Monthly Archive

Via Greg Mankiw I see Steve Allen’s got a plan for jobs

The numbers [for the new stimulus package] are sobering: $233k per job for the payroll tax cuts and $350k per job for the infrastructure spending.  And these jobs would only be around for the duration of the new stimulus package!

My plan for zero unemployment: There were 14m unemployed workers in August.  The $447b stimulus package could be used to generate a check of almost $32,000 to each and every one of them.  As a condition of receiving that check, they would be asked to work at some organization, for profit or nonprofit, for one year.  These jobs would last just as long as the stimulus package and some of them would no doubt turn into real jobs.  Isn’t this a plan everyone could support?

So there are few issues with this plan. I understand that Steve is being facetious, but I will deal with why you should take facetiousness seriously in a later post. For now, we simply will.

So part of the problem is identifying who these 14M unemployed workers are. We don’t actually count up the unemployed people in America. We sample people using a telephone poll and use that to estimate unemployment.

The other issue is monitoring whether or not they go to work at some job. So once you find all of these people then you have to create some administrative system to ensure that they are complying with the terms of this proposal.

The third issue is the potentially very low real return on labor. So, if they can pick any job there is a good chance they will pick some pointless job. So the return on the labor is really low.

Contrast this with a payroll tax cut. First, off even if it created ZERO jobs its still might not be a bad idea because the government is now earning positive spread on borrowing for taxation.

You would need to structure the re-tax appropriately but you could lower the total tax obligation of the US taxpayers by pushing taxes into the future. So, that’s like a win right there.

Then there is the immediate positive impact on credit constrained households. I am not talking multiplier at this point, I am simply suggesting that in a credit constrained environment the marginal utility of income can go very high. The condition that the discounted marginal product must be equalized across time may not hold.

Indeed, we should expect that it does not hold or else people would not be complaining about there being a recession.

Then on top of that you create jobs and lower unemployment. So you get all of these baseline benefits AND unemployment goes down. You are not simply buying reductions in unemployment.

Infrastructure spending is the same way but of course depends on your estimate of the marginal return to infrastructure. If its high then the double dividend is the same or greater than the payroll tax cut case.

If the marginal return to infrastructure is low then you will get less of a return.

But, in neither case are you buying reductions in unemployment.

I think some economists are mislead because a common analogy is used in thinking about protectionism. However, that analogy does not transfer to this case.

I’ve seen some chatter over whether or not Social Security is a Ponzi Scheme. I think this is mostly a debate over nothing.

What is at issue is that the term “Ponzi Scheme” sounds bad and has poor affect. Some people wish to attach this to the Social Security system and some people wish to divorce it from the Social Security system.

However, is there really any disagreement over the actual mechanics of the systems? What the thing itself is apart from how you feel about the words used to describe it?

I don’t think there is.

However, one thing that does seem to be missing from the conversation is the importance of the concept of claim.

What makes investing in stocks or or bonds or participating in Social Security different from chain letters is that with the chain letter you have no claim. You are hoping that people will continue this process and give you back the money you put in.

With the other vehicles you can use the force of the state to compel people to give you back the money you put it. This is what I am calling “claim.”

Absent state intervention there is nothing stopping me from selling you stock in a company and then skipping town and spending all of your money. There is nothing stopping me from selling you a bond and then using the money to buy hookers and cocaine. Indeed, more than a little of this has been known to happen.

However, under a system of financial rules and regulation the state steps in to (1) attempt to prevent me from doing that in the first place. (2) Seize my assets if I do (3) attempt to repay claimants any monies they are owed.

Now, schemes like the one Bernie Madoff started are particularly hard to deal with because he is telling investors that their claims are growing when indeed they are not. So even though the state can come and try to get your money back from Bernie, it can’t get the claim you thought you had because it never existed in the first place.

Bernie just wrote down on a sheet a paper: you earned 20% return last year. But, nothing actually happened. It was just a sheet a paper. This is known as a lie.

In contrast the companies which comply with SEC regulations have existing claims, so there is a much better chance of getting your claim fulfilled.

Social Security likewise has an existing claim. Now because the claim both comes from the state and is enforced by the state you run into the problem of the state simply deciding that it does not want to enforce your claim. This is known as a benefit cut.

However, so long as the state wants to enforce your claim it clearly has the means to do so. It can forcibly extract resources from its citizenry to make good on its promises. This is called taxes.

Since the United States has not and is not close to exhausting its power of taxation there is no threat to the claim of Social Security besides the state deciding that it no longer wants to enforce it.

The thing to remember, however, is that, that is the fundamental issue: does the state want to enforce this claim or not. If it wants to it clearly can. If it doesn’t want to, then no one can make it do so.

So to the extent there is something to argue about, what you want to argue about is “do we want to continue to enforce this claim.”

Now, being all politically determinist and whatnot, I am going to tell you that no such choice actually exists. You will enforce this claim. Attempts to avoid it are futile. However, I understand that, that perspective is no fun.

Nonetheless, if we are going to argue we should at least be arguing about the core issue and not semantics and affect.

I finally red Ed Glaeser’s piece. Like some other writing on the subject, I think the slant is a bit odd. There seems to be a presumption that because the program isn’t as good as the completely uninformed might believe it is not worth considering. 

I am not sure why this follows.

In any case there is only one technical quibble I have. Glaeser says

Refinancing makes little sense as stimulus, whose goal is to provide a temporary benefit that induces more spending today. Instead, state-supported refinancing is a benefit that pays off year after year for as long as three decades. As the loss to investors is experienced immediately, while the benefit to credit-constrained borrowers is spread over time, the net effect on the economy may well be negative.

There may be some behavioral economics reason for framing this as benefits pay year-after-year while investor loss is experienced immediately. However, from pure financial economics this doesn’t work out.

We can take a couple of tacks to see this. I’ll mention just two

1) We could look at it through the lens of the permanent income hypothesis. This may appeal to some of my readers. The investors take a one time hit today. However, the homeowners get a permanent reduction in their payments. The permanent income hypothesis, however, suggests that the investors ought to treat the shock as if it were spread out over their lifetimes. Thus the two shocks are the same.

2) I tend to think more like this. The coupon is the coupon. What in fact happens to bond holders is that they are forced to take on some lower yielding security. For simplicity lets just say they repurchase Agencies, though it wouldn’t matter so long as the bond holders are profit maximizes.

So what you have really done is simply swap the coupon. Whereas bond holders were taking a 4% coupon they are now taking a 3% coupon. The coupon is always less than the final mortgage rate.

Everything else is a wash. Homeowners who move or sell their homes will not gain the full benefit of this program, but they would have swapped their coupons early anyway so bondholders do not experience the full lose in that case. Everything just rolls through.

There is even a slight advantage because the lower payments should have an externality effect of making foreclosures less likely and thus less downward pressure on the mortgage market.

Put another way. Glasear says

After all, if refinancing saved so much money by reducing defaults, private lenders would surely find mortgage modification far more appealing than they do.

But obviously what you want as a lender is for all other lender to lenders to modify and for you to keep soaking your borrowers. That way, the pressure in the secondary market eases without you having to give up yield.

Tyler Cowen implies no

This BLS graph (look under “And which industries show declining employment over the summer?”) shows a strong seasonal trend which may confound some month-specific citations, but still the number seems to be back to where it had been in earlier years (admittedly the scaling and visuals are not what I would wish for) and more importantly it is hard to spot much effect of the recession at all:

The BLS graph looks strange to me but this is total state and local education employment over the last 10 years, Seasonally Adjusted.

Now state employment is actually up because of Community Colleges mainly, I think. But its not up much. Maybe 40K since the recession ended.

The real action is local where we have lost just under 300K since the recession ended.

I am sorry Dean Baker, it pained me to write that. But, seriously why be such a so-and-so all the time. Especially when you got this so wrong.

It is easy to show that the main factors keeping demand depressed are the sharp falloff in construction due to the overbuilding from the bubbles in residential and non-residential construction and the large trade deficit. The trade deficit was offset in the bubble years by bubble-driven consumption and construction, but it is ridiculous to envision the U.S. economy returning to this growth path.

The Post should try to find some economists with a better understanding of the economy as sources for its news articles.

So here is the total construction series from FRED.

Here are growth rates

I can see a burst alright but that doesn’t look like much of a bubble.

Here are log-levels

Does that overbuilding look commensurate with the bust?

Just a quick one since I was on Fred. Here is Federal Nondefense Investment plus State and Local Investment plus Private Investment in Structures. Basically total public and private investment in our built environment.

This is levels

This is growth rates

So the more I thought about it the more I think confusion with “what is investment” might actually be more rooted in what is consumption?

I suspect there is a tendency to equate consumption with things you go buy from the store. Nothing could be further from the truth. Well, actually lots of things could be further from the truth, 2 + 2 = 5, for example. And, really to be honest there is actually some truth to the idea that consumption is stuff you buy from the store. But, its not the whole truth by gosh and that’s what we are here to dig up!

So here are some major categories of personal consumption expenditures.

If you can’t see that blue line is housing. The first yellow line is health care services. The light green line is financial products and insurance. Notice, how we have yet to hit anything that you buy in the store.

The burnt orange line is food services and accommodations. There we go, that’s something we buy. Though look its actually smaller than financial services. Then comes motor vehicles in silver. That’s probably the biggest consumption purchase most people make but its not much above the next category in light blue pharmaceuticals.

In light yellow is furnishings and rounding out the bunch is education.

There are plenty of other things but these are the big fish. See how few of them are things that are bought in the store? Indeed, the second largest – housing – is mostly imputed.

That is, no one actually buys anything. Imputed housing consumption is what you would have had to pay yourself in rent but didn’t because you own the place you are living in.

Financial services is also imputed. It’s the difference between the risk free rate of interest and the rate of interest that banks charge on loans. Basically it’s the spread that financial institutions get.

Why is that consumption?

Because there is no other economic way of making sense of it. If someone wasn’t producing a “service” then no one could be making money in this market. However, people are making money hand over fist. So they must be producing something. What that is, we can’t measure but we can take the difference between the money the receive in and the money they pay out and that gives us how much service that industry is adding to the economy.

Now that you see this you can more easily understand the following chart

How is it that personal consumption expenditures barely dipped and then recovered while retail sales got hammered and have yet to recover.

Its because housing services, health care services and financial services, the three largest components of PCE, are largely unaffected by the choice of consumers to spend or not. Indeed, two of them are not even market transactions at all. On the other hand retail sales are sharply affected by consumer choices.

Infinitely so it seems.

Greg Mankiw is one of my favorite economists and has been personally extremely kind to me. Unfortunately, however, I haven’t been keeping up with his blog recently.

I went to look back through the archives and I found a pointer to this article by Virginia Postrel on lightbulbs.

I know Virginia through facebook and she is intelligent and articulate. She obviously thought writing this article was a good idea and Greg thought it was worth pointing to.

However, it reads to me like 1500 words on why I shouldn’t feed Kitty Litter to my Infant Son.

The punch line is

What matters, from a public policy perspective, isn’t any given choice but the total amount of electricity I use (which is itself only a proxy for the total emissions caused by generating that electricity). If they’re really interested in environmental quality, policy makers shouldn’t care how households get to that total. They should just raise the price of electricity, through taxes or higher rates, to discourage using it.

Instead, the law raises the price of light bulbs, but not the price of using them. In fact, its supporters loudly proclaim that the new bulbs will cost less to use. If true, the savings could encourage people to keep the lights on longer.

Even if you care nothing about individual freedom or aesthetic pleasure, this ham-handed approach wouldn’t pass muster in a classroom at Harvard’s Kennedy School of Government. As pollution control, it’s horribly inefficient.

The bulb ban makes sense only one of two ways: either as an expression of cultural sanctimony, with a little technophilia thrown in for added glamour, or as a roundabout way to transfer wealth from the general public to the few businesses with the know-how to produce the light bulbs consumers don’t really want to buy.

Or, of course, as both.

Who doesn’t know this?

Obviously this is an expression of cultural sanctimony with a little technophilia thrown in for added glamour. I mean would the supporters of the bill even deny this?

Wouldn’t they say something like smart green-conscious people and companies will find that the bulbs produce good light save money and protect the planet. That’s just shorthand for what Virginia said.

But, of course I am not at all the person to ask on these types of issues.

So I see a lot of people looking at low investment in the US and saying this is the problem. And, I don’t disagree!

But then they assume that investment is a reflection of business, in particular corporations, willingness to expand capital. This is wrong. The majority of investment is in structures and the majority of structures are residential.

So when we say “investment” the biggest component of that is housing.

Lets look at some graphs, because that makes anything more fun.

So this is FPI or fixed private investment. Non-fixed investment is inventories. They are counted as investments basically to make GDP add up to the right number, that’s all. So FPI is investment in things that are supposed to yield long term benefits.

That’s ugly. No wonder our economy sucks.

Alright but lets takeout residential investment.

That looks better already. Still kind of down in the dumps though.

Lets take out construction all together. The BEA calls that Investment in Equipment and Software as opposed to Structures.

Well, that’s much better. Indeed its performed better than GDP since the end of the recession.

Of course investment is more volatile so it might be helpful to use different axes and a shorter time horizon.

Still looks like E&S is doing well.

Another way would be to compare the growth rate in E&S now to in the past. This is especially fun because we get to see growth rates relative to the 1990s.

You can see there was a point where we were growing faster than even in the 90s though we have slowed to merely peak nils level now. Still investment in E&S is strong.

Well, maybe something funky is going on here in the GDP stats. But we can look at Cap-Ex, or New Orders for Capital Equipment. That’s what Wall Street thinks of as business investment.

Here is the raw chart.

We can also look at growth rates

Again very strong performance.

I am trying to think of what other proxies we can use. We can do Industrial Production of Business Equipment

That’s a bit lower, which I believe is represented by lack-luster demand for aircraft.

If you look at manufactures orders for transportation equipment generally, its had rough go of it.

Now a lot of that is cars and trucks, obviously, but aircraft hasn’t been doing well either.

Reihan Salam has a quick piece in the Daily on some problems with the new stimulus bill.

I want to talk about each one. Let’s go

At the heart of the president’s proposed American Jobs Act is a $240 billion extension and increase in the size of the current payroll tax cut. . . .

There is, however, a great deal of empirical evidence suggesting that workers save the proceeds from temporary tax breaks, particularly people who aren’t optimistic about their future economic prospects.

I tend to think the empirical work here over pushes the point. Some of it for example asks people whether they saved or spent their tax rebate checks. Well, of course almost everyone saved it. It would be impetuous to do otherwise.

However, the real question is whether their net spending was higher or lower due to the tax rebate. Were they more free to spend other monies or did they feel ok about dipping into saving to make a down payment on a car given that their savings buffer was now higher. That’s what you are really looking for.

We wouldn’t necessarily expect people to run to Best Buy, check-in-hand, and get a new TV. Though a surprising amount of people appeared to do just that.

Moreover, in our particular crisis which is in large part a balance sheet crisis, increasing household savings will also help to ease the recession. It won’t do much in the short term but it should make the recession end sooner as people repair their balance sheets sooner.

And remember that the payroll tax pays for Social Security. Money diverted from that program has to be made up with higher taxes in the future. As America ages, those higher taxes will be imposed on fewer workers to support more retirees. The math gets dicey very quickly.

The math only gets dicey if people insist on continuing this accounting gymnastics known as the Social Security trust fund. I prefer to think in real resource flows. The government takes command of resources through taxes, it releases command of resources through Social Security checks. All of that happens in the current period and should be analyzed in current period terms.

However, if people want to stick with the gymnastics then you simply have to add more gymnastics to make the balance sheet balance. The Treasury will pay the trust fund on behalf of the public. Or we could get really fancy and the Treasury could pass a wage-subsidy equal to half of your payroll tax. It could then allow that subsidy to be transferable in lieu of taxation. So, workers get a subsidy which they use to turn around and offset their payroll tax bill.

No change to the trust fund.

More generally, however, any effort to cut taxes now will result in higher taxes in the future as long as the government doesn’t change in size. However

1. Tax cuts have macro effects only when we are up against the zero lower bound. Otherwise the Fed can always offset the contractionary effect of a tax increase.  So lowering taxes now and raising them later can make GDP higher all the time
2. The real resource constraint decreases over time. Fundamentally this is because the federal government runs a positive spread on its borrowing. Or in terms that I like to think in, right now the carry on taxation is less than the yield. I know that point can be a bit much for people to swallow. However, it should be clear that when real interest rates are negative, you wind up paying back less than you borrow.

Moving on

The president called for new spending on education and infrastructure. There is an excellent case for infrastructure spending, particularly if it’s part of a long-term plan that includes finding smart ways to pay for it. But as Alice Rivlin, President Clinton’s OMB director, has said on numerous occasions, infrastructure spending is not the best way to stimulate the economy in the short-term. President Obama seemed to acknowledge that fact last year when he said, “There’s no such thing as shovel-ready projects.” Somehow amnesia has taken hold.

I more or less agree with the thrust of this but I think the conclusion is odd. We should have infrastructure. Borrowing costs are cheap. But, we should consider it a bad idea because its not good immediate stimulus.

Why?

I mean yeah, if the choice is between infrastructure or a bigger payroll tax cut then I choose a bigger payroll tax cut. However, if I have gotten as much payroll tax cut as I can get and someone is also willing to give me infrastructure then I will go for it.

Especially since it looks like infrastructure in the US is aging and thus replacing it will yield a positive return, where real borrowing costs are again negative.

The stimulus effect might come late, but we might still need it then and besides we get better roads and cheap financing. That seems on net good not bad.

Now to Schools

Given the amount of money that is wasted in the education sector, there is little reason to believe that a new federal windfall for public schools would be spent wisely. Cash-strapped school districts have finally started to cut spending wasted on bloated administrative budgets, lighting empty classrooms and much else — money that belongs in the classroom, yet somehow never makes it there.

This is a more nuanced public choice problem. Here the choice Reihan lays out is between short term macro stimulus and long term reform. And, I think he is probably right.

The issue is whether the costs are worth benefits. This would require more serious analysis. However, we should keep in mind that it is unlikely that reducing resources for schools – which is the effect of a recession in a balanced budget environment – will result in pure efficiency gain.

Its likely that the same forces which made schools inefficient in the first place will continue to assert themselves even during the downturn and only starve classrooms more.

Now you may get more pushback from local official and crisis may spur people to action. So, this effect has to be counted as well. My end take on this issue is that it’s hard to tell.

On tax loopholes for oil companies

The president did say that he wants to reform the corporate tax code, which is great news. But what kind of reform does he have in mind? Incredibly, the president used a jobs speech to make the case against “tax loopholes for oil companies.” To translate this into language we can all understand, the president is calling for increased taxes on drilling new oil and gas wells

I tend to agree with Reihan here, though as a matter of principle we shouldn’t be attempting to push the economy towards any particular energy sources. However, as efficiency clean-up measures go, getting rid of tax credits for domestic oil drilling would be, to paraphrase Lewis Black, on page six right next to “are we eating too much garlic as a people.”

Moving on to housing

To aid homeowners in distress, the president shared his intention to help refinance mortgages at today’s low interest rates in order to give families as much as $2,000 in extra spending money. Alas, there still is no such thing as a free lunch. As Harvard economist Edward Glaeser has explained, this refinancing effort would lose investors in the mortgage market a large amount of money in the short term and it would pay dividends to homeowners over the decades-long life of a mortgage. Because many mortgage investors live in the United States and might otherwise spend that money they’d lose in the process, this measure might actually destimulate the economy in the short term.

I am going to go ahead and say I haven’t read Ed’s piece yet, so maybe he makes some good non-obvious points. However, the basic mechanism outlined here seems “silly” to me. Silly is not quite the right word but I am not sure what is.

So, whatever gain homeowners receive is roughly equivalent to the loss that bondholders receive. If the bondholder wants to count all loses as coming in the current period he can. If the homeowner wants to count all gains coming the current period he can. But, in both cases it’s the coupon that has changed.

Now there are two potentially important effects.

1) Being able to ride underwater homeowners is a positive of buying a Fannie/Freddie bond. You don’t have to worry about default because the bond is insured. However, if the homeowner is locked out of refinancing then the homeowner looses a valuable refinancing option. That’s good for you as a bondholder. Knowing that, you as a bondholder are willing to accept a slightly lower yield on the bond. If the government signals that it is willing to take that advantage away it will raise the cost of borrowing for future households.

2) Lowering the current cost of mortgages has an externality effect. It means that fewer homeowners will default, which means there is less distressed inventory coming on the market, which means there is less pressure on home prices, which means fewer homeowners will default.  So just as a wave of defaults can build on itself, a wave of non-defaults can build on itself.

Those two effects cut the otherway.

However, for the stimulative effect you are causing losses to folks who are by and large not liquidity constrained in exchange for gains to folks who are almost by definition liquidity constrained. This will almost certainly then be stimulative in a short run macro way.

So on net I would say that once again this isn’t the stimulus that I would have designed but it is much, much closer to what I would have designed and I think its strongly workable.

When borrowing is cheaper than free?

So what happens if we simply suspend taxation for a few years and then pay it back later?

I know, I know there are issues about market freak out and the signals that such a move would create. Some will also object that such a move would alter interest rates based on sheer volume but I doubt that actually.

Even still lets put all that aside for the moment.

If the government suspends taxation and then tries to raise the money later to repay what it borrows it will actually be extracting less real resources from the economy.

Okay but there is the issue with rates. Won’t they have to double and doesn’t that mean the deadweight loss will quadruple you say.

I’m glad you asked.

Because even though negative real interests rate make the point obvious what really matters are real interest rates relative to real economic growth. Here are real interest rates over 30 years.

Now do you believe that the real US economy will grow faster than 1.1 percent per year over the next 30 years? We should hope so, because if it doesn’t then lots of our forecasts are going to be waaay off.

Well that means that if we suspend taxation, borrow to fund the government and then keep rolling in the interest payments into the debt, our total obligation as a fraction of the economy will keep falling every year over the 30 year horizon.

Suppose real growth is 3 percent per year. Then this years obligation as a fraction of GDP falls by 1.9 percent per year, every year for 30 years. This means that in 30 years this obligation as a fraction of GDP will be only 56% as large.

Even if we then pay it all off in one lump payment we will only have to increase taxes by 56%. That increases deadweight loss by 146%. However, we saved 100% of deadweight loss in the current period. So our net increase in deadweight loss is only 46%.

And that’s paying it all back in one year. Stretch it out over a number of years and you can actually reduce the deadweight loss.

Fundamentally that is because the US government is earning a positive spread on its borrowing. The US tax base is growing at a faster rate than is the cost of delaying taxes. In such an environment you make money by pushing taxes into the future.

I largely agree with Betsey’s analysis except for this part here

The centerpiece is a series of sharp payroll tax cuts. The usual problem with payroll taxes is that they largely subsidize existing workers. But this plan — three separate payroll tax cuts — is different.

The first tax cut is the most innovative: No payroll taxes at all for firms increasing their wage bill. In economics, all the action is at the margin. If we want people to do more at the margin — hire more people — then the incentives to do so should be targeted at the margin. We will get much more bang-for-our-buck by giving the biggest tax breaks to the hiring of extra workers.

What is the point of getting more bang for our buck? Real interests rates are below zero. Any positive bang passes the cost benefit test.

In essence the US government can arbitrage out market frictions. Firms may not be able to borrow a zero cost but the US government can borrow at zero cost give them the money and then tax them back later at a lower rate. Lower both because the real return cost of government borrowing is negative and because the economy is likely to grow between now and then.

So why not just cut everyone’s payroll tax down to zero. Its really big. Its really simple. No one has to worry about what qualifies as a “new worker.” No one has to worry about people trying to play worker switch-a-roo.

Not too mention there is likely to be some bang simply by lowering payroll costs. There are some firms for which cash-flow is simply no issue whatsoever, but for most firms its at least some concern.

Lets just remove the concern all together, cut the payroll tax to zero!

Also, as I always mention, the sheer absurdity of a zero payroll tax continuing indefinitely makes it easier to allow it to expire when the economy recovers.

Both Matt and Ezra have posts on the issue and I take it, that’s it’s still a major talking point. Even some of my friends on Facebook have started saying that we don’t have a credit problem we have a business hiring problem.

However, it’s not even clear that we have that. What we have is the aftermath of a rough recession. There are good points to be made about capital expenditures but we don’t even need to go there. Lets just look at employment.

This is all private employment in the United States over the last 15 years. You can see that the latest recession was bad. But, if anything the post recession period looks better than the 2001 recession.

After the dot-com bust private employment continued to drift down for another 2 years before finally picking up. And, on could argue there was a lot uncertainty!

The next big thing had just turned out to be a bust. Terrorists were blowing up buildings. The US was going to war and a bunch major corporations had cooked their books.

However, this time private employment more or less turned around in short order and is rising with roughly the same slope as it did towards the end of the last expansion. That’s important because both the end of the last expansion and this period share something in common. The mind-blowing bust in construction.

I still argue that this is a phenomenon begging for a deeper explanation and one that should be one of the major stories of the period. There is a sticky price story to be told but for reasons that would take too long I am not even fully comfortable with that.

However, lets take construction out of the picture since presumably no one is saying that ObamaCare and uncertainty about the Bush Tax Cuts is why we aren’t building more homes.

Now look at the slopes in the last two expansions. They are darn near parallel. The 90s were better, there is no doubt about that. However, no is not clearly worse than the Bush Boom in terms of job growth.

We can calculate growth rates just to check our eyes and make sure we are seeing what we think we are seeing.

Here is percent change from a year ago

Looks pretty similar.

Here is absolute change month-to-month. That’s like the “jobs report” numbers that you hear reported in the news.

Again, it looks pretty similar. We are on a down-stroke but unless that down stroke continues its nothing out of the ordinary from what we say during the last expansion.

The rate of private non-construction expansion now matches what it was during the the best part of the last expansion. Its hard to see how that makes us think there is regulatory uncertainty.

David Altig has a nice chart comparing labor force growth in various industries. Lets give it a look and see what it is telling us.

So on the Y axis we have post-recession employment growth. On the X-axis we have employment growth over the mid-nils, the previous episode of expansion.

The size of the bubbles represents the number of folks employed in each industry. The bubbles themselves are labeled so you can see which industries we are looking at.

The 45-degree line represents points where growth (or decline) in the previous expansion and growth (or decline) since the recession would be equal. Bubbles below the line are industries which are growing slower (or declining faster) now than before.

Bubbles which are above the line are industries which are growing faster (or declining slower) now than they were before.

A couple of basic facts we can notice.

1. Most of the mass is below the line. That means that most of the economy is performing worse than in was in the nils in terms of employment.
2. Information is the only category in the third quandrant, meaning it was declining before and its still declining. This surprises most people. However, information is dominated by publishing and that in turn includes a lot of newspapers. That should make it clear why they are where they are.
3. If you look at the slope of the bubbles, except for a few outliers they are not that far off 45 degrees. This means that while the rate of growth is slow, the relative growth rates have not altered that much. If you were slow before, you are likely even slower now.
4. Manufacturing is the big outlier. Manufacturing collapsed in the nils but is stalled now.

Now what can this tell us about the general class of restructuring stories. First, it says that there hasn’t been much. In terms of employment the main restructuring has been from government to manufacturing. That is government is the biggest outlier below the line, and contains a hefty mass. While Manufacturing is the biggest outlier above the line and also contains a hefty mass.

Its true that this is happening. We are losing fewer manufacturing workers but we are laying off teachers. However, its not immediately clear why this represents a rebalancing that would produce recession.

Also, its hard to tell a story where this is the undoing of loose Fed policy. Indeed, it would be easier to tell a story where it was the undoing of excessively tight Fed policy. Loose Fed policy is going to tend to expand manufacturing both by lowering domestic interest rates and by lower the dollar.

The story that could make sense is that this was all the result of a change in China’s policy. China stopped manipulating its exchange rate. This relieved pressure on US manufacturing but also forced the US government to shrink as its main creditor pulled back.

However, that’s not exactly what happened either.

Overall I don’t know if there is much of a structural story to be told. I think the slowdown in manufacturing job loss is in large part because the shift to China played itself out, at least for this round. The decline in government jobs is because of State and Local balanced budget constraints.

Other than that you can see that even construction, everyone’s favorite culprit for misallocation, nearly lines up with education and health in terms of its distance from the 45-degree.

This is because the boom in construction just wasn’t as big as people think it was and because the contraction in construction began well before the recession started.

Believe it or not I am trying to keep myself off the blog, but sometimes when I am taking care of my son and he falls a sleep for a bit, I am like – oh great time for a blog post – and here I go.

So, I have seen more than a few people worry about money coming off of the Fed’s balance sheet and creating hyperinflation in the United States. More often that not this is phrased as “Well right now banks are hording cash but as soon as they stop the Fed is going to be in trouble”

I want to respond to that but its difficult to find the exact framing.

On the one hand the issue of an exist strategy and effectively transitioning to a new monetary model is not trivial and shouldn’t be taken lightly. Fed officials are rightfully wringing their hands over the execution of such maneuvers.

On the other hand its not the kind blatant monkey business that I think some people are envisioning. It is overwhelmingly likely that the Fed is going to be successful at making this work.

So briefly lets think about why someone might suspect hyper-inflation or at least a very high level of inflation is coming and why the Fed will overwhelmingly likely to prevent.

So by law banks are required to hold reserves to back up their deposits. In the United States a bank must have $10 in cash on hand or at the Federal Reserve, for every $100 in deposits.

Now, typically banks don’t want to hold more in reserves than they have to. This is because cash just sitting in vault or on deposit with the federal reserve (traditionally) earns no interest. The entire point of being a bank is to earn interest and so if you have excess reserves you are really sleeping on the job.

Now the first place you are likely to look for lending opportunities is in your local area. You want to loan money to borrowers at an interest rate that will prove profitable. However, what if you don’t see any too many good lending opportunities. Maybe your local economy is depressed or maybe your borrowers are in really risky situations that have you nervous about their ability to pay you back.

What you can do is loan the money to some other bank. There are other banks out there that might be in areas with a strong economy or who specialize in lending to the type of customers who are good credit risks or in a promising industry. You loan the money to that bank and then that bank loans the money to its customers.

The market where banks loan each other money is of course the Federal Funds market.

Now as it turns out what usually happens is that small local banks loan money to big Money Center banks. As you may have noticed the big money center banks – Bank of America, JP Morgan, etc – can always find ways to lend out money. They have very smart people who spend all day thinking of new ways to make profitable loans.

So if First Bank of Main Street doesn’t see good opportunities in its local, it loans money to Bank of America.

Now, since we’ve already built up this structure is worth spending a few sentences on how the financial panic affected all of this.

We have First Bank of Main Street (FBMS) lending money to Bank of America (BAC). BAC is a big bank full of smart people who can always find ways to make money.  But, wait a second! It looks as if BAC may have made some mistakes. They wound up making a whole bunch of bad loans that might not get paid back.

What should FBMS do? Well they don’t have super analysts on staff who can figure all of this out and even if they did the big boys on Wall Street got it wrong so who is to know what’s right. Well, in this case FBMS should stop lending to BAC and protect its customers.

But, now OMG! BAC is watching all of its reserves wash away. It needs to have a 10-1 ratio. Every dollar that FBMS pulls back means that BAC has to reduce its loan portfolio by $10. BAC is going to have to really start shutting down its loans.

But, many large corporations depend on BAC. That’s where they get money to meet payroll or pay vendors or other immediate needs. What are they to do? Are they going to be able to meet payroll this week?

Full scale panic ensues.

Now the Fed steps in and says hey BAC, we’ll loan you the money you need to cover your reserve ratio. You won’t have worry about borrowing from FBMS.

So the Fed injects all of these reserves into the banking system.

Now normally that would simply cause the Fed Funds rate to simply collapse to zero and indeed the Fed pushed the Fed Funds rate pretty close to zero. But, the Fed Funds rate is also a useful tool for monitoring the what’s going on in the banking system.

So the Fed said here is what we will do. We will pay interest on reserves. That way if anything crazy happens you can just keep your reserves and earn interest, you don’t have to run the risk of loaning them out to banks with shady books.

So where are we now? Well BAC got in the reserves it needed to keep its lending going. FBMS got back all the reserves it had loaned to BAC and so now FBMS has excess reserves sitting on the books.

Shouldn’t FBMS loan out those excess reserves?

Well there is really no reason to. Before the crisis started FBMS would have rather loaned their excess reserves to BAC than to customers in their local area. Now, after the new policy FBMS would rather just earn interest from the Fed than loan out reserves to folks in their local area. As far as FBMS is concerned nothing has really changed.

Well what if loan demand picks up in the local area? Won’t FBMS loan out its reserves? It will start to but then the Fed can simply raise the interest it pays on reserves. This means that FBMS could either make loans to customers or just hold the extra reserves.

This is the exact same trade off that FBMS would have faced if the Fed had raised the Federal Funds rate. It could have loaned out money to customers or it could have loaned the money to BAC.

In effect the interest of reserve policy lets the Fed stand in for BAC. This is important because BAC needs some time to get its act together. But as far as FBMS is concerned there is really no difference between the two scenarios. All that matters is the interest they are earning on their excess reserves. It’s the same whether those reserves go to BAC or are held by the Fed.

So, even though FBMS officially has more excess reserves on its books, its desire to lend is no different than under normal conditions. Thus, any increase in inflation that could be chocked off by raising the Federal Funds rate can be choked off by raising the interest rate on reserves.

The Fed has complete power to slow the expansion of lending and hence the emergence of hyper-inflation as it did before and it doesn’t have to remove its reserve injections to make it happen.

So I haven’t seen the speech but I can tell from the chatter that the President is pushing for an extension of the payroll tax cut. Obviously I am very much in favor of this.

I also see that he is looking for tax incentives for businesses that hire new workers. This is not my preferred way to go but its better than nothing.

As always I want to be on the record AGAINST targeted stimulus. I think broad and bold is the better way to go especially with tax cuts.

Its really, really hard to think of how a tax cut could be “wasted.” The only problems are if it causes deficit financing issues or if it is paid for by later taxes that are really really bad.

Given that the medium term deficit is a complete non-issue and that the payroll tax is one of our most regressive taxes, I am little worried about that. Maybe you could fear that it would be paid for by some horrible tax on corporation but first that seems unlikely simply on its face and second even if you believe that there is a reasonable possibility of it happening you have to discount such tax hikes because they occur in the future and they do not occur with probability one.

In his very nice Gnome piece Bob concludes

The Keynesian focus on aggregates such as the "stock" of capital and "supply of labor" leads to faulty policy recommendations. The Austrian School has always had a rich conception of the structure of production. Of the major schools of thought, only the Austrians can appreciate what happens to the economy in the wake of a gnome attack — or the collapse of an unsustainable inflationary boom.

Which is in some ways ironic because I am working on data for a paper right now that looks the movement overtime in 72 economic sectors across 50 states across 40 years. Indeed, I am looking for a gnome attack. The extent to which deviation in those variables differs from a normal distribution.

Now, Bob is correct, that at the moment I do not have a good proxy for the location of all capital, at least not stored on my computer. And, I only have rough estimates for the location of all skilled labor in America. But, I did just get a new RA so we will see what I have by May.

However, the larger point is that I think Bob’s analysis and that of many economists in this debate misses what working economists do every day. By that I mean the guys and gals who produce forecasts and analysis for banks and major corporation.

Much of what they do is scour through data looking for these types trends. How is construction in the Great Lakes doing? Is die-press manufacturing in the Mid-Atlantic expanding. Are the railroads that run between Chicago and New York operating with a higher or lower empty car percentage than the ones going from New Orleans to Atlanta? How many new cars did we sell in Imperial Valley last month? What was the average rent in Cleveland?

To be even more specific one of my favorite reports to look through is same-store-sales. We get that from every major realtor every month. And, we get Redbook every week.

That lets us know how the labor day weekend did for example. Or if Macy’s is doing relative better than Bloomingdales. In some of the conference calls we can get details on what kind of things went out from each retailor in each region over the quarter.

Now, the gold mine of gold mines is pure scanner data, which no one that I know of has real time access to. With. that we can tell the exact moment when each thing was sold. When the customer uses a bonus card we know the exact household that bought it.

The thing is, I haven’t seen anything in any of this data that tells a non-Keynesian story. Again, maybe we can find it. Maybe people have suggestions on where to look, but right off it just doesn’t seem to be there.

A couple of things

First Bob says

My answer to Karl (starting at the 44:00 mark) involved the Austrians’ sophisticated view of the economy’s capital structure. A cruder Keynesian model, which involves aggregates such as K and L, can’t grasp the Austrian diagnosis of the typical boom-bust cycle, and consequently yields disastrous policy advice — such as massive deficit spending to prop up “aggregate demand.”

I think crude Keynesianism does just look at basic aggregates. I believe it was Bob Solow who said that if God had intended there to be more than two factors of production he would made it easier to draw three dimensional graphs.

So it was asked. So it has been delivered.

Indeed we don’t have to stop at three anymore

More generally we can use GAMS (General Algebraic Modeling System) to model as many markets as we want. How many you want? We can have 50,000 markets. Its only a matter of time before we can do millions of markets.

The computer scientists tell us impossible to build a complete model of the entire economy including every possible market, that will solve faster than the actual economy will solve, so there will always be a level of abstraction. But, we certainly don’t have to settle for K and L.

The thing is we still don’t get the effects that Bob is talking about. No Gnomes, even in 500 dimensions.

To illustrate what’s wrong with the typical Keynesian view of the economy, in the debate I told the spectators to imagine that one night, mischievous gnomes decided to rearrange all of the capital goods and skilled laborers in the country. The next morning, brain surgeons who were supposed to report to a hospital in Albuquerque would wake up in Miami. Factory owners in Trenton would open their doors and see that their assembly lines were gone, replaced by defecating cows. Farmers in Iowa, for their part, would be baffled to see drill presses and computer servers sitting in their empty fields.

Suppose the Keynesian statisticians in this absurd thought experiment could make perfectly accurate measurements of their standard variables. What would they say? In the first place, they would be horrified to report that “real GDP” — the flow of newly created goods and services — suffered the worst collapse in world history. The annualized rate of real output in one day would have fallen perhaps 99 percent. Factories would be idle, and workers would be wandering the streets in a daze. Official unemployment statistics would be 90 percent or higher in the days immediately following the gnomes’ evil prank.

The government and the public would demand that the elite economists explain this calamity. The Keynesians would check the various aggregates and consult their models. Was it a “supply-side” disturbance? It wouldn’t appear to be so: the total stock of capital goods was the same as it had been the week before, and the same would be true of the supplies of various types of labor. It wasn’t as if the economy had been struck by an earthquake or a plague; the same “productive capacity” was still there. Furthermore, there wasn’t any negative “technology shock,” as far as the Keynesians could ascertain. The recipes for turning inputs into outputs would all still work, just as they did the week before.[1]

This is why the discussion of Co-movement is so crucial. If there were gnomes moving stuff around then we should see stuff moved around. But, we don’t.

We can look at market after market and it seems like there is some effect which is hitting everything to a greater or lesser degree. For example. Health care is an example of a sector that just keeps adding jobs.

As a New Keynesian I would say this is in large part because consumer foot very little of the health care bill. The government foots nearly half and third-party insurers who are contractually obligated to pay foot most of the rest.

Nonetheless, even in this market – a market that everyone thinks will keep expanding – look what happed to construction.

The top line is private construction spending on health care, the bottom is public construction spending on health care. Can you see how in late 2008 private health care expenditures falls.

Can we also see how public health care spending did not fall until late 2009.

What’s our gnome explanation for this. Who moved the private bulldozes in the fall of 2008 from the hospital parking lots and why did they wait until 2009 to move to move only a couple of bulldozer from the VA hospital?

In my world Lehman Brother moved the bulldozes. Lehman created a sharp rise in liquidity demand that had even hospitals hording cash. No one thought the market for sick people was drying up. They though the market for cash was drying up and so they pulled back on spending.

We can go through private spending series after private spending series. We can look at very short lived items like hot food. We can look at long lived items like industrial machinery. They all move the same. Indeed, lets look at those two

They rise together. They peak at roughly the same time, they fall together, and they recover together.

Capital goods are more sensitive to the financial crises than is hot food but nonetheless they move in rough tandem. This is what tells me that Aggregate Demand is a general effect. Its something that hits everything to a greater or lesser extent.

If we are looking for a gnome effect, we really want to see some sector of the economy that is moving out of sync. We want to see some place which should have been getting lots of resources but wasn’t.

We then want to see resources being transferred into that area as people realize what went wrong. Its hard to find what that thing is.

Bob Murphy looks at bond spreads:

The above chart doesn’t look to me like investors around the world have rushed into safe assets, and that’s why (incidentally) yields on Treasuries are so low. (If that’s what were going on, wouldn’t the spread between AAA and BAA be bigger now than it was in 2007?) It also doesn’t look to me like there’s a glut of desired saving that can’t clear because of the 0% lower bound. (If that were the case, wouldn’t corporate yields be at least a few points lower now than in 2007?)

So a couple of things. First Moody’s Seasoned is an index of bonds with a roughly 30 year maturity. So you would do better to compare Moody’s Seasoned to 30 year Treasuries or 3-Month Treasuries to Commercial Paper. We will do both.

Here is Seasoned vs 30 UST

You can easily see the flight to quality in late 2008 with all spreads going higher. Then you see a tightening of spreads after TARP. And no you have pretty solid co-movement.

We can look at commercial paper as well. Like 90 day T-bills they have very short maturation.

I don’t have easy access t non-AA commercial paper but we can compare financial paper with non-financial paper. It was financial paper that was under the most stress during the crisis as it was used to leverage up brokerage houses such as Lehman Brothers.

Again you can see the exploding spreads in late 2008 and their subsequent calm down.

So that’s comparing apples to apples.

From a bigger picture the explosion in spread that you see in Bob’s blue graph above is a story about the yield curve, not about public vs. private bonds.

Short term maturities collapsed while long term drifted down. This is because at present no one believes that low interest rates will last forever. Eventually the economy will recovery and the Fed will raise rates.

Incidentally I think this is evidence that the market is indeed not fooled by Fed action. Bond traders now that cheap money now does not mean cheap money forever and hence long bonds do not yield much lower than they did during the end of the boom.

Krugman echoes what I told National Journal a while ago on gold prices, but I think he makes it a bit more complicated than it has to be.

What effect should a lower real interest rate have on the Hotelling path? The answer is that it should get flatter: investors need less price appreciation to have an incentive to hold gold.

But if the price path is going to be flatter while still leading to consumption of the existing stock — and no more — by the time it hits the choke price, it’s going to have to start from a higher initial level. So the change in the path should look like this:

And this says that the price of gold should jump in the short run.

A simpler way to tell the story is this: after adjusting for risk the price of any asset has to rise at the long term interest rate.

Why?

Because if it rose slower than the long term interest rate then it you can make an easy profit by selling the asset buying bonds, earning interest on the bonds and then buying the exact same asset back later.

On the other hand if it rose faster than the interest rate you could make an easy profit buy borrowing money in the bond market, buying the asset, letting the asset go up in price and the sell it to pay off your bonds plus profit.

So we know all assets rise at the interest rate after accounting for risk.

So what happens when the interest rate goes down? Well we know that long term price appreciation will slow which means one of two possibilities

1) The current price will stay the same but slow price appreciation means the future price is lower

2) The current price will jump and slow price appreciation will get us to the same future price.

How do you know which one will happen? The short answer is that its almost always scenario (2).

The long answer is that declines in the interest rate that reflect declines underlying long run productive capacity will produce scenario (1). Declines that driven by nominal factors will produce scenario (2).

An anonymous commenter (whom I can only assume is Michael Woodford come to praise my deep and well informed knowledge of monetary policy) says,

Great work. Nitpck: if the aim of govenment stimulus is to “normalize” monetary policy by pushng interest rates above the zero bound, this can be accomplished most cheaply by directly subsidizing investment, rather than pushing for large increases in spending and hoping that crowding-out effects will lead to higher natural rates. The amounts involved would be vastly smaller, and it could even be done in a budget-neutral fashion, with no impact on the government’s long-run fiscal postion.

This is certainly true.

One of the nice things about a payroll tax cut is that because the tax is flat we don’t have to worry so much about stimulus being hijacked attempts at social or industrial policy.

Once we start saying “we are going to subsidize investment” then you are opening up the flood gates for rent seeking. I am not sure if that’s a better outcome than simply cutting payroll taxes.

Where I think I am most vulnerable is to a Ricardian Equivalence critique. That is, folks will say that temporary tax cuts will simply be saved. I think the evidence on this is mixed and it is less likely to be true in a financial crises than at other times. However, it is an important objection.

Effem makes an important comment

The Fed can dictate the USD-denominated price of any asset. All the money in the world is but an insignifcant fraction of the amount of USD the Fed is able to print.

Is that not totally obvious?

This does seem obvious but it is at odds with the results of a competitive market equilibrium.

Suppose that the Fed tries to goes in and trillion dollars worth bonds at 10am on Tuesday morning. What happens?

Well, the price of bonds is driven way up. That’s of course the same as saying the interest rate is driven way down. For the purposes of this post I am going to speak in terms of bond prices rather than interest rates but keep in mind that the two are equivalent ways of discussing the same thing.

So, bond prices are driven way up. That’s going to get some people to start selling bonds who otherwise wouldn’t and some people to stop buying bonds who otherwise would.

In both cases money is being driven out of the bond market. Where does it go. Well some of it is going to go into other assets, stocks or oil futures for example. And, if you watch CNBC you can see that an announcement of more bond purchases by the Fed will immediately send stocks and futures prices up.

And, its important to note this happens immediately – within a few seconds thanks to computer trading. If it were possible for a computer to read and interpret a Fed statement reliably then the price of the assets would probably rise within milliseconds of the Fed statement being released. Its only the time it takes for human eyes to read and understand what is being said that slows this process down.

So here we are 10:02AM and stock and futures prices are rising. What does that do?

Well presumably it drives some people to sell who wouldn’t have and some people not to buy who would have. That is, money starts moving out of the stock and futures markets.

Where does it go?

It a perfectly competitive world it goes into the markets for real goods and services. People seeing higher stock prices realize that they are now richer and they can afford to buy a new car, or fancy dinner or something else.

However, because markets are competitive that immediately bids up the price of new cars and fancy dinners. Not only that but by the substitution effect it bids up the price of used cars and not-so fancy dinners. This in turn bids up the price of bicycles and food at the grocery store.

In fact, the price of every single thing in the country is immediately bid up as buyers move in and out of various markets.

Its now 10:05AM on Tuesday. The price of everything in America is going higher. That seems really too bad for people who weren’t in stocks and bonds in the morning because now they can’t afford stuff.

That is, except for the fact that all of these higher prices have no made every industry earn economic profits. The market abhors economic profits. And, so every industry attempts to expand to take advantage of those profits.

To do that they must hire more workers. Except when every single industry is trying to hire more workers at once, their won’t be enough to go around. Wages will have to rise. So want ads are all changed and everyone offers a higher wage than they were before. They also have to give higher wages to their existing workers or the existing workers will take a new offer somewhere else.

So now its 10:10AM on Tuesday and all prices and all wages in America have risen.

The price of bonds has risen as well, but the price of bonds in comparison to the price of everything else has not changed. The injection of money has simply lead to an increase in all prices, stocks, bonds, houses, gasoline, everything.

In this case money is simply a veil and the Fed has no traction over real bond prices.

Yet, we do think the Fed has traction over real bond prices? How is this possible? It must be that money is in some since not a veil which means on “some level” that prices are sticky.

Why they are sticky is up to dispute, but I am not sure how you write down a story of human economic behavior where prices move smoothly and the Fed has control over real bond prices.

Some people have asked for me to show my sides and elucidate my position more completely. I’ll give the slides here and maybe some commentary later.

There is a strain of thought in American politics which suggests most of our problems could be solved by a good dose of self-esteem. If we only believed in democracy harder. If we believed in capitalism and the possibility of the American worker. If we believed in our children and their teachers.

If we believe in all of these things then they would get better. America would win wars, create jobs and raise the brightest minds of our future. We just need more self-esteem.

There are plenty of writers who can offer a take-down of tinkerbellism and I encourage them to do so.

However, as is my wont, I want to be a little more Meta about this. There is an aphorism in business that pessimists are more accurate but optimists get more things done. A favorite professor of mind used to say that we can mock the MBA cheerleading squads all we want but they are the ones driving new Mercedes while we are the ones fixing our own cars.

That is, to say that for all its seeming ridiculousness the cult of positivity at least seems to work. Yes, there could be some psuedo-effect where the only people are able to maintain that go-get-em disposition are those who by luck are winning anyway. Nonetheless, we shouldn’t put all our eggs in that basket.

Nor, if we step outside ourselves for a moment, should the fact that the tinkerbellism are so often factually wrong deter our faith in tinkerbellism. The common wisdom acknowledges that they are wrong but suggests that they are more successful anyway.

And, since the ultimate goal of policy is not to be right but to be successful in improving the human condition, we have to be mindful of the potential usefulness of tinkerbellism

Here is the year over year data in Existing For Sale Home inventory. If there is too much of anything then it is this. That so much of the commentariat lives in pre-existing owner-occupied homes I think skews perception.

Converting rentals into condos makes puts more owner-occupied units on the market but does nothing to increase housing supply, for example. And, though we did have a buldge in single family construction during the 2000s we had a collapse in multifamily and mobile homes. Both are traditionally a significant source of housing for many Americans.

And, of course even single family built for sale has been in the toilet for going on 5 years.

However, because there are a back-log of existing single family homes for sale it can feel to a certain segment of society like there are too many homes.

Yet, even that is starting to deteriorate rapidly. From Calculated Risk.

The integral under the redline will turn negative in the next year or so at this rate. By many accounts, however, it overestimates the inventory. The shorter lived blue line is likely to have given better estimates. Thus we could be very well approaching a negative integral by the end on 2011.

You can make an argument that the boom in home construction was unsustainable, though I think that argument is fairly weak. I don’t see how anyone can consider the collapse in home construction sustainable. Not, unless we are approaching a serious paradigm shift in how Americans live.

So a significant portion of the Keynesian / Non-Keynesian debate is taken up by mostly superfluous concerns about government. Non-Keynesians in particular I think – just calling a spade, a spade – are motivated in large part by antipathy towards government intervention.

So lets step back and see if we can get Keynes by private association. This is an important exercise for Keynesians as well, because if we can’t make private Keynesianism work then we have got to point to specific externalities involved.

So suppose that a group of private citizens got together and offered the following contract. In good times – as measured by the employment level of all club members – we will collect $1000 in taxes from each household.

If times turn bad we will take all the money collected so far and bury it on a private farm which only our members have access to. The members who geniunely cannot find jobs will see it in their best interest to spend their days digging up the the bury money.

Through this means we will ensure that no one in the club is ever unemployed.

Would people go for this?

If not why not?

If, so what explains the paucity of such clubs?

Perhaps we think digging up money is just too wasteful. How about then a club which hires only its own members to perform maintenance on club members homes? Will that work and if not why not?

Personally, I tend to think that money has to be involved somehow and the ultimate question whether the club has its own currency. However, we can probably think of good thought experiments there.

In any case analyzing Club Keynes can help us get around the “I hate government” / “I think government can help” difficulties in analyzing what should be a set of purely economic relationships.

A few commenters was puzzled by my instance on sticky prices or some other mechanism specific mechanism for allowing the Fed to control short term interest rates.

This is actually an extremely important stylized fact that we only briefly touched upon in my debate with Bob Murphy. Its really important because of how obvious and straight forward it seems to market participants but how counter it is to basic economics.

The problem is this. Sure the Fed can print a lot of money and use that to buy bonds but why should that effect the relative price of bonds? The Fed isn’t changing anything fundamental about the bond market. What it is changing is the supply of money. The only thing that should change is the relative supply of money.

Why?

Well, because the response to price is imbedded in the mind of each market participant. The market price simply emerges. This will be critical later.

So when the Fed starts buying bonds it doesn’t change anything about the actual preferences of market particpants or the real constraints they face. It simply pumps more money into the bond markets.

That money will cause some bond buyers to refrain from buying bonds and some bond sellers to sell more bonds. Those particpants end up with more money which they spend elsewhere.

And, indeed we can see that within moments of the Fed announcing its intention – its mere intention – to buy more bonds, the price of stocks and futures contracts will begin to rise. That’s money going out of bonds and into stocks and futures, on the anticipation of Fed action.

The larger question is – why doesn’t money spill out into every market right away: houses, cars, groceries, clothes, etc. In fact, we think that it will eventually and that’s how money creation ends up fueling inflation. People try to buy more of everything, but there isn’t more and so the price must rise.

Yet, if all markets were as smooth as stock markets then this would happen immediately. The price of everything would rise, all the money the Fed tried to pump into the bond market would bleed out and bonds would be left the same as they were before.

Money would be a veil and doubling of the money supply would simply lead to a doubling of the price level, end of story.

That is not, however, what happens.

At minimum it takes time for prices to rise. Most don’t move nearly as fast as stock and futures prices. Moreover, it really seems like output rises as well. Perhaps that’s a measurement problem but at minimum something is happening.

How that something happens is a question that needs to be answered because it can’t be done with simply perfectly competitive markets. Such markets should act exactly like stock and futures markets. They should respond instantly to Fed movements and then be done. No lagging effects. No change in output. No alteration of interest rates.

It has been mentioned that bond traders can’t undue Fed action because they don’t know what the real price “should be.” However, the point of emergent order is that no one knows what the price should be.

The price is whatever results from individual buyers and sellers acting on their own preferences and constraints. The Fed doesn’t do anything to fundamentally alter these preferences and constraints – at least in a perfectly competitive economy – and so it cant do anything to alter bond prices.

Sellers keep selling based on their attempts at profit maximization and buyers keep buying. If you try to pump this system up with artificial money demand then the demand should simply spill out to the rest of the economy, rise all boats and leave relative prices unchanged.

Brad Delong continues on a theme that needs more emphasis

Zombie Claim #2: America has overinvested in housing and needs the construction sector to be depressed for a while.

• To the contrary, the housing bust has now been much longer and deeper than the mid-2000s housing boom–we are now far below trend in the cumulative number of houses built:

The issue is a constant conflation of home prices with home building. The later was unprecedented, the former was entirely precedented as you can see in the graph above, home building was actually higher in the mid-1980s.

What is unprecedented is the home building bust.

Here is another chart comparing prices and housing starts since the 2000 when the Case-Shiller 20 city index began

These are real home prices in blue and housing starts per new resident in red.

The same graph using the 10 city index, starting in 1988

The run-up in home starts was correlated to the run-up in home prices but was much more mild. On the other hand the collapse in starts was far more pronounced than the collapse in prices.

This seems like the exact pattern you would expect with downwardly rigid prices. The boom is reflected more in prices than in production. The bust is reflected more in production than in prices.

Broken Windows, Hurricanes and Alien Invasions. There is a lot of chatter about Bastiat versus Keynes. However, I think the conversation could benefit from two quips. First by James Tobin

It takes a heap of Harberger triangles to fill an Okun’s gap

The second I am still working to refine but it would go something like this

To an economist with supply and demand everything looks like a surplus problem

The heart of both phrases are the issues like unemployment are much bigger deals than traditional market distortions. However, we have this really powerful set of tools for analyzing market distortions and that mistakenly leads people to believe that the key to all problems lies in market distortions.

I’ve tried to show this in pointing out that the US today is significantly wealthier than either the US in 1998 or Australia today. However, if you said the economy was “better” in 1998 or that the economy is “better” in Australia everyone would know what you mean and its hard to find someone who would disagree.

Indeed, no small number of Americans believe that the economy was better in the 1960s and its not hard to understand what they mean. If you really stop and ask whether they willing to give up your iPhone for the 60s they would say no. Now, if they paused further and gave serious attention to the externality effects of 60s glam they might change their mind again.

But still, the point is American markets are more liberalized. Trade is freerer. Technology is more advanced and because of all of that consumption is much higher in the United States now than ever before, but it doesn’t feel better than ever before.

In fact it doesn’t clearly feel better than when things were much worse – decades ago.

What’s going on here?

Part of the problem is that unemployment is awful. Its awful on many levels. First, the raw drop in production is a huge loss to human welfare. Human time is the fundamental asset in our society and the time that wasn’t spent building or creating new things is time that is lost forever.

Unemployment is awful in that it concentrates the economic losses on a few households. I think we all accept declining marginal utility of income. That implies that if everyone in the economy where to lose 6% of his or her income that would be bad. However, if 6% of the people in the economy were to lose all of their income that would far, far worse. Unemployment is the latter scenario.

Lastly, unemployment is horrible because it creates a sense of fear that is paralyzing to the labor market. One of the key facts we should always keep in mind is that as unemployment rises labor turnover goes down.

That is, fewer jobs are destroyed in periods of high unemployment. This is because the main way that jobs are destroyed is through quits. People leave for greener pastures. When unemployment goes up this stops happening and the churn of creative destruction slows down.

All of this is to say, it shouldn’t be hard to imagine that we can do things that make the economy less wealthy but make people feel better about it. One easy thought experiment would be to simply transport ourselves back to 1998. However, another might be breaking windows.

Is the world less wealthy with broken windows, no doubt. But, West doesn’t have a wealth problem. It has an unemployment problem. If you think about the alternatives available throughout recent history many if not most Americans would trade away their wealth to relieve their unemployment.

Continuing the theme of employment vs. wealth we can look at the wealth of various countries versus the United States. Below are the GDP per capita of Australia (blue), Germany (red) as a fraction of US GDP per capita.

Germany is approaching 82% of the productive capacity per person as the US while Australia is about 84%. So, they are closing in on the United States but not there yet.

However, here is the unemployment rate in the three countries

One thing that we don’t do enough when thinking about US real time policy is watch international trends. Europe has been making headlines because its potential to blow up the world and because it serves as a morality tale for supporters of austerity.

However, just watching the ups and down of other countries can be informative in breaking apart trends that result from some unique domestic policy and wider worldwide movements.

All of that is simply to point that Australia is the land that the ‘nils forgot. There its forever 1998.

Here is employment ratio in the US vs Australia

The two countries match in ups and downs (though the downs down-under were worse) up until about 1998. Then the US stats in on a slow slide, while Australia just keeps on going.

Even the hit Australia took from the “Great Recession” was barely noticed.

Perhaps more pain inducing for Americans. Here are relative unemployment rates.

The 1992 recession hit Australia hard but after that’s its been unemployment has been down, down. It should come as no surprise that I consider this a triumph of Australian monetary policy. In 1993 Australia adopted a level targeting plan that centered around an average inflation rate of 2 to 3%. This implied that if inflation ran too low the central bank would let it run high.

The results are below:

Via Tyler Cowen, Jason Lanier says

Once again, whenever you improve efficiency, when you save money, it’s only the same thing as making money if you’re already rich. If there are people who aren’t rich enough to benefit from that, it just makes them poorer because they have less to do, and less ways to earn money.

I want to keep my rep for epistemic openness but my immediate response is to say no, no, no.

What you are describing is a monetary contraction. We talk like this: Lots of efficiencies drive down costs for everyone but now there is not enough work to do.

What you are saying really is that the rate of inflation collapsed and the central bank did not offset this by printing up more money. Consequently several things happened.

1) People who borrowed X fraction of total human satisfaction in say 1990 believed that their labor would be responsible for Y amount of the total human satisfaction in 2010. However, when 2010 came their labor was only responsible for Y/10 of total human satisfaction and hence they cannot make good on their debts. The solution is to cut the value of bonds by 1/10th.

Bondholders will not be screwed on net because satisfaction is so much cheaper and easier to get in 2010 than it was in 1990. However, if you fail to do this bondholders will be living the highlife, clipping coupons and surfing the net for free.

2) The rapidly falling cost of tech pushes up the real interest rate and causes a sharp reduction in spending. An professor of mine in grad school used to tell a story about the donut seller from hell.

You walk in and ask for a donut. It costs $1. The donut seller says you know, if you are getting one you might as well get two $1.80. That sounds good to you so you say, Ok. Then he says well if you are getting two you might as well get three for $2.40. You say OK. He says well how about 4 for $2.80. Every time you agree he marches further down the demand curve to increase the sale. It doesn’t stop until you wind up with 5 dozen donuts for breakfast.

Similarly an economy could face technological deflation from hell. You could by an LED TV today. Or, you could wait for a 3D TV in six months.. Or you could wait for a no-glasses 3D TV in a year. Or, you could wait for 4D TV in two years. Or you could wait for complete emersion VR in 3 years, Or, . . .

It just goes on, and on and there is never a good idea to buy now, no matter when now is.

That’s obviously an extreme example, but the point is that deflation increases the value of waiting. New and better forms of consumption being created for low prices increases the value of holding on to your money today.

This must be offset by monetary increases.

Adam brings up some Tyler Cowen predictions from 2005. Of particular importance, I think, is this one:

2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.

Adam doesn’t list them but the prediction above goes hand-in-golve with these two

1. I would think that Asian central banks, by buying U.S. dollars, have been driving a massive distortion of real exchange and interest rates

5. I would think that the U.S. economy is due for a dollar plunge, and a massive sectoral shift toward exports.  Furthermore I would think it will not handle such an unexpected shock very well

One of the key facts about the last crisis is that manufacturing and construction employment moved in opposite directions.

That’s quite distinct from their normal pattern of moving in the same direction. Indeed, it’s a big part of why the mid-2000s boom was so odd and so weak employment wise.

This is important because it means it doesn’t quite make sense that what happened here was action by the Fed. If the Fed were printing too many dollars it would drive down both interest rates and the value of the dollar. This would increase construction and manufacturing.

However, what’s happened is that interest rates were low while the dollar was high. That means that someone must be buying lots of US bonds with some other currency they are printing. The obvious culprit is the Bank of China.

However, if this thing is going to come to an end because of the unsustainability of this relationship then we should expect a rapid unwinding of the BOC’s position. This would mean a collapsing dollar and rising US interest rates.

But, that’s not exactly how the burst happened.

The dollar soared and US bond yields collapsed.

This is why I think neither the Fed nor the Bank of China can claim this crisis. It was creature of Wall Street and of financial innovation that didn’t go as planned.