"It is increasingly clear by now that a severe U.S. recession is inevitable in next few months. Those of us who warned for the last 12 months about a combination of a worsening housing recession, a severe credit crunch and financial meltdown, high oil prices and a saving-less and debt-burdened consumers being on the ropes causing an economy-wide recession were repeatedly rebuffed the consensus view about a soft landing given the presumed resilience of the US consumer."Roubini is a smart economist who often goes against the consensus view."But the evidence is now building that an ugly recession is inevitable."
Saturday, May 31, 2008
Nouriel Roubini: "clear by now that a severe U.S. recession is inevitable in next few months."
Nouriel Roubini, a leading economist at New York University, is now saying that a US Recession is almost here:
Friday, May 30, 2008
Why the Telecoms Shouldn't Get Immunity for Spying on Americans
House Democrats will soon propose to deny legal protection to phone companies that helped the National Security Agency wiretap Americans without warrants after 9/ll. This makes sense.
I'm old enough to remember J. Edgar Hoover’s FBI and Nixon’s CIA, and the Federal Intelligence Surveillance Act of 1978. But anyone who's even halfway sentient ought to know there's a Fourth Amendment to the Constitution. So you'd think that executives at the nation’s biggest telecoms -- AT&T, Verizon, and so on -- would be alert to the possibility that government might illegally snoop on Americans. Yet these executives didn’t blink an eye when the NSA came knocking. You want records of domestic phone calls? Sure, help yourself! Emails? Yeah, we got tons. They’re yours!
When word of this leaked out and the companies got sued by Americans who didn’t particularly like the idea of government rummaging through everything they said or wrote, the telecoms went to Congress and complained it wasn’t their fault. They deserved immunity from such lawsuits, they said, because they were only following orders.
Only following orders? What if the government told telecoms to use their technologies to spy on American bedrooms, or turn over our bank accounts, or our photographs, home videos, anything else we store on computers or transmit through cables or over the Internet? The "only following orders" excuse would make telecoms extensions of our spy agencies.
Corporate executives have a duty to disobey government orders when they have reason to believe those orders are illegal or unconstitutional -- and make the government go to court to get what it wants. The duty to refuse is especially important when it comes to the nation’s telecoms, whose technological reach is extending deeper and deeper into our private lives.
Sure, there’s a delicate balance between fighting terrorism and protecting civil liberties. But that’s for courts to decide – not spy agencies and not telecom executives. If in doubt, the telecoms could have gone to the special courts set up precisely to oversee this balance, and get a declaratory judgment. The House proposal would give federal courts special authority to hear classified evidence and decide whether the phone companies should be held liable.
The only way to keep pressure on telecoms to protect Americans, and not become agents of our spy agencies, is to continue to allow Americans to sue them for violating their legal rights.
I'm old enough to remember J. Edgar Hoover’s FBI and Nixon’s CIA, and the Federal Intelligence Surveillance Act of 1978. But anyone who's even halfway sentient ought to know there's a Fourth Amendment to the Constitution. So you'd think that executives at the nation’s biggest telecoms -- AT&T, Verizon, and so on -- would be alert to the possibility that government might illegally snoop on Americans. Yet these executives didn’t blink an eye when the NSA came knocking. You want records of domestic phone calls? Sure, help yourself! Emails? Yeah, we got tons. They’re yours!
When word of this leaked out and the companies got sued by Americans who didn’t particularly like the idea of government rummaging through everything they said or wrote, the telecoms went to Congress and complained it wasn’t their fault. They deserved immunity from such lawsuits, they said, because they were only following orders.
Only following orders? What if the government told telecoms to use their technologies to spy on American bedrooms, or turn over our bank accounts, or our photographs, home videos, anything else we store on computers or transmit through cables or over the Internet? The "only following orders" excuse would make telecoms extensions of our spy agencies.
Corporate executives have a duty to disobey government orders when they have reason to believe those orders are illegal or unconstitutional -- and make the government go to court to get what it wants. The duty to refuse is especially important when it comes to the nation’s telecoms, whose technological reach is extending deeper and deeper into our private lives.
Sure, there’s a delicate balance between fighting terrorism and protecting civil liberties. But that’s for courts to decide – not spy agencies and not telecom executives. If in doubt, the telecoms could have gone to the special courts set up precisely to oversee this balance, and get a declaratory judgment. The House proposal would give federal courts special authority to hear classified evidence and decide whether the phone companies should be held liable.
The only way to keep pressure on telecoms to protect Americans, and not become agents of our spy agencies, is to continue to allow Americans to sue them for violating their legal rights.
Thursday, May 29, 2008
Wednesday, May 28, 2008
The fiscal stimulus: ineffective or wrong?
The latest economic data show that output growth has weakened and unemployment is creeping up. The government is worried, with good reason, that the economy is going through a pronounced slowdown, perhaps even a recession. To limit the damage, Congress yesterday approved a battery of fiscal measures. By my reckoning, however, the plan will at best provide a short-lived nudge to consumption, but not employment; at worst, it’ll do nothing.
Starting in May, the government will send $600 checks to individuals ($1,200 for couples and an extra $300 for each child). People who earn too little to pay income taxes, but make more than $3,000, will receive a $300 payment. Payments will total $106 billion and will add to the budget deficit.
Cash outlays are supposed to boost private consumption expenditures and accelerate overall growth. $106b may seem a small stimulus for a $14 trillion economy, but the payments are expected to have a “multiplier effect”: higher demand will prompt businesses to hire more workers, and increased employment will further stimulate private consumption, which in turn will induce more hiring. The process continues ad infinitum. The outlays, therefore, can have a final effect on aggregate demand that is many times bigger than the initial stimulus —hence the name “multiplier.”
The effectiveness of the measure hinges on two factors. First, the fraction of the government outlays that will be spent immediately. According to Bruce Bartlett, previous experiences with tax rebates in 1975 and 2001 indicate that it's small. The recent study by Elmendorf and Furman indicates that it's a 50 percent.
The second requirement, which has received less attention, is that businesses will respond to the initial surge in demand by hiring new workers. If they don’t, then the fiscal package will have no second-round impact on demand, and the stimulus to consumption will total just $50b.
Because the first two quarters of 2008 will be marked by considerable uncertainty about the course of the economy in the medium term, the announcement of the fiscal plan will not have an immediate effect on hiring. Manufacturers may ratchet up their inventories, in anticipation of the small jolt of demand in May, but they will do so by using overtime and temp workers, rather than hiring permanent employees. In the services sector, we won’t see any change in employment until the late spring, and even then employers will similarly meet spikes in demand with overtime hours and temp workers, at least initially. If, come June, forecasts have improved, we may see employment pick up over the fall. But by then the effect of the government checks will have played out. In conclusion, the fiscal package won’t provide any significant boost to employment.
A less obvious reason to reject the stimulus is that the slowdown in aggregate demand is necessary, even healthy. Most of the growth experienced between 2002 and 2006 was based on low interest rates, over-valued real estate, and loose lending standards.
Chart 1, from a story by Michael Mandel at BusinessWeek, tells it all. Mandel estimates that, “if consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.” That extra spending was financed with debt. Quite literally, Americans were borrowing their prosperity from the future —not exactly a sustainable growth path.
Chart 1 (left) and 2 (right). Click to enlarge.
The growth of productivity, the value of output per hour worked, confirms the hypothesis that consumer expenditures were out of line with real income gains, at least over the last five years. Robert Gordon of Northwestern University estimates that trend productivity growth peaked in 2002, and has slowed down ever since (see Chart 2, via Michael Mandel’s blog). The gap between long-term growth of GDP and consumption, on the other hand, has widened over the same period.
So, if the recent growth rate of expenditures was excessive, why is Congress rushing to prop it up? More importantly given that the stimulus will be financed with future tax increases: why are legislators borrowing even more from future prosperity? The answers to these questions have a lot to do with politics and very little with economics.
Notice the hodgepodge of enigmatic measures included in the fiscal package. Congress grants payments of $300 to low-income seniors and disabled veterans, but not to other disabled people. It allows federal housing agencies to insure jumbo mortgages, as if subsidies to the purchase of expensive homes was going to parachute the economy. And it includes specific provisions to prevent illegal immigrants from claiming payments, precluding illegals from contributing to the consumption surge, however small that may be. So, if you think about it for a minute, what Congress did is give itself a votes-buying package, which does stimulate something: re-election.
Technorati tags:
economics, macroeconomics, fiscal policy, fiscal stimulus, stabilization policy
Starting in May, the government will send $600 checks to individuals ($1,200 for couples and an extra $300 for each child). People who earn too little to pay income taxes, but make more than $3,000, will receive a $300 payment. Payments will total $106 billion and will add to the budget deficit.
Cash outlays are supposed to boost private consumption expenditures and accelerate overall growth. $106b may seem a small stimulus for a $14 trillion economy, but the payments are expected to have a “multiplier effect”: higher demand will prompt businesses to hire more workers, and increased employment will further stimulate private consumption, which in turn will induce more hiring. The process continues ad infinitum. The outlays, therefore, can have a final effect on aggregate demand that is many times bigger than the initial stimulus —hence the name “multiplier.”
The effectiveness of the measure hinges on two factors. First, the fraction of the government outlays that will be spent immediately. According to Bruce Bartlett, previous experiences with tax rebates in 1975 and 2001 indicate that it's small. The recent study by Elmendorf and Furman indicates that it's a 50 percent.
The second requirement, which has received less attention, is that businesses will respond to the initial surge in demand by hiring new workers. If they don’t, then the fiscal package will have no second-round impact on demand, and the stimulus to consumption will total just $50b.
Because the first two quarters of 2008 will be marked by considerable uncertainty about the course of the economy in the medium term, the announcement of the fiscal plan will not have an immediate effect on hiring. Manufacturers may ratchet up their inventories, in anticipation of the small jolt of demand in May, but they will do so by using overtime and temp workers, rather than hiring permanent employees. In the services sector, we won’t see any change in employment until the late spring, and even then employers will similarly meet spikes in demand with overtime hours and temp workers, at least initially. If, come June, forecasts have improved, we may see employment pick up over the fall. But by then the effect of the government checks will have played out. In conclusion, the fiscal package won’t provide any significant boost to employment.
A less obvious reason to reject the stimulus is that the slowdown in aggregate demand is necessary, even healthy. Most of the growth experienced between 2002 and 2006 was based on low interest rates, over-valued real estate, and loose lending standards.
Chart 1, from a story by Michael Mandel at BusinessWeek, tells it all. Mandel estimates that, “if consumer spending had tracked the overall economy over the past decade as it has in the past, Americans today would be spending about $600 billion less a year. The extra spending has amounted to a total of about $3 trillion since 2001.” That extra spending was financed with debt. Quite literally, Americans were borrowing their prosperity from the future —not exactly a sustainable growth path.
Chart 1 (left) and 2 (right). Click to enlarge.
The growth of productivity, the value of output per hour worked, confirms the hypothesis that consumer expenditures were out of line with real income gains, at least over the last five years. Robert Gordon of Northwestern University estimates that trend productivity growth peaked in 2002, and has slowed down ever since (see Chart 2, via Michael Mandel’s blog). The gap between long-term growth of GDP and consumption, on the other hand, has widened over the same period.So, if the recent growth rate of expenditures was excessive, why is Congress rushing to prop it up? More importantly given that the stimulus will be financed with future tax increases: why are legislators borrowing even more from future prosperity? The answers to these questions have a lot to do with politics and very little with economics.
Notice the hodgepodge of enigmatic measures included in the fiscal package. Congress grants payments of $300 to low-income seniors and disabled veterans, but not to other disabled people. It allows federal housing agencies to insure jumbo mortgages, as if subsidies to the purchase of expensive homes was going to parachute the economy. And it includes specific provisions to prevent illegal immigrants from claiming payments, precluding illegals from contributing to the consumption surge, however small that may be. So, if you think about it for a minute, what Congress did is give itself a votes-buying package, which does stimulate something: re-election.
Technorati tags:
economics, macroeconomics, fiscal policy, fiscal stimulus, stabilization policy
Tuesday, May 27, 2008
Monday, May 26, 2008
The American Recession and the World's Emerging Economies
It used to be that when the American economy sank into recession, developing economies sank along with it. But that probably won't happenthis time. And a big reason lies in the Middle East and in China.
Much of the Middle East is swimming in oil money -- petro-dollars -- while China has built up its own huge stock of sino-dollars. These petro-dollars and sino-dollars aren't just sitting there in the Middle East and in China. They're being put to work - building new infrastructure in both places: skyscrapers, power plants, power grids, roads, ports. And building middle classes that, while still relatively small, want the things middle classes in advanced nations want - cars, refrigerators, houses, and lots of stuff to fill their houses.
All this spending on infrastructure and on goods and services by emerging middle classes, in turn, is pulling in resources, goods and services from the rest of the world. That includes exports from other emerging economies.
This means the world's developing nations are no longer nearly as dependent as they used to be on consumers in the United States and other rich nations to keep them going by buying their exports. In fact, consumer spending is rising almost three times as fast in developing nations as in rich nations. Real capital spending is rising by double digits there while it's rising only a bit over 1 percent a year in rich nations. And emerging economies' trade with each other is increasing faster than their trade with richer nations.
Is this de-coupling of emerging from developed economies good news for the United States? Yes and no. It's good news to the extent that even as America falls into recession, developing nations will continue to demand some of our exports. They'll also continue to generate healthy returns for American investors who put money into them. And they'll invest in U.S businesses and financial institutions that desperately need the capital. These revenues will offset a bit of the decline here.
But in a more significant way, the de-coupling is not at all good news for us. It means the price of many things we buy from developing nations -- especially raw materials like oil - will continue to be high, and might even rise. Years ago, recessions in the United States depressed prices in the developing world, including oil prices -- and these price drops helped cushion us against even deeper recessions. Now it's the reverse. China's almost insatiable need for Middle-East oil, for example, continues to bolster oil prices even though demand for oil is slowing here as the American economy slows. As a result, high global oil prices are making our slump even worse.
So it's two cheers for the developing world. Emerging economies are growing almost regardless of downturns in rich nations. In terms of global equity and long-term stability, we should all be happy about that. But viewed narrowly and in the short term, from the perspective of world's richest nation now heading into deep recession, it's only two cheers rather than three.
Much of the Middle East is swimming in oil money -- petro-dollars -- while China has built up its own huge stock of sino-dollars. These petro-dollars and sino-dollars aren't just sitting there in the Middle East and in China. They're being put to work - building new infrastructure in both places: skyscrapers, power plants, power grids, roads, ports. And building middle classes that, while still relatively small, want the things middle classes in advanced nations want - cars, refrigerators, houses, and lots of stuff to fill their houses.
All this spending on infrastructure and on goods and services by emerging middle classes, in turn, is pulling in resources, goods and services from the rest of the world. That includes exports from other emerging economies.
This means the world's developing nations are no longer nearly as dependent as they used to be on consumers in the United States and other rich nations to keep them going by buying their exports. In fact, consumer spending is rising almost three times as fast in developing nations as in rich nations. Real capital spending is rising by double digits there while it's rising only a bit over 1 percent a year in rich nations. And emerging economies' trade with each other is increasing faster than their trade with richer nations.
Is this de-coupling of emerging from developed economies good news for the United States? Yes and no. It's good news to the extent that even as America falls into recession, developing nations will continue to demand some of our exports. They'll also continue to generate healthy returns for American investors who put money into them. And they'll invest in U.S businesses and financial institutions that desperately need the capital. These revenues will offset a bit of the decline here.
But in a more significant way, the de-coupling is not at all good news for us. It means the price of many things we buy from developing nations -- especially raw materials like oil - will continue to be high, and might even rise. Years ago, recessions in the United States depressed prices in the developing world, including oil prices -- and these price drops helped cushion us against even deeper recessions. Now it's the reverse. China's almost insatiable need for Middle-East oil, for example, continues to bolster oil prices even though demand for oil is slowing here as the American economy slows. As a result, high global oil prices are making our slump even worse.
So it's two cheers for the developing world. Emerging economies are growing almost regardless of downturns in rich nations. In terms of global equity and long-term stability, we should all be happy about that. But viewed narrowly and in the short term, from the perspective of world's richest nation now heading into deep recession, it's only two cheers rather than three.
Sunday, May 25, 2008
Saturday, May 24, 2008
Recession buzz
Chart 1 (click to enlarge)
It’s been hard for news readers to avoid the word “recession” this January. The number of newspaper stories mentioning it has certainly been overwhelming (see Chart 1). Weak economic data might seem to justify the gloom. Growth has slowed down and the labor market has weakened. Still, we haven’t seen a single quarter of negative growth, and the employment figures have been equivocal, and certainly not recessionary. So, given what we know about the state of the economy, is all this recession chatter justified, or are journalists getting carried away?
To answer that question, I have put together data on the tone of economic reporting in the newspapers, as well as on indicators of the health of the real economy. Then I have estimated a statistical model and compared the level of pessimism of the newspapers with the actual mood that one would expect based on the known state of the economy. The results are pretty exciting. So exciting, in fact, that I plan on updating and reporting my calculations every month, here on EconWeekly.
My measure of usage of the word “recession” is The Economist’s R-word index: the number of stories containing that word in the New York Times and the Washington Post. The index is a surprisingly good indicator of economic slowdowns. It never fails to rise sharply at the beginning of recessions. (See Chart 2.) And in spite of its simplicity, it captures the sentiment of the newspapers pretty well. Mark Doms and Norman Morin, of the Federal Reserve Board, constructed a much fancier recession index for a research project on the subject, containing dozens of media sources and carefully filtering the search terms. And yet, the difference between their measure and The Economist’s R-word index is almost always small. (See Figure 4.1 in Doms and Morin’s paper.)
Chart 2 (click to enlarge)
To gauge the present and immediate future of the economy, I include the following variables in my statistical model: the unemployment rate, the growth of the S&P500 index, the growth of the price of oil, the growth of personal consumption expenditures, and the spread between the ten-year bond and the one-year Treasury bill. (Econometrics jocks can find the details of the statistical model below.)
My model shows that newspapers have indeed been too gloomy this past month. In January, known economic conditions would have justified about 200 stories mentioning the word “recession”; the actual count was around 300. Up until December, however, newspaper mood was approximately in line with the actual state of the economy. (See Chart 3.) Why did newspaper sentiment diverge from economic fundamentals last month?
Chart 3 (click to enlarge)
In January we witnessed a sequence of unusual events. There was ongoing talk about the fiscal stimulus package, which is being introduced precisely to avoid an economic slowdown. The President sketched a plan on January 18, then the House of Representatives announced theirs a week later, and then the Senate considered changing it. Then there was a mini crash in the stock market, followed by the surprise cut of the Federal Reserve’s target interest rate on January 22, and then another cut at the Fed’s scheduled meeting on the 30th. Every newspaper story that reported any of these events most likely included the word “recession.”
But, at least in part, I believe that the buzz has to do with incentives in the news industry. Even when reporting facts, every media outlet strives to agree with the views of its audience. Fox News would lose its parish if it started “showing” that the Iraq surge was wrong and ineffective, and the Wall Street Journal would clash against the opinions of its readers if it started “proving” that the Bush tax cuts were a bad idea. Maintaining an audience depends vitally on conforming to their prior expectations. (Note to self: what do EconWeekly readers expect?)
Economics reporting is a bit different because the state of the economy can be measured and verified more objectively. As a result, views are more homogeneous across audiences. Still, media outlets need to take into account three factors which determine the views news consumers, and therefore the choice of tone and volume of economic reports: intrinsic pessimism, past reports on the state of the economy, and reports from other media outlets.
Bryan Caplan of George Mason University has identified pessimism as one of the four capital biases of the average Joe. (Read this summary.) People routinely see negative trends in long-term living standards, wages, inequality, etc. The gloom extends to the state of the economy at any given moment. About half of Americans have been thinking that we are in a recession, or on the brink of one, since October! Where that pessimism comes from, I have no idea. David Hume, Caplan says, thought that “the humour of blaming the present, and admiring the past, is strongly rooted in human nature.” It sounds appealing. But whichever the reason, the media recognize the appeal of worrying reports about the economy —and deliver.
Inherent pessimism influences the interpretation that the media put on any given piece of hard data. But once the newspapers set clouds in the horizon, their incentives to deliver negative news become stronger, because they need to conform to the readers’ expectations. A newspaper that changed its view on the state of the economy would go against the prior views —plus, it would be accused of the horrible crime of flip-flopping. A newspaper has therefore an incentive to keep a certain mood even on something as relatively objective as the state of the economy. Past negative reports will lead to more negative reports in the future, feeding a cycle of pessimism, unless new hard data against such views are so strong that the paper is forced to tone it down over time.
Finally, people are exposed to reports from more than one source of information, even if it’s secondhand. Any newspaper that strayed from the average mood of all other newspapers would conflict with the established view, alienating itself. Any given outlet has thus an incentive to stay in line with the tone of all the major media, resulting in “herd behavior”: the tendency to base decisions (in this case the tone of the news) on the behavior of the rest of the community (other media outlets).
The combination of natural pessimism and the need to conform to the public’s views, therefore, explains why sometimes reporting on the economy is not consistent with actual events, as is the case now. Only policymakers, animal spirits and time can determine whether we’ll see a recession in 2008. For now, skip the editorials on economics.
Statistical model:
VAR, with monthly data, from January of 1976 through the latest month available. Each equation includes six lags. The variables are: the R-word index, the unemployment rate, the change in nonfarm payrolls, the slope of the yield curve (10-year minus 1-year), the growth of personal consumption expenditures on durable goods accumulated over the current and previous two months, and the growth of the industrial production index, also accumulated over the same period. I also include a set of monthly dummies and a dummy variable that equals 1 if the NBER announced a decline in real GDP. The unemployment rate is the first release reported by the BLS. The change in payrolls mimics the one reported by the BLS, that is, it is equal to the first estimate of payrolls for month t, minus the revised (first update) figure for month t-1. Both unemployment and payroll figures come from ALFRED. The yields on the ten-year bond and the one-year Treasury bill are monthly averages, from FRED. Durable expenditures come from the NIPA accounts, via FRED, and the industrial production index is from the Federal Reserve, also via FRED.
Technorati tags:
economics, news, media bias, recession, media
Friday, May 23, 2008
Economy Slowing Says Calculated Risk
Great Blogger, Calculated Risk "Clearly the economy is slowing sharply"
Thursday, May 22, 2008
Will HRC Spoil the Party?
I'm thrilled at the record Democratic turnouts across the country, and at the ground-breaking reality of the Democrats' two candidates. But I'm also becoming anxious at the prospect of a fight that could reduce the possibility of either of them entering the White House in January of 2009.
Is HRC willing to sacrifice that possibility in order to preserve a tiny possibility that she'll get the nomination? With her win in Ohio and projected win in Texas, that seems so. In the days leading up to the Ohio and Texas primaries, we had HRC's statement that both she and McCain have the experience to be Commander-in-Chief but Obama doesn't. This is the first time in my memory that a major candidate in a primary has said that the other party's nominee would be a better president than his or her own primary opponent. We also had the outpouring of negative advertising from her campaign that both candidates had largely managed to avoid up to this point.
And while I can understand her decision -- bolstered by yesterday's results -- to fight on in this primary election, the reality is that she can only win by convincing large numbers of superdelegates to join her and re-engineering the Michigan and Florida primaries to her advantage, and then taking the fight all the way to the convention in August -- which if she gets that far, will be one of the most divisive in forty years.
I suppose I should not be surprised. If HRC has experience in anything, it's in fighting when cornered. When Bill Clinton lost his governorship, it was HRC who commissioned Dick Morris to advise the Clintons on a no-holds-barred campaign to retake the governor's mansion. At the start of 1995, when Newt Gingrich and company took over Congress and the Clinton administration looked in danger of becoming irrelevant, it was HRC who installed Dick Morris in the White House, along with his sidekick Mark Penn, to "triangulate" by distancing Bill Clinton from the Democratic Party and moving the Administration rightward. (When Morris was subsequently discovered to have a penchant for the toes of prostitutes the White House dumped him but kept Penn on.) And now Mark Penn is the "chief strategist" of HRC's campaign.
The sad news is that whether the Clinton scorched-earth strategy ultimately succeeds or fails, it will have caused great harm. In the unlikely event it succeeds, the result will be a shame and not a little ironic. Barack Obama has breathed life into the Democratic Party, and into American politics, for the first time in forty years. Not since Robert Kennedy ran for president has America been so starkly summoned to its ideals; not since then has America -- including, especially, the nation’s youth -- been so inspired. The Clintons would prefer to write off “Obamania” as a passing fad, but the reality is that idealism and inspiration are necessary preconditions for positive social change. Nothing happens in Washington unless Americans are energized and mobilized to make it happen. HRC's tactics are the old politics the nation is recoiling from -- internal division and national fear. This only serves to deepen Americans' cynicism about politics, and makes social change all the harder to achieve.
Is HRC willing to sacrifice that possibility in order to preserve a tiny possibility that she'll get the nomination? With her win in Ohio and projected win in Texas, that seems so. In the days leading up to the Ohio and Texas primaries, we had HRC's statement that both she and McCain have the experience to be Commander-in-Chief but Obama doesn't. This is the first time in my memory that a major candidate in a primary has said that the other party's nominee would be a better president than his or her own primary opponent. We also had the outpouring of negative advertising from her campaign that both candidates had largely managed to avoid up to this point.
And while I can understand her decision -- bolstered by yesterday's results -- to fight on in this primary election, the reality is that she can only win by convincing large numbers of superdelegates to join her and re-engineering the Michigan and Florida primaries to her advantage, and then taking the fight all the way to the convention in August -- which if she gets that far, will be one of the most divisive in forty years.
I suppose I should not be surprised. If HRC has experience in anything, it's in fighting when cornered. When Bill Clinton lost his governorship, it was HRC who commissioned Dick Morris to advise the Clintons on a no-holds-barred campaign to retake the governor's mansion. At the start of 1995, when Newt Gingrich and company took over Congress and the Clinton administration looked in danger of becoming irrelevant, it was HRC who installed Dick Morris in the White House, along with his sidekick Mark Penn, to "triangulate" by distancing Bill Clinton from the Democratic Party and moving the Administration rightward. (When Morris was subsequently discovered to have a penchant for the toes of prostitutes the White House dumped him but kept Penn on.) And now Mark Penn is the "chief strategist" of HRC's campaign.
The sad news is that whether the Clinton scorched-earth strategy ultimately succeeds or fails, it will have caused great harm. In the unlikely event it succeeds, the result will be a shame and not a little ironic. Barack Obama has breathed life into the Democratic Party, and into American politics, for the first time in forty years. Not since Robert Kennedy ran for president has America been so starkly summoned to its ideals; not since then has America -- including, especially, the nation’s youth -- been so inspired. The Clintons would prefer to write off “Obamania” as a passing fad, but the reality is that idealism and inspiration are necessary preconditions for positive social change. Nothing happens in Washington unless Americans are energized and mobilized to make it happen. HRC's tactics are the old politics the nation is recoiling from -- internal division and national fear. This only serves to deepen Americans' cynicism about politics, and makes social change all the harder to achieve.
Wednesday, May 21, 2008
Tuesday, May 20, 2008
On college endowments
According to a study released yesterday by the National Association of College and University Business Officers (NACUBO), the endowment fund of Harvard University is worth $34.6 billion, a 19.8% percent higher than a year ago. 76 colleges and universities sit on endowments over $1b. Even more impressively, almost every one of the 733 institutions analyzed reports a double-digit increase in the value of its fund. (Look up the endowment of your alma mater here.)
Chart 1 (click to enlarge)
The increase in the value of the endowments has been the result of at least two factors: risk taking and stock market bonanza. First, higher-education institutions invest large portions of their wealth on high-risk, high-return securities. On a dollar-weighted average, in 2007 they held a 47.4% of their funds in equities, an 18.2% in hedge funds, a 5.4% in private equity, and a 3.6% on venture capital investments. Wealthier universities hold riskier portfolios than the average. (See Chart 1.)
Second, average stock prices have increased almost every single year for over 25 years. In spite of the burst of the dot-com bubble in 2000, the inflation-adjusted Dow Jones Industrial Average Index ended 2007 at a level five times higher than in 1982. Even the most passive portfolio manager would have achieved high returns in this stock market.
Chart 2 (click to enlarge)
No surprise then that most universities have performed so well. Over the last ten years, the return on most endowments beats the S&P 500 index, which grew at a healthy 7.1% annual rate itself. (See Chart 2.) In the case of the largest portfolios, universities beat the market by a long shot.
News of these fabulous riches has prompted some sectors to demand that universities share more of their wealth. Lawmakers remind them that, as tax-exempt institutions, “they’re supposed to offer public benefit in return for (that) exemption.” Private foundations, which are also tax-exempt, are required by law to spend 5% each year; the average for colleges is 4.6%, with little variation across levels of wealth (see data). Parents, on the other hand, don’t understand why tuition keeps going up while universities continue to amass wealth. Little do they suspect that the cost of college is stoked by the self-interest of parents and students themselves, not that of universities.
The classic explanation for the rise of tuition is that the college premium —the positive gap between the earnings of college graduates and high school graduates— has increased the demand for college education, thereby raising its equilibrium price.
More interestingly, the stock market has also made tuition rates go up, according to a paper* by my former colleague at the University of Chicago Pablo Peña (pdf). Rises in asset prices increase the amount of resources available to universities. Part of that wealth is spent on inputs that improve the quality of education: more and better qualified professors, and newer and more sophisticated facilities, such as labs, computers and libraries, for instance. Higher quality, in turn, increases the amount of human capital accumulated in college, and ultimately affects life-time earnings, i.e. the returns to education. Prestige considerations may be at work too: celebrity professors and state-of-the-art facilities increase the reputation of the institution, adding to the value of the diploma. Therefore, larger endowments spur the demand for college education, and drive up tuition rates.
Differences in the value of endowments across universities are vast: the combined value of the top ten colleges represents 35% of total endowment assets. In light of Pablo’s theory, the implications of this inequality depend on what universities and colleges spend their money on.
If they continue to use their wealth to improve the quality of the service they provide, demand for college education and tuition levels will continue to rise. Differences in tuition rates and education quality between top-notch and second-tier institutions will continue to widen too, since endowments and asset returns are highly concentrated. Also, because the ablest students —those with highest SAT scores or best records of achievement in high school— benefit the most from the quality of college education, the matching of the best students with the best institutions will intensify. Differences in the quality of students across colleges will increase.
On the other hand, universities could start using their endowments to increase capacity or subsidize the cost of college. In this unlikely scenario, the equilibrium price of higher education will probably decline, the quality of college education will drop, and the college premium —the earnings of college graduates vis-Ã -vis high-school graduates— will drop.
Selected institutions have recently been announcing that they will increase financial aid. Recent announcements might suggest that this could actually happen among selected institutions. Harvard and Dartmouth have eliminated loans from their aid packages and will be giving grants instead; and Yale has followed in their footsteps. These de facto cuts in average tuition rates are not going to change the system. First, they won’t change the quality of education at top universities, for which the foregone tuition revenue is peanuts. Second, they won’t reduce the cost of attendance of the average college student, because the number of institutions that can afford foregoing tuition revenues is small.
But improved aid packages at top schools will make their programs affordable to the brightest students, regardless of their financial situation. If the newfound altruism of the Harvards and Yales has any effect, that will be an even more pronounced assortative matching of colleges and applicants by quality. The scope of these developments is very limited, but it’s good news —at least for believers, like myself, in a free, merit-based education system.
More data:
Tuition rates: table of nominal rates (html), graph of real rates (pdf, Figure 1)
Technorati tags: economics, education, college, endowments, college tuition
Chart 1 (click to enlarge)
The increase in the value of the endowments has been the result of at least two factors: risk taking and stock market bonanza. First, higher-education institutions invest large portions of their wealth on high-risk, high-return securities. On a dollar-weighted average, in 2007 they held a 47.4% of their funds in equities, an 18.2% in hedge funds, a 5.4% in private equity, and a 3.6% on venture capital investments. Wealthier universities hold riskier portfolios than the average. (See Chart 1.)
Second, average stock prices have increased almost every single year for over 25 years. In spite of the burst of the dot-com bubble in 2000, the inflation-adjusted Dow Jones Industrial Average Index ended 2007 at a level five times higher than in 1982. Even the most passive portfolio manager would have achieved high returns in this stock market.
Chart 2 (click to enlarge)
No surprise then that most universities have performed so well. Over the last ten years, the return on most endowments beats the S&P 500 index, which grew at a healthy 7.1% annual rate itself. (See Chart 2.) In the case of the largest portfolios, universities beat the market by a long shot.
News of these fabulous riches has prompted some sectors to demand that universities share more of their wealth. Lawmakers remind them that, as tax-exempt institutions, “they’re supposed to offer public benefit in return for (that) exemption.” Private foundations, which are also tax-exempt, are required by law to spend 5% each year; the average for colleges is 4.6%, with little variation across levels of wealth (see data). Parents, on the other hand, don’t understand why tuition keeps going up while universities continue to amass wealth. Little do they suspect that the cost of college is stoked by the self-interest of parents and students themselves, not that of universities.
The classic explanation for the rise of tuition is that the college premium —the positive gap between the earnings of college graduates and high school graduates— has increased the demand for college education, thereby raising its equilibrium price.
More interestingly, the stock market has also made tuition rates go up, according to a paper* by my former colleague at the University of Chicago Pablo Peña (pdf). Rises in asset prices increase the amount of resources available to universities. Part of that wealth is spent on inputs that improve the quality of education: more and better qualified professors, and newer and more sophisticated facilities, such as labs, computers and libraries, for instance. Higher quality, in turn, increases the amount of human capital accumulated in college, and ultimately affects life-time earnings, i.e. the returns to education. Prestige considerations may be at work too: celebrity professors and state-of-the-art facilities increase the reputation of the institution, adding to the value of the diploma. Therefore, larger endowments spur the demand for college education, and drive up tuition rates.
Differences in the value of endowments across universities are vast: the combined value of the top ten colleges represents 35% of total endowment assets. In light of Pablo’s theory, the implications of this inequality depend on what universities and colleges spend their money on.
If they continue to use their wealth to improve the quality of the service they provide, demand for college education and tuition levels will continue to rise. Differences in tuition rates and education quality between top-notch and second-tier institutions will continue to widen too, since endowments and asset returns are highly concentrated. Also, because the ablest students —those with highest SAT scores or best records of achievement in high school— benefit the most from the quality of college education, the matching of the best students with the best institutions will intensify. Differences in the quality of students across colleges will increase.
On the other hand, universities could start using their endowments to increase capacity or subsidize the cost of college. In this unlikely scenario, the equilibrium price of higher education will probably decline, the quality of college education will drop, and the college premium —the earnings of college graduates vis-Ã -vis high-school graduates— will drop.
Selected institutions have recently been announcing that they will increase financial aid. Recent announcements might suggest that this could actually happen among selected institutions. Harvard and Dartmouth have eliminated loans from their aid packages and will be giving grants instead; and Yale has followed in their footsteps. These de facto cuts in average tuition rates are not going to change the system. First, they won’t change the quality of education at top universities, for which the foregone tuition revenue is peanuts. Second, they won’t reduce the cost of attendance of the average college student, because the number of institutions that can afford foregoing tuition revenues is small.
But improved aid packages at top schools will make their programs affordable to the brightest students, regardless of their financial situation. If the newfound altruism of the Harvards and Yales has any effect, that will be an even more pronounced assortative matching of colleges and applicants by quality. The scope of these developments is very limited, but it’s good news —at least for believers, like myself, in a free, merit-based education system.
More data:
Tuition rates: table of nominal rates (html), graph of real rates (pdf, Figure 1)
Technorati tags: economics, education, college, endowments, college tuition
Monday, May 19, 2008
Risk Factors For A 2008 Recession
Here are the top risk factors for 2008 US Recession:
- Continuing Housing Bust
- High Oil Prices
- Security Issues
- Credit Crunch
- High Consumer Debt
- Large Trade Deficit
- Consumer Spending is slowing (it makes up 70% of the US GDP)
- Commercial Construction decline
Sunday, May 18, 2008
Are We Heading for Another Great Depression (Part Two)
I think the chances of a Depression are no higher (and not much lower) than twenty percent. Why not higher? Because, unlike then, our monetary authorities know how and when to pump more money into the economy; our Congress and White House know how and when to stimulate with fiscal policy; and the US economy is more integrated with the rest of the world (which is riding out the storm better than we are) than then. But no lower because the similaries with what led to the Great Depression are so stark. Then what do I suggest in addition to the standard remedies? Here's what I wrote in the NY Times a few weeks ago:
TOTALLY SPENT
WE’RE sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn.
The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going.
The only lasting remedy, other than for Americans to accept a lower standard of living and for businesses to adjust to a smaller economy, is to give middle- and lower-income Americans more buying power — and not just temporarily.
Much of the current debate is irrelevant. Even with more tax breaks for business like accelerated depreciation, companies won’t invest in more factories or equipment when demand is dropping for products and services across the board, as it is now. And temporary fixes like a stimulus package that would give households a one-time cash infusion won’t get consumers back to the malls, because consumers know the assistance is temporary. The problems most consumers face are permanent, so they are likely to pocket the extra money instead of spending it.
Another Fed rate cut might unfreeze credit markets and give consumers access to somewhat cheaper loans, but there’s no going back to the easy money of a few years ago. Lenders and borrowers have been badly burned, and the values of houses and other assets are dropping faster than interest rates can be lowered.
The underlying problem has been building for decades. America’s median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what’s been earned in America since then has gone to the richest 5 percent.
Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us because, after all, they’re rich. They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.
The problem has been masked for years as middle- and lower-income Americans found ways to live beyond their paychecks. But now they have run out of ways.
The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. The percentage of American working mothers with school-age children has almost doubled since 1970 — to more than 70 percent. But there’s a limit to how many mothers can maintain paying jobs.
So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.
But there’s also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks by refinancing home mortgages and taking out home-equity loans. But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.
The binge seems to be over. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth.
The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. That would only drive up the prices of everything purchased from abroad. Most routine jobs are being automated anyway.
A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. The current supplement for a worker with two children who earns up to $16,000 a year is about $5,000. That amount declines as earnings increase and is eliminated at about $38,000. It should be increased to, say, $8,000 at the low end and phased out at an income of $46,000.
We also need stronger unions, especially in the local service sector that’s sheltered from global competition. Employees should be able to form a union without the current protracted certification process that gives employers too much opportunity to intimidate or coerce them. Workers should be able to decide whether to form a union with a simple majority vote.
And employers who fire workers for trying to organize should have to pay substantial fines. Right now, the typical penalty is back pay for the worker, plus interest — a slap on the wrist.
Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.
These measures are necessary to give Americans enough buying power to keep the American economy going. They are also needed to overcome widening inequality, and thereby keep America in one piece.
TOTALLY SPENT
WE’RE sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn.
The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going.
The only lasting remedy, other than for Americans to accept a lower standard of living and for businesses to adjust to a smaller economy, is to give middle- and lower-income Americans more buying power — and not just temporarily.
Much of the current debate is irrelevant. Even with more tax breaks for business like accelerated depreciation, companies won’t invest in more factories or equipment when demand is dropping for products and services across the board, as it is now. And temporary fixes like a stimulus package that would give households a one-time cash infusion won’t get consumers back to the malls, because consumers know the assistance is temporary. The problems most consumers face are permanent, so they are likely to pocket the extra money instead of spending it.
Another Fed rate cut might unfreeze credit markets and give consumers access to somewhat cheaper loans, but there’s no going back to the easy money of a few years ago. Lenders and borrowers have been badly burned, and the values of houses and other assets are dropping faster than interest rates can be lowered.
The underlying problem has been building for decades. America’s median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what’s been earned in America since then has gone to the richest 5 percent.
Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us because, after all, they’re rich. They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.
The problem has been masked for years as middle- and lower-income Americans found ways to live beyond their paychecks. But now they have run out of ways.
The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. The percentage of American working mothers with school-age children has almost doubled since 1970 — to more than 70 percent. But there’s a limit to how many mothers can maintain paying jobs.
So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.
But there’s also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks by refinancing home mortgages and taking out home-equity loans. But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.
The binge seems to be over. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth.
The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. That would only drive up the prices of everything purchased from abroad. Most routine jobs are being automated anyway.
A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. The current supplement for a worker with two children who earns up to $16,000 a year is about $5,000. That amount declines as earnings increase and is eliminated at about $38,000. It should be increased to, say, $8,000 at the low end and phased out at an income of $46,000.
We also need stronger unions, especially in the local service sector that’s sheltered from global competition. Employees should be able to form a union without the current protracted certification process that gives employers too much opportunity to intimidate or coerce them. Workers should be able to decide whether to form a union with a simple majority vote.
And employers who fire workers for trying to organize should have to pay substantial fines. Right now, the typical penalty is back pay for the worker, plus interest — a slap on the wrist.
Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.
These measures are necessary to give Americans enough buying power to keep the American economy going. They are also needed to overcome widening inequality, and thereby keep America in one piece.
Saturday, May 17, 2008
Friday, May 16, 2008
Income mobility and education
As goats on a tree, reaching for the best leaves, we all strive to be the ones at the top. But even in America, the land of opportunity, only good climbers make it. And lately even the fittest seem to be having a hard time.
The table below shows the percentage of people who moved from a given group in the income distribution to any other one, between 1994 and 2004. (The data come from the Panel Study of Income Dynamics, and the income measure is household taxable earnings.) The lowest degree of income mobility occurs among the poorest and the wealthiest: 58% of households in the bottom 20% of the distribution stay there, and 60% of those in the wealthiest quintile don’t move either.
Pooling people from all ages together, however, can be misleading. The typical earnings profile over a lifetime is hump-shaped: earnings start low, rise up until the individual is in her 50s, then begin a slow decline, and fall sharply with retirement. Because of this non-monotonicity, movements up and down the earnings distribution may have little to do with climbing the social ladder.
As an example: suppose the economy is populated by two individuals, one of whom is 35 and earns $45,000, and the other one is 55 and makes $75,000. So the older person is at the top of the distribution. Ten years later, the young individual has accumulated experience and earns $65,000, whereas the older person, now 65, has retired and doesn’t earn any labor income. The younger individual is at the top of the earnings distribution now. If we were oblivious to the age of these individuals, this two-person society would look remarkably mobile: the poorer person moved to the top and vice versa. In reality, the observed mobility is the product of the normal course of earnings over peoples’ lives.
The fortunes of a person are more likely to change early in life. Twentysomethings are less likely to be attached to a house, a family, or a job. They job-hop, experiment, go back to school. Over time, some people land a dream job —or a “comfort job”— and stay there. And some others simply grow roots: they have mortgages to pay, and spouses and kids to drag along. We also become more risk averse with age.
The data bear these intuitions: 67% of households whose head was between 22 and 29 in 1994 had switched quintiles ten years later; 54% of those between 30 and 39 did so, about the same as among the 40-49 age group.
Things get much more interesting when I look at mobility within education groups. Schooling is probably the single most important factor determining a person’s chance to “make it.” People with less education are less employable. They also experience smaller changes in productivity, so their earnings curve is less steep. And they have fewer opportunities to fill high-powered positions —the sort that provide a pay boost if one is successful. In this, however, the evidence doesn't support my expectations.
Between 1975 and 1985, and within the group of college graduates, 61% of households moved to a different economic class, whereas 59% of high school graduates were mobile -barely a difference. And twenty years later, 54% of college grads and 60% of people with a high school degree were mobile. (See chart.)
Click to enlarge
What made the economic ladder more slippery for college grads? Following the reasoning above, maybe people have less appetite for risk, and are taking jobs that are safer but also offer fewer opportunities to leap-frog over income classes. Starting up a business, for instance, is one of the riskiest endeavors one could pursue. But statistics show that animal spirits have not subdued —the fraction of entrepreneurs and self-employed has risen over the last 30 years.
A second explanation is that unobserved ability, not education, is behind opportunity. A couple of decades ago earning a college degree was a major feat. Only the well-off, highly-motivated and bright ever put their feet in a University. Nowadays going to college is almost a given. As a result a college degree has become a weaker signal of one’s competence. Highly capable individuals still get ahead, but the vast majority of college graduates do not belong to that breed.
Finally, but not less importantly, it might be a problem of too many grads chasing too few jobs with incentive-based pay. In spite of all the talk about stock options, the number of positions with (significant) variable compensation has grown more slowly than the body of individuals with a University diploma. More well-educated people land jobs without the power or the incentives to rise fast on the pay scale.
This calcification of the white-collar society is worrying. More and more individuals go to graduate school in order to earn that M.B.A., M.A., or even Ph.D., that will give them an edge over their peers. That behavior is perfectly rational, and yet self-defeating. The latest batches of college grads remind me of hamsters on a wheel rather than goats.
Technorati tags: economics, income mobility, inequality, income inequality, upward mobility
Thursday, May 15, 2008
Recession Fears Grow
Reuters reports that "Unsold goods are piling up in warehouses as the housing meltdown and soaring oil prices strain consumers, raising fears that already glum fourth-quarter growth prospects may tip toward recession."
"The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.
"The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.
"We expect the challenging retail environment to continue for the foreseeable future," Mike Ullman, chairman and chief executive officer of department store chain J.C. Penney (JCP.N: Quote, Profile, Research), said last week. He added that the company would keep inventory levels tight through 2008."
Respected economist Nouriel Roubini writes "Any recession call for the U.S. is clearly dependent on US consumption faltering. Since residential investment is only 5% of even a worsening housing recession cannot – by itself – trigger an economy-wide recession. Rather, since private consumption is over 70% of aggregate demand a sharp and persistent slowdown in consumption growth – below 1% or even negative - is necessary to trigger a full blown recessionWednesday, May 14, 2008
Are We Heading for Another Great Depression?
Probably not. But go back 75 years and you'll find eerie similarities. Marriner S. Eccles who served as Franklin D. Roosevelt’s Chairman of the Federal Reserve from November, 1934 to February, 1948 gave his view of what caused the Depression in his memoirs, "Beckoning Frontiers" (New York, Alfred A. Knopf, 1951):
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression.
As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low. Private debt outside of the banking system increased about fifty per cent. This debt, which was at high interest rates, largely took the form of mortgage debt on housing, office, and hotel structures, consumer installment debt, brokers' loans, and foreign debt. The stimulation to spending by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices. Earnings began to disappear, requiring economies of all kinds in the wages, salaries, and time of those employed. And thus again the vicious circle of deflation was closed until one third of the entire working population was unemployed, with our national income reduced by fifty per cent, and with the aggregate debt burden greater than ever before, not in dollars, but measured by current values and income that represented the ability to pay. Fixed charges, such as taxes, railroad and other utility rates, insurance and interest charges, clung close to the 1929 level and required such a portion of the national income to meet them that the amount left for consumption of goods was not sufficient to support the population.
This then, was my reading of what brought on the depression.
Tuesday, May 13, 2008
Who's Paying For Your Fix?
by Kate Duncan
May/Jun 2003 Issue
Unless your morning latte was a fair trade blend, it probably cost more than what the farmer who picked the beans earns in a day.
Conventional coffee prices are at their lowest in a century, even below the cost of production. Farmers have been leaving the fruit to rot on the tree, pulling the kids out of school, abandoning the family land and pouring into the cities to find non-existent work. That’s why, as the most heavily traded commodity after oil, and the most common beverage after water, coffee is a major focus of the fair trade movement.
If your morning latte was a fair trade brew, it means the person who farmed the beans is earning enough to support his family. This is all well and good, but the way fair trade is usually explained - with prices, numbers and statistics - ignores it’s lasting benefits. The true point of fair trade is the cultural, communal, and environmental stability it bolsters.
A farmer who sells through fair trade is a member of a cooperative that is a vehicle for community empowerment. And not just a neighborhood watch: The people typically organized via fair trade are those whom the free market has filtered to the lowest economic stratum. Rather than maneuvering them into a position where they’re forced to take what they can get, fair trade recognizes farmers as equal partners, a platform from which they can command more control over their business and lives.
'Fair trade is a different kind of business relationship between the producer and buyer, which has been an inspiration to help these communities pull together instead of caving to the pressure of all the things trying to blow them apart,' says Monika Firl. Monika heads up producer relations for Cooperative Coffees, and as such, led half a dozen coffee roasters and me (as a grateful representative of Idyll Development Foundation, one of Cooperative Coffee’s funders) on a buying trip to farmers’ co-ops in Nicaragua, Guatemala, and Mexico in February, where we were able to see the effect for ourselves. [Clamor]
Monday, May 12, 2008
Personal bankruptcy and consumption smoothing
The welfare effects of bankruptcy legislation are not correctly understood. Policymakers and the general public think, for the most part, that laws that protect borrowers in the event of default are beneficial to consumers. In practice, however, those laws have negative effects on the households that need credit most — and, ironically, those whom the legislation was intended to protect.
Traditionally, Chapter 7 has been the most popular type of bankruptcy filing. Under that section of the Bankruptcy Code, a filer relinquishes her assets, minus a certain exempted amount, and in return is discharged from her unsecured debt (credit card debt, personal loans, student loans, etc.).
State law sets those exempted amounts. In Illinois, for instance, exemptions are: $7,500 for home equity, $1,200 for motor vehicles, $750 for tools of the trade, and $2,000 for any other generic property. So suppose that you file for bankruptcy in the “Land of Lincoln,” and that you have $20,000 worth of home equity, and a car with a market value of $600. Then you can sell the house and keep $7,500 of the proceeds, and sell your car and keep the $600 (since that’s below the $1,200 limit).
Since 1978, with the passage of the Bankruptcy Reform Act (BRA), there’s also a federal exemption. Some states allow filers to choose between the state and the federal amounts. Obviously, if given the opportunity, filers use whichever is highest.
There is an enormous disparity of bankruptcy exemptions across states, even after accounting for the existence of the federal limits. For example, in 2006 the states of Texas, Florida, Oklahoma, Iowa, Kansas, South Dakota, and the District of Columbia, all allowed for an unlimited homestead exemption. In the states of Ohio and Virginia, at the other extreme, the limit is set at $5,000 (and those states don’t allow for the application of the federal exemption). The map below shows the maximum exemption that a married homeowner could claim in 2003, after combining homestead and non-homestead amounts, and taking the highest of the state and federal limit (where the federal limit is available). The limits also vary over time, although high-exemption states tend to remain the same over the years.
The amount of the exemption provides insurance for the debtor’s consumption. Suppose that a debtor suffers a setback, such as illness or unemployment, and that she is forced to default on her credit card debt and student loans. In the absence of any exemption, creditors would take a blanket security interest in all of the debtor’s possessions. The existence of an exemption means that she is left with at least a small amount of assets after filing for bankruptcy. Legislators see it as a way to provide a “fresh start.” An alternative view is that a certain amount of assets, and hence consumption, are insured against negative events.
On the other side of the coin, lenders are hurt by this form of consumer protection. Higher exemptions reduce the payments received by the lender in the event of default, and increase the probability of bankruptcy, since the borrower’s punishment for doing so becomes smaller. Creditors rationally respond to higher exemptions by raising interest rates and rationing credit. This rationing may take the form of fewer households with access to debt, smaller loans, or both. Fewer and smaller loans reduce the amount of consumption that households can finance with debt in times of low income.
In theory, then, bankruptcy exemptions have an ambiguous effect on consumption smoothing. Higher exemptions allow bankrupt households to keep more assets; but those same higher exemptions reduce the supply of credit. It is, therefore, an empirical matter whether higher limits enhance or detract from the role of debt as a consumption insurance mechanism.
To answer that question, I put together data on consumption and lay-offs of American households (from the Panel Study of Income Dynamics), as well as bankruptcy exemptions, for as many years as I could get consistent data for. (In practice, that is 1976 through 2003, with the exception of 1994-1997.) The idea is to estimate by how much a family’s consumption is reduced when its main income earner gets laid off, and see how much the hit to consumption changes with the bankruptcy exemption.
As a warm-up and point of reference, I estimate that, without taking into account the exemptions, a household whose breadwinner gets laid off reduces its consumption by five to six percent. Once I include bankruptcy laws in the econometric analysis, I find that households that live in states with unlimited exemptions reduce their consumption by 16 to 18 percent. Households in the top third of the distribution of (limited) exemptions reduce their consumption by nine to ten percent. For households with lower exemptions the effect of unemployment on consumption is low and statistically insignificant. (See chart.)
Click to enlarge
My interpretation of the results is that consumer debt is an important mechanism of consumption insurance. People use loans and credit card debt not only to finance big-ticket items, but also to make ends meet when disaster strikes. Legislation that makes it harder to obtain debt, such as bankruptcy exemptions or interest rate caps, ends up punishing the weakest: people with low wealth, who could make the most use of credit as an insurance device.
Don’t get me wrong: this is not a call to eliminate bankruptcy exemptions. There is a place for them as a means to provide safety to people who have been struck by unexpected events. A zero-exemption policy would probably expand credit supply — at the cost of leaving thousands of families destitute and without a chance to recover. But exorbitant homestead exemptions go way beyond providing a chance for a “fresh start.” Likewise, there’s no reason why people should be allowed to keep $60,000 worth of personal property, as they can do in Texas.
Surely, medical expenses can easily run into the hundreds of thousands of dollars. But that’s a reason to reform health insurance. Limiting the enforceability of credit contracts is a bad way to lay out safety nets.
This post was based on my own research. The write-up of the paper is still in the making. It will be available on my website by January 28. In the meantime, you can have a look at the slides I prepared for a presentation this Friday.
Technorati tags: economics, personal bankruptcy, consumption, bankruptcy exemption, consumption smoothing
Traditionally, Chapter 7 has been the most popular type of bankruptcy filing. Under that section of the Bankruptcy Code, a filer relinquishes her assets, minus a certain exempted amount, and in return is discharged from her unsecured debt (credit card debt, personal loans, student loans, etc.).
State law sets those exempted amounts. In Illinois, for instance, exemptions are: $7,500 for home equity, $1,200 for motor vehicles, $750 for tools of the trade, and $2,000 for any other generic property. So suppose that you file for bankruptcy in the “Land of Lincoln,” and that you have $20,000 worth of home equity, and a car with a market value of $600. Then you can sell the house and keep $7,500 of the proceeds, and sell your car and keep the $600 (since that’s below the $1,200 limit).
Since 1978, with the passage of the Bankruptcy Reform Act (BRA), there’s also a federal exemption. Some states allow filers to choose between the state and the federal amounts. Obviously, if given the opportunity, filers use whichever is highest.
There is an enormous disparity of bankruptcy exemptions across states, even after accounting for the existence of the federal limits. For example, in 2006 the states of Texas, Florida, Oklahoma, Iowa, Kansas, South Dakota, and the District of Columbia, all allowed for an unlimited homestead exemption. In the states of Ohio and Virginia, at the other extreme, the limit is set at $5,000 (and those states don’t allow for the application of the federal exemption). The map below shows the maximum exemption that a married homeowner could claim in 2003, after combining homestead and non-homestead amounts, and taking the highest of the state and federal limit (where the federal limit is available). The limits also vary over time, although high-exemption states tend to remain the same over the years.
Bankruptcy exemptions under Chapter 7 of the Bankruptcy Code
(in 2003, for a home owner)
Click to enlarge
(in 2003, for a home owner)
Click to enlarge
The amount of the exemption provides insurance for the debtor’s consumption. Suppose that a debtor suffers a setback, such as illness or unemployment, and that she is forced to default on her credit card debt and student loans. In the absence of any exemption, creditors would take a blanket security interest in all of the debtor’s possessions. The existence of an exemption means that she is left with at least a small amount of assets after filing for bankruptcy. Legislators see it as a way to provide a “fresh start.” An alternative view is that a certain amount of assets, and hence consumption, are insured against negative events.
On the other side of the coin, lenders are hurt by this form of consumer protection. Higher exemptions reduce the payments received by the lender in the event of default, and increase the probability of bankruptcy, since the borrower’s punishment for doing so becomes smaller. Creditors rationally respond to higher exemptions by raising interest rates and rationing credit. This rationing may take the form of fewer households with access to debt, smaller loans, or both. Fewer and smaller loans reduce the amount of consumption that households can finance with debt in times of low income.
In theory, then, bankruptcy exemptions have an ambiguous effect on consumption smoothing. Higher exemptions allow bankrupt households to keep more assets; but those same higher exemptions reduce the supply of credit. It is, therefore, an empirical matter whether higher limits enhance or detract from the role of debt as a consumption insurance mechanism.
To answer that question, I put together data on consumption and lay-offs of American households (from the Panel Study of Income Dynamics), as well as bankruptcy exemptions, for as many years as I could get consistent data for. (In practice, that is 1976 through 2003, with the exception of 1994-1997.) The idea is to estimate by how much a family’s consumption is reduced when its main income earner gets laid off, and see how much the hit to consumption changes with the bankruptcy exemption.
As a warm-up and point of reference, I estimate that, without taking into account the exemptions, a household whose breadwinner gets laid off reduces its consumption by five to six percent. Once I include bankruptcy laws in the econometric analysis, I find that households that live in states with unlimited exemptions reduce their consumption by 16 to 18 percent. Households in the top third of the distribution of (limited) exemptions reduce their consumption by nine to ten percent. For households with lower exemptions the effect of unemployment on consumption is low and statistically insignificant. (See chart.)
Click to enlarge
My interpretation of the results is that consumer debt is an important mechanism of consumption insurance. People use loans and credit card debt not only to finance big-ticket items, but also to make ends meet when disaster strikes. Legislation that makes it harder to obtain debt, such as bankruptcy exemptions or interest rate caps, ends up punishing the weakest: people with low wealth, who could make the most use of credit as an insurance device.
Don’t get me wrong: this is not a call to eliminate bankruptcy exemptions. There is a place for them as a means to provide safety to people who have been struck by unexpected events. A zero-exemption policy would probably expand credit supply — at the cost of leaving thousands of families destitute and without a chance to recover. But exorbitant homestead exemptions go way beyond providing a chance for a “fresh start.” Likewise, there’s no reason why people should be allowed to keep $60,000 worth of personal property, as they can do in Texas.
Surely, medical expenses can easily run into the hundreds of thousands of dollars. But that’s a reason to reform health insurance. Limiting the enforceability of credit contracts is a bad way to lay out safety nets.
This post was based on my own research. The write-up of the paper is still in the making. It will be available on my website by January 28. In the meantime, you can have a look at the slides I prepared for a presentation this Friday.
Technorati tags: economics, personal bankruptcy, consumption, bankruptcy exemption, consumption smoothing
Sunday, May 11, 2008
Housing Bubble Sites
National Sites
Regional Sites
- The Housing Bubble
- The House Bubble
- Housing Panic
- Paper Economy a US Real Estate Bubble Blog
- Housing Doom Housing Bubble
- Doctor Housing Bubble
- Bubble Markets Inventory Tracking
- Priced Out Fovever
- HousingTracker
- Matrix
- The Real Estate Bloggers
- The Mortgage Lender Implode-O-Meter
- Housing Bubble Casualty
- Housing Bubble Bust
- Bubble Pictures
- Bubble News Network
- Lawrence Yun Watch
- Is There a Housing Bubble
- Real Estate Comments
Regional Sites
- DC Home Prices
- Greater Northern VA Housing Bubble Fallout
- Frankly Realty (Virginia)
- Baltimore Metro Area Housing Blog
- Baltimore Housing Bubble
- Chicago Bubble Blog
- Irvine Housing Bubble
- The Jersey Shore RE Bubble
- New Jersey Real Estate Report
- Socket Site (San Francisco)
- Patrick.net (San Francisco)
- Bay Area Real Estate Blog
- Burbed (San Francisco)
- Marin Real Estate Bubble
- Sonoma Housing Bubble
- Seattle Bubble
- Calgary Contrarian
- Vancouver Housing Market Blog
- SoCal Real Estate Bubble Blog
- Flippers in Trouble (Sacramento)
- Portland Housing
- Proffesor Piggington (San Deigo)
- Pacific Beach Bubble
- Boston Bubble
- California Housing Forecast
- Massachusetts Housing Market
- Vancouver Condo Info
- New York City Housing Bubble
Saturday, May 10, 2008
Hillary and Barack, Afta Nafta
Was Hillary Clinton really against NAFTA in 1993? I was in the administration then, and I remember her position quite precisely. And I'll get to that in a moment. But before I do, I want to say something: It’s a shame the Democratic candidates for president feel they have to make trade – specifically NAFTA – the enemy of blue-collar workers and the putative cause of their difficulties. NAFTA is not to blame. Consider the numbers. When NAFTA took effect, Ohio had 990,000 manufacturing jobs. Two years later, in 1996, it had 1,300,000 manufacturing jobs. The number stayed above a million for the rest of the 1990s. Today, though, there are about 775,000 manufacturing jobs in Ohio. What happened? The economy expanded briskly through the 1990s. Then it crashed in late 2000, and the manufacturing jobs lost in that last recession never came back. They didn’t come back for two reasons: In some cases, employers automated the jobs out of existence, using robots and computers. In other cases, employers shipped the jobs abroad, mostly to China – not to Mexico.
NAFTA has become a symbol for the mounting insecurities felt by blue-collar Americans. While the overall benefits from free trade far exceed the costs, and the winners from trade (including all of us consumers who get cheaper goods and services because of it) far exceed the losers, there’s a big problem: The costs fall disproportionately on the losers -- mostly blue-collar workers who get dumped because their jobs can be done more cheaply by someone abroad who’ll do it for a fraction of the American wage. The losers usually get new jobs eventually but the new jobs are typically in the local service economy and they pay far less than the ones lost.
Even though the winners from free trade could theoretically compensate the losers and still come out ahead, they don’t. America doesn’t have a system for helping job losers find new jobs that pay about the same as the ones they’ve lost – regardless of whether the loss was because of trade or automation. There’s no national retraining system. Unemployment insurance reaches fewer than 40 percent of people who lose their jobs – a smaller percentage than when the unemployment system was designed seventy years ago. We have no national health care system to cover job losers and their families. There's no wage insurance. Nothing. And unless or until America finds a way to help the losers, the backlash against trade is only going to grow.
Get me? The Dems shouldn't be redebating NAFTA. They should be debating how to help Americans adapt to a new economy in which no job is safe. Okay, so back to my initial question. The answer is HRC didn't want the Administration to move forward with NAFTA, but not because she was opposed to NAFTA as a policy. She opposed NAFTA because of its timing. She wanted her health-care plan to be voted on first. She feared that the fight over NAFTA would use up so much of the White House's political capital that there wouldn't be enough left when it came to pushing for health care. In retrospect, she was probably right.
NAFTA has become a symbol for the mounting insecurities felt by blue-collar Americans. While the overall benefits from free trade far exceed the costs, and the winners from trade (including all of us consumers who get cheaper goods and services because of it) far exceed the losers, there’s a big problem: The costs fall disproportionately on the losers -- mostly blue-collar workers who get dumped because their jobs can be done more cheaply by someone abroad who’ll do it for a fraction of the American wage. The losers usually get new jobs eventually but the new jobs are typically in the local service economy and they pay far less than the ones lost.
Even though the winners from free trade could theoretically compensate the losers and still come out ahead, they don’t. America doesn’t have a system for helping job losers find new jobs that pay about the same as the ones they’ve lost – regardless of whether the loss was because of trade or automation. There’s no national retraining system. Unemployment insurance reaches fewer than 40 percent of people who lose their jobs – a smaller percentage than when the unemployment system was designed seventy years ago. We have no national health care system to cover job losers and their families. There's no wage insurance. Nothing. And unless or until America finds a way to help the losers, the backlash against trade is only going to grow.
Get me? The Dems shouldn't be redebating NAFTA. They should be debating how to help Americans adapt to a new economy in which no job is safe. Okay, so back to my initial question. The answer is HRC didn't want the Administration to move forward with NAFTA, but not because she was opposed to NAFTA as a policy. She opposed NAFTA because of its timing. She wanted her health-care plan to be voted on first. She feared that the fight over NAFTA would use up so much of the White House's political capital that there wouldn't be enough left when it came to pushing for health care. In retrospect, she was probably right.
Friday, May 9, 2008
Sugar Giants Shove Their Sweetener
by Chris Tenove
Jul/Aug 2003 Issue
What does anybody know about the sugar industry? The people who put the frosting on the frosted flakes keep a low profile and are happy when folks are too busy eating to ask a lot of questions. Now, though, a dust-up with the World Health Organization (WHO) has flushed them into the limelight, where they're pitting profits against public health.
The conflict was inflamed by a new set of dietary guidelines drawn from two years of research by the WHO and the UN Food and Agricultural Organization. The guidelines are part of a worldwide strategy to tame the swelling epidemic of obesity, diabetes, osteoporosis and cardiovascular diseases. One recommendation is that free sugars (i.e. sugar added to foods) should make up no more than 10 percent of our daily caloric intake. The sugar lobby reacted to that suggestion like a toddler asked to hand back his Halloween booty...
'It was particularly stupid for them to put in writing that they're going to try to get Congress to take away WHO's money,' says Michael Jacobsen, executive director of the Center for Science in the Public Interest. 'It gave consumers a chance to see the kind of bullying that is usually done behind closed doors.' [Adbusters]
Thursday, May 8, 2008
A bash for confidence indexes
Every month the University of Michigan and the Conference Board conduct a survey of households’ confidence on the state of the economy. Each pollster asks several questions and summarizes the results with an index, which is closely watched for signs of consumer distress. Last November, the Michigan index fell by 4.8 points from October; the Conference Board Index dipped by 7.9 points. Supposedly this is bad news because worried consumers are thrifty consumers. Don’t let the surveys fool you: they are almost complete rubbish — unless you know how to use them.
At first glance, both the Michigan index (MI) and the Conference Board index (CI) are correlated with the business cycle: they sink around the beginning of a recession and rebound near the end (see chart nearby, originally published by the Wall Street Journal). They even seem to track the quarter-to-quarter growth of consumption expenditures. Look a bit closer, however, and you’ll see that confidence and reality get out of synch sometimes. For instance, both the MI and the CI were abnormally low relative to consumption growth in 1992-1993, and again during 2002 and 2003. The indices dipped during the Asian crisis of 1998, but consumption growth didn’t budge; conversely, expenditure growth fell dramatically in early 1995 even though sentiment didn’t change.
Formal statistical analyses have found that consumer sentiment says very little that forecasters don’t know already. That is, once this quarter’s spending, interest rates, etc. are known, it does not help much to predict future spending growth. Confidence and expectations matter. The issue, I reckon, is that these particular indices fail to capture them.
A cursory look at the guts of the MI and the CI will convince you that they are literally meaningless. Each of them is a mishmash of five opinions — which, by the way, are not the same for both surveys (see table below). The questionnaires represent but the pollster’s guess of what determines spending. There’s no guarantee that the questions are the ones that actually matter.
For instance, the MI doesn’t include questions on job security, whereas the CI doesn’t ask about present personal finances. The potential irrelevance of the surveys becomes painfully clear when one examines the first question of the MI: “Do you think now is a good or bad time for people to buy major household items?” With such a specific wording, that question should predict expenditures on cars, appliances, furniture and such, i.e. durable goods. But once past purchases are included into the forecasting model, confidence and expenditures are barely correlated. [1]
Even if one of the indexes had the right composition, there’s no reason why all the questions should be given equal weights. Personal finances and availability of jobs, for example, may influence a consumer’s expenditures more than overall business conditions; short-term prospects should matter more than distant ones. In both the MI and the CI, however, every question counts the same.
Despite my bashing of the indexes, the surveys are worth keeping. Each of them contains some question that can help predict one or other component of expenditures. More specifically, the Conference Board’s questions about job prospects help forecast expenditures on durable goods: sentiment about the current job situation (question number two in the table) significantly predicts purchases of vehicles and other durables; expectations about future jobs (question four) predicts expenditures on vehicles only. [1] The Michigan survey, on the other hand, contains questions which are not used in the indexes. It would be worth exploring whether they are useful for forecasters.
Unfortunately, the component questions are not accessible to most people. If they are, it’s only with significant delay. And even if they were published timely, most people wouldn’t be able to use them because they can’t handle the number crunching. So here’s my advice for the everyday news consumer. First, don’t draw any conclusions from month-to-month changes of the indexes, no matter how large they are. Start believing them only after several months of consecutive rises or declines. Second, the Conference Board index is a better predictor than the Michigan index, because the latter doesn’t include any question about jobs. Third, rather than sentiment indicators, pay attention to data on the labor market: the unemployment rate and the payroll numbers, for example, averaged over at least three months. Not only do they gauge consumers’ confidence more accurately than the confidence indexes themselves: they influence spending decisions directly (the more unemployment, the less disposable income).
In all fairness, the intention of the MI and the CI was never to forecast any specific variable. They were designed over 40 years ago as a rough measure of the households’ view of the state of the economy. Even if the surveys captured expectations correctly, it should be up to economists, not statisticians, pollsters or newspapers, to figure out how those expectations translate into realized outcomes. Some day we’ll know how to do it. I’m pretty confident.
References and further reading:
[1] Bram and Ludvigson (1998) Does consumer confidence forecast household expenditure? A sentiment index horserace (pdf)
[2] Carroll, Fuhrer and Wilcox (1994) Does consumer sentiment forecast household spending? If so, why? (pdf)
[3] Croushore (2006) Consumer confidence surveys: can they help us forecast consumer spending in real time? (pdf)
Technorati tags: economics, consumer confidence, consumer sentiment, forecasting, expectations
At first glance, both the Michigan index (MI) and the Conference Board index (CI) are correlated with the business cycle: they sink around the beginning of a recession and rebound near the end (see chart nearby, originally published by the Wall Street Journal). They even seem to track the quarter-to-quarter growth of consumption expenditures. Look a bit closer, however, and you’ll see that confidence and reality get out of synch sometimes. For instance, both the MI and the CI were abnormally low relative to consumption growth in 1992-1993, and again during 2002 and 2003. The indices dipped during the Asian crisis of 1998, but consumption growth didn’t budge; conversely, expenditure growth fell dramatically in early 1995 even though sentiment didn’t change.
Formal statistical analyses have found that consumer sentiment says very little that forecasters don’t know already. That is, once this quarter’s spending, interest rates, etc. are known, it does not help much to predict future spending growth. Confidence and expectations matter. The issue, I reckon, is that these particular indices fail to capture them.
A cursory look at the guts of the MI and the CI will convince you that they are literally meaningless. Each of them is a mishmash of five opinions — which, by the way, are not the same for both surveys (see table below). The questionnaires represent but the pollster’s guess of what determines spending. There’s no guarantee that the questions are the ones that actually matter.
Click to enlarge
For instance, the MI doesn’t include questions on job security, whereas the CI doesn’t ask about present personal finances. The potential irrelevance of the surveys becomes painfully clear when one examines the first question of the MI: “Do you think now is a good or bad time for people to buy major household items?” With such a specific wording, that question should predict expenditures on cars, appliances, furniture and such, i.e. durable goods. But once past purchases are included into the forecasting model, confidence and expenditures are barely correlated. [1]
Even if one of the indexes had the right composition, there’s no reason why all the questions should be given equal weights. Personal finances and availability of jobs, for example, may influence a consumer’s expenditures more than overall business conditions; short-term prospects should matter more than distant ones. In both the MI and the CI, however, every question counts the same.
Despite my bashing of the indexes, the surveys are worth keeping. Each of them contains some question that can help predict one or other component of expenditures. More specifically, the Conference Board’s questions about job prospects help forecast expenditures on durable goods: sentiment about the current job situation (question number two in the table) significantly predicts purchases of vehicles and other durables; expectations about future jobs (question four) predicts expenditures on vehicles only. [1] The Michigan survey, on the other hand, contains questions which are not used in the indexes. It would be worth exploring whether they are useful for forecasters.
Unfortunately, the component questions are not accessible to most people. If they are, it’s only with significant delay. And even if they were published timely, most people wouldn’t be able to use them because they can’t handle the number crunching. So here’s my advice for the everyday news consumer. First, don’t draw any conclusions from month-to-month changes of the indexes, no matter how large they are. Start believing them only after several months of consecutive rises or declines. Second, the Conference Board index is a better predictor than the Michigan index, because the latter doesn’t include any question about jobs. Third, rather than sentiment indicators, pay attention to data on the labor market: the unemployment rate and the payroll numbers, for example, averaged over at least three months. Not only do they gauge consumers’ confidence more accurately than the confidence indexes themselves: they influence spending decisions directly (the more unemployment, the less disposable income).
In all fairness, the intention of the MI and the CI was never to forecast any specific variable. They were designed over 40 years ago as a rough measure of the households’ view of the state of the economy. Even if the surveys captured expectations correctly, it should be up to economists, not statisticians, pollsters or newspapers, to figure out how those expectations translate into realized outcomes. Some day we’ll know how to do it. I’m pretty confident.
References and further reading:
[1] Bram and Ludvigson (1998) Does consumer confidence forecast household expenditure? A sentiment index horserace (pdf)
[2] Carroll, Fuhrer and Wilcox (1994) Does consumer sentiment forecast household spending? If so, why? (pdf)
[3] Croushore (2006) Consumer confidence surveys: can they help us forecast consumer spending in real time? (pdf)
Technorati tags: economics, consumer confidence, consumer sentiment, forecasting, expectations
Wednesday, May 7, 2008
More Americans Expecting Recession in The Next Year
More Americans are expecting a recession in the next year. Consumers are waking up to the reality that the economy has a significant chance of recession next year.
Recession times are increasingly being expected. The coming holiday spending season will likely provide important clues to where consumer spending is headed. Consumer spending is about 70% of the US's GDP. Consumer spending is a key factor in a forecasting a recession.
The economic mood took a sharp turn for the worse over the past month, with 40 percent of Americans expecting a recession in the next year, according to a Reuters / Zogby poll released Wednesday.
That was a big rise from a month earlier, when 31 percent of the likely voters polled predicted a recession. The darker mood came as mounting concerns about housing and credit markets pounded Wall Street, and oil prices approached $100 per barrel.
That was a big rise from a month earlier, when 31 percent of the likely voters polled predicted a recession. The darker mood came as mounting concerns about housing and credit markets pounded Wall Street, and oil prices approached $100 per barrel. (CNBC 1/21/07)
Recession times are increasingly being expected. The coming holiday spending season will likely provide important clues to where consumer spending is headed. Consumer spending is about 70% of the US's GDP. Consumer spending is a key factor in a forecasting a recession.
Tuesday, May 6, 2008
2008 and 1968
Almost forty years ago, Bill Clinton and I sailed across the Atlantic to take up residence as students at Oxford University. I recall only two things from that trip. The first was becoming seasick and retiring to my small cabin, followed a few hours later by a knock on my door and the appearance of a tall, lanky southerner with chicken soup in one hand and crackers in the other. Bill Clinton didn't say "I feel your pain" -- that phrase came years later on the campaign trail -- but I was nonetheless touched by his empathy and generosity. And despite my queasy stomach we talked long into the night, mostly about America and what had happened to it.
Both of us had been politically active, but now felt relief in getting away from the turbulence and disappointments that marked the nation. A month or so before, Chicago had been the scene of a riotous Democratic convention during which numbers of young people who had been lured into politics by Eugene McCarthy's antiwar campaign and then by Robert Kennedy's rousing call for social change were beaten by the police. By then Kennedy had been assassinated; McCarthy's presidential bid had gone nowhere; the Democrats were in the process of nominating as president Hubert Humphrey; and the Republicans, Richard Nixon. The Vietnam War continued unabated. Several American cities were again in flames.
My other recollection from that voyage was finding Bobby Baker in the ship's stateroom. That he had chosen to travel to England at this time, on this particular ship, seemed a cruel joke, suggesting there was no real escape. For readers who don't remember, Baker had been a crony of Lyndon Johnson's secretary to the Democratic Party when when LBJ was Senate Majority Leader, until Robert Kennedy, as Attorney General, had exposed his alleged deals with organized crime, and Baker was forced to resign. Kennedy's investigation had led to allegations that Johnson himself received kickbacks from military contractors. It was tawdry stuff, rendered even tawdrier when several newspapers found evidence that Baker had also been involved in procuring women for JFK.
Why do I trouble you with these reminiscences? Because the upheavals of 1968 splintered the Democratic Party and marked the beginning of the ascendance of a new Republican majority coalition consisting of neo-conservatives on foreign policy, supply-side tax cutters on the economy, and evangelical Christians on social policy. The Democratic establishment drifted into the
comforting somnolence of a seemingly solid majority in Congress, losing touch with the white working class that had been at the center of the New Deal coalition. Their ideals shattered, left all but abandoned politics --some vanishing into the hills of Vermont or the small towns of the Pacific Northwest to meditate and find spiritual enlightenment; the more academically inclined disappearing into hermeneutics and deconstructionism; blacks gays, and women losing themselves in identity politics; and the few who remained (including Bill and me) supporting George McGovern in his disastrous run for president in 1972.
Since then, it's been basically right-wing politics -- Nixon, Ford, Reagan, and the two Bushes, punctuated by Jimmy Carter's undistinguished single term. And, oh yes, my old friend's administration, of which I am proud to have been a member. But Bill Clinton did not move the Democrats or the nation left. He moved the Democrats to the middle. And by warding off Newt Gingrich and his Republican congress, Clinton kept the nation essentially where it was.
Are we approaching another turning point, like 1968, but one that reverses the great pendulum of American politics and moves the nation back to the left? The George W. Bush presidency has been such an abject failure -- only 26 percent of Americans approve of the job he has done -- that America may be ready. Polls show a significant majority of Americans believing the country is off track. The economy is heading toward a recession, or worse. Inequality of income and wealth are wider than they've been in a century. Iraq is a mess, and America's image has plummeted in much of the rest of the world.
But there won't be a return to the pre-1968 left, regardless of who's elected next November.
Although John McCain, the presumptive Republican standard-bearer, supports reform of the immigration laws, initially opposed Bush's generous 2001 and 2003 tax cuts for the rich, has sponsored campaign-reform laws, and doesn't cow tow to the evangelical right, McCain is no heir to Robert Kennedy. He has shown no interest in reducing the trend toward widening inequality or overcoming remaining barriers to upward mobility. He has reversed his earlier views on the Bush tax cuts. And he is an unredeemed hawk on foreign policy.
What of the Democratic candidates? John Edwards, perhaps the most left-leaning of the three major Democratic candidates, and the only one who consistently emphasized the widening income gap and the worsening plight of America's poor, was forced out of the race after a string of Democratic primary defeats. Of the two who remain, Hillary Rodham Clinton is no sixties lefty. As a senator, she voted in favor of Bush?s Iraqi war resolution in the fall of 2002, and, more recently, in favor of certifying Iran's Revolutionary Guard as a terrorist organization. She also voted in favor of a ban on burning the American flag. She wants universal health care but won't support a single payer plan, which is perhaps the best way to control medical costs, although obviously no guarantee. She won't commit to raising taxes on the rich to finance any social program including health care, except for rolling back the Bush tax cut for the wealthy. She won't even pay the large, looming cost of the baby boomers' Social Security by raising the portion of income subject to Social Security taxes.
Barack Obama at least has the courage to demand that the rich pay more for Social Security, but his health plan is no more radical than Clinton's. He talks more openly than she does about the need to reduce inequality but has not been specific about to what extent he'd raise taxes on the very wealthy to pay for social programs, beyond reversing Bush's tax cut. He has been against the Iraqi War from the start but so far has avoided much detail about how and when he'd extract American troops or deploy them elsewhere.
Yet the striking thing about Obama, and the enthusiasm he has stirred up, has little to do with the specifics of the policies he advances. It is rather his almost pitch-perfect echo of the John F. Kennedy we heard in 1960 and the Robert Kennedy last heard in 1968. It is a call for national unity and national sacrifice -- not in the interest of military prowess but in the cause of social justice, both in the nation and around the world. His appeal is for more civic engagement, not necessarily more government. He has the voice and wields the techniques of a community organizer (which he was on the streets of Chicago), asking people to join together, calling the nation to form a more perfect union. Not since the sixties has America been so starkly summoned to its ideals. Not since then has America-- including, especially, the nation's youth --been so inspired.
It is easy for cynics to write off Obamania as a passing fad, as lofty rhetoric that can't and won't hold up on close inspection -- another bout of the kind of naive and romantic enthrallment that occasionally claims American voters until common sense sets in. This is surely what Hillary Clinton and my friend from forty years ago are counting on. But if the Clintons stop to think back to what they felt and understood in those years leading up to 1968, they may come to a different conclusion, as have I.
Neither John F. Kennedy nor his brother Robert were idealists. They were realists who understood the importance of idealism in the service of realism. They grasped the central political fact that little can be achieved in Washington unless or until the public is energized and mobilized to push for it; the status quo is simply too powerful. The ideals they enunciated helped mobilized the nation politically. That mobilization contributed to the subsequent passage of civil rights and voting rights laws, Medicare, and environmental protection. For purposes of practical electoral strategy as well as high-minded moral aspiration, they never tired of reminding the nation of its founding principles -- most fundamentally, that all men are created equal.
Both of us had been politically active, but now felt relief in getting away from the turbulence and disappointments that marked the nation. A month or so before, Chicago had been the scene of a riotous Democratic convention during which numbers of young people who had been lured into politics by Eugene McCarthy's antiwar campaign and then by Robert Kennedy's rousing call for social change were beaten by the police. By then Kennedy had been assassinated; McCarthy's presidential bid had gone nowhere; the Democrats were in the process of nominating as president Hubert Humphrey; and the Republicans, Richard Nixon. The Vietnam War continued unabated. Several American cities were again in flames.
My other recollection from that voyage was finding Bobby Baker in the ship's stateroom. That he had chosen to travel to England at this time, on this particular ship, seemed a cruel joke, suggesting there was no real escape. For readers who don't remember, Baker had been a crony of Lyndon Johnson's secretary to the Democratic Party when when LBJ was Senate Majority Leader, until Robert Kennedy, as Attorney General, had exposed his alleged deals with organized crime, and Baker was forced to resign. Kennedy's investigation had led to allegations that Johnson himself received kickbacks from military contractors. It was tawdry stuff, rendered even tawdrier when several newspapers found evidence that Baker had also been involved in procuring women for JFK.
Why do I trouble you with these reminiscences? Because the upheavals of 1968 splintered the Democratic Party and marked the beginning of the ascendance of a new Republican majority coalition consisting of neo-conservatives on foreign policy, supply-side tax cutters on the economy, and evangelical Christians on social policy. The Democratic establishment drifted into the
comforting somnolence of a seemingly solid majority in Congress, losing touch with the white working class that had been at the center of the New Deal coalition. Their ideals shattered, left all but abandoned politics --some vanishing into the hills of Vermont or the small towns of the Pacific Northwest to meditate and find spiritual enlightenment; the more academically inclined disappearing into hermeneutics and deconstructionism; blacks gays, and women losing themselves in identity politics; and the few who remained (including Bill and me) supporting George McGovern in his disastrous run for president in 1972.
Since then, it's been basically right-wing politics -- Nixon, Ford, Reagan, and the two Bushes, punctuated by Jimmy Carter's undistinguished single term. And, oh yes, my old friend's administration, of which I am proud to have been a member. But Bill Clinton did not move the Democrats or the nation left. He moved the Democrats to the middle. And by warding off Newt Gingrich and his Republican congress, Clinton kept the nation essentially where it was.
Are we approaching another turning point, like 1968, but one that reverses the great pendulum of American politics and moves the nation back to the left? The George W. Bush presidency has been such an abject failure -- only 26 percent of Americans approve of the job he has done -- that America may be ready. Polls show a significant majority of Americans believing the country is off track. The economy is heading toward a recession, or worse. Inequality of income and wealth are wider than they've been in a century. Iraq is a mess, and America's image has plummeted in much of the rest of the world.
But there won't be a return to the pre-1968 left, regardless of who's elected next November.
Although John McCain, the presumptive Republican standard-bearer, supports reform of the immigration laws, initially opposed Bush's generous 2001 and 2003 tax cuts for the rich, has sponsored campaign-reform laws, and doesn't cow tow to the evangelical right, McCain is no heir to Robert Kennedy. He has shown no interest in reducing the trend toward widening inequality or overcoming remaining barriers to upward mobility. He has reversed his earlier views on the Bush tax cuts. And he is an unredeemed hawk on foreign policy.
What of the Democratic candidates? John Edwards, perhaps the most left-leaning of the three major Democratic candidates, and the only one who consistently emphasized the widening income gap and the worsening plight of America's poor, was forced out of the race after a string of Democratic primary defeats. Of the two who remain, Hillary Rodham Clinton is no sixties lefty. As a senator, she voted in favor of Bush?s Iraqi war resolution in the fall of 2002, and, more recently, in favor of certifying Iran's Revolutionary Guard as a terrorist organization. She also voted in favor of a ban on burning the American flag. She wants universal health care but won't support a single payer plan, which is perhaps the best way to control medical costs, although obviously no guarantee. She won't commit to raising taxes on the rich to finance any social program including health care, except for rolling back the Bush tax cut for the wealthy. She won't even pay the large, looming cost of the baby boomers' Social Security by raising the portion of income subject to Social Security taxes.
Barack Obama at least has the courage to demand that the rich pay more for Social Security, but his health plan is no more radical than Clinton's. He talks more openly than she does about the need to reduce inequality but has not been specific about to what extent he'd raise taxes on the very wealthy to pay for social programs, beyond reversing Bush's tax cut. He has been against the Iraqi War from the start but so far has avoided much detail about how and when he'd extract American troops or deploy them elsewhere.
Yet the striking thing about Obama, and the enthusiasm he has stirred up, has little to do with the specifics of the policies he advances. It is rather his almost pitch-perfect echo of the John F. Kennedy we heard in 1960 and the Robert Kennedy last heard in 1968. It is a call for national unity and national sacrifice -- not in the interest of military prowess but in the cause of social justice, both in the nation and around the world. His appeal is for more civic engagement, not necessarily more government. He has the voice and wields the techniques of a community organizer (which he was on the streets of Chicago), asking people to join together, calling the nation to form a more perfect union. Not since the sixties has America been so starkly summoned to its ideals. Not since then has America-- including, especially, the nation's youth --been so inspired.
It is easy for cynics to write off Obamania as a passing fad, as lofty rhetoric that can't and won't hold up on close inspection -- another bout of the kind of naive and romantic enthrallment that occasionally claims American voters until common sense sets in. This is surely what Hillary Clinton and my friend from forty years ago are counting on. But if the Clintons stop to think back to what they felt and understood in those years leading up to 1968, they may come to a different conclusion, as have I.
Neither John F. Kennedy nor his brother Robert were idealists. They were realists who understood the importance of idealism in the service of realism. They grasped the central political fact that little can be achieved in Washington unless or until the public is energized and mobilized to push for it; the status quo is simply too powerful. The ideals they enunciated helped mobilized the nation politically. That mobilization contributed to the subsequent passage of civil rights and voting rights laws, Medicare, and environmental protection. For purposes of practical electoral strategy as well as high-minded moral aspiration, they never tired of reminding the nation of its founding principles -- most fundamentally, that all men are created equal.
Monday, May 5, 2008
There Was a Reason They Called It... The Casino Economy
by Thomas Croft
02 Jul 03
In the last three years, a 'perfect storm' of rising energy costs, record consumer and corporate debt and massive trade and current account deficits joined with unsustainable investment practices, and resulted in an economic collapse. The first recession since 1929 to be primarily caused by over-investment, these 'collateral damage' investing schemes-in overseas boondoggles and sweatshops, extreme mergers, absurd dot-coms and derivative scams-all came home to roost. Enron used all of these investment tricks and more. The corruption scandals of 2001-2 completed the melt-down. Now, the world is probably in a double-dip recession, thanks partly to the scandal and continuing international disruptions.
The problem with casino bets and Russian Roulette is that somebody always loses. [CounterPunch]
Sunday, May 4, 2008
The burden of spending
Over the 12 months to October 2007, home prices in the 20 largest metropolitan areas declined by 6.1 percent. And they have fallen every month since January. With less equity to borrow from, homeowners could cut their spending. As a second whammy, a large volume of adjustable rate mortgages are scheduled to reset to higher interest rates between 2008 and 2012. The burden of higher monthly payments could force households to reduce their expenditures too.
Economic growth and consumer debt are inextricably connected in the U.S. And it’s been that way for so long that it’s easy to forget why and what that implies.
Spending has outpaced personal income since the mid 1980s. Households saved ten percent of disposable income in 1985, five percent in the mid 1990s, and then nothing in 2005. (See chart 1, maroon series, scale on the left axis.)
Chart 1 (click to enlarge)
Economic growth and consumer debt are inextricably connected in the U.S. And it’s been that way for so long that it’s easy to forget why and what that implies.
Spending has outpaced personal income since the mid 1980s. Households saved ten percent of disposable income in 1985, five percent in the mid 1990s, and then nothing in 2005. (See chart 1, maroon series, scale on the left axis.)
Chart 1 (click to enlarge)
Low interest rates motivated the consumption ramp-up. Loose monetary policy played its part, but it would be incorrect to blame it all on the Fed. The massive accumulation of wealth by developing countries lowered the opportunity cost of spending, as Alan Greenspan has explained.
Interest rates motivated it, but the borrowing spree was made possible by innovations in the financial sector that increased the supply of debt. The introduction of the FICO score in the early 1990s improved the assessment of a borrower’s creditworthiness – or at least lenders believe so. By pegging interest rates to an index, instead of offering fixed rates, lenders transferred some financial risk to borrowers. Securitization of debt balances shifted some more of that risk off the lenders’ balance sheets.
The problem with a growth path based on borrowing and spending is that it has a natural end. An individual’s debt limit is determined by her creditworthiness, income capacity and collateral. That limit may be high relative to current income, and it may even be unknown to the borrower — after all, it’s up to the lender to draw the line. But once debt balances reach that limit, spending can grow only as fast as income (minus debt payments). Consumption is pinned to the vagaries of income. At the aggregate level, that means that economic growth is more vulnerable to unemployment and to the swings of the stock and real estate markets.
For instance, back in 2001 unemployment was rising, investment fell sharply, and share prices crashed. But overall the economy held up better than expected. Why? One explanation lies in real estate wealth. That year house prices rose by nine percent and consumers borrowed against home equity.
As a gauge of the current level of indebtedness, households now spend almost 15 percent of their disposable income on interest payments, including mortgages. (See chart 1, blue series, scale on the right axis.) If you include repayment of principal, the fraction of debt payments is much larger. Debt repayments are linked to interest rates, and hence subject to unforeseeable increases. Hence the worry about mortgage resets.
The main variables that determine spending and access to debt are outside the policymaker’s control. The cost of borrowing depends on the world level and distribution of savings. Lenders will continue to improve their assessment and management of risk, thus reducing the cost of credit. And central banks are capable of controlling inflation, but not of preventing asset bubbles or stimulating long-run growth.
But don’t despair: tax policy can mend our spending ways. First of all, do no harm. Tax laws can distort the cost of borrowing. The Tax Reform Act of 1986 partially addressed this issue by getting rid of the deduction for interest paid on consumer debt (credit card and uncollateralized loans). The deduction for mortgage interest should go next. I concede that there’s a (weak) case for subsidizing home ownership. But these days a house is much more than a place to live: it’s a piggy bank to draw from. There is no reason why the government should subsidize that.
Second, replace the personal income tax with a tax on consumption. A basic tenet of economics is that if you tax something you get less of it. An income tax punishes work. Instead, the government could levy a tax on the difference between income and contributions to savings. The new tax could be progressive, rather than flat, and could include personal deductions, just like the current personal income tax.
The main obstacle to those tax policies is political. The mortgage interest deduction is popular, and a consumption tax is still regarded as an oddity. No presidential candidate who actually cares about being elected would make such proposals. Perhaps in 2012, if the then incumbent president can afford it. Changing the nature of American economic growth is a cause worthy of spending political capital on.
Technorati tags: economics, consumption, consumer debt, consumer expenditures, economic growth
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