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He writes

As relates to the financial crisis, Quiggin has this to say: ‘The obvious criterion of success or failure for a macroeconomic theoretical framework is that it should provide the basis for predicting, understanding, and responding to macroeconomic crises. If that criterion is applied to the current crisis, the DSGE approach to macroeconomics has been a near total failure.’

But prediction need not always be the criterion for success of an economic model. Clearly, if we are judging a forecasting model, we want it to predict well, in some well-defined sense. But in other cases forecasting is not the name of the game. In arbitrage pricing, under some assumptions the model implies that changes in asset prices cannot be successfully forecast. By the criterion of prediction, the model is indeed a total failure. It tells you that a monkey could do as well at predicting asset prices as an economist who understands the model. Yet the model is actually not a failure, as it teaches us something interesting.

I understand what Williamson is getting at here, but this is essentially wrong. If economics is to be distinct from mathematics or aesthetics it has to predict something. Moreover, it is only different from mathematics and aesthetics to the extent that it does predict something.

Now, your prediction to might be: the number of people who consistently beat randomness at guessing asset prices will approach zero as the number of trials increases.

But, that is telling you something about the world.

This is important though because I have seen Williamson suggest that being able to predict financial crises is not important. Its hugely important if you care about financial crises. It may be impossible, sure. However, if there is some human or algorithm which is doing it, then for the study of financial crises that human or algorithm should dominate whatever other body of research you have.

I can’t help but say, this is because even if the world is simply a one-time pad, if someone has the pad, well then, they have the world. But, I hope Steven gets what I mean.

With malice toward none, with charity for all, with firmness in the right as God gives us to see the right, let us strive on to finish the work we are in, to bind up the nation’s wounds . . .

~ Abraham Lincoln, Second Inaugural Address

Paul writes

Look, I understand why influential people are reluctant to admit that policy ideas they thought reflected deep wisdom actually amounted to utter, destructive folly. But it’s time to put delusional beliefs about the virtues of austerity in a depressed economy behind us.

It is this blog’s overarching conceit that none do more harm than those who seek to do a principled good. The selfish will always accept a Coasian bargain. True believers will stop at nothing.

Offer them a peace that lets them keep their faith.

I’m fairly certain that almost everyone is tired of reading about comparisons of public sector and private sector pay, but a new paper in the Journal of Economic Perspectives is worth reading if you are at all interested in the issue. They lay things out very clearly, and bring some new evidence to bear using micro level data from an employer based survey that includes non-wage compensation. Their main result is that, compared to the private sector, state public sector workers are paid 3-10% more, and local public sector workers are paid 10-19% more.

The paper includes a useful discussion of the issues that divide many papers on this topic and which explain why different researchers often find different answers to these questions. It boils down to what should and shouldn’t be controlled for in the regression analysis. While it’s not always clear which is which, there are broadly speaking to kinds of factors:

….skill-related factors that an individual can transfer from job to job and a second set of variables that are descriptive of the job or sector and possibly indicative of noncompetitive pay differentials such as  rent-sharing.

Studies will differ in whether they consider employer size and union wage premiums as reflecting skill-related factors or non-competitive pay differentials. The authors agree with that I have argued in past blog posts, that neither should be controlled for in the regression:

We treat union status and organizational size as not reflecting worker skills. Controlling for union coverage seems inappropriate, because union wage premia probably do not refl ect ability differences, and those in the public workforce would not likely take their public sector unionization rates with them if they were to move to the private sector…  Troske (1999) tests several explanations of the employer size-wage effect and a significant unexplained premium remains. This and other evidence leaves the door open for the possibility that rent-sharing may be involved. Absent evidence that larger public sector organizational size reflects unobserved ability, we do not control for employer size.

That union status should not be included seems pretty clear, but as the authors acknowledge the firm size issue is not so certain. As a recent CBO report points out, the size premium could reflect a higher degree of specialization at larger firms. However, even if this is the case, the higher specialization may not be transferrable between jobs. In the end, I would agree with the authors of the JEP paper that the best approach is to not control for firm size.

I don’t think regression analysis like this can answer the public sector compensation premium question with certainty, but it is informative. And to the extent that it is useful, I believe these authors take the correct approach and provide the best estimates that the available data can give us. If you’re going to cite empirical analysis on the public sector compensation premium, this is the study you should cite, not other studies that make questionable assumptions or lack sufficient data.

Based on some stuff I have seen on the internet there seems to be some confusion here.

First, negative real rates of return are not odd or some sort of fear inducing perversion. Indeed, they are normal. Positive real rates of return are an oddity created by population pressure, social relationships and/or technology.

However, if its just you on a desert island and you have to bury food in the ground for safe keeping chances are you will dig up less food than you bury. In general investing only makes sense when there is seasonality, which is why tropical animals don’t do it.

And, animals that do invest always take a loss even if they invest in the form of fat stores. However, because the marginal product of labor is vastly different between the spring and the winter it is worth it in utility terms even if the material return is negative.

That humans don’t always take a loss is why the world we live in is so vastly different. Our world changes over time because we can use our brains to think of ways to get more out than we put in. However, this is a special case and should not be taken as some basic property of the world. Its just not.

Second, in particular if your story is that America put too much into housing then your story is that America is “overbuilt” which means that the capital stock should fall, which means that on average people shouldn’t be willing to pay you for capital.

Now, because there are different types of capital you could potential just say housing capital has a negative real return but some other capital has a positive real return.

Okay that’s fine.

But, real interest rates weren’t that high when people were plowing bunches of resources into housing. Now, they have to plow all those resources into non-housing AND the wealth effect of the collapse in housing prices means that people will try to invest even more. So, you have tons of resources flooded towards non-housing capital. 

Its not unrealistic for this to drive the risk-free return negative. The human story is that all the guaranteed projects are taken. So, now you have to invest in a risky project.

If you don’t want risk then essentially what you have to do is invest in a risky project and then buy insurance against failure. However, because this requires that someone else take on real risk (no non-risky projects left) they have to be compensated. Your compensation of them drives the risk-free return negative.

This is completely natural.

I actually don’t think the real return to housing is negative, but that instead because structures are attached to the ground it is difficult to use them as collateral when nominal land prices are falling

Nominal land prices are still falling in many parts of America and have been for going on 7 years. 

I heard a story once from guy whose great grandfather bought land in Florida during the boom in the 20s. It did not return to its nominal boom price until the 80s. That’s a long time.

Commenting on the commentary about the output gap Arnold Kling says

Mainstream macro in the 1970s (which a lot of people seem to have gone back to) held that there was a NAIRU, meaning the non-accelerating inflation rate of unemployment. If unemployment was above that, inflation would fall. If it was below that, inflation would increase. So, policy should shoot for the NAIRU.

These days, unemployment is 8.3 percent, and inflation is increasing. Just sayin’.

Pointer from Mark Thoma.

[UPDATE: Along similar lines, a (the?) blogger at Sober Look writes,

if the economy is operating significantly below potential, inflation should have negative acceleration into a deflationary environment. However the two measures have diverged recently, indicating that the slack in the economy may not be that great.

Which was a wake up moment because if you asked me what the Fed had to do to bring down unemployment, my right off the cuff answer would be – tolerate a jolt of inflation.

Not, because of any macro time series, but simply because of the raw fact that a booming economy is about to make both the energy markets and perhaps more importantly, the rental market really, really, tight.

Even if you only care about Core PCE, you are about to see core PCE take off as rents must rise. They must rise because the rate they are at is only consistent with a depressed economy.

In short, if the economy were better household formation would pickup. But, if household formation picked up, there wouldn’t be enough places to live. Which in turn would mean rents would pick up sharply.

This would soon be alleviated by a boom in apartment building which would drag employment further down and eventually drag down rents.

However, to break through this level of unemployment one would have to tolerate high rents for at least 18 months or so.

Which takes me back to Larry Ball on Hysteresis in Unemployment

The second broad issue is the nature of hysteresis. Through what mechanisms do short-run unemployment movements influence the NAIRU? What determines the strength of these effects in different countries and time periods? What are the implications for monetary policy?
My discussion of these topics is speculative. In my view, it’s clear that some form of hysteresis exists, but it’s not clear why. The relationships among unemployment, the natural rate, and inflation appear to be non-linear, but it’s hard to pin down the non-linearities precisely. As a result, policy implications are not crisp.

Well here we have a mechanism. And, its not a – can we explain non-linearities in the relationship between unemployment and inflation. It’s a straight-up, look if you do something that will decrease unemployment its going to result in a temporary rise in one large set of prices because that the only way we can make this thing work.

If the Fed responds to that by raising rates, that’s not going to do anything do address the underlying problem. Indeed, its only going to make it worse as you will have even more household dislocation and even fewer apartments.

You have to tolerate the rent increases. I don’t see another way to get kids out of the their parents basements.

As I said, Bullard’s thinking on the output gap mirrors that of a lot folks.

Tyler Cowen points to this from Sober Outlook.

A key part of the post says

This output gap, thought often taken for granted, may in fact be much smaller. Some recent work by Barclays Capital has already shown that the potential GDP (red line) is basically extrapolating the bubble of the pre-crisis era and is therefore unreliable.

The CBO number crunchers wish to believe in their ability to compute the potential GDP of the US economy.  The reality is that nobody knows how much output the US economy is truly capable of. But there are signs that the gap may now be below the CBO’s assertion.

In one sense the bolded paragraph is true. No one knows for sure exactly what you could get out of the US economy, especially if you want to get the highest value added production. This is part because its not completely clear what “highest valued added production” might even mean in thoroughly consistent way.

However, it we take a step back and ask more or less how much could you squeeze out the US economy, in terms of easily recognizable production we could probably back of the envelope this without too, too much trouble.

For example, if we started building lots of cars at roughly the prevailing mix as in 2007, it would be difficult to come up with a concept of “highest value added production” under which that would be the right thing to do.

If nothing else overwhelmingly the odds are that the mix of cars should be tilted slightly more towards high fuel efficiency models if one wanted to maximize value.

Nonetheless, if we produced 600K F-150s we can be pretty confident that we could exchange the marginal F-150 for not too many fewer unskilled labor hours than we could in 2007.

That is, we take the very last F-150 to roll off the lot and we put out the call to America and say, of everyone out there who is willing to work the most hours for me in exchange for this truck. Its unlikely the number will be much lower than it was in 2007.

Which in economic terms is to say if we use unskilled labor – which is raw human time or the basic unit of life – as the numeraire good, the marginal valuation of an F-150 at 600K units is not likely to be that much less than it was before the crisis.

All that is to say that we could back of the envelope this sucker and we wouldn’t be too far off.

However, I think the even deeper point comes from a self-link in the post

Barclays Capital: …the CBO estimates that output was at potential during the housing bubble years and that any deviation from the trend established during those years represents an output gap. In contrast, our view is that the housing bubble pushed the economy above its potential; thus, we believe the output gap is much smaller.

In fact if one zooms in on this chart, it starts to make much more sense than the original BEA/CBO analysis that assumed the US was producing at capacity prior to the financial crisis. The Barclays chart shows that economic output between 2004 and 2007 had been growing at a rate above what it is normally capable of. One can only interpret this production level above capacity as simply funded by credit, particularly real estate driven credit.

The key question – and maybe someone at Barclay’s wants to have this conversation – is what reason is there to believe that the housing bubble punched the economy above its potential?

My main reason for asking is simply that I just don’t know of any actual empirical evidence to suggest this is the case or what a consistent narrative about this would be.

However, to nudge folks forward into the conversation I will note that standard economics – sans Barro -  says the exact opposite. A housing bubble should drive output below its long run trend.  Ditto for a credit bubble.


Well, because as people got wealthier they would attempt to cash in on some of that wealth. IE, cash-out-refinances, etc.

They would then use those funds to buy things.

One of the things people like to buy is not working or investing in the future. Both working and investing in the future are costly and folks only do it because there is a return – which is determined by the actual marginal products of capital and labor.

As you get wealthier the marginal benefit of that return is worth less to you and so you do less of it. You work less. You invest less.

Working less directly subtracts output from the economy. Thus making it smaller.

Investing less leaves us with a smaller capital stock meaning we are able to produce less in the future, thus subtracting from future output.

So, both of these factors depress output.

Now, what happens when the bubble pops. In a smoothly functioning economy those trends reverse. First, you start saving more because suddenly you are not as wealthy as you thought.

Second, you start working more to because (A) You can’t live off cash-outs anymore and (B) you have to repay the cash-out you already performed, when you thought you were richer.

In this case what we would see is production roar back towards the trend line it was on before.

In a fundamental way we would say that the output (the potential output) of the economy is determined by tastes and technology, neither of which has changed. And, so the long run path of the economy has not changed.

The only alternative is to suggest – as Stephen Williamson might be – that the housing bubble or its predicates were themselves a technology that in fact boosted the productive potential of the economy.

Once they are gone we are left with an inferior technological stock.

To be more specific, the idea would be that collateral is a productive asset solely on the basis of it being collateral because it facilitates mutually beneficial trades that could otherwise have not occurred.

I am sympathetic to this view. Indeed, I used to quasi-hold it and I still think its qualitatively true. I just don’t think that its quantitatively important. The stream of housing services that could be obtained in a high collateral world is higher, but its not that much higher and we are still receiving the stream.

Via Annie Lowery

In a call with reporters, Alan Krueger, the chairman of the council, said the recovery had been strengthening even faster than he and other economists expected recently and the report notes that the “sharp drop” in unemployment this winter took them “by surprise.”

Obviously the economy is tracking exactly as I expected and indeed I think has not yet hit its stride which I still expect to come in roughly two to three month’s time.

However, it is interesting to see how consistently surprised the rest of the profession is over these developments.

At this point its hard not to believe that my method of micro-data, macro-narrative doesn’t have some advantages. That is, I look at auto sales, rents, debt-ratios, charge-offs, remodeling permits, etc , but the story I tell is at its heart not about auto sales, its about Marginal Productivity of Capital and the natural rate of interest.

She writes

Housing has been down so long that any gain is welcome. But the 1.5% rise in January starts was less positive than meets the eye.

First, economists expected a bigger advance. After all, the mild weather should have allowed builders to break ground on many more projects than in a typical January. Economists at IHS Global Insight warn the building activity pulled forward into the tepid winter months could mean a payback in starts come the spring.

Second, the mix of projects suggests demand for new homes is coming from renters, not buyers. All the increase was in multifamily buildings. Single-family housing starts actually fell 1.0% last month.

For the last few years, housing’s problem has been insufficient demand to clear out the overhang of supply. For whatever reason–lack of downpayment, financing problems, the inability to sell a currently owned house–buyers are still largely missing from the housing equation.

. . .

The Housing Market Index compiled by the National Association of Home Builders and Wells Fargo has increased for five months in a row. A growing share of builders expect sales to pick up over the next six months [although it should be noted that the expected sales index remains far below the readings during the boom years.]

The better expectations are probably based partly on the improvement in the labor markets. Faster job growth will supply more income and confidence to potential buyers.

I am not sure which economists expected a bigger advance, the consensus numbers I saw were in the 670 range versus 699 reported.

More importantly she seems to suggest that the increase coming from multi-family is a “less positive” factor. Its not clear to me why. This is exactly how we expected this to play out.

Lastly the expectations from builders are almost certainly based on orders and inquiries which are rising. Though, the improved job picture helps, its by my lights the change construction that is fueling job growth.

Lets look at construction unemployment

FRED Graph

We don’t have seasonally adjusted data but look at the torque on that last trough. Compare to the rest. Its moving down hard.

Consider also the monthly rental income data

FRED Graph

Its not only moving up like bullet but at an increase pace

FRED Graph

Rental property is like a license to print money and we know a competitive market abhors, well rents.

There is also the rapidly increasing financial room available to households

FRED Graph

and for what its worth – which is not too, too much except historical comparison – we can look at housing affordability which breaking ever new highs.

FRED Graph

All of those factors are pushing home construction forward.

For some reason, I don’t completely understand, the New York City blogosphere seems highly concerned with the “housing overhang.”

However, existing inventory is not that high

More importantly, its not clear that it matters. Look at inventory in the period from 2001 to 2006.

Now look at Case-Shiller over that same period

FRED Graph

Can you see something indicative of a doubling of home prices in the inventory data? If anything there is a slight rise during that period which is co-incident with a rise in sales.

Since we walked right past the obvious solution of the ECB just floating Greece the cash let me offer another solution: Devaluation by Groupon.

The Greek government sells 100 Euro vouchers for 50 Euros. The Greek government would then accept these vouchers as payment for taxation or settlement of judicial claims at face value.

Presumably the ability to settle claims or pay taxes at 50 cents on the Euro would create a demand for these vouchers which would fly into circulation and immediately sweep out the Euro as currency.

The reason being that no matter what kind of contract you either had or attempted to write in Euro that contract could be settled in vouchers, so vouchers strictly dominate Euro as a means of payment.

Greek citizens would then be willing to sell goods and services at a step Euro discount to non-Greeks since they know they can just take the Euro to the government and receive a voucher.

This would cause more Euros to flow into Greece and then on up to the Greek government. This gives the Greek government the means to repay some its creditors.

Though the official currency is still the Euro you have effectively issued an alternate currency and forced a devaluation.

The major issue I see is how to handle private debts euro denominated debt between Greeks and non-Greeks. If such debts were enforced in Euro then the value effectively doubles for the Greeks who are now doing business in vouchers. If it settled in the vouchers then the value is cut in half for the non-Greek who has to take the voucher.

I am tempted to say the solution is to have external private debts paid in Euro but then have Greek citizens be able to claim a refundable tax credit for half the amount of any debt incurred before the introduction of the vouchers. This credit is of course paid in vouchers.

Off-the-cuff I think this whole scheme gets us the monetary benefits of a devaluation without screwing external creditors.

If Greece then later wants to move off the voucher it would first stop selling them. Then the government would have to run a budget surplus and just tear up the excess vouchers it collects.

This will cause the Voucher-Euro exchange rate to rise. Once it reaches parity, you petition the ECB to allow you to swap Vouchers for Euro.

Nouriel Roubini writes

Third, while US data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011. Moreover, given continuing malaise in credit and housing markets, private consumption will remain subdued; indeed, two percentage points of the 2.8% expansion in the last quarter of 2011 reflected rising inventories rather than final sales.

Nouriel and I were simpatico on the housing/financial collapse. Biggest difference is that he predicted that two major broker-dealers would go under. I said the Fed would never let even one go under. I’m gonna say [because it paints me in a better light] that we split the difference with only one being allowed to fail.

In any case, that was then, this is now. Things really are different. Yet, when I read Nouriel I read the same story, as if it is forever August 2007 and folks just can’t read the tea leaves.

There are risk but the fundamentals are completely unlike what they have been for the past several years.

The Abstract from PlosOne

Bisphenol-A (BPA) is a widespread endocrine-disrupting chemical (EDC) used as the base compound in the manufacture of polycarbonate plastics. It alters pancreatic β-cell function and can be considered a risk factor for type 2 diabetes in rodents. Here we used ERβ−/− mice to study whether ERβ is involved in the rapid regulation of KATP channel activity, calcium signals and insulin release elicited by environmentally relevant doses of BPA (1 nM). We also investigated these effects of BPA in β-cells and whole islets of Langerhans from humans. 1 nM BPA rapidly decreased KATP channel activity, increased glucose-induced [Ca2+]i signals and insulin release in β-cells from WT mice but not in cells from ERβ−/− mice. The rapid reduction in the KATP channel activity and the insulinotropic effect was seen in human cells and islets. BPA actions were stronger in human islets compared to mouse islets when the same BPA concentration was used. Our findings suggest that BPA behaves as a strong estrogen via nuclear ERβ and indicate that results obtained with BPA in mouse β-cells may be extrapolated to humans. This supports that BPA should be considered as a risk factor for metabolic disorders in humans.

Two quick things

One: metabolism is, well, complex. The hunger regulating mechanism is for obvious reasons extremely primal and the system is shot through multiple redundancies and fail safes to ensure the organism does not accidently starve to death. As such you don’t want to hang your hat on such a minor result.

Two: At the same time. BPA looks exactly like what we would expect the obesity molecule to look it from a macro point of view. Its something that was suddenly everywhere. It works on a key channel. Even without any direct empirical evidence it would a plausible candidate for “metabolic lead.”

Via Scott Sumner

U.S. factories are creating many new jobs. But owners are hard pressed to find skilled American workers to fill them.

There is a “critical shortage of machinists,” a common and crucial position in factories, said Rob Akers, vice president at the National Tooling and Machining Association. “Enrollment in this field in technical schools has been down for a long time.”

The problem comes at a terrible time. Domestic contract manufacturers — known as “job shops” — are seeing a boom in business.

Scott has some good ideas on immigration but let me propose the tried and true method:

You stand outside your competitors shop at shift change. When a worker comes out with a machinist name tag you run after him. The you say, “Whatever this guys is paying you I’ll pay you 15% more”

You continue this process at various plants until you have all the machinist you need.

Now, two things will happen. One, the salary for machinists will go through the roof. Don’t blink when it triples – this is the way capitalism works – and that will cause lots of kids to say, man I should be come a machinist. That will increase supply.

The high prices will also cause some entrepreneurs to say: Man, couldn’t we really figure out a way to do this with unskilled labor. I mean I have a ton of kids sitting outside my door who want to work. There has got to be some way to use them

However, crying to the editors at Yahoo that you have no machinists is not helping anyone.

As per usual I wanted to give both of these things more attention but its to the point that something is better than nothing.

First, this chart from Calculated Risk

Nothing had or has me doubting the basics of the Smith/Yglesias growth thesis than this chart.

That smack down looks awful structural. It looks like something happened to driving big time. The only reason I persisted in making aggressive calls on auto sales was because I just couldn’t think of a convincing narrative about this as permanent structural. There were many candidates, I don’t have time to go through, but none of them really convinced me.

This has to be temporary I thought – even if its an age of driving shift thing – that’s not permanent.

If its just cash constrained households economizing on trips and businesses economizing on shipping then we are going to see a roar back and that means huge auto sales. Depending on the speed of convergence 20 Million SAAR would not be crazy. Note we are at 14.2 now.

The thing is a roar back will also mean very rapid increases in gasoline consumption which in turn means much higher prices. What does that mean for the recovery. Three very quick factors

1) Higher gas prices shunt consumer funds towards Oil Producing countries who then send the funds to US Treasuries. This is effectively a monetary contraction because lending does not increase– no change in interest on reserves. Yet, Treasury buying increases, this implies that excess reserves go up. This is contractionary for the economy.

Importantly this does not require the Fed to tighten. No action on the Feds part is passive tightening in the face of higher gas prices because the funds go straight to T-Bills. Its as if consumers are just saving more.

2) Higher gas prices cause effective depreciation rate of cars to go up. Old cars now even more costly to maintain. Natural rate of interest rises. Unconstrained consumers willing to dig deeper to buy new more fuel efficient cars.  This is expansionary for the economy.

3) Higher gas prices cause more investment in oil and gas exploration, a change over from heating oil to natural gas in some plants, major oil and gas infrastructure projects. Think of it as raising the marginal productivity of energy extraction, distillation and distribution capital. Natural rate rises. This is expansionary.

Now I am not sure how these three shake out. I really have no handle on (2) and though I am reading up on (3) I cannot yet give an opinion on the size of the energy sector expansion we could see.

So, its hard to say even if higher gas prices are contractionary or expansionary. However, unless something odd happens, they are coming.

I just noticed that Paul Krugman made essentially the same point. However, the intuition behind what Bullard’s argument is incredibly common place and so it might still be useful to have two posts.

Bullard writes

If households and businesses had ignored the house price developments as a sort of amusing side show, it would not have been so important. But our rhetoric about the decade suggests otherwise.  Households consumed more through cash-out refinancing, developers built more, borrowing increased, Wall Street produced new financially-engineered products to feed the boom, and ancillary industries like transportation thrived.  Output went up, and labor supply was higher than it otherwise would have been.

If I am correct this paragraph is the crux of his point on the output gap.

I want to examine further

1) What the rhetoric actually suggests

2) What the data from the period tells us about that rhetoric and our current situation.


The Rhetoric

Lots of things were said about the boom both during it and immediately after, however, a single phrase stands out to me as particular well used: “Lived beyond their means.”

This was said both about households and about government. It was said about middle-class suburban America in particular and the American polity in general. What does it mean? Or, more precisely what did people mean by it.

I think that they meant consumption was exceeding permanent income. This necessarily implies savings was lower than optimum. Either, too little is being saved in good times, dis-savings is occurring to fast or too soon or there is too much borrowing. I think the last option captures what most people saw and felt.

However, if this is the case and if at some point it were to come to an end then our expectations on both macro and micro levels is that consumption will have to fall, but production will have to rise.

This is key because although we might expect to consume less and in utility terms to be poorer, we should expect output to rise. This seems counterintuitive, but likely because we are so used to equating output with wealth and wealth with higher levels of consumption. But, this of course not the case.

Just as it is possible to live beyond ones means it is possible to live well within ones means. China and Northern Europe – importantly in fact – are the case in a few data points.

The Data

Lets consider the time path of residential investment and consumption as a fraction of GDP. As is well known they began to grow beginning in the late 90s and continued to do so until the peak of the housing bubble in 2005.

FRED Graph

One interpretation is that this represented simple “over-consumption” all the way through.

Another, is that the US had seemingly shifted to a higher productivity regime in the 90s as a result of Information and Communication Technology. The gains, however, were not lasting and a correction set in in 2005.

Another, perhaps in line with your view is that the deviation in the in the 90s may have been consistent with optimal resource allocation but was distorted in the early 2000s.

I offer a fourth interpretation that centers around developments in international finance and trade. In particular, I draw your attention to the correlation between the increase in GDP fraction represented by consumption residential investment with the increasingly negative contribution of Net Exports.

FRED Graph

Note that these are plotted in equal terms on the same axis. Thus the increase in GDP derived from consumption and residential investment was matched nearly exactly with the negative contribution of Net Exports.

There underlying story is involved but I as a baseline interpretation I submit that following the Asian Financial Crisis the United States increasingly took on the roll of global banker, providing Safe Liquid Assets in the form of US Treasuries and Agencies.

Demand for these assets grew rapidly but ironically the US government moved during this same period to reduce its debt-to-GDP ratio. The result was extremely low interest rates and easy financing that would eventually be dubbed “a conundrum.”

US residential investment peaked in 2005 and this process reversed itself. Net exports fell and the consumption/housing/exports deviation moved towards zero.

Importantly, however, though through this entire process, the net pressure on US GDP was close to zero. The process simply shifted US GDP away from net exports and towards consumption and residential investment.

Both the rhetoric and the data surrounding the first decade of the 21st century suggest that the US “lived beyond its means” by supporting ever increasing consumption and residential investment with decreasing net exports.

I can’t remember if I ever published my skills-shmills post but Derek Thompson does the heavy lifting

Although Latinos make up only a seventh of the population, they have "racked up half the employment gains posted since the economy began adding jobs in early 2010", the Los Angeles Times reported this morning. In 2011, the trend accelerated. Of the 2.3 million jobs added in 2011 according to the Household Survey of the Bureau of Labor Statistics, 1.4 million, or 60 percent, were won by Latinos.

This remarkable statistic is a keyhole into America’s two-speed recovery. One true story of the recession is that employment gains have been biased toward the highly educated. More than half of the jobs added in 2011 went to Americans with a college education. Another true story of the recession is that most of the other jobs have been low-paid and went to the less-educated. Educational attainment among Hispanics remains very low. Just 10% of foreign-born and 13.5% of native Latinos have finished college, placing the group’s completion rate at about a third of the national average.

This trend is likely to accelerate.

I have been joking across town that if the Fed keeps the faith we will see “Trabajar Para GM” billboards going up across Ohio before the end of 2013.

If the Fed Funds rate stays at zero through 2014 I give at least 5% odds on a bill being filed in a US state legislature to lower the minimum factory working age to 14.

David Brooks says

I don’t care how many factory jobs have been lost, it still doesn’t make sense to drop out of high school. The influences that lead so many to do so are much deeper and more complicated than anything that can be grasped in an economic model or populist slogan.

I don’t pretend to include all influences, but when I was but a wee pup I tried to build a model that captured what David is talking about and show that it does make sense to drop out of high school when lots of factory jobs are lost.

The response I got was universally: cute but no cigar.

I’ll link to my old paper here.

There is a lot of throat clearing at the beginning, but if you care about Brook’s point specifically then jump to page 18.

It would be nice if there was an Intrade on whether APPL will pay a dividend so we could get an independent metric of expectations.

However, if Matt and I are right then if and when it becomes well accepted that APPL will pay a dividend the share price will rise sharply. Of course, I should say will expectedly rise since there are always confounding factors.

But, because I ‘d rather have a firm loss than a wishy-washy win, I will go with will rise sharply.

With luck the news/realization/rumor mill will hit suddenly rather than slowly spilling out over months. Then we can have a clear test.

Curt, a loyal commenter writes

Innovation decreases prices, and wealth signaling subsidizes research and development – without which luxury goods like automobiles, televisions, washers and dryers, even makeup and hair products would never become consumer goods. Innovation is the source of disequilibrium. And all increases in consumption are made possible by the creation of a disequilibrium that makes it possible for capital to be risked in order to create a new method, product or service.


This is the Concorde.

This is a man pretending to assemble flat pack furniture

We can debate which one is more innovative .

However, it is clear that one of them answered the question: What Would Like to Do Today, for a vast number of human beings and the other did not.



This is an 18th century French Wall mounted Barometer– I am told it still works

This is a fly shuttle

A flying shuttle

Again, both quite innovative for their time. Again, one answered the question: What Would You Like to Do Today and the other did not.

Also, I see for the queue has to be address of what seems to a growing obsession with innovation.

On one level I actually don’t think much will come of all of this talk, but its so widespread that just in expected value terms its worth addressing.

As a short introduction, it is certainly true that innovation is why our lives are so much more pleasant that those of our ancestors. But, it is a mistake to draw a straight line from innovation to improvements in living standards.

The innovation has to do something that matters and matters to a lot of people.

So before going wild over innovation, we might want to ask – what would you like to do?

Now to be sure there is innovation generated preference. I.E.: “If I had asked them what they wanted, they would have said a faster horse”

However, we should think about what it would really take to draw more out of this type of evolutionary process.

So, despite my repeated attempts to drill a deep pessimism into my readers lots of my commenters still take my attitude about the future as Cassandra-ism.

Indeed, it’s the exact opposite. If I had to yoke with someone more famous I would pick Camus, though – and perhaps you laugh – I find much of his words a quasi-optimistic copout.

Suicide is fully rationally and consistent with our (the black-black existentialist) stated views on absurdity. One can embrace simply by saying: I am viscerally afraid to die. I viscerally long for the morrow. None of this makes any sense.

Yet, when I open my eyes the question “So, what now” is imposed on me by simply being a conscious being. And, so we love the moments not because there is any sense to it or because we have escaped or transcended absurdity in anyway, but simply because we are therefore, why not.

Still, if not rebellion per se we can seek insight. Again, for no other reason than that we are and we wish. And, yes formal ethics is a game we choose or choose not to play. I prefer the terminology, table we wish to sit at or not, because I do not like the English language connotation of “game.”

As I said to Bryan Caplan in our debate, there simply is no response to “I don’t want to play this game”  That is, to say if you don’t wish to sit at this table then that’s the end of the conversation. We can and Bryan and I did, go for drinks.

In any case, to the events of the day.

Understanding that things won’t work out in the end helps you take a more level headed approach to things that are happening now.

For example, both Megan and Kelly were taken aback at my attitude on long run fiscal issues. There are a lot of levels of disagreement, different with each, but key is that I push this line of reasoning:

  1. That we cannot as individuals or as a state afford everything we would like is simply scarcity and is the furniture of our world.
  2. If we are lucky we will have the choice to kick-the-can-down the-road.
  3. Kicking-the-can-down-the-road is of its nature preferable because bad things now are worse than bad things later.
  4. There is some price to can kicking but before I endorse increasing the suffering of actual existent people I would need at least an argument as to why that price is high.
  5. “Being responsible” is not an argument. Its an attempt to display high status
  6. In actual fact the claims of long term calamity are overblown. Calamity usually comes swift by its nature and for reasons I can go into later.

My case in point on this is Greece. Greece’s “insolvency” was handled extremely poorly. Its an example of folks choosing policy that makes almost everyone poorer and the poor relatively.

Nonetheless, lets see what happened when sudden austerity comes clamping down.

At least 45 buildings were burned, including one of the capital’s oldest cinemas, while dozens of stores and cafes were smashed and looted.

The stench of tear gas still hung in the air on Monday morning, choking passers-by. More than 120 people were hurt in the rioting which also broke out in other Greek cities. Authorities said 68 police needed medical care after being injured by gasoline bombs, rocks and other objects hurled at them, while at least 70 protesters were also hospitalized.

Police arrested at least 67 people, while in several cases they had to escort fire crews to burning buildings after protesters prevented access.

This is not exactly civilization ending stuff.

The precautionary principle has yet to show its merit.

Ordinary Optimal Control still wins the day.

As a note, I know some people will find this all confusing because you can’t tell whose side I am on. My point is beyond all that.

My point is that the entire paradigm is wrong. There is no “we just have to” either for reigning in spending or maintaining the welfare state. Nor have there been any consequences so discontinuous as to be approximated by “we just have to.”

What do you think you want to do?

That’s the public finance question.

Paul says

But I’d also like to stress a related point. Brad doesn’t actually fall into this fallacy, but you often find people writing about the Great Recession and subsequent Lesser Depression as if they were largely about trying to find a place for all the people formerly employed in construction. And the fact is that this just isn’t right. As Larry Mishel shows, the unemployment rate would be almost as high as it is even if we ignore everyone in or formerly in construction.

This was much the subject of my much talked about – primarily by me – presentation at GMU were I attempted to “Address Austrian Economics on Its Own Terms”

The basic story is one of misallocation of resources, but you can slice the resource picture dozens of ways and not get anything that could plausiable be called mal-investment.

You can see this in part by the fact that the price of houses didn’t even rise that much. The price of land rose. Further, renovations are hitting record highs even as new construction is hitting record lows. This story is all about land as the option value and collateral value of land – not fungible real resources.

In anycase I would present my slides had someone – who will remain nameless thought not photoless – maliciously and with dastardly wicked and boundlessly evil aforethought destroyed my data files.

First of all I think there is this chart which should but this baby to bed Yes, those little blue dots you see are residential constructions contribution to payroll growth

FRED Graph

And even still the timing is wrong

FRED Graph

The peaks and troughs are different and the recovery is fundamentally different.

Residential construction is an import story about the last 8 years of the US economy but it is by no means the story of the Great Recession.

The condusion I believe comes from a rampant inflation of price and output.

Here he is doing the Lord’s work

Think about this for a minute. It may seem very natural to you that people who pay large fees to a company to manage their wealth should expect that company to earn them a higher return than they would earn if they just stuck their money in a low-fee index fund.

But does this expectation make sense in the long run? Suppose you gave $1M of your money to a hedge fund with an awesome brilliant manager who was incredibly talented at picking bonds that were going to go up in price. Soon your money doubles to $2M, then to $4M, even as the average bond price goes up only a little bit. You keep your money invested with the same manager (paying the same high fee), assuming that he will continue to double your money in the same amount of time, again and again. But as the manager accumulates a bigger and bigger share of the total bond market, it becomes harder for him to beat the market average.

To see this, just imagine if your hedge fund manager did so well that pretty soon he was managing the wealth of every bond investor. In that case, it will be impossible for him to beat the market, because he is the market, literally. So it makes no sense to expect the same excess return (i.e. the same percentage points of market-beating performance) year after year.

This runs true for many things.

For example, the question is not whether or not health care costs will bankrupt the economy. That is nonsense. The question is whether the economy will become health care and whether that’s a good thing or a bad thing. whether we desire this outcome or not. [I, at least, should honor my own requests]

I also want to note that the meat of Noah’s post began with the phrase

Think about this for a minute

My growing sense is that the core intellectual struggles surrounding the Great Recession have been practically resolved.

There were three core things that needed to be understood.

1) That the near term future of capitalism could only be secured by hurling huge sums of money at the US banking system in 2008-2009. That was done.

2) That a perhaps not cataclysmic but nonetheless horrific second global financial crisis could only be secured against by hurling huge sums of money at the European banking system in 2011. That was done.

3) That the global downturn is a phenomenon of Aggregate Demand in general and liquidity/collateral constraints in particular. As such it would be alleviated by the easing of credit and the transferring of liabilities from the liquidity constrained to the liquidity free.

Though too little was done in time, this point has more or less been ceded by a critical mass of the intelligentsia. Furthermore, in the US, per-capita depreciation is proceeding at such a rate that the liquidity free would be induced – against their individual risk tolerance and rate of time preference – to procure large quantities of capital.

The attempt to do this will transfer purchasing power to the liquidity constrained and will thus alleviate the crisis.

And, there are enough people with strong enough voices who understand and are communicating this to keep efforts at stopping at bay.

More could be done policy wise, but I do not think at this point more is likely to be forth coming simply because we talk about it. Too much is riding on the opinions of people who are not interested in the conversation.

So, as a practical intellectual matter the Great Recession is done.

It is time to move to other things.

Here are three that I think are important to get to next.

Reason and Economic Policy

I used to believe that the disagreements in the economics/policy/elite journalism world were founded on attempts to seize the zeitgeist through intellectual intimidation. That is people pretended to be arguing over policy issues but instead were try to push the political culture towards their preferred answers to meta-questions of policy.

For example, is providing lots of assistance to the poor something society should embrace. Is letting people keep what they earn something society should embrace.

Everything else, I thought, was window dressing.

Yet, watching the blogosphere I have come to doubt this. For example, there were strong pushes to adopt policies which would make almost everyone poorer and the poor relatively poorer. Who supports this outcome?

For sure, there is disagreement on values but I don’t think in translates into that much disagreement on policy. There is also bullshit, properly defined, but I think it is of a derivative order. The bullshitters are attempting to prop a policy view that has genuine support.

So, I think “being genuinely wrong” is a more important problem than I originally realized.

The thing is, everyone is looking at roughly the same evidence. So the problems here have to be problems with reason and interpretation.

Listening to people debate I think the biggest problem is reason. In some cases one could replace the words “progressivity” with “jam” or “growth” with “blueberry muffins” and the arguments would be no more or less sensible. That is to say, the disagreement is not even semantic.

This is one reason why I encourage my colleagues to be gentle rather than mean. Another – so that we my be honest – is that I am, obviously, viscerally uncomfortable with meanness.

Nonetheless, if people are making errors of reason yelling at them is not likely to help them because being yelled at makes it more difficult for people to focus. It is also not likely to put readers in a mode where they are more open to reason. Instead they are likely to view this as a sporting match and try to determine who is and is not on their team.

GDP is Dead

I wanted to make my first mention of this funnier, but its better just to get something down.

Its understandable that before the internet, fast search and laptops capable of handling huge data files folks would want the best summary statics of the economy they could get.

The concept of GDP is a good attempt at a consistent representation of the total economic output of a region.

However, in the modern era we don’t really need it for most purposes. Maybe some sort of historical and cross country record keeping where the data is incompatible.

In the US, however, we have much more direct measures of the variables of interest. Indeed, we have access to many of the addends which are used to create GDP in the first place and there is no reason I know of that we couldn’t lobby to make all of them available.

Given that, why still focus so much on GDP?

In order to make it consistent and add up correctly we have to make lots of compromises which obscure our understanding of the economy. Why not brush GDP aside and focus on the disaggregated data that we care about.

Indeed, given the way he talks about the issue I wonder if Scott Sumner might be happier with nominal compensation of employees as his stabilization target:

FRED Graph

Here is the trend by the way

FRED Graph

Notice the different dynamics of the two “bubble” recessions.


As I have been talking around for a while there is – what look to me – to be poor intuition concerning physical capital and investment. This is unfortunate because unlike a lot of concepts in economics physical capital is tangible. We can actually go visit the capital.

To make this more clear, here is the simple data


This is important because the blue category is the stuff of everyday life. The red are things we might not interact with everyday but deeply get on a non-macro economic level.

Our daily experience can influence how we think about the capital stock. More importantly, we can relate our daily feelings with our feelings about growth and the US.

For example, when you say this capital gains tax increase will reduce investment and hence growth what you mean is that some developer will decide to build a smaller shopping center. I don’t mean this derisively. One of my biggest complaints is that Cameron Village needs to be expanded and that there is neither a Ross nor a Marshalls Inside-the-Beltline.

Yet, these are the complaints of investment and capital accumulation and we should understand that.

You can also think about how the type of things we debate on a macro level weigh against concerns like: local zoning restrictions or enterprise-ready open source software.


I forgot to note that I included manufacturing facilities in the “Everything Else” category even though they are buildings because most folks don’t regularly interact with a manufacturing plant.

I understand that this will be somewhat quite annoying. I can’t think of any other way, but it needs to be done. Perhaps, Matt Yglesias can help on the communication front.

Phil Izzo writes

People dropping out of the labor force are making the unemployment rate look smaller, but not as much as some might think.

The jobless rate was reported to be 8.3% in January, marking the fifth consecutive decline. Some greeted the drop with skepticism, noting that the labor force — the number of people working or actively looking for a job — has declined and that is distorting the number.

The unemployment rate is calculated by taking the number of unemployed and dividing it by the labor force. When people stop actively looking for work because they get discouraged, it reduces both the number of unemployed and the size of the labor force.

In the second bolded passage, Phil notes that when people drop out of the labor force it causes the unemployment rate to fall.

In the first bolded Phil says that people dropping out of the labor force makes the unemployment rate look smaller.

In the third bolded passage Phil says that there is fear that there is distortion.

In the post he moves on to provide empirical evidence.

Yet none is needed.

A thing cannot be distorted if it appears faithfully, which is what the bolded passages imply by syntactic construction.

This matters because virtually all of the errors that have been made by economists, analysts and the administration in regards to this recession have been logical errors, not misinterpretation of evidence.

Dozens of posts I haven’t had time to make but I’ll comment on this by Brad Delong.

Economagic Economic Chart Dispenser

I cannot help but think that I ought to have something truly smart to say about this graph.

But I don’t

Not sure what counts as smart but try this

The blue line tells you about the business cycle.

The red line tells you about government austerity and the labor-leisure tradeoff

Bryan has responded to my post on the sheepskin effect in typical Caplanian style: even if my critic is right, it just means I’m more right. In this case he says that my argument that ability bias explains some of the sheepskin effect is just evidence against the human capital model of education, because ability bias is a competing theory. I don’t have a dog in the bigger fight on what explains the overall education wage premium. It looks to me like the general consensus is behind the human capital theory, but I’m open to being convinced that signaling is an underexplored and underappreciated explanation. But I don’t think the story I’m telling about the sheepskin effect provide evidence against the human capital theory.

I would argue that Bryan is conflating two kinds of ability bias: the ability that endogenously determines the treatment of attending college, and the ability that endogenously determines the treatment of graduation conditional upon attending. It may be that randomly assigning people the treatment of attending college will lead to the exact same average estimated returns to education. This would not be inconsistent with claim that randomly assigning people to drop out of college would greatly reduce the measured sheepskin effect.

So why might ability bias be a bigger deal for graduating than for attending? Because even the dropouts themselves thought that they looked like someone who would complete college until at some point they no longer did. Attending and then dropping out of college, I would argue, most often results from some unpredicted negative shock. This becomes more true the longer someone attends college, because if you’ve spent 3.5 years in college thinking that this represented a good investment, you need a pretty big negative shock to make that no longer the case after the majority of the costs are sunk. This is going to be true as long as there is some signaling sheepskin effect.

I’m not positive this is correct, but I’m thinking of this ability bias as a downward bias on the part of the spline regression measuring the linear effect of years of education for years 12-16 rather than an upward bias on the dummy variable representing 16+ years of education.

Some notes on the comments I made here, inspired by correspondence.

Note 1: My comment was original in the sense that I didn’t pick it up from anywhere. However, its by no means a philosophical leap and so I would be shocked if no one has asserted it, even if there is some straight forward demonstration that it is wrong.

Note 2: When I say causality is superfluous I mean that it is not a meaningful metaphysical construct. Either you are talking about something plainly physical or you are talking about nothing.

You may be simply making a description of space-time. So if I say: “the cue ball hit the eight ball and caused it to move.” I may simply be describing the shape of these objects through time.

This is the same kind of statement as: “The camera is on the table”

We can further talk about the “statics” underlying the camera being on the table. Or we can talk about the “dynamics” of the cue ball hitting the eight ball. However, these are all generalizations of observations we have regarding objects in space-time.

And, importantly the generalizations are derived from objects that we have in fact experienced.

On the other hand, if you mean that there is some sort of metaphysical necessitation such that when cue balls hit eight balls the latter must move. And, further that this metaphysical necessitation may be hidden from us (ala David Hume) then you are speaking of nothing.

When people utter the words “the cue ball caused the eight ball to move”  they are usually providing a description of how they feel about the cue ball and the eight ball.

And, the reason that confirmation of this statement alludes us is because there is no truth to be had outside of the mental and emotional state of the speaker.

Note 3: None of this is to say that we can’t apply the term causation to our generalizations about the shape of objects through time. It is simply that this re-defining strips away any metaphysical specialness associated with the term.

This via Bill Mcbride is why I say the catch has not set in, from NAHB:

The apartment sector is a bright spot in the overall housing market leading the industry’s path to recovery. However, the lack of credit to finance the development of new apartments is likely to cause a supply and demand imbalance, said panelists during a press conference held today at the National Association of Home Builders (NAHB) International Builders’ Show (IBS) in Orlando, Fla.

Multifamily housing demand will outpace current capacity to finance production and could put the brakes on the recovering industry. “While we are forecasting construction of 208,000 multifamily residences in 2012, that figure is well below the 350,000 units a year that is needed to maintain balance in the market,” said Sharon Dworkin Bell, NAHB senior vice president for multifamily and 50+ housing

Point 1: Importantly for those who like to think in terms of multiple equilbria, I would not that Sharon Dworkin Bell and her panelists are simply taking the world as it is. They cannot get credit and so they are saying: because we cannot get credit we will not build as many homes as we would be profit maximizing to do.

They are not, however, suggesting that we have entered into some new regime where it doesn’t make sense to build apartments. No, the bank simply will not fork over the cash.

Point 2: Nonetheless, they still see a rise on the back of pure per-capita-depreciation. Last year there were only 165K stats and this year they are expecting a 30% increase, though they are noting that livable homes per capita will continue to fall.

Point 3: What Sharon Dworkin Bell and the NAHD cannot see is the dynamics on the entire system.

As the natural rate of interest rises, they will find that banks become more willing to lend. This will allow them to build more homes. This entire will increase banks willingness to lend. This will allow them to build still more homes.

This is why you can have a situation where the builders themselves are surprised at the total number of homes which they start the during the year.

This is what the Smith/Yglesias Thesis posits as “The Kick” and it seems fairly close at hand barring obvious shocks: euro crisis, US banking crisis, large tax increases, Fed raising rates prematurely, oil price dynamics that are contractionary and strongly so.


Also via Bill McBride from the NAHB

February 9, 2012 – The residential remodeling market will continue to experience measured growth in 2012 after the Remodeling Market Index (RMI) rose to a five year-high at the end of 2011, according to panelists at a press conference held today at the National Association of Home Builders (NAHB) International Builders’ Show (IBS) in Orlando, Fla. While the overall housing market conditions continue to create a drag on remodeling growth, the growing trend among home owners to remain in their homes and remodel has provided a boost to the remodeling market.

“Remodelers are poised to continue our industry’s gradual improvement as we start 2012,” said 2012 NAHB Remodelers Chairman George “Geep” Moore, Jr., CGR, CAPS, GMR, a remodeler from Elm Grove, La. “It is our hope that home owners who want to remodel this year face less constrictions from lack of financing, fear of lost equity and challenging appraisals.”

The strongest sectors of the remodeling market at present are aging-in-place retrofits, energy efficiency upgrades, and reinvesting in distressed properties.  The leading indicator for remodeling points to continued market volatility, but stronger growth in the second half of 2012.

Spending on improvements to owner-occupied housing is nearly equal to that of new residential construction,” said Paul Emrath, NAHB’s vice president for survey and housing policy research. “NAHB predicts that residential remodeling will rise 8.9 percent in 2012.”

I gave a talk at GMU on the Great Recession where I made the point that the key thing about structures is that they are stuck to the ground.

This means that when you want to build a structure you have to go tell a bank manger that you wish to take a bunch of his money and nail it to ground. When the value of the ground is collapsing the bank manager will understandably look at you askance.

However, the conversation is a bit easier when it comes to retrofitting a structure already attached to the ground. Thus we see this divergence where new construction hits record lows while remodeling hits record highs.

This is further evidence that the marginal product of residential capital is actually soaring but that credit and collateral constraints prevent builders from acting on it.

The sheepskin effect is the impact on your wages of completing college or high-school that is in addition to the marginal value of the years of educational experience. Consider someone one test from graduating college, so they have 96% of a college degree. The extent to which finishing college increases the wage premium by more than 4% is the sheepskin effect. Bryan Caplan has interpreted this effect as being strongly supportive of the signaling effect of education, but is this so? As Bryan puts it:

“If finishing your last year of college sharply boosts your income, the reason probably isn’t that colleges withhold the financially lucrative material until your senior year.”

But what does it tell you about someone when they have invested a lot of money into college, come very close to collecting the payoff, but then failed to do so 75% through their senior year? Is the only difference between this person and someone who finishes college really just the small amount of extra education and the sheepskin effect? It seems extremely likely to me that someone who fails to collect their sheekpskin effect is going to be systematically very different from someone who has, and most of the plausible differences I can imagine will tend to decrease future wages for the dropout.

This is to say that dropping out is not just lacking the positive signal of education completion, but having the negative signal of failing to collect a large NPV payout. The human capital model of education could be completely correct and it wouldn’t be inconsistent with falling short of graduation having a negative wage impact. This perhaps explains why, as Bryan tells us, the sheepskin effect takes such an incredibly long time to wear out: it’s an indicator of something real about human capital, and not just an indicator of college completion.

ADDENDUM: I sense I’m not really being clear here. To put it simply: people who drop out at 96% have more wrong with them than just having 4% less education than graduates. If u could cause random drop outs at 96% completion you would observe a much smaller sheepskin effect. I don’t believe it would be zero, but I think it is incorrect to interpret the sheepskin effect as being equivalent to the signaling effect of education alone. Call it the signaling effect of failing, as it is distinct from the normal signaling effect of education.

Here are three different looks at the job growth since the recession’s end, the 4-week average of initial claims, the ADP report and BLS Payroll.

FRED Graph

The Payroll measure is sans non-postal federal employees, the easiest way I could find to take out census.

In any case the story here is broadly consistent of ever new highs. The new claims data is also break strong new weekly lows (highs in this inverted chart), suggesting that our best guess at payrolls is a step up in the next report.

This period is crucial for the US economy because we have not yet hit “the kick.” That is, growth is not feeding on itself. This is – by my lights – all very basic depreciation of capital effects.

Once, the economy emerges from the Liquidity Trap then growth can self-feed. More jobs means more cars and homes, means more jobs . . .

At that point I think our major question mark is how oil affects the recovery. Its actually not easy to intuit. I will try to post on this later today but we can easily imagine a world of $5 gasoline in the not too distant future. The question is whether that brings growth to a halt, is only a speed-bump or indeed accelerates the rate of growth.

I could tell any of these stories and I am not sure at this moment how to sort through the fundamentals and pick which one is more likely.

Felix Salmon reports:

Bullard’s a career central banker who has never had a lucrative private-sector career, but he’s still doing OK for himself: his annual salary is $281,300, which should be more than enough to bring up a family of four in St Louis.

Here’s the thing, though: Bullard’s disclosure form is completely blank. Which means that, except for his house and his Federal Reserve retirement benefits, he has no investments at all worth more than $1,000 — not even a savings account. Or, to put it another way, the president of the St Louis Fed, earning well over a quarter of a million dollars a year, is living paycheck-to-paycheck. Every two weeks, he gets paid $10,819, less taxes and deductions, and yet by the end of the year he still doesn’t have even $1,000 in a checking account.

As well, he should.

Will Bullard be laid-off: Ha!

Is there a private label investment vehicle more secure than his Fed retirement benefits: Double-Ha!

The only question is whether he has disability insurance – which would be wise even in his case.

Otherwise, wherefore savings?

Savings are just a promise from one human to another. All promises can be broken. Bullard has a set of promises – explicit and implicit – from the folks who actually own the printing presses. Those are the kind of promises you want.

I have noticed that Bank Economists, and Financial Journalists seem to be very concerned about the labor force participation rate. Moreover, this concern preceded the recent hubbub over benchmarking the labor force.

My question – why?

To a first approximation I just don’t care about the labor force participation rate and I am not sure why anyone should. You could say that it reflects the size of the taxable economy moving forward and that’s important for measures of the burden of the welfare state, but lets be serious. The movements are small, the workers marginal and the general trend towards an aging nation visible for decades now.

Sometimes I think I am detecting a sense that folks are concerned that Labor Force participation will affect the unemployment rate. Eh. Its complicated but there is no lump of growth nor a lump of job creation even in a recession. To put it terms now common place, the number of people who want to work affects the natural rate of interest.

If lots of people are trying to work they will drive up demand for capital and durable goods in the attempt and this will drive up the natural rate. In the face of a constant Fed Funds rate this will mean a faster growing economy.

Just keeping track of stat I call New Private Labor Demanded. It is simply private job openings minus private quits. It’s a stab at how aggressively private businesses are trying to add workers. I’m thinking the creative part of creative-destruction.

FRED Graph

A few people have asked about my debate with Bryan Caplan on the issue of how deserving the poor are. I’ll try to give a sense of the case I wanted, though perhaps failed, to make.

My thesis may be best understood this way:

There is no reason to view emotional or mental deficiencies as different in kind from physical ones. To put it in the harshest of terms, if you think someone who is born blind is deserving of sympathy and support then you should think someone who is born lazy and stupid is deserving of sympathy and support.

Further once you concede that the lazy and stupid are deserving of sympathy then its difficult to construct a set of poor people who are not, since these are among the least sympathetic qualities that could cause someone to be poor.

Thus the vast majority of the poor are deserving of sympathy or support.


As to those attributes. To a wider audience this might be a question, but I had assumed that the audience I was going to speak to at GMU would swallow without objection the notion that IQ is more or less fixed before the age of 12. We can talk about the relative influence of genes, prenatal care, nutrition, early childhood education, lead, etc. However, I didn’t think they would dispute that your IQ is determined before what most people would think of as your moral agency. If so, can it reasonably be your fault that you are stupid?

As it happened I was also debating Bryan Caplan, who I thought and still think, would admit that one’s actual level of conscientiousness is probably genetically determined. And, further that this personality attribute underlies most of what the normal world would call “laziness.”

And so again, if one is sympathetic towards those born blind does it not follow that one should be sympathetic towards those born lazy?


Now, that having been said I recognize that there will be a huge visceral aversion to this line of reasoning. And, so I want to do what I can to calm that aversion.

My point was that the reason we feel so differently about disabilities like blindness as opposed to disabilities like laziness, is that its really difficult to fake being blind. Thus there is much less concern that the blind person is taking advantage of you by lying about their blindness.

Its much more difficult to confirm laziness. So much so that people are hesitant to think of it as not a innate property of the person at all. However, our psychological research strongly suggests that this is not true.

What is true is that someone could claim to be lazy when what they really are is indifferent to your suffering. They could say, “ Holding down a job is especially difficult for me” when in reality they feel “I am simply much more concerned with my own happiness than I am with yours and prefer a state of the world in which you suffer so I don’t have to”

Since from the outside we can’t tell which of those two things is true we reject all claims about laziness as unjustified.

However, we can recognize that this is a product of our limited knowledge and not the world itself. If we could tell who had genuinely low conscientiousness versus who simply claimed to have it in order to pass suffering on to others then we would want to distinguish between the two.

This means that our problem is practical and not moral.

It is not that the lazy are underserving but simply that we lack the technology to distinguish them from those faking laziness.

The irony of this, however, is that if we adopted an economic system that was extremely intolerant of laziness, then everyone who still exhibited laziness would be genuinely lazy.

The authentic thing to say to them then would be: I am very sorry that you were born this way. I wish things were different. Unfortunately we lack the technological sophistication to create a better world.

It would be inauthentic to say: You chose not to work and so you deserve what you get.

Indeed, as economists we can instantly detect the inauthenticity of the last statement by conducting the following thought experiment. Suppose that we took someone who is currently in poverty and told them that on threat of death they will obtain and hold a middle class job as well as save and invest according to middle class norms.

And, suppose the person complies. Would it then make sense to say: congratulations you deserve all the net happiness that comes from these actions? After all, our working assumption as economists is that the net happiness from these actions is negative.

That is, the cost of obeying these social norms exceeds the benefit of obeying them and that is precisely why the person didn’t do it of their own accord.

What does it mean to say that the desert of making hard choices is misery?

I think the natural response here would be to say, very well but how do you know they are miserable. Perhaps they feel the same I as I do but were even happier on the street.

Perhaps, and this goes to the deep question interpersonal comparisons of happiness and suffering. Yet, if we want to stop here and say “we can go no further” then don’t we have to give up on all of our notions of suffering and sympathy?

In the face of the seeming agony of  achild slowly dying of cancer and the parents grieving the creeping loss are we prepared to say: Well I really don’t know if the lived experience of these people is better or worse than my experience of a pin prick and so sympathy is unwarranted here.

My sense is that we do want to admit the meaningfulness of the suffering of others and that we have at least a somewhat workable mechanism at determining what that is. We should then apply this mechanism to those suffering from laziness.

My approach would go as follows. If you see someone who is a beach bum and looks to not have material care in the world you may be able to imagine saying “I wish that I could be as free of material concerns as that fellow.”

We would not deem him to be suffering and so his poverty is not something about which we would have sympathy.

On the other hand, if you observe an individual repeatedly trying to obtain and hold jobs and repeatedly being fired for not showing up on time or screwing off in minor ways, then we imagine saying “I am glad I am not this fellow. He can’t seem to get it together for the life of him.”

We would then deem him to be suffering and so his poverty is something about which we would have sympathy.

Taken all together this says: Even the least sympathetic reasons for being poor stem ultimately from inborn conditions. A person with those conditions faces a high tradeoff between material comfort and emotional distress. I can recognize what it would mean to say the nature of this tradeoff is preferable to my condition or unpreferable to my condition. If it is unpreferable then I can say, this person was born worse off than me and so is deserving of my sympathy.

And, since we find reason to be sympathetic to some of the least sympathetic reasons, for being poor, consistency should lead us to be sympathetic towards almost all reasons for being poor. And, hence we should declare that few if any persons deserve to be poor.

A Few Notes

Why does this matter: Well on one level I simply appeal to the aesthetic. We try to understand our world and our intuitions about it in a consistent way because doing so is beautiful.

In practice I would say it puts an increased focus on the ability of our technology to support the deserving poor without encouraging fakery.

In a very practical sense it might suggests that programs which depend on 1-1 relationships should be given high levels of moral praise as poverty elimination systems. So, that might mean local charities and organizations with the discretion to support individuals or not based on a long history of working with them should been seen as doing a special good.

Isn’t poverty much more complicated than you laid out: For sure. My point is that there are lots of gray areas regarding sympathy and poverty, but rather than getting bogged down in that lets look at the strongest reasons to be unsympathetic and see if they withstand scrutiny.

Is this just more Pity-Charity Liberalism: Yes. And, I think it’s an ethically more meaningful enterprise than getting up in arms about failures of the meritocracy. I don’t know any moral reason why the talented deserve to prosper and the untalented to fail and so the leveling-of-the-playing-field is of purely instrumental importance. It matters if it makes a more productive society or increases personal fulfillment, but it is not a moral cause unto itself.

I’ve been unavailable for a bit and will do a sort of potpourri post commenting on issues that I missed. This is convenient for me since it allows me to treat many issues in a cursory manner and without facing too much scrutiny leave myself painted in the best light.

Smithianism and Recovery Winter

Matt Yglesias’s and my joint theme of a near-term turn around in the US economy got a big boost on Friday with a strong jobs report. That said, the underlying notions at work here are not chartism – the idea that things will get better because they have been getting better – there is a logic to this story that goes beyond one month’s worth of data. I’ll pick that up later in the post.

For now, I want to say that I have two problems with Matt’s use of the phrase Recovery Winter.

First – and most importantly – “Recovery Winter” lacks the degree shameless self-promotion that the phrase Smithianism delivers and does little to flaunt the genius associated with our early revelation. I would like to say my early revelation and argue that Matt’s grace was to be wise enough to know truth when he read it, but I cannot be sure.

Second, it hangs its hat on the winter in a way that is not fundamental to the thesis. A shock could come that slows the economy next month or the month after. However, unless it is a particularly strong nominal shock it will not change the underlying dynamics and the economy should come roaring back as the shock subsides. Again, there are fundamentals at work here.

Where is Keynes?

There seems to be some argument over whether or not a recovery at this time could be seen as Keynesian?

I think some of the disagreement and some of the widespread disbelief come out of the sense that government is the major player in the recovery.

Now the US government – in all in facets – has some extraordinary powers. Those powers allow it to influence an economy over the course of the business cycle. However, it is not as if the economy is somehow simply the product of government policy. Even if the government does nothing, something will nonetheless happen, and indeed an entire dynamical system will be at work.

Regarding our present case, we might have wanted the mountain to come to Mohammed and for the government to take action to raise the natural nominal rate of interest, either through borrowing and spending on government-y things; transferring monies such that they moved from the liquidity free to the liquidity constrained; or by promising to deliver more inflation.

The US government, for the most part, demurred.

In the short-run this is tragic, but in the long run it will not effect the path of the economy. Mohammed shall go to the mountain.

That is to say, the natural rate of interest will rise on its own through obsolesce, decay and increases in population. We can literally – and I mean literally – see this at work. I hope to talk more about this in a series on “Touching the Capital Stock”

The point, however, is getting all wrapped up in government policy is likely to obscure your vision of how the economy works. And, it is working in a way that looks thoroughly Keynesian to me.

The Tortoise and the Hare

Kathleen Madigan argues that the recent burst in hiring is just catch-up and that we will return to a slow and gloomy trend. I have fundamental reasons for doubting this.

We really are short on housing and vacancies are low. The inventory of unsold houses looks big but it is tiny in comparison to the stock. What’s more the gap between current for-sale inventory and “normal” inventory is not as large as the gap between the current households and a “normal” number of households given population.

The size of the vehicle stock in the US is falling. And, let me be clear on this: I am not saying that we are producing fewer cars. I am saying the total number of drivable cars in America shrinks with each passing day. Deprecation is in excess of production. And the rate of depreciation is set to increase markedly.

Household debt obligations as a percentage of Personal Income are quite low and may very well hit a record low over the next year.

How can this be you ask? We have so much debt! The rate dear friend, the rate. If everyone refinanced into a 1% mortgage and 2% credit consolidation loan, household financial obligations would hit the floor.

Sadly, this shall not come to pass.

Nonetheless, we are still looking at record low refinancing for many households and very importantly we are looking at record low financing for new households. To be young and have a job in 2011 was a many splendid thing. And, though the unemployment rate was high, millions of people still fit in that category.

Still the people demand charts and so, I will chart.

FRED Graph

The unadjusted rolling 12 month change in payrolls is rising. What’s more we are currently plowing through at 2.9 Million SAAR. If the next two months deliver even a 2.2 – 2.4 Million SAAR then we will clearly break trend here. Even in pure chart form a mean reversion argument has to deliver quickly, if it is likely to deliver at all.

Multiple Equilibria

Noah Smith likes models that produce long recessions as a consequence of multiple equilbria. I like all kinds of models. Good stories can be good to tell and to learn to tell well even if they aren’t strictly speaking “true” – whatever we might mean by that.

However, I would note that one problem with the multiple equilibrium story in general, is that world of recessions just doesn’t look like that. The world of long run growth, sure. But, the world of recessions is full of talk of “if only” not “that’s just not how things work these days”

That is, people don’t act like they look out their window and see a world that has by its nature changed since 2005. They look out their window and say that they don’t have the opportunities they had in 2005. They are describing constraints, not a different equilibrium path.

Now perhaps we can say path determination occurs on Wall Street and the consumer or businessman in the street just lives with it. That I could go with. Still it seems a stretch.

Future Congresses Spending Future Monies and Collecting Future Taxes in the Future

Its interesting to note the volume of chatter amongst policy wonks – though notably not actual changes in policy – that center around projections of the future.

This is only one of many charts that I see folks getting exercised about


Now I do understand that the purpose of this chart is to accuse others of being ne’er-do-wells and miscreants. Which is fine. Yet, in my heart I fear that there are a few cold and lonely souls who seek to truly change the world for the better. Such dreams should be crushed before they come to crush the dreamer.

So, one of the key things about the future is that it is not now. Yet, you are, by the very nature of your being, now. This puts a fundamental wall of separation between you and the future. This wall can be breached by your imagination but that is only imagination. It does not exist outside of your mind.

What you can do is, right now, create artifacts that will exist through time and thus be available to “you” in the future. You can also – though I caution everyone against this – enlist the promises of other persons to do things for you in the future.

The availability of these two options gives people a false sense of connection with the future that they then port into realms where it does not apply. Government budgeting is one of these.

For the law is no artifact and the promises of government are enforced ultimately by the government itself – which is to say not enforced in any meaningful sense of the term. Future congresses will do exactly what they want with exactly the resources they have available to them at the time.

Now, if you are absurdly clever you might get future congresses to want different things by framing the political zeitgeist in ways that suit you. More likely, however, efforts at attempting to influence future deficits by getting something different to happen in the future are a waste of time.

Still, one could build a bunch of infrastructure now, in the hopes that it would still be here in the future and thus support future generations. Or, one could try to uncover a bunch of scientific principles that will aid mankind in the future. These are real things that could be done now. Though I doubt that they will really make difference.

One could import a bunch of taxpayers who, presuming they set down roots and integrate themselves into the economy, will pay taxes in the future. This is a real thing that could make a difference by its sheer size. But, it works, if it all, precisely because you could do it now.

On the other hand, thinking that you are going to implement some plan to spend a lot less money or collect a lot more money from some given group of people in the distant future is a fool’s errand.

Overpaying Government Workers

Adams writes

Likely prompted by a new CBO study that argues federal workers are overpaid relative to private sector workers, Karl presents two questions I believe meant to imply that the government cannot overpay for workers

. . .

I could buy Karl’s story that extra wages was buying valuable extra skills. This could be the case if the “overpaying” was happening for financial industry regulators. But the CBO report shows that the overpayment amount is inversely correlated with the level of education, with the most overpayment coming for workers with less than a bachelors degree., e.g. those that are least likely to have heterogeneous skills that extra wages can buy, and jobs with the flexibility to have those skills pay off.

I pose two questions. My co-blogger disagrees with my story. Noah Smith scores the debate.

Soon I will write a one-word book and all the world will be abuzz.

Until then though, the point of that was, that simply by offering more money the government cannot upend the principles of supply and demand. Simply comparing the wages and salaries of private sector workers to public sector workers doesn’t tell you whether the supply or the demand differs and it doesn’t tell you what factors influence either of these.

There are many dimensions on which this can operate but two obvious ones are these. First, the government may seek to hire an engineer to fire rockets into space. So it turns out not a lot of people are offering this type of job. So it also turns out lots of little kids dream about having this job. One result of these two facts is that other things being equal the government might be able to get away with paying the engineer less than he or she could demand elsewhere.

On the other hand, the Department of Defense hires civilians to drive trucks and stock shelves who are expected to conduct themselves with a level of professionalism exceeding that of the median high-school-or-less worker. The DoD is also not shy about stating that it would prefer not to deal with lifelong civilians at all, if it can get away with it.

Well qualified veterans in the Best-Qualified category who provide all applicable veterans’ documentation (see “Required Documents” for more information) and meet all experience and/or education requirements will be referred before non-veteran candidates.  If there are no well qualified veterans in the Best-Qualified category who have provided all applicable veterans’ documentation, non-veterans will then be referred for consideration.

Perhaps you don’t approve of these preferences. Which is fine.

However, at a minimum we want to ask who is the government turning away and why, and who is turning down the government and why.

What does Apple owe it’s workers? I’ve read some silly proposals since the big New York Times story on the difficult and sometimes dangerous conditions in it’s factories. For instance, the idea that Apple should give some of it’s massive cash horde to workers in China. But Apple and its shareholders don’t owe these workers anything, and they certainly haven’t taken anything from them. In fact, in operating out of self-interest they have helped bid up the wages of the workers there. It is profit seeking by corporations, and not their charity or generosity, that has and continues to greatly improved the lives of the global poor.

Since Apple is already giving so much to the workers of China as a byproduct of self-interest, why of all the charitable causes they could spend their profits on should they decide to use them on workers in China who are relatively well off compared to the rest of China? People in China are clamoring for jobs in Foxconn, why should Apple provide charity to the relatively lucky ones who have jobs already? This is to say nothing of the extremely poor in many areas of the world. This also makes the questionable presumption that it is corporations rather than shareholders who should be engaging in charity.

The most positive thing you can say of the criticism of Apple is that there are probably some margins where more safety, health, and working conditions can be achieved at a relatively low-cost, and that by being profit motivated Apple is likely to press it’s supply chain to find these least-cost improvements. If anyone is going to find welfare improving changes to make, it will be them and not regulators or other government entities.

The most negative thing you can say is that this whole incident creates the false appearance that, once again, Apple and other multi-national corporations are doing something wrong when in fact they are having an extremely positive impact. Public opinion isn’t a nuanced thing, and the general perception here does not seem to be of a tremendously good process that is doing a lot for the global poor, but could perhaps be slightly improved on the margin, but more importantly should not be significantly impeded. Instead we’re seeing guilt, shame, and outrage directed broadly at Apple, globalization, and ourselves.

Another risk is that public outrage pushes Foxconn and other manufacturers to replace workers with robots faster than they would if they simply were minimizing costs. There is nothing wrong with mechanization per se, and it is in many cases inevitable. But mechanization is a good thing because it is cost minimizing and productivity enhancing, if done on the margin for PR it lacks it lacks that benefit.

Arguments like I’m making here spur a lot of righteous indignation, and complaints that I and others who refuse to scream that something must be done are uncaring and we simply place no value on the lives of the Chinese. I’m afraid these people don’t even understand what the disagreement is about. Or as Paul Krugman once put so aptly:

Such moral outrage is common among the opponents of globalization–of the transfer of technology and capital from high-wage to low-wage countries and the resulting growth of labor-intensive Third World exports. These critics take it as a given that anyone with a good word for this process is naive or corrupt and, in either case, a de facto agent of global capital in its oppression of workers here and abroad.

But matters are not that simple, and the moral lines are not that clear. In fact, let me make a counter-accusation: The lofty moral tone of the opponents of globalization is possible only because they have chosen not to think their position through. While fat-cat capitalists might benefit from globalization, the biggest beneficiaries are, yes, Third World workers.

Trust me: I really don’t care that much about paying a little more for my Apple products, just like I doubt Paul Krugman cares about paying a little more for his sneakers. I also value the welfare of the workers of China very highly. More highly, it would seem, than those who constantly call on politicians and corporations to “bring back our jobs from overseas”, and complain about outsourcing. Those who would paint this disagreement as being between those who care about poor foreigners and those who don’t are either lying of confused.

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