Brooks On Sequestration

David Brooks gets cynical:

… Politicians in both parties are secretly discovering that they love sequestration now. It allows them to do the dance moves they enjoy the most.

Democrats like the idea of a sequester (after all, it was their proposal back in 2011 that is coming due this week):

Democrats get to do the P.C. Shimmy. Traditional presidents go through a normal set of motions: They identify a problem. They come up with a proposal to address the problem. They try to convince the country that their proposal is the best approach.

Under the Permanent Campaign Shimmy, the president identifies a problem. Then he declines to come up with a proposal to address the problem. Then he comes up with a vague-but-politically-convenient concept that doesn’t address the problem (let’s raise taxes on the rich). Then he goes around the country blasting the opposition for not having as politically popular a concept. …

Republicans like it too:

Republicans also secretly love the sequester. It allows them to do their favorite dance move, the Suicide Stage Dive. …

In this dance, the Republicans mount the stage and roar that they are about to courageously cut spending. In this anthem they carefully emphasize cuts to programs the country sympathizes with, such as special education, while sparing programs that actually created the debt problem, like Medicare.

Then, when they have worked themselves up into a frenzy of self-admiration, they sprint across the stage and leap …

Brooks nails the Republicans and the sequester:

… Voters disdain the G.O.P. because they think Republicans are mindless antigovernment fanatics who can’t distinguish good government programs from bad ones. Sequestration is a fanatically mindless piece of legislation that can’t distinguish good government programs from bad ones.

And, oh yeah … don’t forget it was proposed by the Democrats.

It doesn’t matter much though, since no one in D.C. is getting to the heart of the problem:

… What’s America’s biggest problem right now? It is that business people think that government is so dysfunctional that they are afraid to invest and spur growth. So what are the parties going to do? They are going to prove that government is so dysfunctional that you’d be crazy to invest and spur growth.

From Brooks’ February 22 column in The New York Times, entitled “The D.C. Dubstep”.

FWIW: Someone leaned on Brooks after this column was published in print. Online there is a correction that sounds like an apology to the Obama administration.

Herbalife

This post is not required for class. I provide it because it may be of interest to those whose curiosity was piqued by our class discussion of Ponzi/pyramid schemes, Bernie Madoff, and affinity fraud. For better or worse, multi-level marketing is bigger in Utah than in other places, and multi-level marketing is often associated with both Ponzi/pyramid schemes and affinity fraud.

Anyway, the supplement maker Herbalife is publicly traded. Late last year, a whale of a private investor shorted* Herbalife stock, and began a publicity campaign arguing that it was a pyramid scheme whose stock value would soon fall.

If you’re interested, you can read more in “Let Herbalife Customers Decide” in Holman Jenkins weekly column, from the February 20 issue of The Wall Street Journal.

* Shorting is when you borrow shares of stock (rather than money), and then sell them. In essence, you are betting that the stock price will fall, so that you can buy the shares back at a lower price, and then repay off the loan.

Armen Alchian, R.I.P.

Another big name economist (whose name and work you should be familiar with) has passed away. Alchian would have been 99 in a few months, and many hoped he would be awarded a Nobel Prize before he died.

Alchian had little direct influence on macroeconomic theory (as taught in school) or macroeconomic policy as practiced in national capitals.

However, the idea that property rights and the institutional arrangements that support them are critical to understanding economic outcomes does go back to Alchian and others. And those insights are indirectly but strongly tied to common macroeconomic positions, like opposition to nationalized single payer healthcare because it diverts attention from efficient provision of healthcare.

In micro, Alchian is best known for the Alchian-Allen theorem. This says that if you have two competing goods, one cheap and one expensive, that adding a fixed cost to both of them will tend to shift demand towards the more expensive product because it’s become relatively cheaper. For example, Wal-Mart will do less well in expensive urban areas, like Manhattan or San Francisco, because the additional fixed cost of land makes makes less difference to an already expensive upscale good.

And … a chunk of this class are usually finance majors. It now appears that Alchian did the first event study, which are now a critical part of financial research. No one knew about this work that he did in the late 1940’s until 50 years later because it was classified.

Here is his obituary in The Wall Street Journal. Here is a short blurb at Marginal Revolution, with, as always, many interesting comments.

FWIW: I only met Alchian once. It was on a cold, wet, night in July, on a harbour cruise of San Francisco Bay. It was put on as part of the Western Economics Association meetings in 1996. My wife and me were bored at the stuffy conversation inside, so we went out on deck. Alchian came out too, and we began to talk. We mentioned that we had our honeymoon in Lake Tahoe, worked in around attendance at the 1993 Western Economics Association meetings, and had thus made much of our honeymoon tax deductible. It turned out that Alchian was one of the founders of the Western Economics Association because he’d worked in Los Angeles since the 1940’s, and it was hard to get snooty northeastern economists to pay attention to his work. So, he was thrilled that his association had helped a young economist stretch his vacation dollars further.

Same Article, Different Point

Towards the end of “In Shovels, a Remedy for Jobs and Growth" Jared Bernstein is quoted:

Jared Bernstein, the former chief economic adviser to Vice President Joseph Biden who is now at the Center on Budget and Policy Priorities, argues that while fiscal consolidation would have been necessary at some point, the government slammed the brakes on spending before families were ready to spend again, while they were still working to reduce large debt burdens.

“The stimulus didn’t last long enough,” Mr. Bernstein said. “We pivoted to deficit reduction too soon.”

Not everybody agrees. Conservative economists, and most Republicans in the House, make the exact opposite argument: that spending cuts stimulate growth by giving businesses confidence that the government will be able to pay its debts.

Conservative politicians might say that, but macroeconomists don’t — but I’ll get to that later.

The general point being made here is OK. If 1) you think the economy could be better, and 2) you think that government could help make it better by spending more, then 3) this is a great time to increase government spending to do that. Bernstein is emphasizing point 1, while Larry Summers (discussed in the same part of the article) is emphasizing point 2. The conclusion is that with real interest rates negative, the government should be borrowing a ton and investing in improving the economy. Fair enough.

So what’s wrong with what Bernstein said specifically? He’s really making 2 points: 1) there was a stimulus, and 2) the stimulus wasn’t spread out enough.

This is at variance with the facts on both counts. Both were covered years ago on this blog.

• In Spring 2009 “How What Congress Will Do Differs from What the Economy Needs” notes that before the Obama stimulus package was passed 4 years ago it was clear it was stretched too far out into the future.
• In Spring 2010 "Has Government Spending Increased At All?" noted that increases in federal spending were roughly cancelled by declines in state and local spending.
• In Spring 2011 “Keynesian Theory Suggests the Stimulus Package Was Just Crap” and “Was “the Stimulus Package” An Expansionary Keynesian Policy?” argued that only about 3% of the Obama stimulus package had been spent on stimulation within the first 21 months after it passed.
• In Spring 2012 “Wow” discussed the release of an internal Obama administration memo from late 2008 that argued that only about 40% of what was in the stimulus package would actually be stimulating. Largely this is because they put everything stimulating in there that they could think of, and that’s all it amounted to.

Let me summarize: they couldn’t figure out that much to do that was stimulating, so they spent a lot of extra money on stuff they knew wouldn’t work, but the stimulating part was really thinned out, and as a result largely cancelled by other factors … but nonetheless obvious 4 years ago that the package would still be hanging with us now.

And Bernstein’s going around saying the stimulus package didn’t last long enough.

Don’t believe him.

This is cross-posted from SUU Macroblog, which is required reading for my macroeconomics classes.

Technorati Tags: jared,bernstein,larry,summers,stimulus,package,obama

The Scorpion

That’s the name being given to the idea behind the shape in this chart (copied and pasted below):*

This is a trendy meme on the internet this winter (universities don’t usually issue press releases for individual researchers).

Anyway, it touches on a few points we’ve already discussed this semester.†

When we looked at the JOLTS data a few weeks back, I pointed out that job openings (among other things) have returned to typical rates from their lows during the Great Recession. That’s the vertical axis here.

And, there are a few posts (like this one) on this blog discussing long-term unemployment (the horizontal axis here): it is unusual that it hasn’t fallen as in other recessions. Note that the chart above goes back to November 2001 (the month of the penultimate trough), so if we’re over 3 years into an expansion we should be back in that region. Clearly, we’re not.

The source article for “the scorpion” argues that this behavior is:

“…driven by something other than a mismatch between workers’ skills and the demands of available jobs.”

Another possibility is that the long-term unemployed in this recession may be searching less intensively—either because jobs are much harder to find or because of the availability of unprecedented amounts and durations of unemployment benefits. This seems to be a more likely explanation, although if a drop in search intensity is due only to the difficulty of finding jobs, it again raises the question why we would not see that phenomenon at shorter durations as well. 

These tend to suggest that it is something other than the jobs, skills and effort that are the problem. I’m always a little leery of saying this, because it’s hard to get data on this, but the more solid explanations that get dismissed, the more likely it is that more subjective explanations — like bad attitudes, drug problems, and other individual inadequacies — are the problem.

* This came from a piece entitled “The U.S. Long-Term Unemployment Crisis Stumps Economists” that appeared in the February 11-17 issue of Bloomberg Businessweek.

† Remember that post from earlier in the semester about the difference between a teacher and a professor

Compared to What?

There’s an older (slightly offensive) acronym SSDD. It’s used for situations in which the same mistake is made over and over again.

When a macroeconomist digests what the media or politicians say, this acronym comes to mind a lot.

As in the article entitled “In Shovels, A Remedy for Jobs and Growth” by Eduardo Porter in the February 13 issue of The New York Times. Porter is a reporter, so he can be forgiven for repeating an official viewpoint:

At the end of last year, according to the nonpartisan Congressional Budget Office, the economy was still about 5.5 percent smaller than it would have been had it avoided the recession and kept growing along its long-term potential path,

Ah … see … actual real GDP compared to potential real GDP. The issue is: how do we get potential real GDP?

There are a number of ways, but the important points are that there is more than one way, and all claims about the size of that gap are based on choosing one method and rejecting the others. But, what if you’re wrong?

Porter provides a graphic.

Graphics look authoritative, but they don’t typically show or explain the underlying assumptions.

Here’s the problem: this shows real GDP returning to potential real GDP, and there are assumptions that produce that result. In macro, we need to question the assumptions.

What this graphic shows is called trend reversion. And trend reversion is a result that follows only from the assumptions of certain models of trend. Porter’s 5.5% claim also results from that assumption.

It doesn’t take much to note that this graphic is showing something that isn’t cool at all. Look at the 2000-1 recession. It’s not there. Look at the 2001-2007 expansion: it has a recession in the middle of it in 2003.

If your model misses stuff we know in the past that badly, why trust it to make forecasts about the future?

Government Doesn’t Do Much Because It Just Isn’t There

Gerald Seib, a respected journalist whose focus is policy coming out of Washington has hit upon a key point that macroeconomists have been noting for years: the government doesn’t do much any more. It can’t. It’s crippled.

Not dramatically, and not necessarily permanently. But in the ways most people think about government—employees on the public payroll running programs—it's actually in decline.

… The part of government that is really increasing right now is the part that churns out checks for people receiving Medicare, Medicaid and Social Security.

Meantime the ranks of government workers at the federal, state and local levels—the bureaucrats everybody loves to hate, as well as more beloved figures such as firefighters—are declining, as is the share of government spending that goes to the programs they run.

What's happening, in short, is that government, particularly at the federal level, is turning increasingly into an entitlement machine, dispensing benefits to those who qualify, while a combination of recession, deficits and an aversion to new taxes is squeezing most remaining government activity.

Read the whole thing, entitled “Hidden Secrets of Spending” in the February 5 issue of The Wall Street Journal.

Critical Thinking About GDP Forecasts

This post is a little premature; we’ll be covering this topic in the last half of February.

Anyway, the editorial entitled “Fiscal Fantasy” in the February 7 issue of The Wall Street Journal presents standard GDP estimates as somehow politically motivated. While much of the article is a solid analysis of the problems we have with funding our government obligations and raising revenue, here’s the offending part:

All of this is based on CBO's [typical analysis which says] … the economy will expand by 1.4% in 2013 and 3.6% on average after that. But every year since 2009 CBO has predicted that a new burst of growth is just a year or two away. Perhaps the Panglosses should revisit their optimism … [link added]

What’s wrong with this? The answer is that, whether low or high currently, we always expect growth rates of real GDP to return to somewhere in the 3-4% range. The reason for this is twofold: 1) the long-term average for real GDP growth rates is in that range, and 2) estimates of autoregressive models for real GDP suggest that when pushed away from its mean, real GDP growth returns to its mean in about a year.

In short, the CBO is predicting that “… a new burst of growth is just a year or two away” because … well … a new burst of growth is always just a year or two away.

That optimistic position (driven by experience with the data) does have a pessimistic flip-side though. If growth rates don’t return to that level within a year or two, one should conclude that there continue to be negative shocks pulling the economy downward.

It probably isn’t a surprise to hear The Wall Street Journal’s editorial page making that claim. Personally, I tend to agree with it; but I’m honest enough to note that I’m biased.

Taking Apart 2012 IV Growth

The initial news last week was shocking: real GDP growth in 2012 IV was negative.

Follow-ups in the legacy media downplayed the overall number, and claimed that the components of that number looked good (here’s some of what was said by The New York Times, The Wall Street Journal, and Forbes). Of course, The White House Blog painted a bright picture as well.

I’m usually pretty sanguine about this sort of thing. Not this time … I’ll start with two quick thoughts, and then end with a longer one.

1) Despite the names peak and trough, it’s well known among macroeconomists that peaks tend to be smoother (and thus harder to spot in real time) while troughs are sharper (and easier to spot in real time). Given that we’re in an expansion, a modestly weak quarter is precisely what a peak would look like.

2) By definition, advance estimates are rough drafts. The BEA doesn’t keep a comprehensive data set of past advance estimates, but they do have a download of all announcements and revisions over the last 44 quarters. How often did the advance estimate come up negative without a peak eventually being declared by the NBER Business Cycle Dating Committee? Not once. Now … bear in mind that this isn’t a huge dataset, and it only has one peak in it.

3) Here’s the longer take. The apologists for last quarter have noted that while the overall sum of growth was negative, the important components looked good. I don’t think this is so. Here’s why.

The story usually goes something like this: the big important components were OK, but they were dragged down by a few bad outliers. Fair enough — let’s go look at the components.

GDP growth is typically broken down into 4 major components: consumption, investment, government spending, and net exports. Consumption is the largest, investment is the most volatile.

Then I went and gathered data on the contribution of those 4 components to reported growth for the last 252 quarters (going back to 1950).

Component	Contribution
Consumption	1.5
Investment	-0.1
Government Spending	-1.3
Net Exports	-0.3
Real GDP	-0.1

Then, I took all 4 elements for those 252 quarters, and ranked them as percentiles. The table shows the medians and interquartile range.

Component	25th Percentile	Median	75th Percentile
Consumption	61	75	89
Investment	14	52	81
Government Spending	29	44	59
Net Exports	17	31	48

Clearly, consumption is always the most important component. It is also the least volatile. Investment is the second most important, but clearly the most volatile.

Lastly, I took the 4 components from the first table, and calculated their percentiles for comparison with the second table.

Component	Contribution	Percentile
Consumption	1.5	69
Investment	-0.1	31
Government Spending	-1.3	10
Net Exports	-0.3	27
Real GDP	-0.1	14

This is far more sobering. Yes, government spending is an outlier — but every component of real GDP growth was below median last quarter!

When had that happened before? The most recent time was 2008 IV – during the worst part of the Great Recession. It also happened in 2007 I and 2006 III — the first two quarters when it looked like something was going wrong with the Bush expansion. Also in 2001 III — the quarter when 9/11 occurred. And 1982 I — the worst quarter of the 1981-2 recession (which was arguably worse than the Great Recession). And 1974 III — right in the middle of the 1973-5 recession (which again, was arguably worse than the Great Recession). And 1970 IV — the trough of the mild 1969-70 recession. And in 1957 II and 1958 I — during the 1957-8 recession (which no expert considers a mild one).

The only false alarms from this signal are in 1968 IV and 1988 III. Both are quarters in which long and strong expansions appeared to falter before recovering their strength.

I can drill down even further. Those 4 components are each divided into two major subcomponents. Of those 8, only Fixed Investment was well above its median percentile contribution. Goods were at the 72nd percentile, while their median in the 71st percentile. And … one of the biggest contributors to making the growth rate higher was Imports. The thing is, Imports get subtracted out of growth … so a bigger contribution to growth means that we didn’t feel flush enough to buy as much foreign made stuff as we usually do. That isn’t good.

At the next level of fineness, there’s 14 components. And what actually was better than the median? Consumption of durables (but not non-durables or services), investment in equipment for firms and residences (but not non-residential structures), and imports of goods and services (both are bad signs).

The bottom line is that it is a very bad sign that the economy was weak across the board in the last quarter.