With Gas at $4 a Gallon, We Need Public Transportation, But Why We Can't Get It

I've never been a big one for buses or subways. I've never been able to organize myself around their schedules, at least when it comes to getting to work. So I usually end up taking my car (or, now that I'm in sunny Berkeley, walking, and not worrying about getting anywhere on time). Now that gas is $4 a gallon, I'm avoiding my car altogether.

For years, policymakers have wondered just how high gas prices would have to go before drivers switch to public transportation. The answer has been assumed to be very high because Americans supposedly are in love with our cars. Yet now we know there's a tipping point, and it's not quite as high as policymakers have guessed. It's around $4 a gallon. We know that's the tipping piont because suddenly millions of Americans are switching to buses, trains and subways to go to work.

Rather than bemoaning this remarkable turnaround we should be celebrating it because public transit not only reduces congestion but also reduces the nation’s energy needs and cuts carbon emissions that bring on global warming.

Problem is, the nation doesn't have nearly enough public transportation to handle the new demand. Even more absurdly, right now when it's needed the most, public transportation across the land is being cut back. This is because transit costs are soaring by the same skyrocketing fuel prices that are forcing people out of their cars, at the same time transit revenues are shrinking because most transit systems depend largely on sales taxes, now dwindling as consumer purchases decline in this recession. A survey of the nation's public transit agencies released last Friday showed 21 percent of rail operators now cutting back and 19 percent of bus operators.

Even though it’s a hundred times more efficient for each of us to stop driving and use trains and buses, there’s not enough money in the public kitty for us to do so.

This is nuts. If officials need more money to cover the extra fuel costs of public transit, they can raise ticket prices a bit without reducing demand; most of us would still find public transit cheaper than driving our cars. But officials shouldn't stop there. They should add services and expand whole systems -- more buses, more trains, more light rail. If they can’t finance this by floating bonds, they should go to Congress and ensure that public transportation is a major part of the next stimulus package.

Public transit has always been the poor stepchild of infrastructure development. America's usual answer to traffic congestion has been to add more lanes on highways, or more highways, or more bridges and tunnels for more cars. America hasn’t been really serious about public transit for almost a century. Most of New York City’s subway system was built over a hundred years ago. Los Angeles ripped out its trams long ago. Boston's Big Dig, one of the biggest infrastructure projects in modern American history, was designed entirely for cars. In recent years, only a few farsighted and ambitious cities, like Portland, Oregon, have invested in light rail.

But now that gas is $4 a gallon, all this may change. And what better way to get the economy going, and save energy and the environment in years to come, than to create a modern, efficient system of public transportation in America?

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

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
  

Why McCain's "Cap-and-Trade" Won't Work Nearly as Well as Obama's

With McCain now on board for a “cap-and-trade” system, it's a certainty that we'll have a president next year who wants to address global warming by imposing an overall cap on U.S. carbon emissions, which will drop annually. The “trade” part of the equation is that companies finding efficient ways to cut emissions can sell the unused portions of their permits to others.

But look more closely and you see a big difference between McCain and Obama (and HRC, for that matter)on how the permits are allocated. McCain’s proposal would give the lion’s share to companies that are now the biggest polluters. This does have some logic to it: after all, as the overall cap tightens each year, the biggest polluters face the largest challenges in cutting emissions.

By contrast, Senators Obama and Clinton have both proposed allocating permits through an auction. Under this system, every company – large or small - would have to buy rights to pollute. As a result, the biggest polluters would have to pay the most - thereby providing them with the greatest incentive to cut emissions right from the start. This makes more sense.

Remember, our atmosphere belongs to all of us. It seems only reasonable that polluters should have to pay to use it. The citizens of Alaska and Alberta, Canada get yearly dividends from the oil companies that take away their natural resources. Why shouldn’t the same principle apply when industries use the biggest common resource of all? The money they pay for permits could be returned as yearly dividends to every American family.

Of course, if polluters have to pay for the right to pollute, some of these costs might be passed on to consumers in the form of higher prices. But the yearly dividend checks would offset any price increases.

So next time you hear about cap-and-trade, ask the all-important question: How are the permits allocated? A carbon auction gets my bid.

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.

Bankruptcy exemptions under Chapter 7 of the Bankruptcy Code
(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

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.

"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 recession

The Real Source of Gladiator Politics

I was on television recently, debating a conservative. It's something I do fairly often. During a commercial break, the producer spoke into my earpiece. "A bit more energy," he said.

"What do you mean?" I answered, slightly hurt. I thought I'd been doing a fairly good job scoring points.

"Rip into him. Only three minutes in the next segment and we want to make the most of it."

John McCain says he's intent on waging a respectful and civil presidential campaign. Barack Obama says the same. Is it possible that during the months leading up to this Election Day the American people will be treated to the kind of campaign we've all been dreaming about, in which the two candidates debate the big issues and avoid the low blows?

We've grown so accustomed to gutter politics we've even turned it into verbs -- "to bork" (to impugn one's opponent's character), "to swiftboat" (to lie about a critical fact in one's opponent's biography), and, perhaps, "to reverend wright" (to create the impression that one's opponent shares a set of beliefs with a person he has associated with).

All three require a relentless attack that feeds on itself. Unproven allegations are repeated so often that the attack itself becomes news, as does the manner in which the target responds, after which point the question becomes whether the attack has hurt its target and, if so, whether the damage is fatal. The target is then watched for any signs of personal distress, defensiveness, or anger. Can the target take it? Will the target recant, backtrack, cover up, apologize, reveal more, disassociate himself, go on a counter-attack? What does the target's response tell us about his or her character? The story then shifts to the media -- are they continuing to report it? Are they being responsible in doing so? And after this self-referential orgy, the story moves to the polls -- is the public losing confidence in the candidate? In the days or weeks this goes on, the target has no opportunity to talk about anything other than the attack, and the public hears about nothing else, so the target’s polls may fall, which creates the final story: Can the target ever come back?

Character assassination, outright lies, and guilt by association are hardly new to American politics. Aaron Burr, New York City Parks Commissioner Robert Moses, Senator Joe McCarthy, and J. Edgar Hoover were avid practitioners. But the modern media, coupled more recently with the blogosphere and YouTube, have made these kinds of attacks even more potent. Political consultants -- those snakelike creatures who slither through the swamps and sinkholes of politics -- have turned all three into low-brow but highly lucrative art forms, cynically valued by the media for their effectiveness. And so-called “527’s -- the headless and mysterious bodies that grow in the interstices of our election laws -- have become their launching pads. In the logic of this underworld, "going negative" is no longer considered a campaign option; it is a necessity. Although it may injure the perpetrator (if it can ever be traced back), it will cause greater harm to the opponent.

So what are the odds that McCain and Obama will make an historic break with this sordid tradition and take the high road instead? Each man may sincerely wish to do so. Both have based their candidacies, to some extent, on creating a new politics that rejects the gutter-ball tactics of the old. Each has enough ammunition against the other (for every Reverend Wright, a Reverend Haggee; for every "we'll be in Iraq for a hundred years gaffe, a "bitter" one) to suggest the wisdom of mutual arms control. Each is distancing himself from his party’s mud-slinging -- the Republican Party is already airing ads linking Obama to Wright, which McCain is disavowing but not shutting down – thereby putting the candidate on a high road even as the party takes the low. Mostly, though, the public is fed up with the rancor -- isn't it?

I asked the producer who was talking into my earpiece why I had to rip into my opponent. "We see viewership minute by minute," he said, hurriedly (the commercial break was about over). "When you really go after each other, we get a spike."

It's the spike I'm worried about. I chose not to rip into my opponent but, then again, I'm not running for president. The public says it's tired of gladiator politics. But take a closer look. Political ripping and slashing is is one of America's favorite spectator sports. And the media that informs us about the candidates, and the advertisers who dictate the terms by which they do so, have data to prove it.

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]

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.

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

Housing Bubble Sites

National 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

Why Is HRC Hanging In There?

Three possibilities:

1. She believes she can still win. The Clintons have been written off and yet rebounded so many times (Bill Clinton’s reelection to Governor of Arkansas after the 1980 loss, the Jennifer Flowers crisis in the 1992 New Hampshire primary, the 1996 reelection victory after the debacle of 1994, the rise in Bill Clinton’s post-presidential stature after Monica and Marc Rich, to name only a few) that they may have internalized a “comeback kid” mentality. They really believe Obama will make a terrible mistake between now and the Convention, or a skeleton will come out of his closet, or Gore will decide to support her, or some other event will tip enough super-delegates her way to give her a fighting chance at the Convention.

2. She wants to establish herself for a 2012 run, if Obama loses to McCain or if Obama proves to be such an unpopular president that the Democrats look for another standard-bearer. In this view, her tenacity throughout this race and her almost-win, coupled with the story she can credibly tell about her appeal to “Reagan Democrats” and the white working class, will make her the logical next choice. Even if she has to wait for 2016, she’s still young enough to be the rightful Democratic heir.

3. She wants the best possible deal she can strike with Obama. She wants Obama to agree to pay her campaign debts, to seat the Michigan and Florida delegations (so she can claim a moral victory), and – the quietest deal of all – a personal commitment from him to appoint her to the Supreme Court when the next vacancy occurs.

My view? Some of all three. But she and her husband are also smart enough to know they’re fast approaching a tipping point, after which time #1 is a complete delusion, #2 is more difficult to achieve because she will be perceived as having endangered the chances not just of Obama but of congressional Democrats seeking to solidify their House majority and also gain sixty votes in the Senate, and #3 become less likely because she’s at her maximum bargaining strength now and is about to lose it (consider Edwards’ endorsement today.)

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]

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)

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

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.

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.

Why Credit Cards are Getting Away With It

The Federal Reserve reported recently that consumer credit -- basically everything we all owe money on except our houses -- rose more than 7 percent last month to $2.5 trillion worth of revolving debt. And the price tag is mounting daily as interest charges accumulate even though most Americans are pulling in their belts and economizing.

For years, banks and the credit card companies that service them have been sending us greater and greater sounding offers. But they've been hiding how much interest they'll be charging and how they calculate the outstanding balance. It's not unusual for them to suddenly increase annual interest rates, impose high penalty fees, even shorten billing cycles to make it harder to pay on time. Sure, they disclose their right to do all this stuff when you sign up, but it's in print so small as to give you a headache even if you understand it.

In other words, they're offering what look like great deals, but the deals are becoming nightmares for millions of Americans. Sound familiar? It's just like what mortgage lenders were doing before the bust.

But the housing bust has been something of a wakeup call, and now both Congress and the Fed are considering banning these practices. Yet the American Bankers Association is vowing to block these reforms. It argues that stopping credit card companies from bilking their customers who get behind on their payments will increase the costs of credit to those of us who pay on time.

If this sounds familiar, too, that's because it's much the same argument mortgage lenders are using for why their abusive lending practices should be allowed to continue.

Make no mistake, the Bankers Association is a powerful lobby, and it's not just Republicans they control. Only 11 of 36 Democrats on the House Financial Services Committee have backed the bill so far, and the going is likely to be rougher in the Senate -- which is why the Fed may be the only hope for protecting Americans while avoiding the kind of meltdown that hit the mortgage market.

It's another reminder of how our democracy has drifted into the hands of non-democratic agencies like the Fed, because the political branches are answerable to money interests rather than to the public interest.

EZer taxes

Imagine if you didn’t have to file a tax return. Imagine if, come T-day, the only thing you needed to do to comply with your tax obligations was to sign a form and mail it. And imagine if this could be done without changing a comma of the tax code. This is not a pipe dream—millions of citizens in different parts of the world already do it.

Austan Goolsbee, professor at the University of Chicago Graduate School of Business and head economic adviser to Barack Obama, is proposing to let the Internal Revenue Service, America’s tax man, put together drafts of individual tax returns and mail them to taxpayers. Experts know the system as “Tax Agency Reconciliation” (TAR). Goolsbee has had the good sense to re-baptize as “Simple Return.”

Tax collection agencies receive all the information they need to fill out the returns of many taxpayers. By law, employers and financial institutions send the data to them. The time spent by filers collecting statements, putting the numbers in the right boxes of the tax form, figuring out the standard deductions and exemptions, and calculating the tax bill--not to mention the fees paid to tax prepapers--are thus a waste.

Sweden and Denmark use the system. In Spain, with seven years of TAR experience, some filers can even request and confirm their pre-filled tax returns by sending a text message. Some Spaniards don’t even have to sacrifice precious TV time: they can do their taxes through their interactive, digital TV sets. (I encourage readers who know of other countries in the EZer Club to let me know in the comments or by e-mail. I’d like to make a list. If you respond, please specify whether the country does TAR or exact withholding.)

The obvious benefit of pre-filled tax returns is the time savings for filers. In the U.S., the average compliance time for the 1040EZ form, the simplest there is, is three hours and 46 minutes. The other types of tax form take over ten hours. Goolsbee estimates that, if his Simple Return applied to 40% of taxpayers, it would save 225 million hours and more than $2 billion in fees.

The fiercest opposition to TAR would thus come from tax preparers. Thousands of jobs, they’ll clamor, will be lost. For an economist, this is the easiest criticism to counter. Those jobs are not providing any service other than helping to comply with a pointlessly dense tax code. Let tax shops fold, and their workers will find jobs producing goods and services that actually add to social welfare. Creating employment by keeping an unwieldy tax code makes as little sense as digging a hole in the desert and then employing jobless people to fill it. If only Congress were brave enough to hold this argument against lobbyists… (Regarding this topic, I believe there was a lively discussion in the comments following Steven Levitt’s post . Read my own rant about the broken windows fallacy.)

Mailing pre-filled tax returns is not an intrusion on private business either. As Goolsbee argues, governments allow online filing and provide printed tax tables, and nobody opposes to those services on the grounds that they undermine the tax preparation business.

Receiving a pre-filled return in the mail does feel a bit imposing though. Some people will see TAR as an intrusion on individual freedom. It doesn’t need to be. Individuals will be allowed to scrap the return prepared by the government and fill out a new one. And if the taxpayer ignores the pre-filled return, and doesn’t fill out her own, her taxes won’t be filed, so TAR doesn’t infringe on voluntary compliance. The key is to disclose, every year and to every taxpayer, that the return sent by the government is not a tax bill, but a draft that can be turned into a final return if the individual chooses to do so.

To be sure, TAR would not eliminate the need to file a tax return for everybody. People who itemize their deductions, or who don’t have all their earnings reported to the government by a third party, cannot use the pre-filled form. Goolsbee estimates that, at most, 40% of all taxpayers could benefit from a TAR system; and that’s only if the Alternative Minimum Tax is reformed. In Spain, 30 to 40 percent are eligible. Taxpayers who don’t qualify tend to file more complicated tax returns, and thus spend more time and money on filing, than those who are eligible. So the benefits of TAR go mostly to people with low-to-middle income or simple household finances, who spend most of their tax preparation time (or money) gathering and filling out documents, not mining the tax code for deductions.

The best way to reduce the cost of compliance for everyone is to simplify the tax code. This can be done by scrapping the income tax as we know it today, or by eliminating tax deductions, exemptions, and exceptions for special groups. But such changes face even taller political obstacles than TAR. So, since the tax-instructions booklet is not going to get thinner any time soon, let your tax man deliver a pre-filled return—and spend some more quality time with your TV.

Technorati tags:
economics, tax agency reconciliation, TAR, tax compliance, taxes

Happy Thanksgiving

Happy Thanksgiving to everyone! Enjoy!

Hillary Clinton Doesn't Listen to Economists

When asked this morning by ABC News' George Stephanopoulos if she could name a single economist who backs her call for a gas tax holiday this summer, HRC said "I'm not going to put my lot in with economists.”

I know several of the economists who have been advising Senator Clinton, so I phoned them right after I heard this. I reached two of them. One hadn’t heard her remark and said he couldn’t believe she’d say it. The other had heard it and shrugged it off as “politics as usual.”

That’s the problem: Politics as usual.

The gas tax holiday is small potatoes relative to everything else. But it’s so economically stupid (it would increase demand for gas and cause prices to rise, eliminating any benefit to consumers while costing the Treasury more than $9 billion, and generate more pollution) and silly (even if she won, HRC won’t be president this summer) as to be worrisome. That HRC now says she doesn’t care that what economists think is even more troubling.

In case you’ve missed it, we now have a president who doesn’t care what most economists think. George W. Bush doesn’t even care what scientists think. He rejects all experts who disagree with his politics. This has led to some extraordinarily stupid policies.

I’m not saying HRC is George Bush. And I'm not suggesting economists have all the answers. But when economists tell a president or a presidential candidate that his or her idea is dumb – and when all respectable economists around America agree that it’s a dumb idea – it’s probably wise for the president or presidential candidate to listen. When the president or candidate doesn’t, and proudly defends the policy by saying she's "not going to put my lot in with economists,” we’ve got a problem, folks.

Even though the summer gas tax holiday is pure hokum, it polls well, which is why HRC and John McCain are pushing it. That Barack Obama is not in favor of it despite its positive polling numbers speaks volumes about the kind of president he’ll be – and the kind of president we’d otherwise get from McCain and HRC.

Haven’t we had enough of politicians who reject facts in favor of short-term poll-driven politics?

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]

On inflation expectations

With Federal Reserve and government doing their best to stimulate demand, people have started looking at inflation. The worry is that the economy is not as sick as our policymakers think, and so the fiscal and monetary medicines are excessive. Markets disagree.

Expected inflation is an important determinant of future inflation. If the public expects higher inflation, workers demand higher wages, prompting employers to raise the price of their goods, which results in higher actual inflation.

Markets in fixed-income securities provide timely information about inflation expectations. Treasury inflation-protected securities (TIPS) deliver interest and principal payments that are tied to inflation. Payments from regular Treasury notes, on the other hand, are not indexed to inflation. The difference between the yield rates of the two types of securities must be equal to the inflation rate expected by the markets—otherwise there would be an arbitrage opportunity. In practice, because of technical issues, the yield spread is only an approximation to expected inflation, and people call it the break-even inflation (BEI) instead. (More on this below.) From here on I use BEI and “expected inflation” interchangeably.

Because the Treasury has created notes with different maturities, we can use the spread between nominal and TIPS securities to gauge inflation expectations for different horizons. For example, today’s difference between the yield of five-year TIPS and that of five-year nominal notes is approximately equal to the inflation rate expected over the five years starting now (2008-2012).

The Fed is interested in long-term inflation expectations, because in the short term prices are affected by transitory or volatile factors, such as commodity prices. One measure of long-term expectations, which we can also derive from yields, is the five-year, five-year forward rate. That is an approximation to the rate of inflation expected for the five years starting five years from now. Today, that would be the period from 2013 through 2017.

* * *

Chart 1 (click to enlarge)
Earlier this month Greg Ip of the Wall Street Journal posted a graph showing the five-year, five-year forward BEI, which generated some discussion in the econ blogosphere. Felix Salmon and Greg Mankiw worried over signs of increasing inflation coming from that graph. Mankiw went as far as saying that the rise in expected inflation is “consistent with the hypothesis that policymakers are overreacting to some economic news with excessive monetary and fiscal stimulus.” Following up on knzn’s analysis (Feb. 3), I find that the worries about inflation in the far-future are overstated—and that inflation expectations over the near-future have been overlooked.

Using knzn’s back-of-the-envelope method, I have produced my own time series of forward BEI, which matches the one posted by Ip quite closely (see chart 1). The graph shows that starting on January 15, the rate of inflation expected for the far future (2013-2017) started increasing abruptly. By the time Ip’s graph was produced, January 30, the forward BEI had increased by 16 basis points.

That is not unusual. We have seen increases of similar or larger size in 2007: between March 9 and March 27 (15 b.p.), May 26 to June 13 (25 b.p.), and between September 11 and September 20 (16 b.p.). But each of those spikes partially reversed over time. In fact, after September 20, the time series began a protracted downward trend that left expectations at the end of 2007 below their level at the end of the summer.

Chart 2 (click to enlarge)

Let’s zoom in on the picture (chart 2). Expected inflation for the far future, the forward rate, did rise in the second half of January. Interestingly, most of the rise happened between January 16 and January 22, perhaps fueled by discussion of the fiscal stimulus package (the President made a call for tax relief on January 18). I guess markets don’t have much faith on the fiscal discipline of the government.
More relevant to the immediate future of the economy: over the second half of January the spot BEI—the rate of expected inflation for 2008-2012—went down. Inflation expectations briefly increased after the January 22 rate cut. But overall, between the 15th and the 30th, expected inflation for the near future fell slightly.

On January 30th and subsequent days the spot BEI fell, which is quite exceptional, because it tends to increase every time the Fed eases—just look at the record in chart 2. In February inflation expectations for the near-future have continued to abate.


Chart 3 (click to enlarge)
Just in case the leaves don't let me see the tree, let me now zoom out and smooth out the time series (see chart 3). The recent rise in inflation expectations for the far future (the forward rate) to which Mankiw and Salmon referred, barely registers. In fact, those expectations have remained quite stable throughout 2007. On the other hand, expected inflation for the near future (the spot rate) started a downward trend in mid-2006. And January certainly didn’t put an end to that trend.

What do we make of this? Worries about an economic slowdown have been simmering ever since house prices began falling, back in 2006. They have intensified as the credit crisis unfolds. Much like knzn, I think that markets expect a deceleration of demand, and hence of prices. Generally speaking, monetary policy has not convinced the public that the slowdown can be avoided, and neither has the fiscal stimulus package. Regarding the far future, inflation expectations are contained.

Addendum: why isn’t the break-even inflation (BEI) equal to expected inflation?

Earlier I wrote that the spread between TIPS and nominal notes is only an approximation to expected inflation. Here I include a list of reasons why the equality doesn’t hold exactly. Please let me know if I miss something.

1. Compound bias
From the Fisher identity

i – r = pi + pi*r

By taking the spread between nominal (i) and real (r) interest rates, we ignore the interaction term pi*r. The BEI rate therefore overestimates expected inflation. If we take the yield on TIPS as an estimate of r, it’s easy to correct for this (just divide the spread by (1+r)). This bias, however, is tiny in the US nowadays, since interest rates are in the one to five percent range most of the time.

2. Inflation lag
Every day, the principal of TIPS is adjusted using the change in the Consumer Price Index. In principle, since the CPI is published only once a month, and with some delay, the adjusted principal would be updated using a lagged measure of inflation. Investors would require compensation for the difference between current and lagged CPI, and the BEI would overestimate (underestimate) expected inflation if lagged inflation were higher (lower) than current inflation.

In practice, we need not worry about this bias in the US, since the Treasury seems to have come up with daily inflation adjustments—I suppose by extrapolation of past CPI figures. Also, the bias is tiny, since monthly CPI increases are small, and not systematic, since the rate of inflation is not consistently increasing or decreasing month-to-month over long periods of time.

3. Protection against deflation
The principal of a TIPS is protected from deflation. At maturity, the investor receives the greatest between the original principal or the inflation-adjusted principal. Because this protection is valuable, the yield on TIPS is lower than otherwise, and the BEI overestimates expected inflation. In practice this bias is negligible, because the probability of deflation is extremely low.

4. Inflation risk
TIPS offer protection against inflation volatility. If investors are risk averse and inflation changes over time, TIPS are more valuable than securities whose value suffers from inflation risk. The yield will be lower, and the BEI will overestimate inflation expectations.

5. Liquidity premium
TIPS are less liquid than nominal notes. Because liquidity is valuable, the price of TIPS is lower and their yield is higher than if these securities were as liquid as nominal notes. For this reason the BEI underestimates expected inflation.

At times of high market volatility, some investors “fly” to liquid securities, in this case nominal Treasury notes, driving yields on those securities down, and introducing a negative bias to BEI as an estimator of inflation expectations.

6. Differences in the duration of the securities
In real terms, the payments from TIPS are constant, whereas the payments from a nominal note decline. The inflation-protected security has therefore a longer duration—sensitivity to interest rate changes—than the nominal security, with respect to the real interest rate.

Technorati tags:
economics, inflation expectations, expected inflation, inflation, TIPS

Googling "recession" from United States has Tripled in the Past Year

Graph of the number of times the word "recession" was googled from United States over the last year. As one can tell it has triple in the past year.

Obama for President

The formal act of endorsing a candidate is generally (and properly)limited to editorial pages and elected officials whose constituents might be influenced by their choice. The rest of us shouldn't assume anyone cares. My avoidance of offering a formal endorsement until now has also been affected by the pull of old friendships and my reluctance as a teacher and commentator to be openly partisan. But my conscience won't let me be silent any longer.

I believe that Barack Obama should be elected President of the United States.

Although Hillary Clinton has offered solid and sensible policy proposals, Obama's strike me as even more so. His plans for reforming Social Security and health care have a better chance of succeeding. His approaches to the housing crisis and the failures of our financial markets are sounder than hers. His ideas for improving our public schools and confronting the problems of poverty and inequality are more coherent and compelling. He has put forward the more enlightened foreign policy and the more thoughtful plan for controlling global warming.

He also presents the best chance of creating a new politics in which citizens become active participants rather than cynical spectators. He has energized many who had given up on politics. He has engaged young people to an extent not seen in decades. He has spoken about the most difficult problems our society faces, such as race, without spinning or simplifying. He has rightly identified the armies of lawyers and lobbyists that have commandeered our democracy, and pointed the way toward taking it back.

Finally, he offers the best hope of transcending the boundaries of class, race, and nationality that have divided us. His life history exemplifies this, as do his writings and his record of public service. For these same reasons, he offers the best possibility of restoring America's moral authority in the world.

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

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:

"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."

"But the evidence is now building that an ugly recession is inevitable."

Roubini is a smart economist who often goes against the consensus view.

Obama, Bitterness, Meet the Press, and the Old Politics

I was born in Scranton, Pennsylvania, 61 years ago. My father sold $1.98 cotton blouses to blue-collar women and women whose husbands worked in factories. Years later, I was secretary of labor of the United States, and I tried the best I could – which wasn’t nearly good enough – to help reverse one of the most troublesome trends America has faced: The stagnation of middle-class wages and the expansion of povety. Male hourly wages began to drop in the early 1970s, adjusted for inflation. The average man in his 30s is earning less than his father did thirty years ago. Yet America is far richer. Where did the money go? To the top.

Are Americans who have been left behind frustrated? Of course. And their frustrations, their anger and, yes, sometimes their bitterness, have been used since then -- by demagogues, by nationalists and xenophobes, by radical conservatives, by political nuts and fanatical fruitcakes – to blame immigrants and foreign traders, to blame blacks and the poor, to blame "liberal elites," to blame anyone and anything.

Rather than counter all this, the American media have wallowed in it. Some, like Fox News and talk radio, have given the haters and blamers their very own megaphones. The rest have merely "reported on" it. Instead of focusing on how to get Americans good jobs again; instead of admitting too many of our schools are failing and our kids are falling behind their contemporaries in Europe, Japan, and even China; instead of showing why we need a more progressive tax system to finance better schools and access to health care, and green technologies that might create new manufacturing jobs, our national discussion has been mired in the old politics.

Listen to this morning’s “Meet the Press” if you want an example. Tim Russert, one of the smartest guys on television, interviewed four political consultants – Carville and Matalin, Bob Schrum, and Michael Murphy. Political consultants are paid huge sums to help politicians spin words and avoid real talk. They’re part of the problem. And what do Russert and these four consultants talk about? The potential damage to Barack Obama from saying that lots of people in Pennsylvania are bitter that the economy has left them behind; about HRC’s spin on Obama’s words (he’s an “elitist,” she said); and John McCain’s similarly puerile attack.

Does Russert really believe he’s doing the nation a service for this parade of spin doctors talking about potential spins and the spin-offs from the words Obama used to state what everyone knows is true? Or is Russert merely in the business of selling TV airtime for a network that doesn’t give a hoot about its supposed commitment to the public interest but wants to up its ratings by pandering to the nation’s ongoing desire for gladiator entertainment instead of real talk about real problems.

We’re heading into the worst economic crisis in a half century or more. Many of the Americans who have been getting nowhere for decades are in even deeper trouble. Large numbers of people in Pennsylvania and across the nation are losing their homes and losing their jobs, and the situation is likely to grow worse. Consumers are at the end of their ropes, fuel and food costs are skyrocketing, they can’t go deeper into debt, they can’t pay their bills. They aren’t buying, which means every business from the auto industry to housing to even giant GE is hurting. Which means they’ll begin laying off more people, and as they do, we will experience an even more dangerous downward spiral.

Bitter? You ain’t seen nothing yet. And as much as people like Russert, Carville, Matalin, Schrum, and Murphy want to divert our attention from what’s really happening; as much as HRC and McCain seek to make political hay out of choices of words that can be spun cynically by the mindless spinners of the old politics; as much as demagogues on the right and left continue to try to channel the cumulative frustrations of Americans into a politics of resentment – all these attempts will, I hope, prove futile. Eighty percent of Americans know the nation is on the wrong track. The old politics, and the old media that feeds it, are irrelevant now.

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.

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economics, news, media bias, recession, media