You are currently browsing the monthly archive for September 2011.

Since 1975 the growth in Credit for Corporate and Non-Corporate Business has been about the same. During the Great Recession they strongly diverged and have not come back together.

FRED Graph

Interesting for Corporations the slowdown in credit growth this time around was about the same as the dot-com bust and the recovery occurred earlier.

For non-corporate business the dot-com bust was a slow motion decent that never went very deep. This time around it was free fall and we are still not back above zero.

This month the manufacturing survey’s improved. In particular the gut wrenching Philly Fed number from last month (-30) improved to severe indigestion (-17) this month.

This marks four consecutive months of weakening or weak manufacturing surveys. This is deeply disconcerting as movements in the goods producing industries remain the primary source of macroeconomic fluctuation, even in our de-industrializing economy.

Retail Sales have also yet to recover from the Summer Slowdown

FRED Graph 

However, at the same time many of my really core numbers look more promising. Used car prices are rising. Rents are rising. Hotel Occupancy is rising.

Inventories are light and getting lighter and will trend lighter based on the latest data.

 FRED Graph

Business lending is picking up.

FRED Graph

I still the the domestic economy looks ready to move. The biggest threat is to imports.

However, as I mentioned much earlier its not clear to me how the a euro crisis nets out for the US. A decline in exports should be matched by a strong decline in gas prices.

At this point I have to wonder if Don Boudreaux is baiting me.

In a post entitled “Ptolemaic Economics” he writes

C. Fred Bergsten claims that eliminating America’s trade deficit is a costless way to boost employment in America (“An Overlooked Way to Create Jobs,” Sept. 29).  He’s mistaken.  Among his several errors is his illegitimate assumption that all dollars that foreigners don’t spend on American exports remain idle, effectively withdrawn from circulation.

Consider two cases.  First, Americans buy $1 million worth of textile imports from the Chinese who then buy $1 million worth of pharmaceutical exports from Americans.  The result: balanced trade.

Second case: Americans buy $1 million worth of textile imports from the Chinese who then buy $1 million worth of land in Texas.  The American seller of the land immediately spends this $1 million on American-made pharmaceuticals.  (Perhaps the Texan is opening a pharmacy.)  The result: a $1 million U.S. trade deficit.

In both cases, Americans producers sell an additional $1 million worth of output as a consequence of Americans importing $1 million worth of goods.  So – although America runs a trade deficit only in the second case – the employment effects in both cases are identical.

Such an example, being entirely plausible, is sufficient to prove the absence of any necessary negative connection between trade deficits and employment.

In general its not necessary that dollars foreigners don’t spend on exports is removed from circulation but practically speaking this is exactly what is happening.


Because most of those dollars end up being invested in T-Bills.

The Federal Reserve essentially targets the T-Bill rate and creates or destroys money to set the T-Bill rate where it wants.

In more detail what happens is this:

The Federal Reserve targets the overnight interbank lending rate, known in the US as the Fed Funds rate. The Fed Funds rate washes with the T-Bill rate. That is, to say the two rates move in lock-step.

If foreigners push more money into T-Bills that will tend to drive down the T-Bill rate. Money will move out of the T-Bill market and into the overnight lending market. That will tend to drive down the overnight lending rate. In normal times the Fed would then shrink the money supply in order to increase the overnight lending rate back to its target.

Now, to get even more into the weeds, currently the Fed is paying interest on reserves. That bounds the overnight lending rate and so the dollars may end up piling up as excess reserves on bank balance sheets.

But, in either case the dollars don’t get back out because the Fed controls the T-Bill rate. Businesses and consumers respond to prices. If the price of T-Bills aren’t moving then neither banks, nor businesses, nor consumers have any incentive to change their holdings of T-Bills. So money that flows into the T-Bill market is effectively destroyed.

Now does this mean that trade deficits always leads to a destruction of currency and if so how can they ever be okay? Well, what can and often does happen is that the trade deficit lowers prices.

The reason people are buying more goods from foreigners than foreigners are buying from the US is because foreign goods are cheaper. Again people respond to prices.

This means that as the US increases its consumption of low cost foreign goods the cost of consumption goes down. This puts downward pressure on inflation. As inflation goes down the Fed should intervene to push it back up again. It does this by creating money.

This money lowers the cost of borrowing and encourages businesses and consumers to take on more debt. This could be consumer debt and you could see an economy where people are simply buying foreign goods with borrowed money. However, it could also be debt used to finance investment.

In that case you are seeing trade finance increases in the amount of capital in the US. This is how we usually think of trade – that it finances real investment – but this need not always be the case.

In either case, however, trade deficits and increased debt are duals of one another. You can close the circle by thinking of the whole thing in real terms. The Chinese sent us more goods than we sent them because we promised to send them something else later. This promise is what we call debt.

However, unless someone in the US economy is taking on more debt as a result of the trade deficit then increasing debt to China or whomever is simply going to wind up decreasing the US money supply.

Kathleen Madigan writes

In the man-versus-machine competition, machine is winning. And it’s not just Watson beating humans on “Jeopardy.”

Since the recession ended, businesses had increased their real spending on equipment and software by a strong 26%, while they have added almost nothing to their payrolls.

This kind of reasoning is tempting. The President even seemed to succumb to it when he suggested that ATM were taking bank teller jobs.

However, the chart above confuses stocks and flows. The size of the labor force is a stock while investment spending is a flow.

If we look at the change in payrolls, just like investment is the change in the amount of equipment, we get very similar lines across the period in question.

FRED Graph

If we want to do a proper index, then we are going to have to go back to Though, I think you get a better picture if you look at the whole recession.

FRED Graph

I skimmed this Larry Mishel piece and what I saw looked roughly in line with my take on the situation. There is little evidence for the business uncertainty hypothesis.

However, I just want to make a quibble with something I noticed.

One can easily document (using NIPA Table 1.4.6 and mixing with population from NIPA 2.1) that the final per person demand for domestically produced goods and service in the spring of 2011 (2011:2) was still 0.7 percent lower than it was before the recession (last quarter of 2007).

One can do this but one probably should not do this. Final Sales to Domestic Purchasers is not a measure of how much stuff consumers bought in the United States. First, off final domestic purchases includes investment.

So if the point is that businesses aren’t willing to invest then final sales will be depressed.

Second of all, final sales also includes personal consumption expenditures. However much of PCE is imputed. That is, no one is actually buying anything. What the BEA is doing is trying to create a measure of what “consumption” in the US is. Well, I consume services from the house that I am living in though I am not paying rent to anyone.

I also consume banking services from Bank of America though I do not pay anything to Bank of America and indeed, Bank of America pays me. Both of these are examples of imputed consumption.

There are lots of other examples. For example, as office buildings in Detroit crumble, that is consumption of fixed capital structures. Though, no one is actually doing anything.

I actually think one of the better measures of what most people are thinking about as demand is retail sales. Those are market transactions. You tack new home sales on to that if you want depending on how you want to look at it and what you are after.

To put a finer point on it than I would like, I think there is a tendency among structuralists and Austrians to complain that Keynesians only look at aggregate data and draw sweeping conclusions, but then the structuralists and Austrians fail to examine the disaggregated data.

I think there are a lot of things going on, but to put it in an Austrian frame, the ability to gather dispersed knowledge has increased many many with the introduction of the computer and the internet. Indeed, this is precisely why they are such a big deal. But, that’s another story.

The point I want to make here, is that we no longer face a tradeoff between simple aggregate measures and thinking about how various parts of the macroeconomy interact.

If the sector level is of interest to you then we have lots of sector data at our finger tips. If that’s not enough the Economic Census lets us dig down to a level of aggregation that is only roughly 3 firms deep.

We can’t get lower than three firms because of privacy concerns – though of course the data does exist and there are probably some circumstances under which it could be accessed.

Right now there are questions about the jobs. Is there such a thing as “the labor market” or are there simply lots of markets in which labor is bought and sold.

I think there is a labor market. Here are a few more pictures that help explain why.

So here are two very different sectors and their job opening rates. Openings as a percentage of employment overtime.


Even though the difference between sectors is at least as big as the difference in sectors, the key is that they move together.

We can also take a much wider view and do all sectors together

FRED Graph

Now layered over top of this is the growth rate real real retail and food service sales. So that is how much stuff consumers are buying.

FRED Graph

There is not a perfect match but I suspect some of that is due to how I am measuring the data. What I really need is year-over-year change in openings compared to year-over-year change is sales.

I can do that for overall opening but it would take longer than I have right now to do it for each individual. I hope from the above we can see that the individuals move together.

FRED Graph

Moreover, openings is a slightly right shifted version of sales. This would seem to indicate that sales moves first. Though, of course, expectations matter.

Via Stephen Williamson I see this chart and narrative


The figure shows total hours worked per adult for the 1930s. There is little recovery in labor, as hours are about 27 percent down in 1933 relative to 1929, and remain about 21 percent down in 1939. But increasing aggregate demand is supposed to increase output by increasing labor, not by increasing productivity, which is typically considered to be outside the scope of short-run spending/monetary policies.

My immediate question –out of curiosity as much as anything else – is whether or not this productivity growth was driven by a shift of labor into high productivity/high wage sectors like manufacturing.

My employment data set only goes back to 1939, so I can’t tell.

I want to push back against this post by Arnold Kling suggesting that the macroeconomy is a myth.

A macroeconomist would argue that structural unemployment always exists. It represents a sort of background noise. Models that assume a single aggregate labor market are only approximations, and if the economy acts as if there were a homogeneous labor market, then this approximation causes no more harm than any other simplifying assumption in economics.

It’s an empirical question. My view is that the variation across sectors and occupations is more dramatic and important than the variation within sectors, even for the period 2007 to the present. That is, for some fairly large categories of workers you will see a higher unemployment rate in 2007 than for other categories in 2011, because the structural factor swamps the supposed aggregate-demand factor.

The last statement is flat obviously true.

FRED Graph 

The question is what about that co-movement. Or to put it another way look what happens when allow for different scales

FRED Graph

See how tight they are. Even the divergence that is there is generated by the sectoral shift towards manufacturing that I pointed to in another post.

I like to phrase the question this way: Are movements in the unemployment rate representative of the general trend in unemployment or the unemployment trend in general.

I think the evidence points towards the former.

I don’t want to have to file this one under Liberalization Failure. I hope the mere suggestion of this is a wake up call to some folks. From

Kotlikoff writing at Bloomberg.

This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith. I think there are fewer markets suffering from this problem than Krugman and Galbraith do, but there are enough such markets to make the case for government intervention. Indeed, the president should put these economists in charge of identifying the markets suffering from this problem and helping their participants set market-clearing prices and wages.

A measure that I am experimenting with is investment intensity. This is the ratio of Capital Goods ex Aircraft to durable goods orders overall.

As I discussed before a good fraction of investment both residential and non-residential is in structures. However, that’s not what most people mean when they say investment. They are thinking of something more akin to equipment.

The census Bureau’s New Orders for Capital Goods measures that. The Census Bureau also tracks New Orders for Durable Goods generally. This allows us to get a ratio of how much of the manufacturing production in the US is going towards consumption vs. investment.

Of course its not perfect because there are signficant imports of both machinery and consumer goods. Still I think it’s a meaningful proxy.

One of the things its shows us is that production in the US is more business heavy than it was even in the late 1990s.

FRED Graph

Its also interesting, but should be immediately clear why, that the ratio fell during the dot-com burst but rose during the housing bubble burst.

I am not really sure how meetings with the President go. When I see pictures of the Oval Office I wonder how anything gets done. There is some old wooden desk and what looks like couches.

There is no smart board, there are no computer screens, no interactive podiums. I wonder why don’t they just draw out battle plans with sticks in the sand and be done with it. 

Anyway, since I assume the only graphics available are those that are printed out and handed to everyone, here is something they might want to pass around the prayer circle.

FRED Graph

This is the estimated real cost of financing the US government over ten years. Its quickly approaching zero.

And, so I ask – Why is the US government still collecting taxes?

I mean seriously. What is it that you hope to accomplish by collecting taxes. One, might say to finance government expenditures, however, they can be financed for free in the bond market.

Lets just forget about stimulus. How about the simple fact that people don’t like to pay taxes. Here is the perfect opportunity to put this off until the future at very low cost. Why not do it?

Why not?


The Treasury Department auctioned five-year notes at a high yield of 1.015 percent and a bid-to-cover ratio of 3.04.

I have some friends who look at the  5-year breakeven and think these means the government is currently borrowing money for cheaper than free.

One-Year Chart for US Breakeven 5 Year (USGGBE05:IND)

I have other friends who look at a longer term picture of the price of gold, conclude that hyper-inflation is on the way and and thus the government is being offered the deal of lifetime.

Say you are in the second camp, then I ask: If bond buyers are willing to hand you a solution to all of the US deficit problems – sell five years and then get the value eroded away by inflation – who are we to say no?

One of my pet peeves is people equating government expenditures or worse government receipts to the “size” of government. There are many issues here not least of which is spending through the tax code.

Tax credits have the same effect as government spending but reduce receipts rather increase expenditure. Thus one can claim to have “shrunk” the government when the scope of government control has been expanded.

However, even more invisible are government regulations, which tend to be far more onerous than taxation and far more intrusive than spending.

To show how this could be we could cut the size of the Federal Government in half tomorrow by scrapping Social Security, Medicare and Medicaid and replacing it with the following regulations

  1. Every person between the ages of 15 and 65 must house, feed, clothe, entertain, transport or otherwise provide for the needs of some person over the age of 65, using not less than 500 hours a year of time or equivalent compensation in kind. The individual assisted as well as hours or in-kind supplies offered must be documented and submitted to local authorities each year. Failure to comply will result in a sentence of no less than 25 years in a maximum security prison.
  2. No person or facility authorized or licensed to practice or dispense medicine in the United States may refuse for any reason the prompt and courteous treatment of any person over the age of 65, under the age of 14 or designated as in need by the local authorities. Failure to comply will result in the immediate suspension of all licenses and a sentence of no less than 10 years in a maximum security prison.

Now you would need some more language to steer the black market in the direction that you want. For example, if the elderly person who is assisted trades the in-kind item to a non-elderly person then it no longer counts, etc.

These regulations would cut government spending tremendously and could result in a large decrease in taxes, but they would be far more onerous than simply requiring that people pay taxes.

For reasons that I can guess at but do not fully understand a lot of arguments seem to turn around someone saying that in theory X could be true; and then someone else saying that no X never happens; and then someone else saying yeah, but X would have all of these good/bad consequences.

Yet, none of these statements are inherently contradictory.

For example, there seems to be a bit of a stir on all sides about the proposition by Modern Monetary Theorists that the government never has to issue bonds but simply can simply write checks for what it wants.

Indeed, the only reason the government ever has to collect taxes is if this process ends up stimulating aggregate demand so much that inflation is on the horizon.

I consider myself a New Keynesian but I see nothing in these basic statements that contradicts my view of the world. It’s a different frame but the basic chess pieces and their positions are the same.

Now, of course this can get you into some hot water, but I never heard the claim that this course of action was without fault, only that it was possible. And, indeed, it is possible.

In fact I can do you one better. The sovereign by virtue of being the sovereign does not even need to collect taxes or issue money. The government could simply commandeer resources by fiat

If the government needs a road built it can simply order ACME construction – on penalty of death of all employees and shareholders – to build it a road. Or alternatively it could draft men and women into a state run construction company. It would need to provide them with room and board lest they perish, but it does not have to compensate them otherwise.

That is what it means to be the sovereign.

Now whether people would go for this and whether you would retain your sovereignty under this type of governance is an open question. Though I don’t think it would be that hard. We had – and to a large extent still have – an ethos in which being drafted to kill and potentially be killed for your country was considered noble.

A civil service draft doesn’t seem that crazy. In any case, I think we can all agree that it is theoretically possible.

Greg Mankiw says he’s not worried about inflation because wage growth is depressed.

I think that’s a good way to talk about inflation and an important point to make. However, at the same time I think we as economists should look at other indicators. One is this

FRED Graph

Now a big factor in Core Inflation is also rents – both actual and imputed – which aren’t captured in this data.

However, the basic point I want to drive here is that for  inflation to occur it has to occur through markets.

You don’t just print money and then bam prices go up. Some set of humans has to decide to bid more, ask more, or raise the listing price. This means we ought to see nominal retail sales rise.

Indeed, we can correlate the two

FRED Graph

I can take out shelter but it doesn’t change the picture much

FRED Graph

And, finally here they are together on the same scale

FRED Graph

You can see that the magnitude of retail sales movements is larger.  That is to be expected since total sales is price times quantity. When movements in the market are dominated by movements in demand price and quantity will go in the same direction and so the affect of total sales will be an amplified effect of price.

One of the last vestiges of the too many homes argument is the shadow inventory. Foreclosures yet to hit market. I tend to be flippant about this type of thing because foreclosures do nothing to change the basic fact that we have a certain number of buildings and a certain number of people.

So, if the people are growing faster than the buildings we are either stuffing more people into the same buildings or we are going to run short on buildings. There is nothing magical here.

In any case, in the long run you like to see all of the indicators telling you the same things. I would like to see rents rising, home prices at least stabilizing and for sale inventory declining.

Indeed, we have all of those.

Case-Shiller Home Price Index

FRED Graph

Months of supply at the current sales rate

FRED Graph


FRED Graph

And lastly stealing from Calculated Risk: Shadow Inventory Estimates

Steven Landsburg has an older post that I agree with 90%

What I like about people in academics is that when we disagree, we actually care about figuring out who’s right — and therefore we have a tendency to reach consensus, though it can take a while.

Anybody who blogs often enough (very much not excluding yours truly) is occasionally going to post something that, at least as written if not as intended, is objectively plain flat out wrong. Paul Krugman did that a couple of days ago, Iresponded, he’s responded to my response, and at least 4/5 of our disagreement is now resolved. That’s exactly as it should be.

There is actually less of this in the Academy than I would wish. Partially, because of the incentive structure I think. If the Academy were more like a giant blogosphere then I think the incentives would be more aligned towards agreement.

There would be less invested in each piece of writing and careers would depend more on how you responded to others rather than a few seminal works. This means that having a reputation for coming quickly to the right answer is almost as important as writing a sweeping treatise that moves the ball forward in one swoop.

In my experience for example, people come to agreement with much less resentment in a workshop than in writing and having a good conference reputation depends in large part on not being an intransigent ass.

Steven Landsburg asks more about Keynesianism and Money. The key question

Once again, money is provided at zero social cost. Once again, it seems to me that the private cost of holding money is positive (that old forgone consumption again). Therefore, once again, people must hold too little money. Therefore, once again, they spend too much. Therefore, once again, an additional dollar spent must do more external harm than external good.

The problem, then, is to identify the bearer of that external harm. Well, what happens when I spend a dollar? Back in the old flexible-price world, I bid up prices. But in the fixed-price world, I can’t bid up prices, so I must bid up the real interest rate instead. That’s good for lenders and bad for borrowers, but that washes out because every lender is matched with a borrower. So where is the missing extra external harm?

My answer, also posted in his comments section.

The issue is that the net private marginal cost of holding a dollar is negative in Keynesian story.

So to be clear – because this wasn’t in your set up – money has private benefits as well as private costs. That is people desire liquidity, or there is money in the utility function, or a cash-in-advance constraint. Whatever, you want.

However, the fact that positive money balances exist tells us that they must have some private benefit or else everyone would attempt to spend down to zero.

Now, what is it that people want? Well, we assume they want real purchasing power. So, what they care about is not the face value of the money in their wallets but what it can buy.

Now imagine that by some magical trick the amount of money in everyone’s wallet is cut in half, but prices remain the same. Real purchasing power is now less than what it was.

Because people were previously holding optimal money balances, they must be holding sub-optimal money balances now.

This means that the net private marginal cost to holding money is now *negative.*

So you get the exact opposite result, spending a dollar causes external benefit because it allows another person to build up their real money balances which makes them happier.

Keith Hennessey says

A tax increase enacted into law now, to take effect in 2013, is only slightly less discouraging to economic growth than a tax increase that takes effect immediately.  A CEO who knows her firm’s taxes will increase in 2013 will be discouraged from hiring, investing, and building now.

The immediate question is why would taxes discourage a CEO from hiring workers or buying new equipment. I used to think that people were assuming fairly sophisticated models from which you can derive this thinking, but the more I have been on the blogosphere I think they are simply using the rule of thumb that when you tax something you get less of it.

Well, maybe.

Here is the problem with applying that logic to a business. In theory a business exists to maximize profits. And, taxes are charged on profits.

However: whatever maximizes profits also maximizes profits divided by two.

Suppose that you figure out the number of workers to hire and equipment to buy and it maximizes profits to hire 50 workers and buy 15 trucks.

Now the government comes along and says its going to take half of all of your profits.

What should you do?

You should hire 50 workers and buy 15 trucks.


Because, doing so gave you more profit than all your other options. If after-tax profits are 50% of before tax profits then that same plan will still give you more profit than all your other options.

The perhaps bigger rule of thumb is that economics rents and taxes always accrue to the factors of production. Another way of saying this that might make more sense to my conservative readers is that you can’t tax a business you can only tax people.

The flip side of that, is that taxes that do not discriminate between businesses do not change optimal business decisions. What they do, do is lower the return to capital. That in turn could lower the amount that people invest. That in turn could lower the capital stock.

However, you wouldn’t expect – at least in this simple model – for taxes on businesses to have any immediate incentive effect on business decisions. We can introduce things like cash-flow constraints and the breakdown of Modigliani-Miller, but these are actually Keynesian effects, not incentive effects.

I want to start a series on Gold and its long run properties because I see that gold has a unique place in the a lot of folks economic thinking. For example, Bob Murphy says

I submit that Krugman, DeLong, et al., will have a hard time really understanding the market’s embrace of gold (and silver), if they try to explain its price with a model that ignores gold’s historical role as a medium of exchange. (To his credit, the deflationist Mish has always emphasized gold’s special place as the market’s money.)

When bad news from Greece causes Treasury prices to rise, everybody accepts the commonsense explanation that, "Investors are fleeing the euro into the dollar." So why should it be such a mystery that Bernanke’s incredible dollar pumping would send worried investors into safe-haven currencies (gold and silver) that cannot be debased?

I’d like to start by suggesting that gold can be effectively debased. I don’t want to get into definitional issues and I am aware that technically debasement of gold would mean swapping out some of the gold for a less precious metal.

However, what I think people have in mind is that the world could not be suddenly flooded with gold. Yet, it could.

So we have one obvious historical example and this was the discovery of the New World. Looking at the effects of gold and silver rushing into Europe is some of the earliest evidence that “money matters” and that markets cannot be understood without appealing to money itself.

This was no debasement by an Empire in decline or other policy or technological advance that could effect real variables. It was simply the discovery of what was at the time more money.

The result was a boom and a subsequent period of rapid inflation.  In addition, bankers and others with large holdings of gold saw big losses after the New World discoveries.

Could something like this happen again? I submit to you that it could. For example roughly 5 billion ounces of gold have be mined in human history. Yet, conservative estimates suggest that at least 25 billion ounces of gold are dissolved in the world’s oceans.

At present it is highly uneconomical to attempt to extract gold from sea water. However, this may not always be the case. There are bacteria which seem to be able to collect gold from the water and form flutes. If these bacteria could be mass engineered in the lab and then seeded into the water they might form an economical way to extract gold.

I am not suggesting that this is likely anytime soon or that you should run out and invest in gold bacteria! It is simply to point out that there is no reason to think the supply of gold is roughly constant or will necessarily grow at the rate of the overall world economy.

The supply of gold could grow much slower than the world economy in which case we would expect the real price of gold to rise quickly. The supply of gold could also grow much faster than the world economy in which case we would expect the real price of gold to decline.

There are other issues which I think dominate the price of gold in the short run, but I want to first make the point that a practical debasement of gold is completely possible.

Steven Landsburg asks

Why aren’t you thrilled with the current state of the economy?

Here’s why I ask: According to what I take to be an orthodox Keynesian view, we are now in a liquidity trap. (My question does not apply to Keynesians, new or old, who believe otherwise.) That means that people want to hold lots and lots of money instead of spending it. Cool! We can provide money at almost zero cost. So it should be easy to make people very happy. What’s the problem?

I love these types of questions. They are simple and piercing. Steven adds a bit of extra that we could discuss but I think its worth answering his question directly.

The problem is getting money to the people. We can produce money at zero cost, but we need some distribution method.

Our normal distribution method is to use the money to buy government bonds. This is called monetary policy. The money then spreads out to the people via the magic of interlocking markets and makes everyone happy. Yea Smile

However, sometimes that mechanism gets broken. The market works on the basis of prices. Yet, the prices of bonds are not infinitely flexible. Once, the yield on bonds goes to zero it can’t go any lower – or to keep things perfectly straight, the price of the bond can’t go higher.

Thus efforts to buy lots of bonds do not wind up pushing up bond prices and send money through the interlocking web of markets. It simply winds up with more money collecting on bank balance sheets.

So what to do?

Well, there are a number of things but one really straight forward thing to do is use the mail system instead of the bond markets.

In this case what we would do is place the money into envelopes and mail them to the people around the country. There are always going to be fights over who should get mailed how much but this is the basic idea.

This is also known as a “helicopter drop” because of its like you went around the country in a helicopter dropping money.

Now I think all Keynesians agree that the Helicopter drop would work if that was the end of the story. The problem is that Central Banks have a tendency to want to vacuum up excess money because of concerns about inflation.

If people think the Central Bank is going to come around with a vacuum cleaner and simply suck-up all the money that got dropped, they’re desire to hold money will increase exactly in proportion to the amount of vacuuming the expect.

In some cases people suspect that the Central Bank will vacuum up every single dollar it dropped. In those cases, the dropping doesn’t make anyone happier because they are just going to get hurt again by the exact same amount.

This is a liquidity trap.

So lets start with what I think is an important distinction between Texas and the rest of the United States.

Here are real home prices for both since 1975, scaled so that the real price at the beginning of the Great Recession is one.

FRED Graph

Why is this important?

Well, first I think there is broad consensus that the Great Recession was in some way related to the boom and bust in the US housing market. The question is how?

Well, in Texas there wasn’t much of a boom or bust. We can see a small rise in real home prices, against a backdrop of falling real home prices over the decades.

However, it isn’t sharp and it didn’t peak until the recession was almost over. I don’t think its crazy to suggest that home prices in Texas were driven down by the Great Recession but did not drive the Great Recession.

Okay, now lets look at housing starts.

Unfortunately I only have 1-unit starts for Texas and they are not seasonally adjusted.

FRED Graph

You can see that the growth in the Texas housing stock was faster than the US on average, but that the fall was almost as large. And, timed around the same point as the fall all around the US. Early, 2005.

So in Texas housing starts were falling even as home prices were still rising.

Lets look also at construction jobs

FRED Graph 

Here the pattern is closer to that of home prices. Texas peaks later and doesn’t fall as far as the rest of the nation.

Yet, housing starts were falling in Texas. . If anything you can see that construction jobs really start going just in Texas around the same time that housing starts are peaking.

This means people must have been building other things besides homes. I really wish I had construction spending by sector for Texas, but I don’t right at my finger tips. My guess is that we are talking about a combination of oil infrastructure and office buildings but I’d really like to know the breakdown, because that would affect the analysis.

Lets look at total non-farm payrolls in Texas vs US

FRED Graph

Again, similar pattern. Latter peak, smaller fall, better recovery.

However, notice that the dates of the recovery are similar as is the shape. Lets zoom in.

FRED Graph

Interesting. Now I am going to look at my favorite, employment in non-goods non-government. But I loose the ability to index, so I am going to use to different scales.

First zoomed in

FRED Graph

Then zoomed out

FRED Graph

Again, I think we are looking at similar recovery dates and similar shaped recoveries, just stronger in Texas

My first cut is to say that we are looking at roughly three events.

One occurred around 2005 and was associated with a precipitous decline in housing starts for Texas and the US as a whole. It was also associated with a pause and eventual decline in real home price appreciation in the US, but not Texas. As well as a pause an eventual decline in construction employment for the US but not Texas

A second event occurred during  2008. This event was associate with a decline in construction employment in Texas and overall employment in both the US and Texas.

A third event occurred in mid 2009, when private non-goods employment in both the US and Texas began to trend upward again.

Now I am using event here loosely. It doesn’t have to be one thing. However, the fact that all of these measures are not occurring within the same phase is interesting. Its not as if Texas is just a shifted version of the US. Some things are shifted, some not. Some things come in together and different things come out together.

If we are all now confused on a deeper level about more detailed things, then I hope I can say this post was useful.

Bob Lucas is interviewed in the Journal.

In it he refers to his speculation that ObamaCare is holding back the US economy and Ed Prescott’s work on Europe. The writer Holman Jenkins, pens this

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. "The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard," says Mr. Lucas. "And it’s really hurting them."

When you read this its really hard to know what was said. And, I don’t actually know what Lucas thinks on this point.

His quoted words

The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard

Are logically consistent with the Prescott models I have seen and with what I would think of as a serious treatment of tax and spending effects.

What Jenkins adds, however, is not

The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households.

I don’t want to turn this into another widely ignored post on the separable log utility function.

Let me just say in human terms, what the basic models say is that giving people free stuff makes them work less. Taxing them more does not make them work less.

In real life what you would be saying is there are some people who are only working so that they can get health care. If you give them government health care they will stop working. This makes logical sense and you can probably find this person. I will not call out on my blog but I could produce this person in a lecture hall tomorrow if I had to.

It is much more difficult to produce the person who will work less because of an increase in marginal taxation. It may sounds trivial but I suggest the exercise of actually attempting to produce the individual. The difficulty of such exercises has led people to suggest that well perhaps there is a general sense of peer work levels that adjust over time to group wide incentives.

Which is of course, one story.

Another is that it’s the benefit side of the equation which is what simple models and your lying eyes tell you it is. Does anyone doubt that they can find the person who started working because of a decrease in the dole? Did they need a complex peer group effect. Or did they simply find that they could no longer afford both rent and breakfast.

For now, I am going with the theory that it’s the benefit side.

However, think of what you are say, because it puts into contrast what I think the actual tradeoff is.

You give someone health insurance and because of that they feel they no longer have to work and so they quit. GDP is going to go down. Someone is going to go without the goods and services produced by that person. The extent of the market will have decreased meaning that the return to research and development will have fallen, etc.

Those are some unfortunate things.

On the other hand, this person was in almost by definition desperate straits. He or she didn’t want to work for some reason. Maybe they want to stay home to raise their child. Maybe they had a sick relative and wanted to be with them more. Maybe they were just old or young and didn’t want to be in the labor market.

However, they got in the labor market because they needed health insurance. Giving them government health insurance eases their burden. It places a burden on someone else and lowers the total productive capacity of society, but it eases the burden of the affect individual.

Now is that a good tradeoff? Maybe yes, maybe no. However, it’s the one that has a lot of power.

You are going to see this same effect with single moms. If you pay single moms to stay home with their children a huge number of them are going to take you up on that offer. If you take that away, millions of those same women will go to work.

However, they went to work at the cost of raising their own child. Is that good? There are clear arguments on both sides, but I think that is the tradeoff.

In any case what this would portend is lower full employment GDP. And, indeed Germany is much closer to full employment than the US but also has a lower per capita GDP.

What is not clear is why it would get us high unemployment and persistent unemployment.

I haven’t spent nearly as much time thinking about the internals of Europe and Eurozone as I should. Mainly I have thought about ECB policy as a whole. However, there is this debate going on over what the individual countries as countries should do.

Its not clear to me, however, that for the PIIGS austerity would be contractionary.

I’ve written and erased several posts on this already but let me just lay down my primary areas of confusion.

In the case of the Eurozone, we see various government borrowing rates diverging from one another and from the interbank lending rate.  This tells me that these governments must be competing against other risky endeavors for funds.

Thus an increase in government borrowing does not lower the risk profile of the overall asset market. It does not mean a one-for-one swap in the interbank lending market. It does not – I don’t think – imply a proportional increase in the money supply even if monetary policy stays constant.

Thus an enormous amount of fiscal traction is lost right there.

Now you could say, doesn’t more borrowing by ANYONE pull on the money supply when the economy is away from full employment. On the one hand there is that effect but on the other hand borrowing in the high yield markets is going to have expectation and liquidity effects that get washed away in the low yield markets.

So, as Greece for example, borrows more money, it becomes less likely that it will pay back existing creditors. That makes existing bonds less liquid and more risky than they were before and so should have an offsetting increase in liquidity demand for holders of those bonds.

Indeed, under some set of parameters, it ought to be the case that Austerity could be expansionary. What you would need to happen is that reduction in liquidity demand for holders of existing bonds more than offset the decrease in borrowing.

Now, this is all very confusing at first glance because the tax base, the currency zone and the interbank lending markets are not the same. Presumably people can move their money in ways the would expose it or not expose it to taxation by the Greek government and the details of that might be important. Also, the exposure of various banks both in Greece and outside of Greece to Greek bonds will vary.

For example, I suppose it is possible to have a Greek bank with no exposure to Greek Government bonds. How then is that bank affected by Greek Government borrowing? I am not sure.

I’ve written that I odds are Health Care reform was much ado about nothing, and to the extent there is any there there, its that the rate of government spending on health care will decline over the out years. Famously, however, it was widely decried as socialism.

Now, while those worries were I think a combination of silliness and rhetoric, this by Ezra Klein really is pushing a socialistic agenda.

Most Americans don’t like the idea that someone who makes money by playing the market gets taxed at a lower rate than they do. But they do like the idea of Google. So argue that the tax change will hurt the next Google.

Similarly, most Americans don’t like the idea that as the rich have gotten richer over the past few decades, they have also gotten huge tax cuts. But most Americans do like the idea of small businesses. So if you want to keep the tax cuts for the rich, argue that they help a small number of small businesses which are both taxed at an individual rate and bringing in more than $250,000 in income a year.

But this is a very bad way to defend very broad policies. If Jackson is right, and there is something special about tech investment that we would like to subsidize, then perhaps we should subsidize it directly. That would be far cheaper than taxing all capital gains at a lower rate. Similarly, if we want to do more to help profitable small businesses, we can offer them targeted subsidies, or specific tax breaks.

Here Ezra has now dispensed with even the pretext of combating externality. If we “like” Google we give Google special favors. If we like small business, we give small businesses favors.

It precisely this effect -  that the whims of the electorate or the wide-eyed plans of the politicians could directly manipulate the industrial organization of the US economy – that makes socialism paralyzing.

Now, obviously it is impossible to stop all efforts at industrial policy and planning. However, there was self-limitation in the social hypocrisy that we are just trying to combat externality. At least then you have to come up with some plausible case and it can be attacked by the other side as being senseless.

However, if we are descending into simply shoveling money towards favored industries because we like them – no pretense necessary – then we are slouching towards socialism.

I am somewhat disappointed both by the mildness of the statement and the once again triple dissent. Kocherlakota signaled that this was going to end. It doesn’t look good for Fed creditability. It also signals that the Fed can be politicized. Neither are good.

I am also not sure what to make of adding that line

–including low rates of resource utilization and a subdued outlook for inflation over the medium run —

to the Funds policy statement. My gut tells me that it was intended as a harmless clarification by a Chairman obsessed with transparency.

However, as a traditional Fed watcher I would read that statement as tightening Fed policy, as it makes the promise seem more conditional.

I think of these terms differently that most people seem to. Tyler and Bryan seem to be referring to things that think will be demonstrably better or worse in the future. This seems to me like a forecast.

I, on the other hand, see optimism and pessimism as a disposition. When I say I am a pessimist I mean that I am more concerned than the average person about all of the ways things can and will go wrong and I think that most people are naively oblivious to the harm they are causing others.

In any case if we are talking forecasts I will say this

1) I think the medium term future for the global economy is extraordinarily bright. That in the next 25 years or so the majority of human beings born on earth can expect to live what I might call a life of opportunity. One in which day-to-day survival is trivial.

2) I think that convergence will proceed at a more rapid pace in the future than it has in the past. That poor countries will grow richer faster.

3) I think that immigration restrictions in the Western Hemisphere will fall dramatically, particularly in the US and Canada, opening up wide-open spaces for people to live and work.

4) I think Europe will decline markedly as an area of economic and cultural importance but the quality of life for people there will remain fairly high and that it will earn rents from being “the world’s museum”

5) I think that violence in the world will continue to fall for the next 30 years or so.

6) I think medicine will hit its next “big bang” in roughly 40 years or so when the ability to remove disruptive long-lived molecules from cells will be practical. This in effect will create rejuvenation. As a side note I think rejuvenation is the only serious effort to combat most of the diseases that plague the western world today. (Hopefully I will still be blogging that all of the life extension in medicine can be traced to: antibiotics, vaccination, sterilization, anesthesia and rejuvenation)

7) I think there is a reasonable chance that we will see the implosion of many old national governments over the next 60 years or so and that there is a reasonable chance that this will be a relatively peaceful process.

8) Consequently I think the number of nations will rise over the next 75 years and that the nation state will end in a great blur. Sort of like how South Florida is composed of many different cities but no one really cares that much.

9) I think that within 100 years the singularity will be reached and subsequently the fundamental nature of life on earth will radically alter within a matter of years or possibly months.

10) I think between here and the singularity there are challenges but that most revolve around a small group of people either intentionally or more likely, by mistake, killing a large portion of humanity.

The things that we commonly worry about: global warming, the decline of education, antibiotic resistance, the wearing out of the Flynn effect, entitlement debts. fresh water shortages, etc will be speed bumps at worst and likely neutralized almost completely by technology.

Lastly as a aside to Byran I predict that in 50 years it will be conventional wisdom among the quirky intellectual set – perhaps what he means by Masonic – that:

  1. We probably exist in a simulation
  2. Free will is an illusion and I mean a genuine illusion, like a mirage.
  3. Its reductionism . . . all the way down.
  4. Emulations are just as meaningful as flesh and blood humans, since humans are just simulations anyway.
  5. The creation of new life is a morally ambiguous exercise

My confidence on these predictions is low but I am still willing to bet, if Bryan is interested in arranging something.

Some readers may be interested in how I can predict (2) and (5). I think some people will gloss over the issue and others will cheekily say that obviously living your day to day life as if determinism were true is just not what was predestined to happen.

I am, of course, happy to read this post by Matt Yglesias which confirms my own biases.

In a June interview with Fox News, President Obama appeared to argue that the country is suffering from high unemployment because productivity enhancing technologies such at ATMshave reduced the need for work.  It wasn’t clear to me at the time if the president really meant that or if it was just a bad moment in an interview,  . . .

Team Obama has, I think, landed on a more sophisticated version of this theory, and that explains some of the reason why Romer & Summers aren’t in the administration anymore and haven’t been replaced by like-minded people.

This confirms my biases because it suggests the world is in some ways a lot simpler than people make it out to be.

We observe a President not pushing for more stimulus and not appointing doves to the FOMC. What could be the reason? You could come up with all sort of theories involving intrigue and political strategery.

However, here is one you might want to try: the President doesn’t want to do stimulus and is not interested in appointing doves to the FOMC.

I would first wait for evidence that overturns that theory. It’s a powerful one and based on extremely common observation that people in general try to do things that they want to do.

Indeed, if I observe a person who cannot communicate – by baby for example – trying to avoid a situation, I am likely to conclude “Charlie does not want to do that” I think this is generally sound reasoning.

Last time I wrote on this I pointed out that transportation was the element of Equipment and Software that saw the biggest fall off. I speculated that is was some combination of autos and aircraft.

Now I have yearly data and we can see for sure who the culprit is – overwhelming its autos and trucks.

Here are the major components of Transportation Investment


The light brown is Light Trucks. It literally goes from first-to-worst From a peak of $75 Billion in 2006 to a tough of $4 Billion in 2009. Autos in red were the same but less so. As were buses and tractor trailers in light green.

The combined fall in those three categories was a little over $200 Billion. The combined fall in all investment in E&S was a little less than $300 Billion.

So the bulk was auto, trucks, buses and tractor trailers.

Two pieces have come to my attention suggesting that it is. The first makes a claim that on first glance seems to be correct but is incorporated in the type of thinking that marks Tyler Cowen’s Great Stagnation thesis and the general conversation. The second, I think, simply fails to live up to its billing.

The first is this paper by Burkhauser, et al. The thrust of the paper seems to be that once you account for tax changes, transfer payment and health care premiums there has been more growth in incomes generally and median income in particular.

This more or less matches my reading of the data. The critique that I think some us are making is that

  1. The taxes and transfers were funded in large part by increases in the Federal debt. Now, there is much more to be said about this. In particular are we simply talking about a case where the dollar as reserve currency has made wage growth more difficult and debt expansion easier and thus this is simply a natural and “appropriate” response. In any case, however, there is the recognition that market incomes are not growing.
  2. The second is that health care is largely a waste of resources and so compensation in the form of health care doesn’t represent a real rise in the standard of living.

We can debate either of those points, but they do not go unrecognized by those concerned with a Great Stagnation.

The second is this piece in The American which purports to dispel, “The Myth of Middle Class Stagnation.” Now, the author, Steve Conover, can be forgiven for displaying a bit of showmanship in an effort to draw attention to his work. As regular readers know, I have not been immune to such temptations.

Still, the case he does make is not the case he says that he is making, even in the body of the text. For example, he writes as if this is his key point:

How could the same official database—the March Supplement to the Current Population Survey—lead us to the following two, seemingly polar-opposite, conclusions:

(a) median household income “flatlined,” underperforming the overall economy; and

(b) middle-class income growth outperformed that for the overall economy as well as that for the rich.

Although it seems impossible, both statements are true. The key lies in the difference between the “median household” versus the “middle class.” The median household is a single theoretical household exactly in the middle of the entire income-ranked list of U.S. households. Conversely, the “middle class” has no official definition, but it is certainly tens of millions of households in size and presumably centered around the median household

Conover is focusing on the period from 2000 – 2007 and so that’s the data we’ll look at. However, by any standard I can see the results for the median are not misleading as to what the “middle” class experienced.

To be more specific the Conover has a problem with conclusions that might be drawn from this chart.

Steve Conover RMHI

And, suggests that the median is too narrow a measure of the middle class. However, it looks to me that the median actually indicative of the entire distribution.

Conover points us to this table. But I think this contains just about all that data and more.


The issue is based on the census data there was stagnation all up and down the income distribution.

Take the 95 percentile for example. A household at the 95th percentile earned 174,850 in 2000 and 177,000 in 2007. Thus even for the 95th percentile there has been only about 1% growth over the period. Take a step one year back to 1999 and even that 1% disappears.

Now, that is slightly better than the small drop the the median household sustained but not by much. We get similar results looking at the data by quintiles.

Conover does a bit of manipulation seemingly centering around controlling for how much work the household performed. He divides through by FTE (Full Time Equivalents). That seems to be wholly beside the point, as lack of strong job growth is commonly cited as the cause of income stagnation. But, whatever. The principle results don’t change. Here is the chart.

Steve Conover Growth Rates

The growth rate for all households per FTE is 0.2% while the growth rate for the top 5% looks to be –0.7%. Combing that with the data above my preliminary conclusion would be that from 2000 – 2007 the rich had the opportunity to work for less, while the poorest lost the opportunity to work at all.

I have to add one more thought on the environment and the economy.

Paul Krugman likes to say that it depression economics the rules are turned topsy-turvy. This type of talk irks me. The world is what it is. That you had an understanding of reality that was rooted in empty tropes and simplistic aphorisms is a statement about yourself not the world.

That notwithstanding, I agree with thrust of Krugman’s point. The rules of thumb that many economists push on a regular basis do not apply when Fed policy is unable to maintain stable prices and employment.

So one of these rules-of-thumb is that pricing externalities improves efficiency. However, underneath the hood of this rule-of-thumb is that resources will move out of the dirty sector and into clean sectors.

One of the issues that we have in recessions is that resources are not smoothly transferring to the sectors where they would be most efficiently used. So that you are pushing resources out of coal extraction for example, does not automatically mean you are pushing them into yoga instructors.

I use the yoga instructor example to point out that in general equilibrium the sectors need not be related to one another in any conceivable way except that they are bought and sold by folks who have some means of creating a chain of exchange between them. Usually this chain is created using money. However, money being all messed up is the essence of a recession

Since, however, I bothered kick environmentalists for a third time today, I’ll not that this post by Steve Sexton has a few issues with it as well.

Here is the punchline

When one considers that which is unseen—the loss of expenditures and jobs by businesses without substantial cash reserves and the loss of jobs among potential entrants—it becomes clear that Krugman’s prescription for job growth [stricter EPA regulations] may not be the antidote to an ailing economy. And even among those businesses sitting on cash reserves, it is likely that regulatory compliance costs would crowd out other expenditures (and thus other employment) as those firms sought to maintain the cash reserves they deemed optimal in the first place as a hedge against an uncertain economic future.

Not to be too coy, but if you want to summarize all of the what-ifs and how-about-this situation, the question you want to ask is would more EPA regulations increase or decrease liquidity demand. My gut reaction is that its going to increase it.

To get a different answer the story you’d have to tell is about decreases in the final demand for electricity or whatever these plants are producing. Otherwise, profit maximization is going to demand that higher costs of capital lowers your demand for liquid assets. Which in turn means that the regulations are expansionary.

Again I really wish I could do all of these arguments justice because these guys are really barking up my tree.

Arnold Kling has the latest in scientific metaphors for why macroeconomics is in dire straits.

Given that the models have no credibility among researchers, why is it that they are used by policy makers, such as the president’s Council of Economic Advisers and the Congressional Budget Office? Greg Mankiw, who has been both a researcher and a policy maker, says that it is because the researchers have failed to come up with a better alternative.

Imagine if somehow we knew how to launch satellites but still believed in pre-Copernican astronomy. We would have no choice but to send satellites into space using calculations that assumed that the earth is the center of the universe.

I love these analogies. Don Boudreaux talked about a flat earth. Jim Manzi talked about a rocket ship. Various folks have mentioned phlogiston. I actually have a huge post in mind on phlogiston that I don’t know if I’ll get a chance to write.

However, the Copernican thing is just great because I think it really gets to the heart of science and engineering.

Arnold seems to be arguing that launching a satellite using pre-Copernican astronomy would be the province of fools. I argue to the contrary that it would work just fine.

Indeed, the Ptolemaic models in use at the time Copernicus released his models were more precise than those of Copernicus. They were a fundamentally worse model, for reasons that we can talk about but deal deeply with the question “what is a model.”

However, they were not less useful, they were more useful.

It was not until Johannes Kepler was able to formulate elliptical models did the Copernicans models begin to exceed the Ptolemaic models in precision.

This is because the history of science is not the history of foolish ideas being overturned by brilliant insight but the history of anamoly. Usually we have a model that is pretty good, to a point, but makes some errors we can’t explain.

In order to correct those errors sometimes we can add retrograde motion but sometimes we have to scrap the whole thing and start over. Importantly, however, scrapping an old “wrong model” for a new “right model” does not necessarily produce an immediate increase in the model’s usefulness or precision.

The old models were in use precisely because people had found ways to tweak them to give the right answers. Unless you can fully incorporate all of those tweaks in one swoop you are likely to end up with something less useful than what you are trying to replace. The hope is that when you are done tweaking your model it will beat out out what we had before.

Its also worth noting that when satellites were put into orbit the models that were used were Newtonian, which the rocket scientists knew full well were “wrong.” However, there were not useful General Relativity models at the time.

However, by the time GPS came along, it had become the case that you must use General Relativity or the estimates of your location will be off by more than is tolerable for GPS to be useful.

The point of all this is not to say that Arnold picked a bad example. It is to say that folks who are pointing out how economics is not like a science are really pointing out that they don’t realize how clunky and full of kludges other sciences are.

There has been some concern over business investment and various plans have been floated to increase that investment. I think most of them are simply of the “Now More Than Ever” variety. That is, they are marginal improvements in the incentive structure facing businesses and folks are arguing that now more than ever we need that.

This doesn’t move me much because there is no evidence that I see that “now more than ever” poor policy incentives are halting businesses investment. Equipment and Software is surging and to the extent its not moving at record levels it is only because of the poor performance of transportation equipment.

That I believe is in part due to concerns over fuel pricing.

Now, although Equipment and Software is surging investment in business structures has been depressed. This is related to the credit crisis though I still believe it deserves more investigation as to the real root cause. However, there is no evidence that I see, that it has any thing to do with policy incentives.

There is one area of business investment, however, that is strongly affected by policy and that investment in Mines and Wells. There are meaningful limitations on our ability to drill new well and dig new mines, especially when they will potentially produce lots of pollution.

However, in contrast to the “Now More Than Ever” arguments I want to say that now is different. There are restrictions on pollution that we could afford in better times that we cannot afford now.

I also want to point out that not just the extra natural resources but the increase in investment in natural resource extraction equipment is not trivial.

I’ve broken down investment in non-residential structures into their major components.


Listed are

  • Mines and Wells (dark blue)
  • Power and Communication
  • Office
  • Multi-merchandise
  • Health Care Facilities
  • Manufacturing
  • Other

As you can see Mines and Wells has grown to the largest and most volatile sector.  Now this is driven in large part by the increase in oil prices and their fall during 2008.

However, restrictions on drilling and mining do discourage a significant amount of production – as is there intention.

My point is that by recognizing the importance of this sector we may reconsider those intentions and see that now may be a time when we are willing to endure more pollution for more jobs and more production.

I spend a lot of my time trying to convince hard money and balanced budget advocates that we are living through a period in history which is worse than that which they fear.

Millions of American are without jobs, underwater on their mortgages and together with Europe and Japan the developed world faces the serious prospect of prolonged stagnation.

We can and should do something about this. We should print more money. We should borrow more money. These are not costless solutions and I do not argue that they are. However, the risks they pose are not as great as the tragedy that we are living through.

However, a similar argument prevails on the supply side of energy production. There are strong reasons to believe that energy shortages will make these problems worse. In the short run energy acts more like a debt service than a consumption commodity.

We can say that households and businesses “must use” a certain amount of energy. What we really mean is that adjustments in the amount of energy they use will throw out of wack enormous long term plans in plants, production, infrastructure, home, and transportation equipment.

Thus the cost of altering energy usage can be enormous.

Now in the long run something has to be done, if for no other reason than fossil fuels are not forever. In the short run there are many who are concerned about pollution, both C02 and the groundwater pollution from new fracking techniques.

I do not argue that these aren’t serious concerns. I do not dispute the science of global warming or the clear evidence of burning water, from natural gas contamination.

However, there are things worse than pollution and we have them. We should take steps to mitigate the harm but our first duty should be to relieve suffering now where we can and lay the foundation for recovery in the immediate future.

Expanding production of our energy resources would relieve strain on households and firms at a time when they are facing enormous strain. Can we bring down the cost of gasoline, overnight. Of course not. However, we can do some things to relieve supply constraints.

We can open up ANWR to drilling, we can increase operations in the gulf and we can push forward on fracking underneath the Eagle Ford and Bakken Shales. We can’t say for sure how much production this will bring to the market or when.

However, we can say that in the short run they increase the demand for non-residential structure investment and in the medium run they ease supply constraints. Both of these are things we could use right now.

As a strong proponent for a higher inflation target I should address this column by Paul Volker in a full and complete manner. For right now though I want to say that I am making a case that I believe is substantially different from that the case Volker is arguing against.

He says

Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

My point is not simply – as seems to be Ken Rogoff’s – that a jolt of inflation inflation would be good for the economy right now – though I believe it would be.

My case is that 2% inflation is a fundamentally bad idea. I argue that 4% inflation is not merely “OK” it is preferable. It is preferable because even in normal times it produces higher nominal interest rates. Higher nominal interest rates in turn give the Fed more leverage under traditional monetary policy.

When you consider the long run costs of inflation you have to consider that there will be unanticipated events. Some of those events will be deflationary. If you don’t have an adequate buffer the Federal Funds rate will bump up against zero.

When you look at the grand scheme, I think it is precisely the problem of government failure that should lead us to prefer a moderate level of inflation. We simply do not have the tools to ensure that NGDP, the price level or whatever target you want is always hit.

We need room to miss. 2% gives us very little margin for error.

From WSJ

U.S. violent-crime rates fell for the fourth consecutive year in 2010, as police agencies across the country reported significant decreases in murders, robberies and property crimes, the federal government said Monday.

Among violent crimes, robberies registered the biggest decline, down 10% in 2010 compared with 2009, while rapes decreased 5%. Murders fell 4.2% during the same period.

Property crimes fell for the eighth consecutive year, with motor-vehicle thefts decreasing 7.4% in 2010 from a year earlier and burglaries down 2% during the period.

Like driverless cars I think the significance of this is underrated. Cities display increasing returns to scale. That is, the more people you pack into one area the more productive they are.

The obvious question then is – why isn’t the world just one big city?

There are a couple of issues

  • Provision of clean water
  • Removal of waste materials
  • Contagion
  • Congestion
  • Import of raw materials and food
  • Weakening of Social Monitoring

The first two were solved with modern plumbing and were the secret to the first big booms in cities. The third was solved with antibiotics and vaccination and allowed cities to have a net native population growth.

It used to be that cities were so dangerous that they were a net population sink. You went to the city to get rich, catch consumption and die early.

The last three are still a problem. Subways help with congestion and driverless cars probably still will more. Nonetheless, the extent of the city is limiting in part by congestion.

Transportation costs are falling but the United States still has multiple cities in large part because different areas of the country are close to different important resource areas.

The last one – the weakness of social monitoring – is why cities are great for artists but young couples raising a family are more hesitant. The anonymity of the city means you can get away with more. That might mean an alternative life style. It might mean rape and murder.

However, with violent crime falling another barrier to urbanization is falling and an opportunity to reap the gains of agglomeration will present itself. I haven’t read Ryan’s book yet but my feeling has been that the future belongs to the New Urban Sunbelt.

The crime to density ratio has always been high here and as it falls that’s good news for sunny cities in the South.

Hystersis is something that concerns me deeply. When we look at the relationship between unemployment and inflation its hard not come to the conclusion that past monetary episodes influence the current relationship between the two.

For me the 80s has always been a particarly important period because we have central banks officially adopting a set of policies designed to bring down inflation. Those policies ranged from slam-bam Volkerism to explicit inflation targets.

Its hard not to believe that this was money pushing on the economy and not real effects masquerading as nominal ones.

In any case, I wanted to look at the series Krugman uses to produce evidence of hysteresis because it doesn’t look consistent with the data to me.

Here is what Krugman offers

You can see that there was a mini-version of the current decline in manufacturing capacity after the 2001 recession: capacity basically stopped growing in the face of a protracted weak economy. But this time around, with manufacturers operating way below capacity with little prospect of needing more capacity any time soon, they’re both scrapping equipment and failing to expand. The result is that when we finally do have a real recovery, we’ll run up against capacity constraints much sooner than we would have if there had been no Lesser Depression.

The story here is that capacity is shrinking because machines are wearing and not being replaced. Well, we have data on investment in industrial equipment.


What we see either in the 2000s or in this period doesn’t look out of the norm overall, just more volatile this time around. For example, we have the biggest percentage collapse in investment followed by the biggest percentage surge.

It’s a volatile time but not one in which investment is completely out to lunch.

I am not sure what Krugman is picking up but given the explosion in the 90s and the drop recently I think it is likely related to the real terms of trade. Capacity went up because manufacturers benefits from changes in the terms of trade. Those effects peaked in the early part of the recession.

Here for example is my extremely rough attempt to compare capacity in US manufacturing to the real cost of Chinese imports.

FRED Graph

I am using the Chinese consumer inflation rate here when I should be using producer prices but its what I got. And, it suggests to me that there could be something there.

Though most of residential construction is in the dumps and unresponsive to changes in the interest rates this is not at all the case for home remodeling. Its doing exactly what the models predict  hitting record highs amid record low real interest rates. From Calculated Risk.

Right now the explanation that I am playing with is that what we think of Keynesian Effects work principally through the interaction of bonds and land. The interaction between rent and interest as it were.

Structures in general and residential structures in particular are extremely sensitive to these effects because they are created by the intersection of land and bonds markets.

Remodeling can be funded in some cases out of cash and other cases out of lines of credit that operate more like credit cards than mortgages. The coupon is not fixed and that may be important.

Indeed, the predominance of fixed coupons is something that should interest us deeply. We are explicitly creating a sticky price. Why is this optimal?

Netflix CEO Reed Hastings writes

Most companies that are great at something – like AOL dialup or Borders bookstores – do not become great at new things people want (streaming for us) because they are afraid to hurt their initial business. Eventually these companies realize their error of not focusing enough on the new thing, and then the company fights desperately and hopelessly to recover. Companies rarely die from moving too fast, and they frequently die from moving too slowly.

When Netflix is evolving rapidly, however, I need to be extra-communicative. This is the key thing I got wrong.

In classical economics AOL should have died. Borders should have died.They should have spun every dime out to the shareholders who could have invested in the next big thing themselves.

However, Hastings is specifically saying this is the mark of a bad CEO and everyone nods there heads. He is saying that we should burn shareholder profits in an effort to move away from what made the company great.

Per Cowen’s law there should be a literature on this, but I have not seen it and it seems like a big deal to me.

Whatever you think of managed care – and I was a fan – its hard to have lived through the 90s and think there is any serious possibility that the private market will be able to constrain health costs in the face of public backlash.

We make policy with the electorate that we have, not the electorate that we wish we had.

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