macroblog

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The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


August 09, 2007


Checking In

Just in case it isn't completely obvious, macroblog is on a temporary hiatus as I make the transition to my new position at the Federal Reserve Bank of Atlanta.  For those of you who have asked -- and really, thanks so much for asking -- this blog will indeed live on.  Hope you hang tight, and don't delete me from your feeds -- I'll be back in action before you know it,

August 9, 2007 in This, That, and the Other | Permalink

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June 21, 2007


Dark Matter By Any Other Name

From Austin Goolsbee, via Mark Thoma:

... The United States miracle of the 1990s was that our productivity began growing faster than that of other countries, even though we were the richest to start with...

To explain the experience in the United States, one would have to believe that Americans have some better way of translating the new technology into productivity than other countries. And that is precisely what [London School of Economics] Professor [John] Van Reenen’s research suggests.

His paper “Americans Do I.T. Better: U.S. Multinationals and the Productivity Miracle,” (with Nick Bloom of Stanford University and Raffaella Sadun of the London School of Economics) looked at the experience of companies in Britain that were taken over by multinational companies with headquarters in other countries. They wanted to know if there was any evidence that the American genius with information technology transfers to locations outside the United States. If American companies turn computers into productivity better than anyone else, can businesses in Britain do the same when they are taken over by Americans?

And in the huge service sectors — financial services, retail trade, wholesale trade — they found compelling evidence of exactly that. American takeovers caused a tremendous productivity advantage over a non-American alternative.

When Americans take over a business in Britain, the business becomes significantly better at translating technology spending into productivity than a comparable business taken over by someone else. It is as if the invisible hand of the American marketplace were somehow passing along a secret handshake to these firms.

Sound familiar?  If you can't quite put your finger on it, here's a refresher from Ricardo Hausmann and Federico Sturzenegger:

There is a large difference between our view of the US as a net creditor with assets of about 600 billion US dollars and BEA’s view of the US as a net debtor with total net debt of 2.5 trillion. We call the difference between these two equally arbitrary estimates dark matter, because it corresponds to assets that we know exist, since they generate revenue but cannot be seen (or, better said, cannot be properly measured)...

At least three factors account for the accumulation of dark matter. The first refers to foreign direct investment (FDI). Consider a simple example. Imagine the construction of EuroDisney at the cost of 100 million (the numbers are imaginary). Imagine also, for the sake of the argument that these resources were borrowed abroad at, say, a 5% rate of return. Once EuroDisney is in operation it yields 20 cents on the dollar. The investment generates a net income flow of 15 cents on the dollar but the BEA would say that the net foreign assets position would be equal to zero. We would say that EuroDisney in reality is not worth 100 million (what BEA would value it) but four times that (the capitalized value at our 5% rate of the 20 million per year that it earns). BEA is missing this and therefore grossly understates net assets. Why can EuroDisney earn such a return? Because the investment comes with a substantial amount of know-how, brand recognition, expertise, research and development and also with our good friends Mickey and Donald. This know-how is a source of dark matter. It explains why the US can earn more on its assets than it pays on its liabilities and why foreigners cannot do the same. We would say that the US exported 300 million in dark matter and is making a 5 percent return on it. The point is that in the accounting of FDI, the know-how than makes investments particularly productive is poorly accounted for.

That story might only go so far, as the Federal Reserve Bank of New York's Matthew Higgins, Thomas Klitgaard, and Cedric Tille claim...

... we review the argument that the United States holds large amounts of intangible assets not captured in the data—assets that would bring the true U.S. net investment position close to balance. We argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.

... but it's apparently more than a fairy tale.

June 21, 2007 in Economic Growth and Development, Saving, Capital, and Investment, This, That, and the Other, Trade Deficit | Permalink

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» Dark Matter By Any Other Name from UniversalUpdate.com
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Tracked on Jun 22, 2007 12:46:50 AM

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June 20, 2007


Apples To Apples

Today at Angry Bear, my friend pgl is doing some back-of-the-envelope econometrics:

From 1980QIV to 1992QIV, average annual real GDP growth = 3.0%.

From 1992QIV to 2000QIV, average annual real GDP growth = 3.6%.

From 2000QIV to 2006QIV, average annual real GDP growth = 2.6%.

Notice something? During the low tax eras (Reagan-Bush41 and Bush43), we witnessed lower growth rates. During the Clinton Administration – which began with its fiscally responsible policies with a tax rate increase – we saw strong growth. Maybe part of the explanation has to do with the impact on national savings from fiscal irresponsibility justified by phony free lunch promises.

I have a bit of a problem with the evidence here.  To get the gist of my objection, take the following quiz: 

Which one of these time periods did not include a recession?

a. 1980QIV to 1992QIV

b. 1992QIV to 2000QIV

c. 2000QIV to 2006QIV

If you answered b, you win the gold star.  And if you knew that, are you really surprised that the period from 1992 through 2000 had higher average growth than the other two periods, which did include recessions?  Suppose we instead make the comparisons including only the expansion years of the Reagan-Bush41 and Bush43 administrations?  Here's what you get:

From 1983 to 1989, average annual real GDP growth = 4.3%.

From 1992 to 2000, average annual real GDP growth = 3.7%.

From 2002 to 2006, average annual real GDP growth = 2.9%.

You could just as well look at those numbers and conclude that potential GDP growth -- measured cycle to cycle -- is declining through time.  And if you accept pgl's characterization of irresponsible policy, followed by responsible policy, followed by irresponsble policy, you might then conclude that policy has very little to do with that trend.

Perhaps you would want to argue that I shouldn't exclude recessions because the absence of a downturn in the 1992-2000 period is itself evidence of the superior growth effects of the fiscally responsible policies of the Clinton administration?  Let me try to talk you out of that with a few more questions: 

1. Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?

2. Do you really want to characterize Bush41 as a tax cutter?  And would you maintain that position knowing that Clinton's major piece of fiscal policy -- the Omnibus Reconciliation Act of 1993 --was pretty much of copy of the Omnibus Reconciliation Act of 1990, the legislation in which President Bush the Elder famously broke his "no new taxes" pledge?

3.  Do you really want to finger the Bush43 tax cuts for the 2001 recession which began a scant two months into the administration and was over even before the tax cuts took effect?

Look -- It might very well be that "fiscal responsibility," as pgl defines it, is a central ingredient of pro-growth policy.  But those GDP comparisons don't make the point.

UPDATE: pgl responds --to no particular objection from me -- here and here.

June 20, 2007 in Taxes, This, That, and the Other | Permalink

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Macroblog asks, "Do you really want to blame the Reagan fiscal policies for the 1980-82 recessions -- which are almost universally attributed to the Volcker Fed's fight against double digit inflation inherited from the policies of the 1970s?"

The first of the two dips, no.

But let's stop and think a moment. Why did Volcker push rates up to such punishing levels? Did it have anything to do with deficits?

If you answered yes to the latter, then Reagan has to take the blame for the second, terribly damaging dip of the recession.

One can argue that Reagan's increase of military spending far beyond what he had promised in the campaign was necessary. I would not. One can argue that his tax cuts were essential as a growth stimulus. I would not. One can even argue that the out-of-control budgetary extravaganza that David Stockman describes was a necessary price to be paid for getting the changes Reagan wanted. I would not.

But one cannot argue that whatever the h--l Reagan was doing didn't to get paid for (it wasn't and hasn't been), which is an important reason for the Fed's severity.

Posted by: Charles | June 20, 2007 at 11:17 PM

Well I am not going to be the 'one' to argue with Charles. I would not and I do not.
No.
Why should I rescue Volcker in preference to Reagan? or pgl in preference to our fine host David?
If you answered politely to the latter, that it is always civil to side with the host no matter how uncompassionately he posts (and fresh from declarations of sensitivity, people!), give yourself a ...gold star? Really?
I cannot be bought by these gold star thingies, you? No, ok give yourself a good slap to the forehead and know that your first swing at it was just a warm-up...to your mighty swath which would be about measuring GDP and not GDP growth rates, about the respective income distributions in those periods (ok, "expansions" look good but pgl battles the political thugs who are as arbitrary as he is.) and the increasing debt.

Posted by: calmo | June 21, 2007 at 02:16 AM

Unfortunately, I don't have time to dig up the actual numbers, but a few years ago I computed annualized real GDP growth as a function of Democratic or Republican Presidents, going back to about 1920-1930 (I don't remember the exact year). I also tried lagging it by 1 or 2 years (assuming there is a delay from when the president takes office to when his policies can have an effect).

The result was quite dramatic. In all cases (0, 1, 2 year lag), the annualized real GDP growth was significantly higher during Democratic presidents.

I'm not sure exactly what it proves, but it was a much larger sample than the one referenced in this blog entry.

Posted by: ErikR | June 21, 2007 at 08:27 AM

You have a valid point that the recessions can distort the comparisons. But the recovery period immediately after a recession also distort comparisons. So if you are going to remove the recession years from the comparisons you should also remove the snap-back years of the recovery that are just as much a distortion.

For the 1980s this implies your should remove 1984 and 1985 when growth was 4.5% and 4.1%. Without these two observations your average growth for the Regan years is much lower. However, you do not get this distortion for the Clinton years since the early recovery period only had 3.3% real gdp growth in 1992.

You are correctly pointing out one data distortion only to replace it with an even more distorted comparison.

Posted by: spencer | June 21, 2007 at 08:53 AM

David - you have a point here, but I would have praised it quite differently. I follow up over Angrybear with re-phrasing what I was trying to say as well as what I think your point is here.

Posted by: pgl | June 21, 2007 at 09:08 AM

To attribute it all to the President at the time? Well, that is seeing a lot more power in the executive branch than I see.

Posted by: wally | June 21, 2007 at 09:26 AM

Wally - it's not the name of the President at issue. It IS the fiscal policy chosen by the government "at the time".

Posted by: pgl | June 21, 2007 at 09:48 AM

Calmo, I'm not quite sure what you are saying.

Let me try to explain why I chose to focus on the very narrow issue I did. Many Net debates try to deal with too much and end up resolving nothing. But on the issue of the twin recessions of the early 1980s, we actually have fairly good inside evidence as to why things unfolced as they did. We have David Stockman's account from inside the Administration. We know that there was tension between conservatives (GOP president, GOP Senate, nominally Democratic but boll weevil-controlled House) and the Fed. We know that monetarism was driving monetary policy, and that fiscal policy was very loose (see www.time.com/time/magazine/article/0,9171,954012-3,00.html, for example). So, there's not really much question that interest rates were held high because of deficits, nor is there any question that Republicans had the upper hand in government, nor is there any question that high interest rates diminish growth.

If David will re-consider this one point, we could move onto the next and the next and maybe come to a conclusion.

Posted by: Charles | June 21, 2007 at 11:29 AM

Thank you for casting that 'one' into the drink Charles. Seriously, one can be a pain in the butt, you know?
And thank you for not enumerating your points for us flow-an-go guys who have trouble even with "points" and "moving forward" sometimes even to conclusions....you know?
Ok, now you know.
This is not a debate...I am unable to act as a fair and balanced moderator and am not about to concede that role to anyone else, you?
I accept 'discussion' when sober and polite, nearly civil...like now.
I appreciate your detail and your bravery at accepting Stockman's account as the veritable truth, but I also appreciate spencer's skill in unraveling this "comparison" of economies over broad horizons and see serious problems of referential opacity...much to the chagrin of economists who need to feel that certain eras were managed better than others...and that their profession, still in its infancy, counts for something.

Posted by: calmo | June 21, 2007 at 12:13 PM

If you measure from the recession bottom there has been no significant difference in real gdp under Clinton and Bush II. Moreover, both experienced weaker growth then Reagan did in the 1980s and he experienced weaker growth then Kennedy/Johnson did in the 1960s.

However, when you look at the composition of growth there are significant differences between Clinton and Bush. Under Clinton investment made a much larger contribution while under Bush it has been consumption and housing that led growth.

To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century.

Posted by: spencer | June 21, 2007 at 04:26 PM

It is very difficult to compare. With Reagan, he was starting out in such a hole, you had to get some parts of the economy started, let alone to stop sputtering. He also increased defense spending, and at the same time Congress increased social spending as well. This greatly inflated the deficit more than it normally would have.

Clinton decreased defense spending and increased taxes. Remember the peace dividend? He also increased social spending. Both Bush I and Clinton started from a firm base, and good consumer confidence. Expectations were higher than they were under the beginning of the Reagan presidency. Bush I was not a good fiscal policy planner, and stupidly raised taxes and lowered expectations, inducing a recession.

None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame.

The interesting thing to look at is what will happen in the future. Congress is debating a new tax bill, and it looks like they will raise taxes, and change a lot of the tax code. If expectations change, it will have a far greater effect on fiscal policy than a deficit or surplus.

One thing is clear, people respond to incentives. If you lower taxes, they will produce more. Raise them and you change their incentives. The one bill I have read about changes the AMT and rates of tax over 250K. You will see a lot of people seeking tax shelters that make above 250K. Cayman Islands anyone?

Posted by: jeff | June 21, 2007 at 05:40 PM

You'd think people writing about economics would understand the difference between correlation and causation. Do tax cuts and deficits cause recessions, or could it maybe just be the other way around? Do Republicans cause slower growth, or do Republicans get elected to clean up the messes created by Democrats (see Reagan, Ronald)?

Posted by: jimmyk | June 22, 2007 at 07:58 AM

Jeff says Reagan started in a deep hole but he should check out my second reply to David (which David provides a link to in his update). According to the CBO, the GDP gap was only 2.4% as of 1980QIV. From mid-1980 to mid-1981, real GDP grew by about 4.3%. Maybe Jeff is thinking about where the economy was at the end of 1982. But didn't Reagan become President in early 1981?

Posted by: pgl | June 22, 2007 at 09:25 AM

My estimate of spencer grows boundlessly it seems (iz he gettin help, people?) and I feel compelled to fall in behind the (political) defusing sagacity of remarks like this:

"To be honest, I do not much care about the debate over why growth is that much different under democratic and republican presidents. However, I do care that the theory that supply-side economics leads to greater investment and higher standards of living is simply incorrect as it has been practiced under Republican administrations over the last quarter century."

And not, say, (the lame, and media cultivated and propagated, and reminder that some of us were born on Thursday) remarks like this:

"None of these Presidents had to deal with what Bush had to deal with, a crashed stock market, an unprecedented terrorist attack. Bush's largest mistake came by not using his veto pen to cut the spending of an unchecked Republican Congress.
Hastert and Frist also should assume a lot of the blame."

Posted by: calmo | June 22, 2007 at 12:38 PM

The reason political parties act as they do is because the only relevent statistic we seem to focus on is GDP growth over their term.

I am thinking Ravi Batra provides the best summary of Greenspn era crap. According to Batra, the Reagan tax cuts were payed for by a huge increase in the most regressive of taxation, social security. People were fooled into thinking they were putting money aside for retirement while, just like now, they are funding a renegade tax-cut-for-the-rich, budget busting, debt induced spurt in GDP.

Like the Reagan-Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 80's, the Bush-Cheney-Rumsfelt-Greenspan real estate scam and debt splurge of the 00's will end badly, ie; recession and deficits.

Posted by: zinc | June 22, 2007 at 03:37 PM

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June 03, 2007


Taking It Slow

The recent spate of relatively good economic news has some people thinking rosier scenarios.  From the Wall Street Journal (page A3 in yesterday's print edition):

The latest data show employment and manufacturing growing at a vigorous rate, suggesting the U.S. economy is regaining momentum after a slow start to 2007...

Nonfarm employers added 157,000 jobs to their payrolls in May, nearly double the 80,000 new jobs recorded in April, the Labor Department said Friday. Led by the service sector, the rebound brought the three-month average job gain to about 137,000, a pace strong enough to keep unemployment low and wages rising. The unemployment rate held steady at 4.5%.

Meanwhile, the Institute for Supply Management, a purchasing managers' trade group, reported that its index of manufacturing activity came in at 55 in May, up from 54.7 in April, indicative of expanded factory production. That is a stark contrast to earlier this year, when manufacturing activity was contracting.

Economists saw the reports as confirmation that the economy is regaining momentum despite the pain that high gasoline prices and the housing slump are inflicting on the consumer...

How quickly the economy rebounds will depend to a large extent on how U.S. consumers, whose purchases make up more than two-thirds of all economic activity, respond to the conflicting influences of high gasoline prices, falling house prices, a robust stock market and rising incomes. Friday, the latest reading on the University of Michigan's consumer sentiment index suggested they were still in relatively good spirits: The index rose to 88.3 in May from 87.1 in April.

It does feel like we've gained a little breathing room, but this picture sticks in my mind:

   

2001_gdp_growth   

   

That second quarter of 2000 should remind us that it sometimes looks pretty sunny before the storm.

June 3, 2007 in Data Releases, This, That, and the Other | Permalink

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Interesting chart and always worth remembering. Although...

January 1, 2000 Fed Funds Rate: 5.5%
May 16, 2000 Fed Funds Rate: 6.5%

Oops!

I do agree that we're not quite out of the woods yet, but I do think we can see the edge of the forest from where we are.

Posted by: Steve | June 03, 2007 at 10:56 PM

"sometimes looks sunny before a storm"...now see Dave if you were a sailor this might B penned a wee bit different...but who cares really about squalls or calms? Tis the tanning season when we roast our butts on the sand and gawk at the sails out there from a safer and drier perspective.
Ok then.
Part of that drier perspective (Shall we just skip that gratuitous "wages rising"? We shall.) includes:
"Economists saw the reports as confirmation that the economy is regaining momentum despite the pain that high gasoline prices and the housing slump are inflicting on the consumer.."
a retroactive recognition that the housing market has spilled over, no? That pain from the "high gasoline prices" is nothing on the pain I feel reading spill containment blurbs like this from folks whose portfolios are quite capable of handling $3 gas...who might appreciate the thinning of traffic congestion with $5 gas.
Last cotton pickin (very dry) thing:
"Friday, the latest reading on the University of Michigan's consumer sentiment index suggested they were still in relatively good spirits: The index rose to 88.3 in May from 87.1 in April."

Let it B known that I will never consent to this index being used as a guide to my spirits. Can you imagine the crafting that goes into teasing out the seasonal adjustments, the weekly adjustments, the personal adjustments? And the audacity to carry that one off to 3 significant digits...with the straightest of faces. (Jamie's Plonking Type I, no?)

Posted by: calmo | June 04, 2007 at 01:53 AM

A man falls out of a very tall building. As he is falling past the 40th floor, someone asks “How is it going?” The man answers, “So far, so good.”

Posted by: Oracle of Cleveland | June 04, 2007 at 08:39 AM

This is on a different topic, but I was wondering if someone had an explanation for the disconnect between advance durable goods new orders/shipments and unfilled orders since 2005? See: http://www.ny.frb.org/research/directors_charts/pi_10.pdf. Thanks in advance, Sam

Posted by: SamK | June 04, 2007 at 10:56 AM

On the one hand the inventory correction -- except for housing -- seems to be over and production is rebounding. On the other hand final demand continues to weaken. So is the extra production going back into inventories?

Posted by: spencer | June 04, 2007 at 12:59 PM

Sam,

I get a dead page ("you are not allowed...") when I hit your link. However, I think I know what disconnect you mean. The rapid rise in unfilled orders vs more moderate gains in new orders and shipments? Boeing accounts for a lot of it. Boeing orders are running massively ahead of shipments in just about every month. Boeing seems to have a maximum capacity of around 37 full-sized commercial aircraft completed per month, and monthly orders are running way ahead of that, on average. The result is a growing pile of unfilled orders.

There are other factors at work, but I think that explains nearly half of the growth in unfilled orders over the past year. Unfilled orders of factory goods were up 19.9% y/y in April while orders ex-transport were up just 11.8%. Unfilled non-defense aircraft orders were up 40.2%, vehicles and parts up just 6.6%.

Posted by: kharris | June 04, 2007 at 01:48 PM

Kharris,

That's it! It makes perfect sense ... Thanks a lot for the explanation,

Sam

Posted by: SamK | June 04, 2007 at 04:58 PM

White House Lowers Growth Estimate
Wednesday June 6, 12:25 pm ET


he White House on Wednesday lowered its forecast for economic growth this year even as it slightly upgraded its outlook for unemployment.

Under the administration's new forecast, gross domestic product, or GDP, will grow by 2.3 percent as measured from the fourth quarter of last year to the fourth quarter of this year. That's down from a previous projection of 2.9 percent.

Posted by: Barry Ritholtz | June 06, 2007 at 01:20 PM

TradeTheNews Economic Forecast: INT'L TRADE
Cargo Execs: April Trade Gap Narrows as Oil Imports Plateau, Dlr Softens
•Import Rebound from the Chinese New Year Lull Fails to Impress
•Oil-Related Imports Flat Versus March, But Seen Shooting Up Again in May
•Auto Imports Softened in April, Nosedived in May

NEW YORK (EconoPlay) June 6 – Export growth remained on a consistent upward trajectory in April, influenced by a weakening dollar – spelling relief for the monthly trade gap in defiance of continuing, heavy petroleum-related imports, cargo officials say.

Imports are presenting a fuzzy and fractured portrait these days. Consumer goods from Asia rebounded from the Chinese New Year hiatus but failed to match year-ago levels. Auto imports slowed in April then took a stunning dive in May.

Petroleum-related imports in April were about even with heavy March inflows. But the trade gap could widen again in May as gasoline imports spiked ahead of the summer drive season at record prices.

The U.S. Commerce Department is scheduled to release international trade data for April on Friday at 8:30 a.m. ET. The above commentary also explored May on a preliminary basis

Posted by: Mark | June 07, 2007 at 03:23 PM

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May 21, 2007


Why Do We Have Money?

UPDATE: The broken link is fixed.

From the Cleveland Fed:

Think about a dollar bill.

If you’re hungry, you can’t eat it; in a rainstorm, it won’t keep you dry. But you can trade it for an apple or an umbrella. If you lived in a world without money, how would you get the things you want and need?

Play Escape from the Barter Islands to find out!

If you are a young student, a teacher presenting economic concepts to young students, or simply someone who feels like a young student, give it a shot.

May 21, 2007 in This, That, and the Other | Permalink

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Or just move to Venezuala. Play barter for keeps.

Posted by: jeff | May 21, 2007 at 10:00 PM

if you were in those situations you wouldn't look towards money but instead towards using your intuition an common sense - which doesn't need a price. i believe the human race could cope without money and instead of working for themselves they should work to better the world for everyone.

Posted by: Radz. | June 07, 2009 at 10:43 AM

what if money wasnt real. Everything could be free. Nobody would care about money. Wouldnt that make life easier?

Posted by: AwesomePerson | October 17, 2012 at 11:45 AM

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May 17, 2007


Soft, Not Too Soft

This morning's email from the Goldman Sachs Global Markets Research Group contains this assessment:

The recent industrial news, including April US industrial figures yesterday, have been positive, especially as it reduces the probability of one of the tail risks in the market, i.e. too soft growth. Nevertheless, we think the market remains too optimistic about US growth trends going forward.  This is highlighted in the current Blue Chip Consensus, which shows US GDP growth rebounding from 1.3% in Q1 (which as the US Daily discusses overnight is likely to be revised down) to 3% as soon as second half of this year.

If our US growth views prove correct, the market may yet need to revise down its growth expectations. In that regard, it is striking how growth expectations in the equity markets (as captured by our Wavefront US growth basket) have continued to grind higher. 

So, while we are comfortable with our view of a US soft landing, markets may need to adjust to a less optimistic macro reality than is priced in. This potential downward adjustment could prove to be one of the several road bumps for risky assets in coming quarters.   

Not everyone will have to revise down those expectations.  The economists queried for last week's Wall Street Journal forecasting survey seem to (at least broadly) share the Goldman view:

On the whole, the 60 economists predict gross domestic product, the broadest measure of economic output, will grow at a 2.2% annual rate this quarter. Over the second half, they expect growth of about 2.6%, which is a slight reduction from what they had forecast in a survey conducted last month. They don't expect growth to reach 3% until the second quarter of 2008.

Certainly the voices of Fed chairs past and present, while not endorsing a particular forecast, are aligned with the no-tailspin crowd.  From Bloomberg:

The Fed chairman maintained his forecast that the slump in housing won't have a broader impact on the economy. "We do not expect significant spillovers from the subprime market to the rest of the economy or financial system,'' Bernanke said.

Fed officials this year have cited the housing recession as a main risk to growth, which was the weakest in four years last quarter. Bernanke's comments today reflect the consensus of policy makers that the downturn in housing is unlikely to cause consumers to cut spending. Former Fed chief Alan Greenspan also said that subprime problems aren't spreading to lower-risk loans.

"The prime market is doing reasonably well,'' Greenspan, who retired in January 2006, said today at a meeting hosted by the Atlanta Journal-Constitution in Atlanta. "Some people are holding off on purchasing homes. Even so, we are getting a gradual rise in the prime market.''

Meanwhile, the rest of the world seems to be doing pretty well, thank you.  Back to the Goldman boys:

We do not expect the prolonged period of sub-trend US growth that we foresee to cause major problems for the rest of the world. Recent data has shown further evidence of global decoupling with softer US economic news on the one hand (soft retail sales), and robust growth dynamics in the rest of the world, particularly in Europe and China (Q1 GDP growth in Euroland was above consensus and the April activity data for China have been strong).

However, this begs the question of how bad it would have to get for the global decoupling theme to unravel?

In our latest Global Economics Weekly, we extended the spill-over analysis we conducted last year to study the growth experience of other major economies (Japan, Germany, UK and France) conditional on whether US economy is contracting (i.e. real growth on qoq terms is negative) or expanding (i.e. real growth on qoq terms is positive)...

... Overall, our analysis supports our thinking that as long as US growth remains in expansion mode (which we forecast), other major economies should be able to decouple.

According to a report in todays the Wall Street Journal, some rather astute folks think it may be the other way around:

Early last year, [chief investment officer at Pacific Investment Management Company William H.] Gross's outlook for the U.S. bond market hinged on housing. "We did our homework," he says. "We sent out scouts into middle America, down to Florida." They did make some correct calls, such as predicting a drop in long-term interest rates last summer.

What Pimco didn't foresee was the impact on the U.S. of the strength in the global economy, led by China and the rest of the Asia. Mr. Gross says they recognized there was inherent strength abroad. But they counted on issues such as the U.S. trade deficit and increasing leverage around the world to have "snapback potential like a rubber band" that would restrain growth and allow the Fed to lower rates. That didn't happen.

Either way, the soft-landers appear to be feeling their oats.

May 17, 2007 in Data Releases, This, That, and the Other | Permalink

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May 16, 2007


The Wisdom Of Forecasting Crowds (Such As It Is)

Ever wonder who you should turn to for expert economic prognostications?  My colleagues Mike Bryan and Linsey Molloy (future Chicago MBA!) remind us that the answer is everybody and nobody:

... we examine economists' year-ahead growth and inflation predictions since 1983 to see whether any have distinguished themselves as particularly good (or bad) forecasters over time.

We find little evidence that any forecaster consistently predicts better than the consensus (median) forecast and, further, we find that forecasters who gave better-than-average predictions in one year were unable to sustain their superior forecasting performance—at least no more than random chance would suggest.

Not that consensus forecasts are all that great:

... we summarize the track record of the median economist’s year-ahead predictions for real GDP growth and CPI inflation since 1983. (Forecasts were compiled by the Livingston Survey.) If we arbitrarily define an accurate prediction as being within 1/2 percentage point of the realized outcome, we would say that since 1983 the median forecast was accurate in only seven years, or about 30 percent of the time... The accuracy of the median forecaster’s prediction of inflation was a bit better over the 23-year period. Inflation predictions were accurate—that is, within 1/2 percentage point of actual inflation—39 percent of the time...

... So suppose the median forecaster expects the economy to grow 3.4 percent next year (its average since 1983). You could conclude—with 90 percent confidence—that the economy will grow between a robust 5.8 percent and a sluggish 1 percent. Similarly, the RMSE of the median economist’s inflation prediction over this period was 1 percent, which means that given an average inflation rate of 3.1 percent, you could be about 90 percent confident that prices will rise between a stable 1.4 percent and an uncomfortably rapid 4.8 percent over the coming year.

Fair warning, I think.

May 16, 2007 in This, That, and the Other | Permalink

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» Forecast Accuracy and Consensus Forecasts from Businomics Blog
A recent report from the Cleveland Fed by Michael F. Bryan and Lindsey Molloy confirm older results that consensus forecasts do better than any one forecaster. (Hat tip to Macroblog.) That's one reason I pay close attention to consensus forecasts, [Read More]

Tracked on May 19, 2007 1:19:48 PM

Comments

What value is any forecast if it's not based on assumptions supported by evidence? Have a majority of macro Economists even agreed that the tripling of home prices in CA (& other bubble states) in the last 10 years was NOT due to fundamentals?
For years Dean Baker's been doing his best to argue that "The story of the (housing) bubble is the sharp divergence between sale prices and rent over the last decade, which indicates that sales prices were not being driven up by fundamental factors in the housing market."
If housing contributed a VERY large portion of our growth for the last four years and that growth was not based on "fundamentals" (AND there's no other sector projecting large enough growth to replace this growth), shouldn't we expect a year or two of NO GDP growth? Shouldn't this be a goal to get our economy back on secure footing?

Posted by: bailey | May 16, 2007 at 11:16 AM

"... to get our economy back on secure footing"

What??!! This is America, the home of the free and the land of the brave. The very thought of "secure footing" is simply not welcome here since it is so... so... UN-American!

"... secure footing ..." sounds like a concept that the Europeans would be attracted to.

The hallmarks of a "healthy" American economy are "dynamic", "unpredictable", "vibrant", "disruptive change", "volatile", "constant change", "innovation", "continuous reinvention", "nimble", "agile", etc. There is simply no room in this list for "secure footing."

The one exception is monetary policy, for which we seek (and currently have) "relatively" low and stable inflation and "relatively" high employment. The emphasis remains on flexibility and tolerance for volatility and a determined effort not to be locked into a fine-tuned, mechanistic approach to "driving" or "steering" the economy.

"... secure footing ..." - No way!

We all need to do our best to avoid such a disastrous and misguided basis for economic activity.

If you ever do achieve a "secure footing", I can assure you that the infamous "invisible hand" of the market economy will eventually knock you off of that "secure" footing.

-- Jack Krupansky

Posted by: Jack Krupansky | May 16, 2007 at 01:09 PM

Buffett on economics:
"I am not a macro guy. I don't think about it. If Alan Greenspan is whispering in one ear and Bob Rubin in the other, I don't care at all. I'm watching the businesses."

"I don't read economic forecasts. I don't read the funny papers."

http://www.businessweek.com/1999/99_27/b3636006.htm

Posted by: RB | May 16, 2007 at 01:16 PM

Jack, Oh for the days when that hand was invisible! I'll buy what you're proposing the MINUTE I see an inflation explanation for our monetary policy that's supported by a representative population sampling.

Until then, I'll stick with my thinking that any Gov't. sponsored policies that act to defend house prices that have tripled in 10 years is unhealthy.

As far as our "home of the free", I recommend you buy some new strings for that old guitar of yours, huh? Then, before you decide upon a melody, take another look at our Governments' long-term liabilities. I suggest you practice up for "the Blues".

Posted by: bailey | May 16, 2007 at 02:19 PM

There are two important aspects to be mentioned when interpreting the results of this study. First, the failure of a number of economists to give an accurate prediction at one year horizon does not mean that such a prediction is impossible in principle. This is a banal logic - individual negative results can not deny any theory. Otherwise, hard sciences would have been extinguished due to a constant failure in the beginning of any study. Just to recall the case with quantum physics. There was an absolute consensus between physicists in the end of 19th century that physics was a self-consistent theory without any problem to solve yet, except might be couple effects (as found to be of quantum character afterwards) which everybody failed to explain. As we know now the consensus was wrong.
Second, there is a relationship that allows to predict inflation at 2.5 year horizon with the RMSFE of 0.5% for the period after 1983. For illustration, a figure comparing measured (smoothed by MA(2)) and predicted (smoothed MA(4)) GDP deflator for the period between 1958 and 2004. For the sake of synchronization, the predicted curve is shifted 1 year ahead.

http://www.geocities.com/iokitov/GDPdeflator.gif

The predicted curve is obtained by the following relationship:
GDPdeflator(t)=4*dLF(t-2)/LF(t-2)-0.03
Therefore, having better measurements of labor force level, LF, two (actually 2.5) years ago one can exactly predict GDP deflator. In the figure, only past (relative to GDP deflator) estimates of labor force are used. So, the prediction is out-of-sample and one can use the term RMSFE, not RMSE. For the annual readings, the prediction is 2.5 years ahead.
CPI, being a part of GDP deflator, is also well predicted but a bit more volatile. This is a common feature of physical systems - violability of amplitude of fluctuations increases from the level of the system as a whole to portions of the system. The smaller is the portion the large is fluctuation. This relationship also demonstrates that the assumption of the impossibility to predict inflation is not valid.

Posted by: I.O.Kitov | May 17, 2007 at 03:38 AM

"... look at our Governments' long-term liabilities."

Sorry, but it is always foolish to focus so intently on only one side or term of an equation. Liabilities? What about assets? What about the positive benefits, economic and otherwise, accrued as we incurred said "liabilities."

I remain completely unwilling to open a "short position" on the future productive capacity of The American People acting in a global economy. It may be difficult to place a value on this asset, but why assume that it is essentially zero and not even acknowledge its existence?

As to "The Wisdom of Forecasting Crowds", the only crowd that matters is all of those colllective "invisible hands" of The American People acting over the coming decades. They will in fact be creating the future and are unlikely to feel constrained by either so-called professional forecasters or "one-siders" who are effectively clueless as to the raw productive economic capacity and potential of The American People.

One other note... the so-called "liability" of the federal debt and deficit is actually an asset in some ways, such as the "value" people perceive in owning Treasury "debt". It really is hagly valued. Worried about the trade deficit with China or China owning so much Treasury "debt"? I would submit that both of those "liabilities" help to stabilize the geopolitical and cultural climate and hence deliver significant "value" to The American People. Somehow, you need to account for such positive benefits and not simply focus obsessively on the raw financial numbers.

BTW, the last numbers I saw showed that the federal budget deficit was shrinking, even as the federal government continues to grow.

-- Jack Krupansky

Posted by: Jack Krupansky | May 17, 2007 at 12:36 PM

For God's sake, Bailey. Can Dave make one post in which you don't make one of your whiny, depressing, government is stupid, the economy is out of control, mortgage brokers are evil, the world's about to end comments? Don't you get tired of making the same comment day after day, month after month, year after year? Have you no idea that your efforts affect nothing?

Posted by: cb | May 17, 2007 at 01:10 PM

Ouch CB, mea culpa! To be fair, I readily confess to being an afficionado of fine WHINE (& the cheap stuff too). But, to be fair, I've never said nor implied Gov't. is stupid, nor that mtg. Brokers are evil. I post only with the hope that sooner or later Economists on BOTH sides, right & left, will get off their soapboxes and reconsider their assumptions.
To your credit I suppose, your comment is similar to one I received a few months back on PK's shadow site.
So, I think it's time once again to head for Hawaii to sop up some sun & reconsider MY approach. Aloha, all.

Posted by: bailey | May 17, 2007 at 05:02 PM

Enjoy your trip!

Posted by: cb | May 18, 2007 at 12:39 AM

Voters have a responsibility to question their leaders, ESPECIALLY Economists who use their professional credentials to espouse political rhetoric. Beyond this I believe Fed staffers have a responsibility to inform their leader when he's being unfairly used by the current Administration.
In Mr. Bernanke's speech yesterday he reported "In 2006, 69 percent of households owned their homes; in 1995, 65 percent did." This is a GWB Administration soundbite for their "ownership society".
I think voters have every right to expect dribble from the Commerce Dept., but we deserve better from our top Economist.
I think Mr. B. should have identified "homeowners" as those who own at least 10% of their homes. At the very least he should have excluded those who have no equity and are reaping HUGE Gov't. tax breaks on mtg. loans they can walk away from with barely a smirch on their already questionable credit.
Mr. B. may be politically naive, but I don't believe it's incidental that "1995" was close to the cyclical depths for housing prices, while in "2006" home prices were still close to the highs.

Posted by: bailey | May 18, 2007 at 12:05 PM

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May 07, 2007


Long-Term Capital Management And The Fed

My colleague Joe Haubrich writes about "Some Lessons on the Rescue of Long-Term Capital Management":

... the LTCM episode raises many key issues about the resolution of financial crises: How far should the involvement of the central bank extend, what is the scope of action each of the various players should be responsible for, and what are the costs and benefits of the differing options? ...

Joe starts with two distinct views of the event and the Federal Reserve's involvement.  First, from Myron Scholes:

Although the Federal Reserve Bank (FRB) facilitated the takeover, it did not bail out LTCM. Many debtor entities found it in their self-interest not to post the collateral that was owed to LTCM, and other creditor entities claimed to be ahead of others to secure earlier payoffs. Without the FRB acting quickly to mitigate these holdup activities, LTCM would have had to file for bankruptcy—for some, a more efficient outcome, but a far more costly outcome for society. If there was a bailout, it failed: LTCM has been effectively liquidated.

On the other side of the fence is Kevin Dowd:

The Fed’s intervention was misguided and unnecessary because LTCM would not have failed anyway, and the Fed’s concerns about the effects of LTCM’s failure on financial markets were exaggerated. In the short run the intervention helped the shareholders and managers of LTCM to get a better deal for themselves than they would otherwise have obtained.

After more discussion of arguments pro and con, Dr. Haubrich concludes with his own take on the lessons learned:

Lesson 1: Context matters. Large losses at a financial firm do not by themselves create a need for Federal Reserve action: there must be a systemic component...

... Federal Reserve Board Chairman Alan Greenspan explained:

The scale and scope of LTCM's operations, which encompassed many markets, maturities, and currencies and often relied on instruments that were thinly traded and had prices that were not continuously quoted, made it exceptionally difficult to predict the broader ramifications of attempting to close out its positions precipitately.

In that passage, Mr. Greenspan continued:

It was the judgment of officials at the Federal Reserve Bank of New York, who were monitoring the situation on an ongoing basis, that the act of unwinding LTCM's portfolio in a forced liqudiation would not only have a significant distorting impact on market prices but also in the process could produce large losses, or worse, for a number of creditors and counterparties, and for other market participants who were not directly involved with LTCM. In that environment, it was the FRBNY's judgment that it was to the advantage of all parties--including the creditors and other market participants--to engender if at all possible an orderly resolution rather than let the firm go into disorderly fire-sale liquidation following a set of cascading cross defaults.

Joe goes on:

Lesson 2: Details matter.

That the problem was resolved successfully depended, in a large part, on “the orderly continuation in the risk arbitrage business of the newly recapitalized LTCM” (Bank for International Settlements, 1999, p. 9) which in turn depended on getting the details of the recapitalization right. In the LTCM case it meant retaining the management, giving enough stake in the firm to provide an incentive for efficient liquidation, and bringing in outside oversight.

Even after taking the intermediate step of “providing good offices,” the amount and type of moral suasion had to be decided on. Each choice in turn faced trade-offs...

Which brings us to:

Lesson 3: Look for the minimum effective intervention; or work with the market not against it.

... there is some evidence that even more reliance could have been placed on the market in the LTCM case. Stock prices and federal funds rates incorporated substantially correct information about exposures to LTCM. Fed intervention, despite its limited character, may have indeed increased moral hazard by increasing the perception of too-big-to-fail.

Oops.

May 7, 2007 in Federal Reserve and Monetary Policy, This, That, and the Other | Permalink

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I asked then Senator Phil Gramm this very question in 1997 after Glass-Stegall was repealed and financial firms began combining. At what point do we have an event where someone is deemed too big to fail? I was referencing Citibank. I did not dream that one hedge fund could cause so much havoc.

Gerry Corrigan was a member of the CME BOD. He told me that in his investigation of LCTM, it was the closest to financial disaster that he would want to see. Obviously, there was a lot of systemic risk to the system.

Was it right to bail them out? At the time, I think McDonough made the right decision. If you read the book, " When Genius Failed", I have a sour taste in my mouth over how the boys from LTCM traded, and the easy lines of credit that they received. However, Goldman is the man in the black hat to me. Before they extended credit to LCTM, they downloaded their positions, pressed them, extended the credit knowing that LCTM would blow out. Goldman made a bushel basket full of money, and they did it at very little risk.

The question is not if the next bailout will need to happen, but when. Will it be prudent to bail out the financial entity that needs it? Or will it be better to let them fail?

Posted by: jeff | May 07, 2007 at 07:12 PM

Jeff's point is well taken. Some agrue that Greenspan's intervention into the LTCM mess set a stage upon which has subsequently been built an very large superstructure.

Some Black Swan event may yet let us know how well we've perceived systemic risk. At that time, should it happen, we'll find out how big such a bailout might need to be, else how troubled will be the times.

Posted by: Dave Iverson | May 08, 2007 at 12:24 PM

Noteworthy, Haubrich concludes with this from NY FRB President Geithner: "...[C]hanges since LTCM have improved the stability and resilience of the financial system, reducing the 'probability of systemic events.' Those same changes, though, 'may amplify the damage casued by and complicate the management of very severe financial shocks.'"

Are we in for a wild ride sometime relatively soon? Who knows? Why so little focus on Nassim Taleb's Black Swan events?

I contnue to wonder just how we get out of this without a Roubini-esq "hard landing". Perchance some years hence I and others will be eating up large portions of "crow." On the other hand, there are many, many cheerleaders and steadfast adherents to narrow-focus models who may have to do so.

Posted by: Dave Iverson | May 08, 2007 at 01:25 PM

Good work Dave... I linked back to this because it ties in to Systemic Risk & Group Behaviour.

Posted by: The Nattering Naybob | May 14, 2007 at 04:29 PM

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April 29, 2007


What Are You Going To Believe -- Theory Or Your Own Lying Eyes?

The blogger epicenter of the free-trade debate is rumbling at Harvard, with Greg Mankiw and Dani Rodrik engaged in a terrific -- and important -- conversation about winners, losers, and how (or whether) economic theory divides the two.  You can check-in on the state of the debate at Angry Bear, where pgl provides the appropriate links.  It is highly recommended reading, but I think it ought to come with a few warning labels.  For example, Professor Rodrik responds to Professor Mankiw with this claim:

... there is no theorem that guarantees that the partial-equilibrium losses to import-competing producers “are more than offset by gains to consumers from lower prices.”

In a related vein, pgl opens his post with:

As we were applauding Dani Rodrik, Greg Mankiw was defending the Dan Drezner lower prices from free trade benefits everyone fallacy.

Let's be perfectly clear:  There are no theorems in economics that guarantee anything about the real world.  Economic models are not descriptions of physical realities but formalizations of stories about how social interactions deliver particular outcomes.  Different, equally coherent, stories deliver different predictions about the world.  The claim that "free trade benefits everyone" is not a fallacy, but a particular outcome based on a particular model.  Different models deliver different answers, so theory alone does nothing beyond eliminating stories that are internally inconsistent.

Or, perhaps, unconvincing.  The missing ingredient in this most recent installment of the free-trade discussion is evidence in favor of one story or another, a task that is a good deal messier than writing down models.  What makes matters worse is that adjudicating the issue is not a mere matter of counting up winners and losers.  In the court of determining what is "good" or "bad", economists have standing to address one question, and one question only:  Can someone be made better off without making anyone worse off?  That too depends on the model at hand, and in fact it's even worse than that.  The Rodrik-Mankiw debate revolves in part around a result known as the Stolper-Samuelson theorem. Greg Mankiw does a good job explaining Stolper-Samuleson and its relevance to the subject at hand, but I'll note one item from the Wikipedia description of the theorem

If considering the change in real returns under increased international trade a robust finding of the theorem is that returns to the scarce factor will go down, ceteris paribus. A further robust corollary of the theorem is that a compensation to the scarce-factor exists which will overcome this effect and make increased trade Pareto optimal.

In simple terms, there are losers, but the winners can win enough to more than match those losses.  All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented.  But what if that is not feasible?  What is the right move then?  To protect the losers at the expense of significant opportunity cost to potential winners?  The other way around?  I've yet to encounter an economist trained to answer those questions, and you should be very suspicious of any who speak as if they are.

April 29, 2007 in This, That, and the Other, Trade | Permalink

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As always, I'll have to complain about the use of the appellation "free trade" in reference to a trading system in which China actively pegs the yuan against the dollar at one-fifth its purchasing-power-parity value, and Japan actively manipulates the yen by a zero-interest-rate policy (no longer using obvious direct intervention as in 2003-2004, when it openly bought $320 billion and budgeted for $1 trillion of additional intervention).

This exchange-rate manipulation creates trade barriers just as real as tariffs of the same magnitude. If absent the manipulation the yen-dollar exchange rate would be around the 80 yen/dollar level of the mid-90s, when Japan-US trade was starting to come back into balance, then the current manipulated rate is equivalent to a 50% tariff in Japan on imports from the US.

Posted by: jm | April 29, 2007 at 02:49 PM

You make the same point Greg did in his comment to my post. The efficiency gains are such that IF the winners decide to compensate the losers, there is still a net gain. No one denies this. What Dani was saying - and I think he's right - is that SINE compensation, there will be losers. You don't deny this - and now Greg is claiming he does not either. So what's the debate here?

Posted by: pgl | April 29, 2007 at 03:47 PM

Dave,

That's a good post, taken as a whole.

I go a step further, though. Once trade policy is implemented, the issue is then based on real world outcomes, not theorems. And it's about at that point that many economists appear to get lost if not intentionally disappear if all isn't going well or according to preconceived notions.

Long before Alan Greenspan stepped to the microphone and explained that U.S. offshore production shifted to China-based operations could be impacted with U.S. trade policy but that such offshore production would not return to the U.S. but rather would flow elsewhere to another cheap global production source...well, long before that I had written, forwarded, and blog post my brief Economic Hydrology Theory (EHT) statement and principles. That statement summarized the offshore production growth situation in clear and precise language.

Economic reality and related outcomes are based on real world results, not classroom dogma whether pitched to kids or adults. Theorems only go so far. Economists who can't venture beyond the academic bounds of such devices and evaluate the real world results, recommending appropriate adjustments in the metrics are not economists that I recommend that any corporate clients hire.

Unlike many, you are an exception. Well reasoned thinking is what I am seeking. And you have it.

>

Posted by: Movie Guy | April 29, 2007 at 08:00 PM

Go tell "pareto optimal" to dead Iraqis why don't we. (if we ever find the documentation we are stealing oil from Iraq)

economist can be dangerously obtuse creatures.

Posted by: andy | April 30, 2007 at 06:23 AM

Had to run an get my glasses after that wallopin, eye-bulgin title Dave...I take it all back --Finnegan's Wake by what'shisIrishface is so Irishly over-rated.

jm, has most of my view of that matter without giving any space to the transnationals who are always neglected in this play ...especially with Paulson's vaulted connections. Same sorta vaulting with energy pricing and this administration...the sacking of Rome by a very few --not the hordes of barbarians as previously thought. [The barbarian critique of History]
Dave writes:
"All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented. But what if that is not feasible?"

And it is hard to believe that the winners cannot be easily identified: those HF managers, those CEOs, those large shareholders.
The appropriate compensation scheme OTOH should be left to the hordes of barbarians because QED the present scheme is FUBAR...such is the inappropriate view of the losers whose eyes as andy points out may be no longer seeing much of anything.

Posted by: calmo | April 30, 2007 at 02:03 PM

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April 25, 2007


Some Inconvenient Truths

The Financial Times has uncovered some stumbling blocks on the road to carbon neutrality.  Its multi-part report starts with a useful tutorial:

Offsetting is a fundamental principle of the Kyoto protocol – an agreement among more than 160 countries that came into force in 2005. It allows developed nations to meet emissions reduction targets by funding projects such as wind farms or solar panels in poorer countries through the so-called “clean development mechanism”. This awards such projects “carbon credits”. The credits, which can be traded on the international carbon markets, sell for between $5 and $15 (€3.66-€11, £2.50-£7.50) per tonne of carbon dioxide. To aid comparison, other greenhouse gases – such as nitrous oxide and methane – are measured as equivalents of CO2.

Carbon markets have grown rapidly since they were brought into being by the Kyoto treaty and the start of the European Union’s emissions trading scheme in 2005, under which companies were issued with tradeable permits to emit carbon. The price of carbon in the EU scheme more than halved last year after it was revealed that more permits had been issued than were needed in the first phase, from 2005 to 2007.

In the first nine months of 2006, according to the United Nations and World Bank, up to $22bn of carbon was traded. About $18bn of this was through the EU’s emissions trading scheme, and $3bn through the Kyoto mechanism.

The third element, the voluntary market, is where most offsets are bought. Businesses participating in this are not bound to reduce emissions, unlike companies under the EU trading scheme or governments under Kyoto. In 2005, the World Bank estimates, the voluntary market formed under 1 per cent of global dealings, trading fewer than 10m tonnes of carbon a year. But by 2010, the consultancy ICF International forecasts it will grow 40-fold to be worth $4bn.

Most companies going carbon-neutral use intermediaries to buy offsets on their behalf.

According to the FT, however, all has not gone well:

The FT investigation found:

■ Widespread instances of people and organisations buying worthless credits that do not yield any reductions in carbon emissions.

■ Industrial companies profiting from doing very little – or from gaining carbon credits on the basis of efficiency gains from which they have already benefited substantially.

■ Brokers providing services of questionable or no value.

■ A shortage of verification, making it difficult for buyers to assess the true value of carbon credits.

■ Companies and individuals being charged over the odds for the private purchase of European Union carbon permits that have plummeted in value because they do not result in emissions cuts.

In the end, the FT editors conclude that it's time to join the Pigou club:

The Kyoto protocol to fight climate change expires in 2012. The shape of a successor treaty is still in doubt, but one aspect seems certain: carbon trading will play a major role. A Financial Times investigation today reveals that carbon markets leave much room for unverifiable manipulation. Taxes are better, partly because they are less vulnerable to such improprieties.

I'm waiting to hear a good case made to the contrary.

UPDATE:  More on the topic, from Greg Mankiw and from Felix Salmon.

UPDATE AGAIN: Yet more at Reviving Economics: Here, here, and here.

April 25, 2007 in Energy, This, That, and the Other | Permalink

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A carbon tax program is not going to eliminate the problems with compliance and monitoring. You still need to figure out who is polluting and by how much, and to verify any claims of output reduction. This has to occur within a multinational framework where many countries are going to be motivated to cheat and to assist their local industries. The system doesn't regulate itself.

Another big question with taxes is whether there would be tax credits for projects that sequester carbon. From the policy perspective, this is desirable: if someone can come up with a cost-effective technology to remove carbon from the air, we would want to reward them. If everyone else has to pay to put carbon into the air, they should get paid to remove carbon from the air.

But once we do this, I think we would see many of the same problems of abuse and misdirection that have bedeviled the carbon credit program. If someone is planting a forest and wants to claim a tax credit, how do we know that the trees are really going to be allowed to grow for the next 50 years? Particularly in the third world, the institutions necessary for accountability and monitoring just do not exist.

While a Pigouvian carbon tax does make economic sense and is probably simpler to implement than cap and trade, it is far from a simple fix. Advocates should be prepared to face the same kinds of messes and problems that the EU carbon trading system has run into in its first years.

Posted by: Hal | April 26, 2007 at 12:41 PM

I forgot to mention another problem with a carbon tax: setting the level. The paradox is that setting the carbon tax rate at a level corresponding to economic estimates of future harm will probably not produce significant reductions in greenhouse gases.

A commonly bandied about figure is $100 per ton of carbon. This is actually rather high compared to most analyses. (Tol[1] reviewed the literature in 2005 and found that $14/tC was the median among over 100 studies, with higher quality studies producing lower values.) The Stern report did come up with a higher number but that is something of an outlier and has been criticized for unreasonably low discount rates[2].

But even if we use $100/tC, that is only about 20 cents a gallon of gasoline. That's going to be a drop in the bucket compared to existing European gasoline taxes. And even in the U.S. it's largely going to be lost in the noise of our month to month gas price fluctuations. I can't believe that an extra 20 cent gas tax is going to force anyone to conserve significantly or change their habits to reduce CO2 emissions.

It may be easy to sign up for the Pigou tax program, but when it is time to bell the cat and put a number on the table for the cost to put a ton of carbon into the air, I think we're going to see a lot less agreement. It's pretty tough to come up with a number that is both scientifically defensible as a cost, and which will also lead to realistic CO2 reductions.

[1] http://www.uni-hamburg.de/Wiss/FB/15/Sustainability/enpolmargcost.pdf
[2] http://www.econ.yale.edu/~nordhaus/homepage/SternReviewD2.pdf

Posted by: Hal | April 26, 2007 at 12:56 PM

Hal,

the short-run elasticity e.g. of gasoline demand with respect to the gasoline price maybe very low, but the long-run effects are much more pronounced. Although it will not likely reduce the mileage, it will definitely make buyers shift toward more efficient cars. The difference between U.S. and Europe does not need to be mentioned. It's like with the recent hike with gasoline prices - it had a deniable effect for the moment, but I bet that people think much more about fuel consumption when they get their new car.

A similar development is likely to be seen in the energy efficiency of housing, an area where there are even higher reserves, I believe.

Having said that, I have to agree with you that 20 cents per gallon (I am relying here on your claim) is very small. In this respect, the increases in market prices will have a much stronger impact. (I was tempted to write "were much better", but did not, since I am not convinced at all what is "better" in this game).

Posted by: pinus | April 26, 2007 at 01:31 PM

Taxes at the point of production of coal, oil, and natural gas should be moderately simple. Other pollutants, even water vapor, should be considered but unless concentrated would probably not be workable. Subsidies for technologies that lower demand and increase efficiency should be more substantial, measurable, and concentrated. Sequestration is more difficult as all the energy inputs must considered and are often difficult to measure. Many actions may have impacts which are nearly incalcuable.

Posted by: Lord | April 26, 2007 at 03:19 PM

Hal -- Your points are well taken. Conceptually the cap-and-trade system will look like some sort of equivalent tax scheme, as Greg Mankiw points out. You note the issue with tax credits, and that does seem to be part of the problem. By way of analogy, think about a tax policy designed to increase saving. We can either tax consumption or subsidize saving. We can construct these policies so that they are in an abstract sense equivalent, but with the latter it might be harder to eliminate loopholes that merely involve shifting around behavior. (Think tax-preferred accounts vs other forms of saving.) I could be wrong, but I take it from the FT article that this is what is happening to some degree with the carbon-trading system. Perhaps there is a way to construct the trading system that avoids that particular problem, but it seems easy with a tax system -- just don't go down the road of crediting particular types of activity (inputs) and focus on outputs. Not easy to do, but it seems to me that applies to both approaches more or less equally once a trading system involves caps.

Posted by: Dave Altig | April 28, 2007 at 09:53 AM

Another issue with regard to a Pigou tax, which is touched on in some of the articles you link to, is what to do with the embarrassing windfall of tax revenues. Classic Pigovian theory would be to rebate them to the public more or less evenhandedly. In practice everyone seems to feel that they have better ideas, whether Mankiw's reduction of corporate income taxes or alternative proposals to boost renewable fuel research.

Actually we in the U.S. are lucky. Since carbon pollution is a global problem, it needs to be solved on a global level. A global Pigouvian tax of say $100/tC would collect $200 billion/year in the U.S. based on per capita U.S. emission of about 7 tC/year. Since worldwide average emission levels are only about 1.4 tC/yr, 80% of the U.S. tax receipts should be distributed to the 100-odd countries which emit less than the global average. This $160 billion will make a nice supplement to our existing foreign aid budget of $15 billion and will no doubt be welcomed by the third world.

The bottom line is that to really do Pigou right most Western countries will have to divert the great majority of these new tax revenues to the poor countries of the world which are getting harmed by global warming caused by the rich. It is plainly equitable, but given the relatively modest funding levels foreign aid has achieved in the past it is questionable how well this will go over as part of the Pigou package.

Carbon numbers from http://www.nationmaster.com/graph/env_co2_emi_percap-environment-co2-emissions-per-capita (dividing by 3 since that page shows CO2 rather than C emissions).

Posted by: Hal | April 29, 2007 at 02:47 AM

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