ensuring a healthy expansion. An additional component is addressing our healthcare system. It is no accident that the period of the most rapidly rising wages for middle income families was the 1990s when healthcare cost inflation was relatively well controlled. Our ability to produce competitively in the United States will be enhanced if we contain healthcare costs. I have heard it said that GM’s largest supplier is not a parts company or a tire company, but Blue Cross Blue Shield.

Then, Doug from Senate Testimony a few weeks ago:

Some observers have asserted that domestic firms providing health insurance to their workers incur higher costs for compensation than do competitors based in countries where insurance is not employment based and that fundamental changes to the health insurance system could reduce or eliminate that disadvantage. Although U.S. employers may appear to pay most of the costs of their workers’ health insurance, economists generally agree that workers ultimately bear those costs. That is, when firms provide health insurance, wages and other forms of compensation are lower (by a corresponding amount) than they otherwise would be. As a result, the costs of providing health insurance to their workers are not a competitive disadvantage for U.S.-based firms.

I score this one for Doug.

Ultimately, what matters to firms is the compensation they pay workers. The composition of compensation between cash wages and fringe benefits like healthcare does not matter for the firms' costs of production. In short run when cash wages are sticky, the cost of healthcare may affect competitiveness: Lower costs of fringe benefits would reduce compensation and thus reduce firms' cost of production. But in the long run, compensation is set by supply and demand in labor markets. If more compensation is paid in the form of fringe benefits like healthcare, less is paid in the form of cash. And if less is paid in fringes, more is paid in wages.*

Let me put the point in the context of General Motors: If, for example, the U.S. taxpayer were to assume all the workers' healthcare costs through a policy of national health insurance, GM would immediately become more competitive. Because cash wages would not be immediately renegotiated, compensation paid by the firm would fall, so costs would fall. But in the longer run, the workers via their union would most likely not be satisfied seeing GM pay lower compensation, so cash wages would start rising. (Those higher wages would help workers pay the higher taxes that would be needed to finance the national health insurance). GM would lose the competitive advantage it temporarily enjoyed.

The bottom line: Larry would look right in the short run, but Doug would look right in the long run.
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* Larry makes precisely this point about wages and healthcare costs in his sentence about the 1990s, without seeming to notice that it belies his very next sentence about competitiveness.

The Obama Program

As described by Larry Summers.

I am terrible at spelling

How about you? (I did so poorly on this quiz that I am too embarrassed to admit how I did.)

Thanks to Newmark's Door for the pointer.

Why the Pigou Club prefers chicken

Instead of a flat tax, a flatulence tax:

Proposals to tax the flatulence of cows and other livestock have been denounced by farming groups in the Irish Republic and Denmark.

A cow tax of €13 per animal has been mooted in Ireland, while Denmark is discussing a levy as high as €80 per cow to offset the potential penalties each country faces from European Union legislation aimed at combating global warming.

The proposed levies are opposed vigorously by farming groups. The Irish Farmers' Association said that the cattle industry would move to South America to avoid EU taxes.

Livestock contribute 18 per cent of the greenhouse gases believed to cause global warming, according to the UN Food and Agriculture Organisation. The Danish Tax Commission estimates that a cow will emit four tonnes of methane a year in burps and flatulence, compared with 2.7 tonnes of carbon dioxide for an average car.

Sen on Capitalism

Reflections of my Harvard colleague Amartya Sen.

No Free Lunch: A Corollary

Click on the graphic to enlarge.

More Competition

Antonio Fatas and Ilian Mihov, professors at INSEAD, have a blog. FYI, Antonio was once a student of mine at Harvard.

Turning Away the Best and the Brightest

That's what the stimulus bill does.

Putting your money where your blog is--not!

As the Washington Times reports, Paul Krugman has not accepted my proposed wager.

Did the Fed cause the crisis?

Alan Greenspan defends his legacy.

The Lorax

My Harvard colleague Ed Glaeser revisits the Dr Seuss classic.

From the CEA Chair

CEA Chair Christina Romer: Lessons from the Great Depression for Economic Recovery in 2009.

My Career as a Coach

On Friday night, I served as "honorary coach" of the Harvard women's basketball team. I was invited by one of the players who is a student in ec 10.

As The Crimson reports, we beat Brown by a score of 81-57. I can now retire with a perfect record.

New Keynesian Multipliers

The latest research from John F. Cogan, Tobias Cwik, John B. Taylor, and Volker Wieland:

New Keynesian versus Old Keynesian Government Spending Multipliers

Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modelling uncertainty, it is essential that policy evaluations be robust to alternative assumptions. We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller.

Much of the new Keynesian research literature has focused on monetary policy. In light of recent developments, I am sure we will see a lot more work on fiscal policy. This paper is one of the first salvos in that debate.

SNL on the Banking Crisis

Soaking the Rich?

A variety of perspectives.

Elmendorf on the Health Care Debate

CBO Director Doug Elmendorf, via Sally Pipes, makes two important points that are often overlooked:

[T]he assertion that the costs of providing health insurance cripples American corporations in the global economy is simply wrong. CBO director Douglas W. Elmendorf explained this last week to the Senate Committee on Finance, which is chaired by Max Baucus, a leading proponent of government health care. The point is that for employers, health care is merely a part of total compensation: It reduces cash compensation for employees but it does not increase costs of employment. To argue otherwise is to argue for lower total U.S. compensation -- that is, lower wages for U.S. workers. Said Mr. Elmendorf, "the costs of providing health insurance to their workers are not a competitive disadvantage to U.S.-based firms."...

Preventative care, disease management and electronic medical records are also constantly cited as big cost-savers. The idea here is that if our health-care system was set up to prevent disease rather than just treat it, and could do so without duplicative paper records, it could save money. It's a great hypothesis, but research does not indicate it amounts to much. "In many cases," as Mr. Elmendorf testified regarding such initiatives, "those studies do not support claims of reductions in health spending or budgetary reductions."

A Shout Out, But No One Hears

A couple of days ago, an article in the NY Times on blogging gave a nice mention to this forum. But my sitemeter showed no significant jump in the number of visiters. Why? Is it because the Times described this blog as "heavy on theory"?

That description, by the way, just goes to show that the author of the article was never a graduate student in an economics PhD program.

The Identification Problem

Source.

How is the President doing?

Neither Stanford economist Michael Boskin nor Princeton economist Paul Krugman is particularly happy with the Obama administration today (but for different reasons).

Update: Nor is The Economist. Nor Robert Samuelson.

Are fiscal multipliers now big or small?

Small, says Richard Clarida:

Because of the financial crisis and the severe damage caused to the system of credit intermediation through banks and securitization, policy multipliers are likely to be disappointingly small compared with historical estimates of their importance. Many of you will remember from Econ 101 the idea of the Keynesian multiplier, which is that the impact of traditional macro policies is “multiplied” by boosting private consumption by households and capital investment by firms as they receive income from the initial round of stimulus. It is important to remember why and how policy multipliers actually work. Policy multipliers are greater than 1 to the extent the direct impact of a policy on GDP is multiplied as households and companies increase their spending due to the increased income flow they earn from the debt-financed purchase of goods and services sold to meet the demand generated by the initial round of stimulus. Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while multipliers for tax cuts can be much smaller, say 0.5 to 1. But these estimates are from periods when households could – and did – use tax cuts as a down payment on a car or to cover the closing costs on a mortgage refinance. For example, in 2001 the economy was in recession, but households took advantage of zero rate financing promotions – as well as ready access to home equity withdrawals from mortgage refinancings – to lever up their tax cut checks to buy cars and boost overall consumption. With the credit markets impaired, tax cuts, as well as income earned from government spending on goods and services, will not be leveraged by the financial system to nearly the same extent, resulting in (much) smaller multipliers.

Big, says Christy Romer:

Critics have complained the Obama administration has been all doom and gloom about the economy, but in an apparent shift in rhetoric since the President's address to Congress last week, one of his top advisers today predicted the stimulus package will prove even more beneficial than expected in helping the nation out of its recession and ushering in a period of "very rapid growth".

“A common argument is that fiscal stimulus will have less effect because financial markets are operating poorly and lending is not flowing. I want to offer a different view,” said Christina Romer, chair of the Council of Economic Advisers. "I think it is possible that fiscal policy will have even more oomph in this situation. When households and businesses are liquidity-constrained by reduced lending, any money put in their pockets is more likely to be spent.”

In a speech this morning at an economics conference in northern Virginia, just outside Washington DC, Romer, noting that "the deeper the recession, the more rapid the rebound," forecasted that when the country recovers from its current crisis, it will enjoy a period of “very rapid growth”.

“When the economy turns around and confidence returns, the resulting pent-up demands spur rapid growth," she said. "What this means for the current situation is that fiscal policy may have a very large effect at some point. Given how far the economy has fallen, it is clear that sooner or later, we are going to have a period of very rapid growth as things return to normal.”

In a previous post, I suggested that, in light of the substantial uncertainty we now face, the marginal propensity to consume is likely larger than normal. As a result, multipliers would be larger than normal as well, as Christy Romer suggests. But I will be the first to admit that all of these arguments--Clarida's, Romer's, and mine--are essentially theoretical. I don't know of much empirical work on state-dependent fiscal multipliers to establish convincingly which side of this debate is correct.

Spotted at a DC Metro Station

The Latest Mortgage Plan

As seen by Yale econ prof John Geanakoplos and BU law prof Susan Koniak:

The plan announced by the White House will not stop foreclosures because it concentrates on reducing interest payments, not reducing principal for those who owe more than their homes are worth. The plan wastes taxpayer money and won’t fix the problem.

Federal Outlays as a Percentage of GDP

Average over the past half century: 20.2 percent
In 2007, the year before the crisis: 20.0 percent
In 2009, from the Obama budget: 27.2 percent
Average 2010-19, in Obama budget: 22.6 percent
In 2019, last year of Obama budget: 22.6 percent

Recall these words of warning:

HOW WILL IT ALL END? Over the last century, the largest increase in the size of the government occurred during the Great Depression and World War II. Even after these crises were over, they left a legacy of higher spending and taxes. To this day, we have yet to come to grips with how to pay for all that the government created during that era — a problem that will become acute as more baby boomers retire and start collecting the benefits promised.

Rahm Emanuel, the incoming White House chief of staff, has said, “You don’t ever want to let a crisis go to waste: it’s an opportunity to do important things that you would otherwise avoid.”

What he has in mind is not entirely clear. One possibility is that he wants to use a temporary crisis as a pretense for engineering a permanent increase in the size and scope of the government. Believers in limited government have reason to be wary.

Another Loss for Economic Freedom

The Crimson reports:

Amendment to Stimulus Bill Restricts Hiring of Internationals

Troubled financial institutions that recruit heavily from Harvard may soon face restrictions on hiring international students if they accepted federal bailout funding. Under a recently passed amendment to the federal stimulus bill, companies participating in the Troubled Assets Relief Program—a government financial-rescue plan implemented last fall—will face more restrictions in hiring H-1B visa holders, foreigners with at least a bachelor’s degree and “highly specialized knowledge” in a particular field.

The Myth of Economic Recovery

A reader, in response to my dispute with Paul Krugman, brings to my attention an article in the March 2008 issue of the American Economic Review:

Growth Dynamics: The Myth of Economic Recovery
Valerie Cerra and Sweta Chaman Saxena

Using panel data for a large set of high-income, emerging market, developing, and transition countries, we find robust evidence that the large output loss from financial crises and some types of political crises is highly persistent. The results on financial crises are also highly robust to the assumption on exogeneity. Moreover, we find strong evidence of growth overoptimism before financial crises. We also find a distinction between the output impact of civil wars versus other crises, in that there is a partial output rebound for civil wars but no significant rebound for financial crises or the other political crises.

P(Depression)=.2

Says my Harvard colleague Robert Barro.

Wanna bet some of that Nobel money?

Paul Krugman suggests that my skepticism about the administration's growth forecast over the next few years is somehow "evil." Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

Team Obama says that real GDP in 2013 will be 15.6 percent above real GDP in 2008. (That number comes from compounding their predicted growth rates for these five years.) So, Paul, are you willing to wager that the economy will meet or exceed this benchmark? I am not much of a gambler, but that is a bet I would be happy to take the other side of (even as I hope to lose, for the sake of the economy).

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Related comments for econ geeks

On the substantive question that Paul raises about the unit root literature and the distinction between cyclical and other fluctuations in output, it is an issue that Campbell and I addressed in a companion paper, where we decided that the conventional wisdom on this matter, which Paul still espouses, does not hold. I do not claim we had the last word on the subject, but it is just wrong to say we missed the obvious point that Paul raises. I don't blame Paul for not being aware of this paper. After all, he is an international trade theorist rather than an empirical macroeconomist, and it is hard for anyone to stay informed about all literatures in the field.

Paul also directs us to a Brad DeLong post that includes this intriguing graph:

Brad infers from this cloud of points that higher unemployment typically points to more rapid subsequent growth.

There is not enough information presented for me to know whether to agree with Brad's inference. My guess is that this regression line (at least I presume it is a regression line) is completely driven by the few observations in the upper right, which are probably all from the Reagan-era boom that followed the 1982 recession. It looks like if you take out that one episode, the relationship would largely disappear. I would be curious to see the statistical significance of the regression, using the relevant serial correlation corrected standard errors (I believe that 8 lags would be needed, given the overlapping data). If I am right that what we have here is an uncorrelated cloud plus the Reagan boom, then I would not expect a high level of statistical significance for this relationship. If I am wrong, and the relationship is highly statistically significant, then it might encourage Paul to take the bet.

Update: Phil Rothman of East Carolina University was nice enough to email me the regression results. For the entire sample, the regression yields an R-bar-squared of 11 percent, and a t-statistic of 3.5. For the sample leaving out 8 quarters of the Reagan boom, the coefficient is smaller, the R-bar-squared is 5 percent, and the t-statistic is 2.1. (See also the figure here.) I will leave it up to Paul to determine whether these results are robust enough to take to the bank, so to speak.

Further update: Here.

Happy Square Root Day!

I hope you are enjoying it. The next one won't occur until 4/4/16.

Team Obama on the Unit Root Hypothesis

All academics, to some degree, suffer from the infliction of seeing the world through the lens of their own research. I admit, I do it too. So when I read the CEA's forecast analysis, this sentence jumped out at me:

a key fact is that recessions are followed by rebounds. Indeed, if periods of lower-than-normal growth were not followed by periods of higher-than-normal growth, the unemployment rate would never return to normal.

That is, according to the CEA, because we are now experiencing below-average growth, we should raise our growth forecast in the future to put the economy back on trend in the long run. In the language of time-series econometrics, the CEA is premising its forecast on the economy being trend stationary.

Some years ago, I engaged in a small intellectual skirmish over this topic along with my coauthor John Campbell. Here is the abstract of our paper:

According to the conventional view of the business cycle, fluctuations in output represent temporary deviations from trend. The purpose of this paper is to question this conventional view. If fluctuations in output are dominated by temporary deviations from the natural rate of output, then an unexpected change in output today should not substantially change one's forecast of output in, say, five or ten years. Our examination of quarterly postwar United States data leads us to be skeptical about this implication. The data suggest that an unexpected change in real GNP of 1 percent should change one's forecast by over 1 percent over a long horizon.

The view that Campbell and I advocated is sometimes called the unit-root hypothesis (for technical reasons that I will not bother with here). It contrasts starkly with the trend-stationary hypothesis.

In the CEA document, Table 2 shows growth rates immediately after recessions end. It demonstrates that growth is higher than normal in most of the recoveries. Is this evidence against the hypothesis that Campbell and I advanced?

I don't think so. The problem is that those numbers start at the end of the recessions, and we do not know when the recession will end. In other words, if God came down and told us the exact date the current recession was going to end, my forecast subsequent to that date would be for higher than normal growth. But absent that divine intervention, there is always some chance the recession will linger (remember the Great Depression), and an optimal forecast has to give some positive probability weight to that scenario as well. The forecast should be an unconditional expectation, not an expectation conditional on a particular end date for the recession.

The CEA document also gives an intriguing picture:

The purpose of this picture is to show that deeper-than-average recessions are followed by faster-than-average recoveries. (Similar evidence was compiled in the 2005 Economic Report of the President, Chapter 2.) This evidence might be taken as evidence in favor of the trend-stationary hypothesis over the unit-root hypothesis.*

There is another possible interpretation, however: Imagine that the shocks to the economy have time-varying variance. When the variance is high and the economy experience a negative shock, one gets a deep recession. But when recovery comes, it tends to be more robust.

For the econgeeks out there, let me put the point more formally. Suppose growth G is a random variable distributed N(M,V(t)), where M is the mean growth rate and V(t) is the time-varying variance. A recession is when G is negative. Now compute two conditional expectations: E[G / G less than 0] and E[G / G greater than 0]. You will find, I am pretty sure, that an increase in V(t) reduces the first conditional expectation and increases the second. That is, higher variance makes average recessions deeper and average recoveries more robust. But if you don't know whether a future date will occur in a recession or recovery, the best forecast is M, the unconditional mean.

Right now, we are facing a particularly high-variance economy. (Just look at the VIX index.) That means, under the conjecture I just described, that when recovery comes, it will probably be a robust one. But this logic is not necessarily a reason to raise the unconditional expectation of economic growth, because we don't know when that recovery will begin.

Finally, I should note that there is much to forecasting beyond the univariate models in my work with Campbell. And our paper, of course, was only one piece of a large literature. The CEA might well be right that we are in for a robust recovery over the next few years. I don't pretend to have as good a forecasting staff sitting in my Harvard office as the CEA has. (I miss you, Steve Braun.) I certainly hope they are right. We could all use some good economic news right now.

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* One odd feature of this figure is that it omits the 1980 recession. Perhaps the CEA left it out because that recession was followed quickly by another recession. As a result, in the two years after the 1980 recession ended, growth averaged less than one percent. That episode underscores my main point: when forecasting, you cannot be assured of being in a recovery state rather than in a recession state.

The CEA on Its Forecast

The Council of Economic Advisers has put out an analysis of the administration forecast.

The Case for Moderation

From David Brooks.

CBO on the Stimulus

The Congressional Budget estimates the impact of the recently passed stimulus call. Scroll down to page 12 for their bottom line.

Consistent with textbook Keynesian models, they report a a significant short-run effect but little long-run effect. In fact, they estimate the long-run effect on GDP may be slightly negative due to crowding out.

As for employment, the CBO estimates the bill will create 1.2 to 3.3 million jobs at the end of 2010. By the end of the President's first term, the projected impact of the bill falls to 0.3 to 0.7 million jobs.

Undergrad Econ Popularity Surges

A story from NPR.

The Personal Cost of Public Service

Katherine Ozment tells us how she feels when her husband, MIT economist Michael Greenstone, gets a job working for the President.

I know what she is going through, or more precisely, my wife does: When I became CEA chair, I left my wife and three kids (then ages 11, 8, and 4) at our home in Wellesley, and I commuted back on weekends. Economists who take policy jobs make some sacrifices to engage in public service, but often their spouses and families make even more.

Cartels and the Secret Ballot

To my surprise, quite a few mainstream economists have endorsed the so-called Employee Free Choice Act. I am surprised for two reasons.

First, the act strengthens unions, and unions are a cartel. When cartels exert their monopoly power, they raise wages above the equilibrium level, leading to a variety of inefficiencies and inequities. As Larry Summers once put it, "Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment."

Second, the act would allow unions to organize without a secret ballot, as long as a sufficient number of workers put their names on cards endorsing a union. Union organizers would be able to use strong-arm tactics to get workers to say they support a union, even when privately the workers don't. In light of the sometimes violent history of the labor movement, this concern seems very real. As a matter of procedural fairness, I cannot understand why one would oppose a secret ballot.

My guess is that if you polled economists, you would find more opposed than in favor of the proposed legislation. But that is just a guess, as I have not seen such a poll conducted.

A New Text for Money and Banking

I don't usually plug textbooks on this blog (I mean, other authors' textbooks), but here I will make an exception. I recently received a copy of the new Money and Banking text by my old friend and sometime coauthor Larry Ball, and it is excellent. If you teach this course, I strongly recommend that you give it a look. To learn more about the book, click here.

Somewhere, Milton Friedman is smiling

According to a new Rasmussen Reports telephone survey, 59% of voters still agree with Ronald Reagan’s inaugural address statement that “government is not the solution to our problem; government is the problem.”. Only 28% disagree, and 14% are not sure.