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September 30, 2006

Upon Further Review...

At Angry Bear, pgl throws the yellow flag on Greg Mankiw:

Greg Mankiw commits an intellectual foul in my view as he graphs the ratio of the Federal government debt held by the public to GDP as if our payroll contributions to prefunding our Social Security benefits are really employment tax increases designed to pay for that tax cut for Bill Gates et al...

Is Greg Mankiw recommending this backdoor employment tax increase? If he is, his graph makes sense.

It is certainly true that "debt held by the public" does not include government liabilities held in the Social Security Trust Fund, and that deficits look a good measure larger if we exclude surpluses of payroll contributions over Social Security benefit payments:




So, Social Security surpluses do indeed finance current spending in any given year. But if those surpluses truly do represent "prefunding our Social Security benefits", then the future payments to beneficiaries will be paid out of the debt accumulated by the Social Security trust fund. And the assets of the trust fund are simply Treasury securities that the government keeps for itself. 

Where will the funds to retire those securities come from?  With no social security surpluses, the answer is general revenues -- mainly individual and corporate income taxes.  While it is possible that some future Congress will choose to address the liability posed by trust fund claims by raising payroll taxes, that is not the default.  It may be fair, of course, to warn of "backdoor" tax increases generically.  Professor Mankiw says as much:

The looming problem with fiscal policy is the longer-term outlook, which will unfold over the next several decades as the baby-boom generation retires and starts collecting Social Security and Medicare. At that point, this series will start rising rapidly unless taxes are raised or spending is reduced compared with benefits promised under current law.

But a backdoor employment tax increase? Not necessarily.

UPDATE: Brad Delong notes, with approval, Jason Furman's comments at MaxSpeak :

My friend Greg Mankiw says we shouldn't be worried about the current fiscal situation, just the looming fiscal challenge. I'm not quite sure what to make of the statement, back in the Clinton administration our argument for running large surpluses and reducing the debt was precisely to prepare for the looming fiscal challenges.

First, although Greg can defend himself on this one, I think his point was pretty close to Jason's.  Second, although there may have been arguments for running large surpluses, the only year in which non-trust-fund surpluses actually arose was 2000.  Third, the policies in place at that time were arguably very far from addressing the "looming fiscal challenges." 

Just to anticipate the response to these comments, I am not arguing for or against economic policies put into place post-2000.  The fact, clearly articulated in the Mankiw post, is that structural imbalances in entitlement programs have not been addressed.  They weren't addressed then, they are not being addressed now.      

September 30, 2006 in Federal Debt and Deficits | Permalink


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I think that you have a pretty clean picture, but that it might be clearer with a couple of assumptions that could be true, but which don't have to be to contribute to the big picture.

Assume that there will be no tax increases of any kind, and no benefit cuts of any kind, and that the scheduled benefits will actually be paid out in full. Also assume whatever future economic and demographic trajectory projections that you feel most comfortable with.

Unless I've missed something, the only variable left to align all of the above assumptions is new borrowing from the public.

Either at some year in the future the payroll tax receipts will start to fall short of mandated benefit payouts or they won't. If they won't ever fall short, then we don't have a problem and there is nothing to discuss.

However, there is near universal agreement that some time in the 2018 timeframe, there will indeed start to be a shortfall.

For simplicity, let the first year's shortfall be $100M. What happens?

First, given all of the above assumptions,the Treasury must sell $100M in new debt to the public.

Secondly, the Treasury must give the $100M proceeds to the SSA to pay out in benefits. In exchange, the SSA will return $100M of its internal bonds for retirement, cancelling the obligation that they represent.

For a number of years thereafter, probably more than 20 or 25, the exact same process will be repeated for increasing sums, possibly to $200B, just for discussion.

The process as described above is only interrupted by the exhaustion of SS Trust Fund, as its bonds and their interest have all been retired/redeemed.

Let's say that in 2043 the last $200B of SSTF bonds are retired in exchange for $200B of new borrowing from the public.

If the 2044 shortfall is $201B, and the SSTF is empty, what happens?

Again, assuming along with everything else above that all mandated benefit payments are made, the Treasury must borrow an additional $201B from the public and turn it over to the SSA even though there are no remaining bonds to retire. This likely requires Congressional approval, but is there any likelihood that Congress will allow benefits to fall short of mandates by $201B in 2044 (maybe by 28%) just to avoid a new public borrowing of $201B when the 2043 level was $200B? The bad news is the $201B to be borrowed. The good news is that there are no further SSTF bonds to be retired. If $200B in new borrowing wasn't worth avoiding in 2043, then why would $201B in 2044 be any more of a problem?

Of course they would both really be problems, but it should be clear that the proximate cause and degree of the problem has everything to do with the shortfall, and nothing to do with the exhaustion of the SSTF.

In this light, it should be clear that the PAST increases in the payroll tax were indeed employment tax increases, and that the resulting surpluses were of no help at all in paying future benefits when shortfalls appear(ed).

While it is possible for individuals to save to prefund future purchases or expenses, it is almost impossible for a government to do so, certainly using the existing method.

Regards, Don

Posted by: Don Lloyd | September 30, 2006 at 01:24 PM

I like your picture of the two measures of the deficit. My latest shows the two measures of debt to GDP. I withdraw the yellow card on Mankiw and pull out the red card (soccer analogy) to CEA chair Crazy Eddie.

Posted by: pgl | September 30, 2006 at 03:30 PM

Even nicer update pointing to Gokhale's 1998 concern that fiscal policy might not stay on a long-run solvency path. He mentioned uncertaintities - with the big one now being resolved: policy makers beginning in 2001 decided to derail the solvency path - BIG TIME!

Posted by: pgl | October 01, 2006 at 09:50 AM

Not only in the long run, but also in the short run the statements about the size of the deficit are conditional.

If we are at the midpoint of a long economic expansion with years of trend or above trend growth ahead of us the debt is reasonable.

But if on the other hand we are on the verge of a significant economic downturn where the defict will rise sharply ending the cycle with debt already at this level is not a reasonable policy.

Posted by: spencer | October 02, 2006 at 11:21 AM

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September 29, 2006

Have Interest Rates Peaked? Part 2

From Bloomberg:

The Federal Reserve will probably lower its benchmark interest rate in the first quarter of 2007 as slowing economic growth diminishes inflation pressures, according to economists at Citigroup Inc.

The biggest U.S. bank by assets previously forecast the Fed would keep its target rate for overnight loans between banks at 5.25 percent through June. The bank now predicts a quarter-point reduction by March, with the Fed holding the rate at 5 percent through September...

Citigroup also lowered its forecast for benchmark 10-year Treasury yields to an average of 4.6 percent in the first quarter, from 4.9 percent.

The motivation for this change of heart is no mystery:

"There's softer growth, and with oil prices down and lower inflation, the Fed in a sense can follow the market's lead,'' Michael Saunders, chief Western European economist at Citigroup in London, said in an interview today. "A modest ease in rates should cushion the economy.''...

"The U.S. economy currently is in the most intense phase of its downdraft, due to plunging housing construction,'' Citigroup Global Markets analysts, including Todd Elmer in New York, wrote in a report to clients yesterday. "The cooling in demand should reduce inflation risks sufficiently to open a window for a token easing early next year.''

Also at Bloomberg, Caroline Baum says things in the housing market are even worse than you think:

For months, builder sentiment looked out of sync with the actual housing statistics. When one considers that the worst news on new home sales may not be reflected in the government data, it's easier to understand why they're so glum.

Simply put, cancellations are rising, and they aren't being captured in the aggregate statistics because of the way the survey is designed. Hence, sales are being overstated and inventories understated.

"Once a sales contract is signed, there's no way of recording the cancellation or putting the home back in inventory,'' says Dave Seiders, chief economist at the National Association of Homebuilders in Washington. "Builders keep track of gross and net sales; we don't have a net sales number from Commerce.'' ...

The effect of higher cancellations is "to overstate the overall level of sales and understate the level of inventories,'' [Joe Carson, director of global economic research at AllianceBernstein] says. The opposite is true at the bottom of the economic cycle, when sales pick up and the resold homes aren't registered as a sale or removed from the "for sale'' pile.

How bad is it?

We know from big builders that cancellation rates are rising. Seiders says the rate "has roughly doubled over the last year'' and is ``more serious at the big companies.''

Just this week, Lennar Corp., the No. 3 U.S. homebuilder, said its cancellation rate was running at more than 30 percent. Net new orders fell 5 percent in the quarter ended Aug. 31.

Cancellation rates rose to 29 percent in the April-June quarter at D.R. Horton Inc., the second-largest homebuilder, and deteriorated further in July, according to the company. That compares with an historical average rate of 16-20 percent.

And earlier this month, KB Home said net orders (an order is considered a sale) plummeted 43 percent in the three months ended Aug. 31, a rate that includes cancellations.

I'm still not sure about the macroeconomic consequences of comparisons like this...

What makes the current situation so worrisome is the "unprecedented inventory overhang, encompassing new and existing markets and many of the largest metropolitan areas,'' Carson says. "Its sheer size raises the odds that prices will fall more and longer nationwide than they did in the 1990s.''

... as I am convinced that overall conditions in financial markets are very much different today.  But I won't object to "worrisome." 

UPDATE: Dean Baker weighs in on cancellations as well:

The [new home] sales figures are also somewhat exaggerated, since there are many more cancellations now than in the past. (Cancellations are never subtracted from sales.)

September 29, 2006 in Federal Reserve and Monetary Policy, Housing, Interest Rates | Permalink


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"its different this time"

"the market has reached a permanently high plateau"

two phrases proven wrong so many times, i'm amazed that economists still have the guts to utter them

Posted by: sw | September 29, 2006 at 11:50 AM

sorry, that came out sounding a little more snarky than i intended :)

Posted by: sw | September 29, 2006 at 12:10 PM

The idea that the Fed will automatically cut interest rates next year is ludicrous. To what end ? The same reason they held interest rates at 1 % while this mess raged on.

The Federal Reserve has a primary responsibility to keep inflation at bay then to keep Americans working. It is not to rescue George Bush or wall street or fudge the economic statistics. It is not to support Chinese economic expansion at the behest of multi-national corporations or a corrupt political party.

The Fed has created or participated in the creation of monsters in every financial arena. Housing, the stock market, the bond market, consumer indebtidness, predatory super banks and brokerages, commodities inflation, foreign exchange, the futures racket.

Every rescue attempt by these clowns has made the problem that much worse. Would it not have been better to have raised rates long before the housing bubble reached the proportions it has ? Now one of the super banks responsible for the dominance of speculation is trying to jawbone up a rescue which likely will make it worse in the end.

The Fed should announce that short rates are neutral and there is no reason to consider reducing interest rates. That's the truth. Why give a heroin addict more heroin as the cure? The US economy needs rehab.

For the first time in years there is actually a bonafide savings incentive rather than disincentive or outright incentive to borrow and spend.

Paul Volker is right.

(not directed at you)

Posted by: quiz | September 29, 2006 at 08:25 PM

Dr. Dave,

Yes things are "different" today, but the parallels between now and 1973 are uncanny, and very scary.

Those who ignore history are doomed to repeat it, over and over again... hit the URL for more...

Posted by: The Nattering Naybob | October 02, 2006 at 08:26 PM

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Bye to everyone!

Posted by: GooogleGuy | October 08, 2006 at 09:51 AM

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September 28, 2006

Have Interest Rates Peaked?

Edward Hugh thinks so.  Though Edward notes that commentary from the ECB suggests otherwise -- an observation made about the Federal Reserve by Tim Duy -- the belief that interest rates will fall before they rise is being driven by a sense that economic growth in developed countries is slow and getting slower.  Slower economic growth means less demand for borrowing by consumers and businesses, and hence lower real (or inflation-adjusted) interest rates. And, so the story goes, as with the U.S. and Europe, so with the world.

The opinion that a nontrivial slowdown may be in full bloom is not hard to find, but in case you are looking you can start in Europe -- at Alpha.Sources-CV (here and here), at Bonobo Land, and at The Skeptical Speculator.   And don't forget the UK

As for the US, I could just say Nouriel Roubini and leave it at that, but if you are particularly interested in the global connections you can soak in Martin Wolf's take from Economist's View.  On the interest rate part of the scenario, here's the view from The Capital Spectator:

Let's start with the bond market, where the benchmark 10-year Treasury yield has dipped below 4.6% for the first time since February. In fact, the 10-year yield has been on a slippery slope for since July, when a 5.2% current yield prevailed early in the month. The catalyst for the decline is, of course, the ongoing stream of economic reports that show the economy is slowing. (The latest is this morning's update on new orders for durable goods, which tumbled for the second straight month in August--the first back-to-back tumble in more than two years.)

I'll tell you the truth -- that durable goods report was not to my liking, as the weakness appears to be fairly broad-based:




I hear you: Don't get carried away with one report.  I'm with you, but I will note that one of the keys to the whole soft-landing scenario is that capital spending will stay robust even as residential investment and, to a lesser degree, consumer spending fade.  If that doesn't happen, the arithmetic starts to get tricky, and those bets on lower interest rates may start to look pretty good.

September 28, 2006 in Europe, Federal Reserve and Monetary Policy, Interest Rates | Permalink


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"one of the keys to the whole soft-landing scenario is that capital spending will stay robust even as residential investment and, to a lesser degree, consumer spending fade."
This is NOT an easily worked out hypothesis. First, corporations invest with the belief the consumer will follow. Second, we'd need to see huge corp. investment to offset just a 20% housing pullback.
The more likely scenario is the Fed WILL intervene to slow down housing's collapse. We'll see the beginning of this soon when (after 10 months of input & rhetoric) it opts to do very little to tighten mtg. lending criteria. I expect the Fed's spinelessless will be seen as so shameful the FOMC will try to distance themselves from the decision.
If BB really wants to be a straight shooter, he'd do well to tell the markets the FOMC is on vacation until after the 2008 elections. BUT, that's not what the Bond Boys are betting he'll do.

Posted by: bailey | September 29, 2006 at 08:14 AM

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September 27, 2006

Housing And Recessions

UPDATE: I've edited the original post to fix some typos and grammatical problems.

I'm not sure that this week's news on the residential real estate front -- on new home sales (here and here) and existing home sales and prices -- did much to change anyone's mind about where the U.S.economy is headed in the immediate future.  Most of the action is still in the forecasts, and those range from cautious to downright apocalyptic.  I'm in the former camp, but Calculated Risk notices something that pushes things a little farther up the anxiety scale:

New Home sales were falling prior to every recession of the last 35 years, with the exception of the business investment led recession of 2001. This should raise concerns about a possible consumer led recession in the months ahead.

Here's CR's accompanying picture:




That's picture's kind of scary, but there are reasons to believe -- hope? -- that things may be different now.  There is no doubt that the banking system in the 1970s, for example -- operating under the burden of all manner of problematic restrictions like Regulation Q -- was substantially less flexible that it is today.  Most of those restrictions were only slowly unwinding by the time of the 1980 and 1981-82 recessions, and in fact explicit credit controls were imposed in 1980.

Invoking the same general storyline, the savings and loan crisis of the latter half of the 1980s resulted in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) which included new regulations on evaluating real estate values and induced major changes in the loan to (regulatory) capital ratios of financial intermediaries.  Although the evidence is in some dispute, in theory the new capital standards (or the expectation of those standards) could have directly restrained lending and hence economic activity in sectors heavily dependent on financial intermediaries -- sectors like residential housing. 

The story I am suggesting, of course, is one in which the housing market woes of past recessions were symptoms of broader disruptions in financial markets, disruptions that directly impacted specific parts of the economy while simultaneously impeding the reallocation of resources to other productive uses.  In this light, it is interesting that the one recession not associated with stress in housing markets is also the one with no obvious interactions between economic developments and financial regulations (such as inflation and Reg Q in the early 70s) or significant changes in the regulatory environment (such as capital controls in 1980, the Monetary Control Act in 1980, and FIRREA in 1989).

There is an argument that this time around the causality is likely to run from problems in the housing market to widespread distress in financial markets -- this is number 20 on Nouriel Roubini's list of reasons the U.S. is heading for a hard landing. Says Nouriel (emphasis added):

There are systemic risks in the financial system around MBS/Housing, credit derivatives, the risk of a stock market 1987-style rout and the risk of a hard landing of the US dollar.

I certainly can't prove that fear unfounded, although I have heard it suggested that exposure to the most exotic of contracts is concentrated in boutique hedge funds, and not in mainstream financial intermediaries.  That is only an impression, and even if true you may not take much comfort in that fact. On the other hand, as Brad DeLong notes, the non-impact of the latest hedge fund meltdown is "reassuring." 

So, for now, I still got high hopes

September 27, 2006 in Data Releases, Housing | Permalink


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I don't get it, it just doesn't seem that complicated. How much have home prices increased in last 4 years vs. our population & the income needed to service the higher prices? Either homes were grossly underpriced for 50 years or they're grossly overpriced now.
I can't imagine why EVERYONE wouldn't readily agree it's highly probable that home prices will revert to their mean long-term growth rate.
If the Fed didn't care when prices were skyrocketing, why should it care as prices revert?
I sure hope BB's Fed doesn't believe it's responsible for seeing we never again "suffer" two successive quarters of negative growth.

Posted by: bailey | September 28, 2006 at 10:29 AM

It is great to see someone bring Req Q into the analysis and note that prior to the 1980 cycle credit to the housing sector was subject to "non-price rationing".

In the 1980-82 cycle we discovered that it took much higher prices -- interest rates --
to dampen demand for housing credit then virtually anyone thought.

So what are we discovering is different this cycle?

Posted by: spencer | September 28, 2006 at 12:48 PM

Isn't today's economy more diverse than any other point in history? In the past a single industry, such as the auto industry, could throw the nation into a recession. From my very limited observations it seems that it would require slowdowns in multiple industries to cause the entire U.S. economy into an overall recession.

Posted by: padraic | September 28, 2006 at 12:49 PM

Like so many charts, I think this one is oversimplified (I could take the track of the dow today and impose it over dow 2000 to 2006 and divine profound things). I think at the least interest rates have a profound interrelationship with that chart and perhaps should be superimposed, and the low interest rates of today provide an economic engine of their own as opposed to the early 80s when they were a drag on all economic endeavors.

In other words, these low interest rates, particularly if the Fed starts cutting again, almost would guarantee a soft landing. The magnitude and variety of the global and American economy (especially now that all our social programs move money through the economy in an almost endless manner), in an environment of low interest rates and falling energy prices, makes it very hard for me to buy into any nightmare scenarios.

That combined with China quite willing to do most anything to keep the American consumer junkies hooked and Ben willing to throw money out of helicopters makes me think there are too many entities out there intent on making any recession "soft". I am not too sure this is a good long term thing, but all of the American economy is so short term based that no one cares about the long term.

Posted by: badbear | September 28, 2006 at 04:29 PM

How scary is a recession, anyway? Sometimes people write as if a few quarters of negative growth would be the end of the world. Aren't occasional recessions supposed to be good for the economy, clear out the dead wood? Maybe we should be rooting for one.

Posted by: Hal | September 29, 2006 at 02:47 AM

Dr. Dave,

The real danger is despite lower rates & energy costs, efforts to save and/or falling home values prohibit borrowing against ones assets....

less borrowing forces lenders to drop rates even lower, thus trapping the banking & financial institutions in the same decelerating income & increasing debt spiral that the consumer is already in.

Hit the URL for more...

Posted by: The Nattering Naybob | October 02, 2006 at 08:23 PM

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September 26, 2006

Of Course Trade Deficits Aren't Necessarily Bad (Wherein In My Readers Set Me Straight)

Yesterday I nodded approvingly to the following remarks on the consequences of trade and current account deficits from Nouriel Roubini, as recounted by the Wall Street Journal:

"Your standard of living is going to be reduced unless you work much harder," says Nouriel Roubini, chairman of Roubini Global Economics. "The longer we wait to adjust our consumption and reduce our debt, the bigger will be the impact on our consumption in the future."

Reader Jim K responded...

"Your standard of living is going to be reduced unless you work much harder...."

Doesn't that depend on what we do with the proceeds of all this borrowing? If it is invested productively, then we won't have to reduce our consumption.

... and reader Gerald MacDonnell seconded the objection:

I agree with Jim. If anything he understates the point. The question boils down to what returns we earn on capital investment here. The tendency for capital deepening to raise labor returns is independent of who owns the capital. And even the net financial return seems likely to rise, despite the rising net tribute paid to foreigners.

Well, those are mighty fine points, and I was mighty remiss in not making them.  So then, is it likely true that the sharp increase in the U.S. current account deficit that commenced in about 1997 has deepened the capital stock beyond what it otherwise would have been?  knzn responds to Jim and Gerald's comments: 

Although the other commentators make theoretically correct points, I think they are wrong empirically. Over the past few years, the US capital surplus (i.e., “borrowing”) has mostly been invested in residential real estate, which is not nearly as productive a use as one might hope for. Residential investment won’t do a whole lot to raise labor returns in the future.

Ben Bernanke raised the same issue a few years back in what, by pure virtue of the number of times I have cited it, is one of my all-time favorite Fed speeches:

Because investment by businesses in equipment and structures has been relatively low in recent years (for cyclical and other reasons) and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things. However, in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.

This is a really intriguing question:  Should we care if investment takes the form of physical capital that will ultimately be devoted to producing goods and services sold in markets, as opposed to physical capital that will ultimately be devoted to "home production" (that is, the manufacture of all those things that make us happy that households create for themselves)?

I'm not so sure.  It would be true that increased quantity and quality in residential housing would do little to raise productivity in market activities, but surely it must raise productivity in home production.  It would also be true that devoting more resources to home production means fewer resources for market production.  In other words, if we decide to enjoy the "output" a larger yard, a more inviting family room, a gourmet kitchen,or whatever, we may have to cut down on our consumption of other things.  But so what?  That's a choice that individuals make all the time, and the truth is that economists don't have much to say about whether it is a good thing or a bad thing: De gustibus non est disputandum.

I can think of at least a couple of reasons to not be indifferent about the market/home investment distinction.  For one thing, as mentioned by Mr. Bernanke, the deck is already stacked in favor of housing via tax incentives, institutions like Fannie Mae, and so on.  A boom in a distorted market may not be such a great thing.   

Perhaps more important from the financial stability point of view, home production is, by definition, non-tradable, so investment in housing has a limited capacity to directly generate the means to pay back foreigners who lend to us.  That's the sense in which I was agreeing with Roubini and knzn -- the payback would have to come in the form of reducing our own consumption of market goods (again, below what it would otherwise be).  Again, that is not a bad thing per se, but there is some possibility that this makes the whole set of transactions riskier from the point of view of the lenders, raising borrowing costs and inducing market volatility.  There is yet scant evidence that this is the case, but I suppose it is a possibility.

Others may have additional reasons for worrying about a shift from market to home production.  I'd like to hear them.  But for now, I take the point that conclusions about the "problem" of the current account deficit are not clear cut.  Consider me duly chastened.

UPDATE:  Be sure to read the very thoughtful contributions to the comment section.

MORE WORTHY THOUGHTS:  From Claus Vistesen, who you should be checking out regularly if you aren't already.   Claus ruminates on this post, and Brad Setser's more extensive version of his comments below.

September 26, 2006 in Saving, Capital, and Investment, Trade Deficit | Permalink


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A few points:

1. The textbook separation of "sources and uses" of funds (i.e. the fungibility of money) means that statements like "the US capital surplus (i.e., 'borrowing') has mostly been invested in residential real estate" can't really be justified. Presumably the funds go to some combination of C, I, and G that we'll never know.

2. To the extent the funds do augment the housing stock, I would argue that the main impact is temporary. If we're left with "too much" housing then we will build less in the future, and use our resources to do something else (hopefully more productive). I don't see why the effects would be permanent.

3. If we have for some reason moved to a permanently higher share of resources devoted to housing, then, as you say, we will have to have less of other stuff, but that would be the result of our preferences. The tax distortions have been there for a long time, and haven't increased, so they can't be responsible (though it's conceivable rumors of their demise could be pushing some investment forward).

Posted by: Jim K. | September 26, 2006 at 11:15 AM

Jim -- We can compare changes. And at the margin, the post-2000 increase in the current account deficit has been associated with:

a) a fall in household savings (i.e. a rise in consumption v income)
b) a fall in government savings (i.e. the tax cuts/ war/ etc)
c) a rise in in residential investment
d) a fall (relative to 2000 levels) in non-residential investment. business inv. has picked up a bit since its lows, but it remains well below its late 90s level.

so I think it is fair to say the recent surge in external debt has been associated with a surge in consumption/ residential investment.

that is my concern: external debt is not a claim on the overall US economy. It is a claim on the external portion of the US economy -- i.e. the United States ability to generate enough export revenue (and revenue from US investment abroad) to pay our external debts and afford the imports we want/ need. it isn't obvious that the surge in debt recently has been associated with a surge in our future capacity to generate exports.

that said, in fairness, it has been associated with a surge in the market value of US external assets. that is more tied to the surge in non-US equity market valuations/ currency moves than any increase in the cash revenues produced by US investment abroad, but it is worth noting.

Posted by: brad setser | September 26, 2006 at 12:46 PM

Dave -- this applies more to your preceding post than your current post, but without jumping into scare mongering, i do think that there is some risk of a significant increase in the US income deficit in the near future. I laid out my thinking in a recent post, but the key points include:

a) by my calculations, a rise in the average interest rate on US external borrowing to around 5% (v a bit over 4% in the first half of 2006) would lead to a deterioration of around $60b in the US income balance.

b) barring any offsetting rise in the income stream from US investments abroad relative to foreign investment in the US, ongoing currnet account deficits in the $900b-1,000b range imply -- depending on the marginal cost of US borrowing -- an increase of roughly $50b in the US interest bill per year. Long-term rates are under 5% on treasuries, but if you add in short-term borrowing and MBS/ agencies, i think the average cost of funds for the US is a bit above 5% right now at the margin.

c) a 1% increase in the average int. rate on US borrowing would increase the US interest bill by about $40-50b a year. That comes from higher interest costs of the portion of the US external balance sheet that is financed with debt -- i.e. the debt for equity swap (higher rates on the debt, no higher returns on the equity) and the US net debt position. those positions currently are in the $4.5 trillion range.

I am assuming that the averate int. rate on Us lending would rise commensurately, so the portion of US external borrowing that is matched by lending would not contribute to the deterioration.

add it up, and it seems to me that a significant deterioration is likely simply from the normalization of US interest rates on the external side, something that is playing out a bit more slowly than I expected....
I would consequently expect an income deficit of around $100b next year, even if nothing "bad" happens -- just from an increase average US extenral interest rates toward 5%.

Plus, as the US net debt position deteriorations/ a growing share of US equity investment abroad is financed with debt, the US exposure to an interest rate shock rises.

Posted by: brad setser | September 26, 2006 at 12:54 PM


Seconding Brad Setser's comment to Jim K, I think that whether, "de gustibus non est disputandum", household investment of borrowed funds is as "good" as any other, depends on the certainty and ease with which the borrower will be able to service the debt. It's important to note that from an external lenders perspective, investment in nontradables is indistuinguishable from consumption [*].

Normatively, a borrow who borrows to finance "in kind" returns, as might be supplied by a nice home, a vacation, or a good meal on a credit card, should not be criticized, so long as the burden she is taking on is one she can reasonably service. But a borrower whose capacity to its service her debt-load is in doubt ought to be criticized for such borrowing, as investing to secure in-kind returns without exchange value leaves ones external balance sheet encumbered by an additional liability with no corresponding asset, damaging the position of creditors.

Exactly the same argument applies to the United States' use of steep credit lines to finance consumption and nontradable investment. The magnitude of the United States debt load and the pace of its increase calls into question our ability to service our obligations (without partially defaulting by devaluing credit claims). Under these circumstances, borrowing for in-kind returns is putting other people's capital at risk for benefits they cannot share. It is behavior as much deserving of criticism and a heavily indebted low-wage worker putting a trip to Vegas on the fifth credit card.

One might ague that the "dollar is our currency, but their problem", so these concerns are overstated. I think that's right as far as it goes. But it does not go very far. The US has a capacity that overleveraged workers don't have, to devalue the claims against it with much less disruption than an individual declaring bankruptcy. The US might well end up having gotten lots of in-kind returns for pennies on the dollar, by playing and winning a zero-sum financial game with its foreign creditors. But zero-sum games are not what trade is supposed to be about. If the US "wins" this way, it will damage not only its future credibility as a borrower, but the case for trade as a positive sum enterprise with benefits for all. It is those who currently championing this moment's "free trade" who are most seriously damaging the long-term case for trade as economists like to envision it.

That was much more of a rant than I intended... I just don't think you should feel "chastened" for your previous expressions of worry, and speaking of in-kind returns, I hope you are hardly chaste at all!


[*] One could quibble -- to some degree nontradables can be considered an investment in future tradables production, as no tradables could be produce if American workers had no homes. But this is analogous to noting that American workers couldn't produce if they didn't buy food. We still mostly consider food expenditures consumption, not investment, and rightly so since we spend dramatically more than the minimum required to sustain production with some spartan lifestyle. Same argument goes for housing.

Posted by: Steve Waldman | September 26, 2006 at 02:13 PM

Brad, Forget the "rise in Residential Investment". We ALL now know it wasn't fundamentals that elevated house prices to these absurd levels. Our housing Bubble was driven by political shenanigans & rampant investor speculation, income can't support it & it WILL be reversed.
Tim Iacono reminds us this morning of the dilemma BB's Fed faces. Is Fed credibility at stake because of BB's misread & speak straight to us about our future prospects? (It's pretty obvious the Bond market doesn't think so, it's betting Bernanke works for them & will start major easing SOON.) Here's an excerpt from Iacona, link follows.
"From the fine blog of Calculated Risk comes this tidbit from last year where then-White House economic advisor Ben Bernanke offered his thoughts on the price of real estate.
Friday July 29, 2005
Bernanke: House Prices Unlikely to Decline.
Bernanke was on CNBC today. From Reuters:
Top White House economic adviser Ben Bernanke said on Friday strong U.S. housing prices reflect a healthy economy and he doubts there will be a national decline in prices.
"House prices have gone up a lot," Bernanke said in an interview on CNBC television. "It seems pretty clear, though, that there are a lot of strong fundamentals underlying that.
"The economy is strong. Jobs have been strong, incomes have been strong, mortgage rates have been very low," the chairman of the White House Council of Economic Advisers said.
The pace of housing prices may slow at some point, Bernanke said, but they are unlikely to drop on a national basis.
"We've never had a decline in housing prices on a nationwide basis," he said, "What I think is more likely is that house prices will slow, maybe stabilize ... I don't think it's going to drive the economy too far from its full-employment path, though."
Is it too early to start talking about the "Bernanke Put"?
The resurrection of this quote is certainly not a good indication of Mr. Bernanke's ability to predict the future - the timing of this assurance is particularly embarrassing. Graphically, with a little help from the Northern Trust, the situation looks like this:
Ironically, it has been almost exactly one year from when the Fed chief's prediction was offered. The report of two days ago, in which median home prices were seen to be declining on a year-over-year basis, was the very first full-year reporting period where Mr. Bernanke's assurances could have been put to the test and, unfortunately, the new Fed Chairman's advice looks to be as bad as the old Fed Chairman's."
My comment is that so far our Fed has refused to reverse its Banks' ridiculously loose mtg. lending criteria. Further, it has refused to state clearly that we can NOT go on expecting monetary policy to be the cure-all for profligate excesses of the Administration, GSEs, Congress, and carefree consumers. The Fed MUST tell the world, Business Cycles are painful but necessary.

Posted by: bailey | September 27, 2006 at 12:55 PM

Jim's use of the term "sources and uses" is very instructive.

For years I have rearanged the BEA savings and investment data
into a sources and uses presentation --it primarilly involves moving the fed deficit to uses rather then negative savings --and have found that it really makes the audience understand what is happening much easier.

For example, one of the observations that falls out of a "sources and uses" table is that in the 1990s boom foreign investment and the federal surplus financed about half of the capital spending boom.

Now this same presentation really makes it clear that the foreign investment is being used largely to finance the federal deficit and/or consumption, not investment.

Posted by: spencer | September 27, 2006 at 04:37 PM

"You load 16 tons and whadya get? Another day older and deeper in debt. St. Peter don't you call me cause I can't go, I owe my soul to the company store."

Some things are taught many times but never learned.

Great blog.

Posted by: quiz | September 27, 2006 at 10:22 PM

Dr. Dave,

The housing "demand" and subsequent price bubble was artificiallly stimulated by loose money and low rates vs naturally by rising incomes & rents.

That is the chicken that will come home to roost and the piper that has to be paid in the end. Hit the link for more.

Posted by: The Nattering Naybob | October 02, 2006 at 08:19 PM

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September 25, 2006

The End Of Dark Matter?

From this morning's Wall Street Journal (page A1 in the print edition), a return to one of last year's hot debates:

Exactly how the U.S. has managed to load on so much debt without seeing its net payments rise remains something of a mystery. Even in the second quarter, the U.S., in effect, was paying only a 0.4% annualized interest rate on its net debt. "It's still quite a good deal," says Pierre-Olivier Gourinchas, an economics professor at the University of California, Berkeley.

In a recent paper, Harvard economists Ricardo Hausmann and Federico Sturzenegger went so far as to suggest that the U.S. might not be a net debtor at all. Instead, they surmised, the U.S. might actually have income-producing assets abroad, such as know-how transferred to foreign subsidiaries, that have evaded measurement -- assets they call "dark matter," after a similarly elusive quarry in physics. Mr. Sturzenegger says the latest data haven't changed his view.

Most economists, however, see a more prosaic explanation: Foreigners have been willing to accept a much lower return on relatively safe U.S. investments than U.S. investors have earned on their assets abroad. Take, for example, China, which since 2001 has invested some $250 billion in U.S. Treasury bonds yielding around 5% or less -- part of a strategy to boost its exports by keeping its currency cheap in relation to the dollar.

Well, to be fair to Hausmann and Sturzenegger, that interest rate differential was part of their story.  Much of the debate was actually about the meaning of that differential: Is it some inherently superior aspect of the US economy that drives foreigners to pay a premium for our financial assets?  Or is it the agenda of, for example, the People's Bank of China, pursuing policies that are more about internal political objectives than market fundamentals? 

In any event, the Journal article suggests that, just maybe, we are seeing the beginning of the end:

As interest rates rise, America's debt payments are starting to climb -- so much so that for the first time in at least 90 years, the U.S. is paying noticeably more to its foreign creditors than it receives from its investments abroad. The gap reached $2.5 billion in the second quarter of 2006. In effect, the U.S. made a quarterly debt payment of about $22 for each American household, a turnaround from the $31 in net investment income per household it received a year earlier...

The gap is still small within the context of the $13 trillion American economy. And the trend could reverse if U.S. interest rates decline. But economists say America's emergence as a net payer illustrates an important point: In years to come, a growing share of whatever prosperity the nation achieves probably will be sent abroad in the form of debt-service payments. That means Americans will have to work harder to maintain the same living standards -- or cut back sharply to pay down the debt.

The article contains a lot of comments hinting at a deep instability that seem, to me, a bit over the top:

If the trend persists, it could also raise concerns about the nation's creditworthiness, putting pressure on the U.S. currency. "It's an additional challenge for the dollar," says Jim O'Neill, chief economist at Goldman Sachs in London...

Among economists' biggest concerns, though, is the fast pace at which the U.S. is accumulating new debt. As that leads to larger interest payments, it will make the current-account deficit harder to control -- a vicious cycle that could accelerate if worried foreign investors demand higher interest rates to compensate for the added risk...

"You end up having to pay more and borrow more," says the University of California's Prof. Gourinchas. "Things could get out of hand very quickly."

And this statement just seems wrong:

The size of the nation's debt payments matters because it represents a share of income that American consumers, companies and government won't be able to spend or save. The higher the debt payments, the harder it will be for the U.S. to prosper.

Any rapid change in capital flows could, of course, be disruptive in the short run, but a lot of borrowing by the country means the same thing as it does for you:  Accumulated debt doesn't stop you from earning income, it just limits your ability to spend it.  Nouriel Roubini puts his finger on what it all really means:

"Your standard of living is going to be reduced unless you work much harder," says Nouriel Roubini, chairman of Roubini Global Economics. "The longer we wait to adjust our consumption and reduce our debt, the bigger will be the impact on our consumption in the future."

No argument here.

UPDATE: You can find quite a few links to comments on dark matter at Alpha.Sources blog.

September 25, 2006 in Exchange Rates and the Dollar, Saving, Capital, and Investment, Trade Deficit | Permalink


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"Your standard of living is going to be reduced unless you work much harder...."

Doesn't that depend on what we do with the proceeds of all this borrowing? If it is invested productively, then we won't have to reduce our consumption. If it's consumed or invested unproductively we will. That's the same as with any other kind of borrowing. The presumption of all these dark warnings is that we are doing the latter, but I don't see what that's based on.

Posted by: Jim K. | September 25, 2006 at 02:49 PM

I agree with Jim. If anything he understates the point. The question boils down to what returns we earn on capital investment here. The tendency for capital deepening to raise labor returns is independent of who owns the capital. And even the net financial return seems likely to rise, despite the rising net tribute paid to foreigners.

Posted by: Gerard MacDonelll | September 25, 2006 at 03:38 PM

Although the other commentators make theoretically correct points, I think they are wrong empirically. Over the past few years, the US capital surplus (i.e., “borrowing”) has mostly been invested in residential real estate, which is not nearly as productive a use as one might hope for. Residential investment won’t do a whole lot to raise labor returns in the future. Moreover, if you compare investment and savings levels (as derived from the national accounts) to historical averages, you would have to say that much of the surplus has been consumed.

On the other hand, we don’t really know the answer to the counterfactual, how much would have been consumed and invested if we hadn’t been borrowing so much. And one could even argue that borrowing for consumption was a reasonable thing to do given expected productivity growth.

But…with Medicare already actuarially bankrupt, it seems to me we should be saving more, despite expected productivity growth.

Posted by: knzn | September 25, 2006 at 04:35 PM

Dr. Dave,

The symbiotic US debt & Chinese savings relationship is going to get severely tested in the next 4 years.

And yes the standard of living is going to come down and quite a bit.

Hit the URL for more...

Posted by: The Nattering Naybob | October 02, 2006 at 08:13 PM

"Your standard of living is going to be reduced unless you work much harder," says Nouriel Roubini,....etc.
"No argument here." ???

I beg to differ, change the word "harder" to "more efficiently" and I might concur, add "Enthusiastically" to that maxim, and I will concur with enthusiasm. Engineers tend to see accountants as puppy dogs, trying to catch their tails, running round in ever decreasing circles till they fall over, panting with a big innocent smile on their face! A 'for instance' as far back as I can remember (pre-1960's) Engineers have scratched their heads in total perplexity at why we put sticky oil in pipes and pump that sticky oil hundreds if not thousands of miles at huge labour. Madness! Engineers would bag the oil into sausages, place each sausage ballel of oil into a magnetic levitation "PIG" and then fly the oil at break neck speed down a much smaller evacuated tube. Deaserts need water, seawater evaporates in the deasert...slightly obvious the "PIGS" brake at each end of their jourlney, the momentum is converted into electricity...which in turn propells the out-going "PIGS". Oil arrives at a Sea-Port, and Sea-Water arrives at the Oil Well. Sea Water turns to Fresh Clean Potable water and Sea-Salt. which is a highly desireable and marketable commodity on it's own.

Common Sense. All we need to do, is do it!

Posted by: Alastair Carnegie | May 18, 2007 at 12:11 PM

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September 21, 2006

Is It All Health Care?

Michael Mandel begins his latest provocative Business Week piece, "What's Really Propping Up The Economy", this way:

Since 2001, the health-care industry has added 1.7 million jobs. The rest of the private sector? None.

In case you don't believe it, he also provides this picture, at Economics Unbound:




As I said, provocative. But I'm not entirely convinced.  If you take a slightly more disaggregated look at private nonfarm employment, you will find that there are really three types of job-growth patterns since 2000:

The no-growth group: Those industries that really did decline, or flatten, and have not yet recovered.  Manufacturing is the biggest and most dramatic case by far, but there are others: Wholesale and retail trade (if we strip out those activities clearly related to the health care industry), transportation and warehousing, "other services" (which includes things like auto repair and servicing, funeral services, and unions), utilities, and information.  Although employment in the mining and natural resources industry has been growing in the past couple of years, the trend had been down for most of the past 15 years -- so I'll throw that one into this group for good measure.

The recession-proof group: These are the industries in which employment grew steadily right through the 2001 recession, and beyond.  The health-care industry is the biggest in the group, but there are others: Finance and insurance (even excluding employment related to medical insurance), education, and social assistance.  Together employment in these other groups add up to nearly the same number of jobs as the health-care industry.

The bounce-back group:  Job growth in this group was hit by the recession -- hard in some cases -- but employment in these sectors has again begun to grow at a steady pace in the past several years.  The leisure and hospitality industry, construction, real estate, and professional and business services are all in this category.

That last group is particularly important.  If we are talking about economic growth -- and I think we are -- the important question concerns what is happening at the margin.  It is indeed clear that there were some very major adjustments associated with the last recession and its aftermath. Whatever the story on those adjustments, these are industries that typically grow in expansions, that have resumed to grow again in this expansion, and for which we have every reason to believe said growth will continue.

There is no doubt that, as Michel indicates in his latest post on the subject, the health-care industry is an increasingly important part of our economy.  Even ignoring the fact that job growth is not exactly the same thing as economic growth -- the manufacturing sector continues to be an important contributor to GDP growth even though it has not been a source of net job creation for ever 40 years -- it is way too simple to say assert that this is the sector "propping up" the economy. And way too easy for policymakers to start down the wrong path if they believe it was so. 

The pictures: First, the no-growth group -










Next, the recession-proof group:







Finally, the bounce-back group:







Here is the data, if you are interested:

Download employment_by_industry_slides.ppt

September 21, 2006 in Labor Markets | Permalink


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Sorry, but this seems no more "provocative" than the Chicago Fed's recent piece by Fisher & quayyum, "the great turn-of-the-century housing boom".

Posted by: bailey | September 22, 2006 at 12:31 PM

offtopic: Professor, I noticed today that the Fed Fund probabities for a rate cut are now slightly higher than for a hike at the December meeting (Pause is still dominant). I was wondering if there was data available to look back at the previous rate cutting cycle (Jan 2001) to see if the Fed Funds futures accurately predicted the first rate cut.

Best Regards.

Posted by: CalculatedRisk | September 22, 2006 at 02:57 PM

"for which we have every reason to believe said growth will continue"

Even if housing declines? Commercial may take up some of this but replace it? Even finance seems heavily housing related. Well soon the boomers will start retiring and we won't need any new jobs but output should continue to rise, at least somewhat.

Posted by: Lord | September 22, 2006 at 04:53 PM

Thanks for all those pretty graphs. I have only a small quibble: is way too simple to say[] that this is the sector "propping up" the economy. And way too easy for policymakers to start down the wrong path if they believe it was so.
And that is, this piece is aimed at the general public (ok, the recreational economists) and not the policymakers who are going to demand much closer attention to the last few months than the decades presented here.
This recreational economist would have wished for more detail in the growth of health care with a view to making certain claims about the boomer's role in that expansion.
Kinda think Lord is right to think that a slowing in housing will have an impact on this health care industry and, although boomers are a big slice needing/wanting as usual, the outsized share, they are not going to get it. Somehow I think that 50%(!) that is spent in the last year of life is a temporary phenomena and we will see more reasonable allocations of resources.

Posted by: calmo | September 23, 2006 at 02:57 AM

That guy must have had a job in Wall Street research at some point in his career. The part being negative 300% of the total is the tip off.

Posted by: Gerard MacDonell | September 24, 2006 at 08:20 PM

CR -- Options weren't available until 2003. However, we can get an idea from futures -- have a look at this article:
The record is that turning points often catch people by surprise (not surprisingly!).

Posted by: Dave Altig | September 25, 2006 at 08:20 AM

It would be nice to see a graph of (health+real estate) and private non-(health+real estate).

Posted by: RB | September 25, 2006 at 09:14 PM

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September 19, 2006

I'll Take It

From the Wall Street Journal Online (subscription required):

U.S. economic growth is likely to slow this year to 3%, a pace slightly below its long-run average of 3.1%, according to a survey of chief executives released Monday.

An index on the economic outlook for the next six months has dropped to 82.4 from 98.6, reaching the lowest point in three years, according to the quarterly survey by the Business Roundtable, a group of CEOs from big corporations. The latest reading remains far above the threshold of 50 below which a contraction is expected...

The survey shows nearly three-quarters of corporate leaders expect their sales to increase over the next six months, while 17% foresee no change and 9% see a decrease. For capital spending 39% of those surveyed see an increase in the next six months, while half expect no change and 11% see a decline. For employment 32% anticipate growth, 39% see no change and 29% expect a decline.

Unfortunately, the survey has only been conducted since 2002, so we don't really know what these CEOs were telling us, in let's say mid-2000, as the economy was about to drop off the cliff.  And I have to wonder about a forecast in which over half the respondents expect both investment spending and employment to stall or decline.  (I also wonder what question the CEOs are really answering.  Is that the absolute level of capital spending and employment they are talking about?  Or capital spending and employment relative to current plans?)

Nonetheless, if you give me 3% growth, I will definitely be a satisfied customer.

UPDATE: Nouriel is having none of it.

UPDATE II: From the official weblog of the National Association for Business Economists:

Below-trend growth during the second half of 2006 is the dominant feature in the near-term outlook. GDP growth is expected to remain subdued over the second half of 2006, averaging just 2.6%.  On a fourth quarter-over-fourth quarter basis, real GDP growth in 2006 is expected at 3.3%, down from 3.5% in the May survey.  Solid gains in consumer spending — albeit restrained by high energy prices — and nonresidential fixed investment are expected to be offset by drag from declining new home construction.

UPDATE III: Today's data helps Nouriel's case.  From The Nattering Naybob Chronicles:

August PPI +0.1% Full Report..

Ugly truth: the drop was led by -2.6% new car prices, -3.4% light motor truck prices & -0.3% capital equipment. NOT a good picture for manufacturing and durable economic activity...

August Housing Starts -6% @ 1.665M Full Report

Inside the number: the lowest since April 2003. falling in 6 of the past 7 months.

August Building Permits -2.3% @ 1.722M

Inside the number: the lowest since August 2002. July Building permits revised lower -3.3%; falling 7 months in a row.

September 19, 2006 in Data Releases, Housing, Inflation, This, That, and the Other | Permalink


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Are we to assume that linking to an instance of your own participation in partisan hair-splitting means you are proud of that participation?

Posted by: kharris | September 19, 2006 at 03:13 PM

k -- I certainly was not being partisan, and I did not -- and still do not -- think of my point as hair-splitting. (Perhaps that because I know I was not attempting to make a partisan point, a fact that many people seem hard to accept because so many others insist on forcing everything through their own partisam seive.) I think it is ridiculous for people to argue contrary to the position that the downturn in the economy was in play in the second half of 2000 --the data speak otherwise. And I think it is important to remember that episode because the data only slowly revealed the unfortunate reality of the situation -- I use that to temper my natural optimism.

Posted by: Dave Altig | September 19, 2006 at 10:20 PM

Let me see, save or spend, save or spend; what a tough decision. I can earn a whopping 5% if I invest my hard earned $$ in a 5 year Bank cd. But, yesterday I got 2 more credit card offers encouraging me with 0% interest until 2008 to buy that boat I've always wanted. I sure would like a new boat like the one my neighbor recently bought. Maybe I should trade in my 3 year old car to take advantage of the 0% 6 year financing deal I just saw on TV.
I've been in cash for two years now waiting for the Fed's baby step increases in its Fed Funds rate to take effect and/or for the world to come to its senses, but maybe it's me who's out of touch.
Maybe it's time to buy a house. After all, asking prices are down about $50,000 (off the highs, with sale prices not falling a lick), and with one of those 0% down no-doc option arms how bad a deal can it be? Even though they'll no longer give me cash-back, they are still offering a nice teaser rate. Isn't the Fed's clamp down on these widely used loans really a statement of support? Besides, if the economy goes south, the Fed WILL turn on the spigots, right? That is what AG said, isn't it? It seems this is the way for me to go. The Fed doesn't even count my large money bank deposits as money anymore so that must be a hint, right? Of course, a house would be a huge call in today's market. But, I see in this morning's paper I could fully furnish it using a no-interest furniture loan and not make a payment until 2008.
Forget all the micro-Economic nitpicking, Dave. What's the FOMC telling all us fence-sitters it would like us to do, SAVE OR SPEND? I couldn't tell from yesterday's statement. Is the market right - are we likely to see TWO Fed eases in the next year?

Posted by: bailey | September 21, 2006 at 03:47 PM

Hi bailey -- Well, I'm pretty sure Chairman Bernanke has said it would be good for the long-run if Americans saved more. That's probably not the sort of advice you were shooting for, but there you have it.

As for waht the FOMC was trying to say, that, of course, is above my rank. But I think they pretty much said what they said last time -- it's a good time to sit tight and see what develops. I guess the market thinks its downhill from here.

Posted by: Dave Altig | September 21, 2006 at 07:14 PM

I do find the stock market a bit interesting now. It rallied on bad news, and then seemed to fall of a precipice when Philly Fed data was released last week.

Market psychology changed on a dime. Everyone is a bear now. Up until then slightly bullish.

Fed will not move at the next meeting. Next move will be an ease.

Posted by: jeff | September 24, 2006 at 09:08 PM

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September 18, 2006

There's Clouds In Them Details

Tim Duy gives me a shout-out in the latest edition of his ever-excellent Fed Watch contribution at Economist's View:

On inflation, see also the rays of hope David Altig sees in the August median CPI data.

That link will send you to Friday's post on the August CPI report, in which I noted that a fair share of individual price changes have been shifting from very high to only moderately high.  The picture in that post pertained to the components of headline CPI, but I could just as well have showed the CPI stripped of energy components:




So, once again, taken as whole the rapidly changing prices in the market basket -- those rising in excess of a 3 percent annual rate -- have tended to rise, well, less rapidly.

I was feeling that maybe there was something hopeful in that, but my colleague Mike Bryan suggested I take a look at the picture without owner's equivalent rent. OK, I'm game:




Uh-oh.  Looks like a decline in the rate of change in owner's equivalent rent is driving those first pictures.  Strip that component out (along with energy) and not only is the largest share (54%) of expenditure-weighted prices rising in excess of 3 percent, but the largest part of that group is rising in excess of 5%, as has been true all summer.

I suppose that by excluding this or including that I could make these picture look about any way I please.  But the exclusion of OER is not arbitrary, and the components left in the less-energy-and-OER index still account for about 65% of the CPI basket.  And the story there just isn't changing much.

UPDATE: I should have noted that, in the comment section of my previous post, the always astute knzn noted the OER connection as well.

September 18, 2006 in Inflation | Permalink


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I would argue that the housing slowdown has had little impact on the overall economy so far - although the loss of housing related jobs will surely be a drag soon - so the hoped for impact on inflation, from the housing slowdown, is still in the future.

How is that for an optimistic view? At least on inflation ...

Best Wishes.

Posted by: CalculatedRisk | September 18, 2006 at 11:48 PM

Close to 70% of our population live in owner occupied houses.
Here's how BLS begins its lengthy explanation of its Owner Equivalent Rent (OER) collection method:
"the expenditure weight in the CPI for rental equivalence is obtained by directly asking sampled owner households the following question:
If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?"
Here's the link:

How much of CPI data is arrived at subjectively?

Posted by: bailey | September 19, 2006 at 10:04 AM

Does anyone remember how some people were saying the Fed should not pay too much attention to OER when it was the main reason core inflation was up quite a bit?
I guess when the data changed the rationale for that changed as well.

Posted by: Iasius | September 19, 2006 at 02:17 PM

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September 16, 2006

Odds And Ends -- September 16 Edition

A few worthy reads, from days recently passed:

On the latest economic statistics: Useful summaries can be found in some of the usual places -- The Nattering Naybob Chronicles (here and here) and The Skeptical Speculator (here and here). Tom Blumer is feeling optimistic (here and here), as is Jim Hamilton. The Capital Spectator, meanwhile, is giving feeling good the old college effort (here and here). But Barry Ritholtz does not yet see a "soft landing", arguing that "we should temper our enthusiasm for lower oil prices". William Polley is feeling like the glass is half empty, and Calculated Risk reports that CFO's are feeling gloomy too. Felix Salmon relays the debate among the thinkers at Morgan Stanley.

On the international front, Menzie Chinn takes a stab at measuring the U.S.-China trade balance. EurActiv summarizes the conclusions of a paper on European and Asian Perspectives on Global Imbalances.  And no list on this topic would be complete without listing Brad Setser's latest musings. Want more? Wander on over to MacroMouse, and you will find some thoughts on the topic from Sybil Star.

The continuing trials and tribulations of the U.S. auto industry attracted a bit of attention this week.  winterpseak, writing at Asymmetrical Information, casts a skeptical eye at proposed employee buyout plans. pgl reviews the evolving state of the automotive industry in China.

At Fistful of Euros, Edward Hugh has a round-up, and his own considered opinions, of a really interesting discussion on the legal feasibility of secession from Eurozone, the candidate departed being Italy.  (Edward views Italy's break away as both legally possible and economically inevitable.)

Speaking of Edward, he has some thoughts on the very brisk pace of economic growth in India. Claus Vistesen chimes in as well. (Maybe this story is related?)

Although it may seem a quaint discussion at the moment, Mike Moffatt takes a shot at the question "What Happens If Interest Rates Go To Zero?" The interest rates in question are nominal interest rates -- and if the meaning of the word "nominal" is not readily apparent to you, Mike provides a link to help you out there as well.  (If you are interested in some thoughts on the subject from the current chairman of the Federal Reserve's Board of Governors and Federal Open Market Committee, you can find them here.)

Dean Baker discusses the possibility of bias in the Consumer Price Index, and makes a suggestion with which I wholeheartedly agree:

On this story, I argue that we should leave the call to the umpire – in this case the Bureau of Labor Statistics (BLS), the agency that constructs the CPI. Of course BLS can and does make mistakes, but they have generally been an honest broker on this issue. When economists have presented solid research showing understatements or overstatements in the CPI, BLS has examined the issue and sought to make the appropriate adjustments... I have my own criticisms of the ump, but at this point, I'm going to defer to the ump's call over the anecdotes of the CPI critics.

Mark Thoma has some (sort of) related remarks.

In the labor market department, there is an interesting post on productivity and wages in Canada and the United States,from Stephen Gordon (hat tip, Economist's View).

A lot of people took notice of the demise of the proposed minimum wage aimed at big box retailers in Chicago.  Dave Schuler was one of them.  On that theme, Greg Mankiw reminisces on Alan Greenspan's views about the minimum wage, wondering if the current chairman will be as forthright.  Actually, I think he already has been.

Speaking of Greg Mankiw, you might be interested in his roll of advocates for Pigouvian taxation.

Tyler Cowen gives a heads up on what will surely be one of the next great policy debates: Have American's incomes become riskier, and if so, what should we do about it? 

Finally, I may be the last person to notice this site, but if you are looking for advanced lecture notes from some very good economists, check out Lecture Notes Online (hat tip, Gabriel Mihalache).

September 16, 2006 in This, That, and the Other | Permalink


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That paper on zero interest rates is completely confused and confusing. "A zero nominal interest rate occurs when the interest rate is the same as the inflation rate." I don't know how to complain there so I'll bend your ear instead. He switches back and forth so fast between nominal and real I got a neck ache.

Posted by: Hal | September 18, 2006 at 06:28 PM

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