The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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March 27, 2009

What do you mean “Fix It?”

Probably like you, I have been consuming mass quantities of commentary on the Treasury's plan to deal with "legacy assets" via its proposed Public Private Partnership Investment Program. The notices are too numerous to single out—Google "Geithner Plan" if you somehow feel you might have missed one—but the New York Times' Room for Debate feature is a reasonable place to get a one-stop view of some divergent opinions the plan has elicited.

I'm not taking sides on the argument, but I was taken with a metric of success that seemed to permeate the Times discussion:

"The market soared on high hopes that this will solve unfreeze credit and revive the crumbling economy. But is this plan sufficient to restore the banking system to health?"

I added emphasis here (with italics), as the notion of restoring the banking system to health (or not) popped up in various ways in the comments from the article's contributing panel of experts. From Paul Krugman:

"We had vast excesses during the bubble years, and I don't think we can fix the damage with the power of positive thinking plus a bit of financial engineering."

From Simon Johnson:

"Secretary Geithner's plan might work, in the sense of facilitating the removal of some 'toxic' assets from the balance sheets of major banks. But it is unlikely to work, in the sense of restoring the banking system to health."

From Mark Thoma:

"How will policymakers be able to tell if the plan is working? The first thing to watch for is whether private money is moving off the sidelines and participating in the program to the degree necessary to solve the problem."

From Brad DeLong:

"… the Geithner Plan seems to me to be legitimate and useful way to spend $100 billion of TARP money to improve—albeit not fix—the situation."

The phrases that interest me are "fix the damage," "to work, in the sense of restoring the banking system to health," "solve the problem," and "improve—albeit not fix—the situation." Each author gives some hint of what they mean by those terms, but in my reading the full meanings are not entirely clear—and I bet not uniform across the contributors.

Let me give an analogy that illustrates why these turns of phrase trouble me. Suppose I have a heart attack, which ultimately leads to bypass surgery. The surgery is successful (by its own measure) and the prognosis for recovery is excellent. Did the procedure "fix" the problem? Not exactly. The procedure put me on the road to recovery, but there will be a protracted period in which I am far from "normal." What's more, it will be an even longer period of time before I am fully up and running on full steam. (And along the way, incidentally, I'd better adopt a new set of rules and regulations governing my behavior, lest I find myself in the same condition again. That will take some getting used to as well.)

So, I wonder, what do most people have in mind when they refer to "fixing" the financial situation, of restoring the patient to health? Do they mean getting back to "normal" or simply being on the road to recovery (even if those travels are slow and painful for some time)?

Given that three of the four authors in the Times debate express the view that more policy steps will be needed, I believe there is an awful lot at stake in determining what success actually looks like.

By David Altig, senior vice president and director of research at the Atlanta Fed

March 27, 2009 in Banking, Financial System | Permalink


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The US government seems to have developed a chronic bad habit of charging into situations with no clear definition of goals, no measure of success and no exit strategy.
Obama, thus far, has been no different in this regard from the previous administrations.

Posted by: wally | March 27, 2009 at 04:04 PM

"The US government seems to have developed a chronic bad habit of charging into situations with no clear definition of goals, no measure of success and no exit strategy."

Why should they be different from anyone else? That's the way most people and organizations operate, though they may have a veneer of rationalization to convince themselves otherwise. And the government does too.

Posted by: Moopheus | March 27, 2009 at 04:55 PM

Do they mean getting back to "normal" or simply being on the road to recovery (even if those travels are slow and painful for some time)?

This would be my guess. I don't think anyone is so confident to say this will totally fix the problem. All of them would say, "it's a start" and leave it at that to wait and see what transpires (all the while trying to spot the outlier effects).

It's taken a while (in gnat time) but a plan now appears to have taken clear shape.

Determine the gap (stress test), see if it can be filled (PPIP) and if not, unwind some TBTF institutions, insurance companies included (new regulations).

Meanwhile hope the economic declines can bottom and even start to recover, thus making the cost a little smaller.

Posted by: Beezer | March 28, 2009 at 10:36 AM

Great points. Maybe a better question is what was broken? I m not being flip, but I think you need to approach the issue from that angle.

Banks can still borrow and lend money. They just aren't doing as much of it to as many customers.

Posted by: Jeff | March 29, 2009 at 09:40 AM

Hey, the problem is that this supposed 'free market' system lacks the one law and regulation that would make it possible: a rule that no corporation may grow large enough or leveraged enough to be "too big to fail."

Any that can't should be forced to sell itself off in two chunks, promptly.

Posted by: Hank Roberts | March 29, 2009 at 11:24 PM

Hank -- Item 4 on the March 23 joint Treasury/Federal-Reserve statement was the "Need for a comprehensive resolution regime for systemically critical financial institutions." Your views are shared with good company.

Posted by: David Altig | March 30, 2009 at 03:25 PM

The meaning of "Fix it" to the Powers that Be is clear: Return to the 2006 status quo, without suffering losses. See

All sane observers outside the system realize that it was an unsustainable excess, but the insiders (including the Obama administration) refuse to admit this.

"It is difficult to get a man to understand something when his salary depends upon his not understanding it."
-Upton Sinclair

Posted by: Hubbert | March 31, 2009 at 08:32 AM


The US government seems to have developed a chronic bad habit of charging into situations with no clear definition of goals, no measure of success and no exit strategy.

Posted by: Australian banks | April 01, 2009 at 05:27 AM

Your anguish is proper. And sadly, you have nailed the crux of the problem.
I wish you were wrong and so FOS you could be kicked into the next county. Unfortunately, you are right.
I never thought I'd find myself on the Atlanta Fed's website reading something like this. The analytical sections of the regional Feds do really good work.
Keep it up.

Posted by: apachecadillac | April 13, 2009 at 10:22 PM

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March 24, 2009

Careful with that language

No doubt about it. The decision last week by the Federal Open Market Committee (FOMC) to further expand its balance sheet by up to $1.15 trillion was momentous. But beyond that number, some commentators seem to have suggested that the FOMC took a qualitative leap into quantitative easing (QE):

Feds Use Quantitative Easing

Fed kept its target rate unaltered and intensifies quantitative easing

QE and the US

The last article above comes from BBC News, where it is made clear that the QE theme is associated with the addition of long-dated Treasury securities to the list of assets that the FOMC has specifically asked the folks at the Open Market Desk at the New York Fed to purchase on their behalf:

"We've now had two weeks of quantitative easing in the UK. But as far as the world's concerned, this is Day One. That's because, as of today, the quantitative easers have the US Federal Reserve on their team.

"The US central bank's announcement yesterday that it would start buying US long-dated Treasury bills as part of a nearly $1.2 trillion stimulus programme came as a shock."

OK, let's repeat. Like any balance sheet, the Federal Reserve's has two pieces, the liability side and the asset side. The FOMC statement was explicitly about the asset side—the quantity and types of assets the Fed intends to purchase. Quantitative easing, on the other hand, is about the liability side. As reader Fischer points out in a comment to our previous macroblog post on the Bank of England's balance sheet:

"The entire point of quantitative easing is to put assets into the economy that increase the money supply..."

That exact point was made by Chairman Bernanke back in January:

"The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach—which could be described as 'credit easing'—resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental."

Of course, some think that such "incidental" expansions are far from trivial. John Taylor, for one, has a different view (registration may be required to see full article):

"An explosion of money is the main reason, but not the only one, to be concerned about last week's surprise decision by the Federal Reserve to increase sharply its holdings of mortgage backed securities and to start purchasing longer term Treasury securities."

I don't think anyone should be dismissive of that concern, which makes item 3 of yesterday's joint statement from the Treasury and Federal Reserve particularly noteworthy:

"3. Need to preserve monetary stability: Actions that the Federal Reserve takes, during this period of unusual and exigent circumstances, in the pursuit of financial stability, such as loans or securities purchases that influence the size of its balance sheet, must not constrain the exercise of monetary policy as needed to foster maximum sustainable employment and price stability. Treasury has in place a special financing mechanism called the Supplementary Financing Program, which helps the Federal Reserve manage its balance sheet. In addition, the Treasury and the Federal Reserve are seeking legislative action to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves."

Let us be clear: We are not trying to characterize the recent Federal Reserve decision one way or another. But as the Bank of England's current strategy and the Federal Reserve Chairman's comments noted above clearly indicate, expansions of the asset side of central bank's balance sheet—"credit policy," if you will—are conceptually, and if sterilized operationally, distinct from quantitative easing. The public discussion will be greatly enhanced if we keep those distinctions at the forefront.

David Altig, senior vice president and research director at the Atlanta Fed, and Daniel Littman, economist at the Cleveland Fed

March 24, 2009 in Federal Reserve and Monetary Policy | Permalink


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"...If sterilized operationally...", and is the FED actually sterilizing its expansion of the balance sheet? How so? Pray tell.

Posted by: APB | March 24, 2009 at 06:02 PM

Bill Mitchell sheds light on that.
"What is quantitative easing?

Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system - that is, crediting their reserve accounts. The aim is to create excess reserves which will then be loaned to chase a positive rate of return. So the central bank exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities).

So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.

Proponents of quantitative easing claim it adds liquidity to a system where lending by commercial banks is seemingly frozen because of a lack of reserves in the banking system overall. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system. That is an unfortunate and misleading representation.

Invoking the “evil-sounding” printing money terminology to describe this practice is thus very misleading - and probably deliberately so. All transactions between the Government sector (Treasury and Central Bank) and the non-government sector involve the creation and destruction of net financial assets denominated in the currency of issue. Typically, when the Government buys something from the Non-government sector they just credit a bank account somewhere - that is, numbers denoting the size of the transaction appear electronically in the banking system.

Does quantitative easing work? The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment.

It is based on the erroneous belief that the banks need reserves before they can lend and that quantititative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates. But the mainstream position asserts (wrongly) that banks only lend if they have prior reserves. The illusion is that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.

But this is a completely incorrect depiction of how banks operate. Bank lending is not “reserve constrained”. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards. If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).

The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.

The reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep. In the current climate the assessment of what is credit worthy has become very strict compared to the lax days as the top of the boom approached."

Posted by: Felipe | March 25, 2009 at 11:25 AM

"The entire point of quantitative easing is to put assets into the economy that increase the money supply..." :)

Posted by: Kenny | March 26, 2009 at 12:06 AM

From quote above:
"central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system"

Are those money by any means *locked* at the CB? I suppose not and therefore question the claim that the asset purchase is sterilized. If the new money stays at the CB that is more a reflection of banks not needing them.

Bank reserves are definitely liabilities for the CB, so to say that the liability side is not affected sounds strange.

Posted by: Johan | March 26, 2009 at 03:43 PM

APB -- I suspect your question is rhetorical, but in case not: For the week ending March 18 the balance sheet was about $2.1 trillion, the monetary base about $1.6 trillion. So a bit less than 1/4 has been sterilized.

That said, the balance sheet grew by $168 billion over the week, and bank reserves by $148 billion (the second largest increase ever). So not a lot of sterilization as of late.

Posted by: David Altig | March 26, 2009 at 05:43 PM

On March 19, 2001, the Bank of Japan issued a monetary policy known as quantitative easing, which stimulated the Japanese economy after the burst of the dot-com bubble. This was the "birth" of the term quantitative easing, even though I do not think it represented the actual birth of the concept. So happy belated birthday to quantitative easing, I guess.

Posted by: dan littman | March 26, 2009 at 05:54 PM

The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves. Bank lending is not “reserve constrained”. Thus, increasing bank reserves will not lead to an increase in bank lending.

The reason why commercial banks are currently not lending much is because they are not convinced there are credit worthy customers.
Quantitative easing is when the central bank purchases investment maturity bonds (or other bank assets) in return for bank reserves and involves no change in the net financial assets of the non-government sector.
I hope this help. Check also Bill Mitchell's blog

Posted by: Felipe | March 27, 2009 at 12:05 AM

OK, *if* purchases are compensated by the Supplementary Financing Program issuing as much short-term debt, there is no effect on money supply.

Posted by: Johan | March 27, 2009 at 06:49 AM

Suppose the Fed decides to buy assets from depository institutions (eg commercial banks).
The Fed buys the asset (let us say worth $1000) from the bank and then makes a payment to the bank crediting the bank's reserve account by the same amount of the purchase.
What are the balance sheet entries? We can use T-accounts to reflect these changes.
First, for the Fed. The Fed increases its assets holdings by $1000 and at the same time its liabilities are increased by $1000.
Now, for the commercial bank. In the first step the bank sells the asset to the Fed in exchange for reserves. The Fed exchanges non- or low interest-bearing assets (which we might simply think of as reserve balances in the commercial banks) for higher yielding and longer term assets (securities or any other asset).
The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell.

(Recall that the government spends by creating deposits in the private banking system).

This is what happened during the financial crisis when the Fed decided to buy assets from the banking system. Banks started to have non-interest bearing excess reserves. They tried to lend them on the interbank market. This put a downward pressure on the overnight interest rate. Note that the Fed has to keep the overnight interest rate close to the target. To accomplish this, they started to sell bonds to drain reserves from the banking system and hit the ffr target. At some point they ran out of bonds to drain these reserves. What did the Fed do? They asked the Treasury to issue more T-bills to, basically, help the Fed drain the excess reserves.
Later on, they recognized that if they started paying interest on reserves that would put a 'floor' for the overnight interest rate.
This means that the overnight interest rate can not go any lower than the rate the Fed pays on them because banks will not lend reserves on the interbank market and accept a rate lower than the one that the Fed pays.

The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves. Bank lending is not “reserve constrained”. The reason why commercial banks are currently not lending much is because they are not convinced there are credit worthy customers.
Check also Warren Mosler' blog http://www.moslereconomics.com/

Posted by: Felipe | March 27, 2009 at 12:15 PM

It would be interesting to know exactly what the sterilization techiques are in this case.

To me, these are the options:
1. Paying interest on reserves.
2. A revival of the Supplimentary Financing Program that was unwinded a while ago:

To me, technique 1 is not under the control of the Fed and technique 2 is for the future, so what we are watching now should be called QE. Feel free to correct.

Posted by: Johan | March 30, 2009 at 06:24 PM

Professor Bill Mitchell has it exactly correct.

For a central bank, it's always about price (interest rates) and not quantities.



Posted by: Warren Mosler | April 01, 2009 at 09:30 PM

Whew! Glad you're, er, focusing on assets and not liabilities. Good thing assets can vastly exceed liabilities, unlike in the old days when they were equal by definition.

Anyway, my terror of price instability stems not from what the Fed intends, but what it can and cannot do. Yours is an optimal control problem and you're inducing explosive oscillations now and promising damping mechanisms later. Any number of contingencies could intervene to disrupt your good intentions. The obvious case is a run on the currency. Failure to gain legislative approval for needed Fed bond issuance would be another killer. Compromise of Fed independence is another. If absolutely everything goes right, I can trust the Fed's intentions, but the safer alternative is to get a margin account and buy all the DBA I can afford.

Posted by: Erzberger's corpse | April 05, 2009 at 07:30 AM

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March 20, 2009

A look at the Bank of England’s balance sheet

The current financial crisis is global in scope, with central banks responding in various ways to mitigate the strains in their respective countries. The Federal Reserve is not the only central bank that has been aggressive in its response. For instance, the Bank of England's (BoE) Monetary Policy Committee, in its March 5 policy statement, explained the details of its new asset purchase program:

"…the Committee agreed that the Bank should, in the first instance, finance £75 billion of asset purchases by the issuance of central bank reserves. The Committee recognised that it might take up to three months to carry out this programme of purchases. Part of that sum would finance the Bank of England's programme of private sector asset purchases through the Asset Purchase Facility, intended to improve the functioning of corporate credit markets. But in order to meet the Committee's objective of total purchases of £75 billion, the Bank would also buy medium- and long-maturity conventional gilts in the secondary market. It is likely that the majority of the overall purchases by value over the next three months will be of gilts."

Thus, the BoE will purchase £75 billion of assets (approximately U.S. $108 billion as March 20 and U.S. $106 billion as of March 5), mostly intermediate-to-longer dated U.K. sovereign debt (or gilts) but also some "investment grade" corporate bonds. Along with this new asset purchase program, to ease strains in credit markets the BoE has previously implemented other efforts, such as purchasing commercial paper, asset-backed securities, and corporate bonds. But these earlier efforts were conducted in such a way that the BoE sterilized its purchases—that is, for every £1 of private assets it purchased, the BoE would issue £1 of its own debt (sterling bills), with the effect being that the money base (bank reserves plus currency in circulation) grew much less than the overall size of the balance sheet.

However, with the new asset purchase program, the BoE is targeting a quantity of U.K. sovereign debt to purchase in an unsterilized manner, hence the key phrase "by the issuance of central bank reserves." As stated, the BoE will be buying gilts, "with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target [2% CPI inflation] in the medium term."

The impact of the BoE's efforts to support private credit markets can be seen in this chart of the size and composition of the BoE's assets:


As the size of the asset side of the BoE's balance sheet grew, so did the liability-side:


Notice that much of the increase in the liabilities has come from "other liabilities" and "short-term open market operations" and not "reserve balances." But with the new asset purchase program, reserve balances will become much larger.

By Laurel Graefe and Andrew Flowers, economic analysts at the Atlanta Fed.

March 20, 2009 in Europe, Monetary Policy | Permalink


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It never occurred to me that quantitative easing, if successful, could be sterilized.

The entire point of quantitative easing is to put assets into the economy that increase the money supply - whether through expanding the quantity of money, or increasing the velocity of money. The former BoE actions did not increase the quantity of currency notes - as said, for ever pound sterling that comprised asset purchases, a pound of sterling was taken out of the economy. They should, however, have increased the velocity of money, by ridding the system of systemic risk. Whether the BoE achieved this is certainly controversial, but doubtless it was their intent in this massive purchase. So, if quantitative easing did occur, then it could not have been sterilized - i.e., the money supply expanded.

Alternatively, sterilization could remain a useful term if defined as an expansion of the money supply strictly through efforts to increase velocity, rather than through the more common route of increasing the quantity of money.

As a tangential thought, it's possible that the BoE's 'sterilization' policy actually contracted the money supply, if the routes through which they took in pound sterling had a higher propensity to spend than the routes through which they issued sterling (i.e. the banking sector). As all the banks are currently holding on to money like Scrooge McDuck, I wouldn't be surprised it this was the case. Perhaps that explains their current policy transformation to unsterilized asset purchases, which face no propensity to spend tradeoff.

fischer out~

Posted by: fischer | March 23, 2009 at 02:47 PM

BoE will probably go for lagged sterilization. I.E. As soon as it sees inflation back pushing above the target level, it will sell off the assets it's bought. That's the idea, anyhow.

Posted by: Bill Petrie | April 03, 2009 at 02:33 PM

Assuming a contraction of credit is near permanent (reserve requirements / a generation of bankers realise risk exists), then maybe the need to sterilise is eliminated. And voila, not only has HMG had its deficit funded, but when its banking assets are sold it will make a profit. We maybe a lot better off than we thought.

Posted by: Simon E | October 27, 2009 at 04:14 PM

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March 17, 2009

A look at postrecession employment trends

Recent Blue Chip survey forecasts gross domestic product growth turning positive in the third quarter of 2009. But for those individuals who have lost jobs, what is foremost on their minds is when the labor market will recover. An examination of labor market performance during and after previous recessions suggests the employment recoveries vary in length, and the employment downturns are generally much longer than the actual recessions.

There have been large differences in employment patterns over previous recessions. For example, over the combined 1980 and 1981–82 recessionary periods the payroll employment loss amounted to 1.3 percent of the average employment level in the 12 months preceding the beginning of the 1980 recession. The share of employment lost was less in the 1990–91 and 2001 recessions, with 0.41 percent and 0.89 percent of jobs lost, respectively. In contrast, the share of employment lost during the current recession has been very large. Even if the recession ended today the share of jobs lost would be 2.7 percent.

Just as there has been volatility in the share of jobs lost, the time until employment has fully recovered (returned to prerecession levels) has also varied across past recessions, as shown in the chart below. The two most recent recessions, which had relatively low rates of job decline, had very drawn-out employment recoveries. In 2001, employment—growing at an average annualized rate of 0.3 percent—took 35 months (nearly three years) to return to prerecessionary levels. The average rate of employment growth was also approximately 0.3 percent after the 1990–91 recession. But because the share of employment lost was less, employment returned to prerecession levels in 19 months. Interestingly, the 1980–82 recessionary period, which had a much larger share of jobs lost, also had the quickest rate of recovery. Postrecession employment grew at an annualized rate of more than 2 percent and took just seven months to reach prerecession levels.


The question then becomes, what does previous experience imply for the path of employment after the current recession? If the current recession ended today with a 2.7 percent job decline, and postrecession employment growth resembled the recovery from the 1981–82 recession, then employment would return to prerecessionary levels in approximately 14 months. But if the employment growth path is more similar to the two most recent recessions, then it would take well over eight years for employment to return to prerecession levels. Of course, history is unlikely to repeat itself exactly, but what history does tell us is that the employment recovery will lag the recovery in overall economic activity, and possibly by a lot.

By Melinda Pitts, research economist and associate policy adviser at the Atlanta Fed

March 17, 2009 in Business Cycles, Labor Markets | Permalink


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While it may be useful to look at percentages, I don't think that is a good way to analyze the recovery in total.

If you don't account for productivity and the marginal cost that it takes to hire new workers, you miss an essential part of the picture.

The American economy is fundamentally different now (2009) than it was in 1980-82. I think that 1980-82 had more in common with previous recessions in the 30's and 40's than 1980 does with today.

It is useful to look at 2001, because at least this is an economic environment where production rates were heavily influenced by technology. However, the reasons for each decline are far different, as is fiscal response to each decline.

Hard to say how fast employment returns. If I were a benevolent dictator, I would provide lots of incentive for entrepreneurship and self employment.

Posted by: jeff | March 18, 2009 at 01:16 PM

It really all depends on what one means by "employment". Those red, blue and orange lines are not just measuring a change in quantity of an unvarying commodity, they are also concealing the changing characteristics of the jobs being measured. The recovery from this recession is likely to involve a much greater qualitative change in jobs than the previous recoveries. The pace of that recovery thus will reflect how quickly the process of change occurs, not simply a quantitative "return to pre-recession levels."

Posted by: Sandwichman | March 19, 2009 at 02:38 PM

Interesting that the employment recovery from each recession takes longer than the one before. Any chance that we are seeing an effect from globalization and the move of manufacturing from the US to cheaper locations? It would seem that a rebound in manufacturing would tend to be a relatively quick process - machines, assembly lines, even experienced labor would be readily available for re-employment. This is sort of related to Sandwichman's comment - maybe we are seeing a qualitative change in re-employment in the recoveries.

Posted by: JAW | March 24, 2009 at 08:58 AM

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March 11, 2009

Another side of the administration’s tax plan

While discussions of the Obama administration's tax plan focus on the expected impact on consumer spending and the federal deficit, not much attention has been given to the incentives of the plan for work effort. Different tax rates, deductions, and rebates provide varying degrees of incentives to work less or work more, and those incentives differ across income groups. Here I want to focus on just one of the proposed changes: the reinstatement of the 39.6 percent marginal tax rate for the wealthy.

Supply side economists tout low tax rates across the board as a way to provide incentives for people to work harder and thus for the economy to grow faster; with this thinking, people work harder because they get to keep more of the money they're working for.

Results in a recent working paper, with coauthor Robert Moore, confirm these predictions by finding that work effort increased across all income levels when tax rates were cut (among other things) in the 2001 Bush administration tax reform. But work effort increased much less among the more educated (higher income) families.


The administration's current budget plan includes a reversion of the marginal tax rate among the wealthiest to the pre-Bush tax rates—an increase from 35 to 39.6 percent. This tax rate increase is equivalent to reducing a worker's wage by 7 percent. The chart shows what the impact on work effort would be across education/income groups if wages were decreased for both groups by 7 percent; education and income are very highly correlated. The analysis found that husbands with a high school degree only would reduce their hours worked by about 63 hours per year (about 2.9 percent), whereas husbands with a college degree or more would reduce their work hours by only 42 hours per year (about 1.8 percent). Working wives in these families would also reduce their hours of work.

So, based on my research, if a need to raise some revenue means tax rates have to be increased for someone, raising them on the wealthiest will result in a smaller reduction in work effort than raising tax rates on the middle class.

The calculations here use results obtained from estimating a joint labor supply model for dual-earner families with different levels of education for the year 2000. A complete analysis of the work effort implications from the administration's tax plan would require accounting for all the changes to marginal tax rates, phase-outs of deductions, and tax credits simultaneously, as well as considering the impact on decisions of family members to enter or exit the labor market in response to the tax changes.

An additional relevant question remains: What is the implication of changing work effort for GDP growth? The relationship between work effort and value of output is not necessarily the same across income levels. In other words, one hour of high-income (higher education) labor is expected to yield a higher value of output in the economy than one hour of labor from a middle-income (lower education) worker. A complete analysis of the aggregate impact of the administration's tax plan would have to also take this into account.

By Julie Hotchkiss, research economist and policy adviser at the Atlanta Fed

March 11, 2009 in Labor Markets, Taxes | Permalink


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"an increase from 35 to 39.6 percent. This tax rate increase is equivalent to reducing a worker's wage by 7 percent."

This is misleading. The increase is an increase in marginal rates only: only on the income above a set level. Therefore moving from 35% to 39.6% marginal tax rate is NOT like a 7% reduction in worker's wage. It is only a reduction of 7% in the marginal wage. Statements like this that say "it's equivalent to a reduced wage of 7%" obfuscate the debate.

Further, workers' incentives are no doubt in response to marginal total taxation, not just marginal Fed Income tax. The brackets for which margina Fed income tax is actually increasing from 35-39.6% are those brackets that pay a lower marginal tax (0%) on SS/Medicare taxes, while lower income brackets face a steep additional approx 7% marginal tax on top of marginal fed income tax rates.

Posted by: EconProph | March 11, 2009 at 01:37 PM

But why is there no mention of the income and substitution effects, and the backward bending labor supply curve? As income gets higher, at some point the income effect outweighs the substitution effect, and the resulting labor supply curve bends back, implying that people at that income level and above would work more when their taxes are raised because of the strong income effect, because they have to to maintain their current lifestyle. Last I checked, research implied that the backward bend began at about the upper middle class level.

And, of course, sadly, the pink elephant of economics, positional/context/prestige externalities (see Cornell Economist Robert Frank's article: http://www.robert-h-frank.com/PDFs/WP.1.24.99.pdf) is almost never mentioned. Cut taxes on the very wealthy and the spending is overwhelmingly on zero sum game positional/context/prestige externality goods that add very little total utils to society, especially relative to the basically non-positional things that money could have been spent on like basic medical and scientific research, alternative energy, education, public health and safety, etc.

Posted by: Richard H. Serlin | March 11, 2009 at 03:21 PM

For an excellent brief article on the income and substitution effects and the backward bending labor supply curve, and the historically weak relationship between income, taxes, and hours worked, see Cornell Economist Robert Frank's article:


Posted by: Richard H. Serlin | March 11, 2009 at 03:24 PM

Richard Serlin makes very good points.

In fact, I think we can speculate on some of the positional/prestige/context spending that occurred in the upper income brackets in the past 8 years as the marginal rates were lowered to 35%. Actually the rate for some has been 16% since for many of these people they were were given a loophole that let them claim that being paid to manage a fund (labor) was actually capital gains (investment of capital) when they had nothing at risk.

What did high income folks do with their lower-marginal tax rate enhanced take-home pay? It appears that more than a few bought second homes (and third homes and more). They bought real estate assets. They "invested" the money, but unlike in past cycles the investments were in hedge funds and derivatives. Financial devices that added relatively little to the real stock of capital goods and productive capability in the economy. As for the additional homes, I don't think that's worked out too well for us, has it?

Posted by: EconProph | March 11, 2009 at 05:10 PM

Your analysis is in a vacuum. What if the hours that the wealthy work are more productive than the hours the middle class work?

The other issue in the Obama tax plan is the increase in not only marginal tax rates, but increases in FICA tax rates, reductions in the ability to deduct to charities and mortgages, and the other increases in the federal bureaucracy that will explode entitlement spending.

I have hearsay anecdotes that say that if you collect welfare under the Obama plan it is more than working 8 hours a day for a minimum wage job. This will certainly also decrease production.

Posted by: jeff | March 11, 2009 at 09:29 PM

Obama would do well to leave the current brackets and marginal rates as they are, and instead add new brackets and higher marginal rates on top of that structure. There is no reason for a progressive income tax system to stop being progressive at $357k of income. He could easily add a 39.6% bracket at 500K or so and a second, even higher bracket at 1M or 2M. Furthermore, why not make the rates on dividends and capital gains progressive?

Posted by: RueTheDay | March 12, 2009 at 08:39 AM

I took a look at your paper. As is common, there are potential problems with the model and paper. It only looks at 2001 changes in taxes; how would it do out of sample. The groupings are course, and there are other issues I won't get into now. But I would like to note that the other research appears to go against your implication (at least many could interpret it this way) that these tax cuts would induce a widespread increase in hours worked.

This is from a survey of the labor supply elasticity literature by Harvard Labor Economist George Borjas, from his 2008 text, "Labor Economics", 4th ed.

Few topics in applied economics have been as thoroughly researched as the empirical relationship between hours of work and wages (pg. 45)...The neoclassical model of labor-leisure choice implies that the sign of the coefficient beta depends on whether income or substitution effects dominate (pg.s 45-6)...There are almost as many estimates of labor supply elasticity as there are empirical studies in the literature. As a result, the variation in the estimates is enormous. Some studies report the elasticity to be zero; other studies report it to be large and negative; still others report it to be large and positive. There have been some attempts to determine which studies are most credible. These surveys conclude that the elasticity of male labor supply is roughly around -0.1. In other words a 10% increase in the wage leads to a 1% decrease in hours of work for men. The dominance of income effects is often used to explain the decline in hours of work between 1900 and 2000 (pg. 46, emphasis added)...Labor supply elasticities in the United States are small: Hours of work do not respond much to wage changes. Moreover income effects tend to dominate (at least for working men). The available evidence, therefore, does not support the argument that income tax cuts could increase tax revenues in the United States. (pg. 51)

Posted by: Richard H. Serlin | March 12, 2009 at 11:57 PM

As a comment on the paper, I was a little bothered by the mention of the dual income model and then a sentence or two about low-income families but nothing clearly stated about the numbers of dual income families at the various economic levels, nor what was done with single parent families, etc. Taking the work at its face, I found the data source fairly weak and the implications then weakened by the paucity of discussion (lack of data?) about exactly which actual group in numbers in society might fit this model.

I would also like to agree generally with the first comment above. A better statement is there would be a 4.96% increase in the marginal tax on income above $x - which I believe is something like $370k for a joint return.

Posted by: jonathan | March 18, 2009 at 06:01 PM

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March 06, 2009

Dueling forecasts

When smart people debate, something interesting is bound to come of it, so I have been reading an interchange over the past couple of days in the blogs of Greg Mankiw and Paul Krugman. Krugman's blog provides the necessary background on the source of the debate:

"Greg Mankiw challenges the administration's prediction of relatively fast growth a few years from now on the basis that real GDP (gross domestic product) may have a unit root—that is, there's no tendency for bad years to be offset by good years later.

"I always thought the unit root thing involved a bit of deliberate obtuseness—it involved pretending that you didn't know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall."

It is certainly true that when "unemployment is high, it tends to fall," but where it falls to is not always so obvious:


Prior to the 1973–75 recession, the average quarterly unemployment rate was 5 percent. If you had a forecast contemplating a return to "normal" following this particular recession you would have been holding your breath for a couple of decades.

Professor Krugman makes the central point, I believe, when he makes reference to the "difference between, say, low GDP growth due to a productivity slowdown… and low GDP growth due to a severe recession." That statement is, itself, recognition that the economy does periodically experience protracted episodes during which average growth and average unemployment simply do not revert to previous levels—at least not for a long time.

One of the striking things about the economic projections reported by the Reserve Bank presidents and Board's governors in the minutes from the last meeting of the Federal Open Market Committee was the rather large variation in views about GDP growth, even as far out as 2011:


That sense of uncertainty is shared by private forecasters:


What gives? There are lots of reasons for differences of opinions, and I obviously cannot (and should not) try to divine what is anyone else's deepest forecasting thoughts. But for me, "low growth due to severe recession" does not automatically imply a demand-driven downturn from which the economy will quickly spring back.

When I look ahead, I envision the U.S. economy over the next several years in terms of a simultaneous process of recovery and reformation: Recovery in the sense that the actual contraction of GDP will end, but reformation in the sense of structural transformation in financial markets, consumer behavior, and perhaps an adjustment of the global imbalances that are arguably at the root of much of the financial instability that has characterized the past decade.

If we are right, the long run is indeed rosy, but the long run will only arrive after some significant and protracted headwinds abate. And that is not a picture that suggests a rapid bounce back to "normal" growth.

By David Altig, senior vice president and research director at the Atlanta Fed

March 6, 2009 in Economic Growth and Development, Forecasts, Labor Markets | Permalink


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That's very nicely, even gently and gentlemanly, put. Thanks for the clarification of something that's been bothering me. We are not only faced with the combination of a major recession inter-acting with a credit crisis (cf. Rogoff and Reinhardt) but the severity is triggering long-delayed structural adjustments in the socionomic system that we've been putting off for far too long. The chickens are coming home to roost and they're big, ugly and mean.

Posted by: dblwyo | March 06, 2009 at 05:58 PM

Most U.S. economic forecasters have plied their trade in the post 1980 world where asset, debt, and consumption growth have outstripped income growth. In the last 10 years non financial debt has increased $18tr
while national income has increased less than $6tr. The process is now running in reverse and has broad implications. The 8tr
in debt paydown/default needed to restore
the longer run debt/income ratio will be a headwind we face for years, not quarters. After-tax corporate profits increased from
a long term avg of 5.5% of gdp to 9% of gdp
during the debt expansion and are now headed
back down, perhaps for good. Business investment plays a key role in most economic
cycles while consumption is more stable. As
consumers repair their net worth through savings and debt repayment, the likely new lower level of consumption will surprise most forecasters. The cycle will steady itself when households have settled in at a lower consumption level that business can deliver at a 5% net margin. That is not in sight yet. The increase in govt spending and the expected improvement in net exports are small in relation to these secular changes.

Posted by: Dave A. | March 07, 2009 at 11:11 AM

"If we are right, the long run is indeed rosy, but the long run will only arrive after some significant and protracted headwinds abate."

I dont see any long run picture being rosy with the derelict energy policy we now have.
Lets not get distracted from that.

Posted by: retracer | March 07, 2009 at 12:08 PM

Interesting. Where does the USG regulatory and tax environment and consequent significant increases in the cost of doing business get factored in? Also, where does the likelihood of increased rigidity in labor markets due to [effectively] government mandated unionization of the U.S. workforce get factored in? The destruction of fossil fuel energy production for the chimera of "alternative" energy production? Etc., etc. The only outcome that seems assured as of today is an exponential increase in government involvement and control of U.S. business and markets. It seems to me that this might influence the dates and strength of "recovery" in the future.

Posted by: boqueronman | March 10, 2009 at 08:14 PM

Thank you for making the point that a reversal in the jobless rate need not mean that there is any particular trend to which the rate reverts. DeLong, in his first (second?) cut at Mankiw's unit root argument, seemed to imply that the jobless rate would return to some trend, so that the unit root question was not a big deal for real GDP. In comments, I made the point that the jobless rate didn't seem to have a stationary trend. No answer from DeLong (who tends not to respond to his comments section in a useful way). It is entirely an ego issue at this point, but I am happy to see I am not alone in seeing this point.

Posted by: kharris | March 11, 2009 at 07:40 AM

If Okun's Law holds, as Krugman seems to accept, the presence of a unit root in GDP says nothing about whether there's a unit root in unemployment. Okun's law says that the rate of unemployment depends on the change in GDP (this works best in log real GDP terms). If log real GDP has a unit root, its change will be stationary, so if Okun's Law holds, the rate of unemployment will be stationary. If we think of this as meaning that unemployment has a dynamically stable equilibrium, it still doesn't prevent the level of equilibrium unemployment from changing occasionally. Then it becomes a matter of distinguishing between those changes in observed unemployment which are due to changes in equilibrium unemployment and those which represent adjustment towards the equilibrium.
I would have expected that someone of Krugman's Keynesian leanings would actually tend to believe that there is a unit root in GDP. If there's no unit root, so GDP is trend stationary, the case for a stimulus program is much weaker.

Posted by: Brian Ferguson | March 11, 2009 at 12:07 PM

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March 03, 2009

Yet another cut at the recent retail price data

Much of modern business cycle theory—and the policy prescriptions that accompany it—rest on the idea that something interferes with markets. After all, if markets are working efficiently, there isn't anything that policy can do to improve matters. What that "something" is remains the great unknown in macroeconomics, but there is a common belief that price "stickiness" lies at the heart of the problem.

While economists wrestle with the question of what, exactly, causes prices to be sticky—that is, adjust more slowly than they would in the absence of whatever is getting in their way—some have taken on the tedious task of documenting the speed at which prices adjust. And, as you might imagine, it turns out that some prices adjust very quickly while others adjust at a glacial pace.

One of the most comprehensive investigations into the evidence of price stickiness was published a few years ago by economists Mark Bils of the University of Rochester and Peter Klenow of Stanford. Bils and Klenow dug through the unpublished data that are used to construct the consumer price index (CPI) and computed the frequency of price changes for 350 detailed spending categories. They concluded that between 1995 and 1997, half of these categories changed their prices at least every 4.3 months. Some categories changed their prices much more frequently. Price changes for tomatoes occurred about every three weeks. And some, like coin-operated laundries, changed prices on average only every 6½ years or so.

It has been argued—notably by Kosuke Aoki of the London School of Economics—that sticky prices are likely to incorporate forward-looking expectations and are therefore "a good candidate for a measure of core inflation."

We decided to take the data we use to compute another measure of core inflation—the median CPI—to produce a "sticky-price" and "flexible-price" CPI. There are some complications to this seemingly simple exercise. First, it isn't clear where one should draw the line between a sticky price and a flexible price. We rather arbitrarily decided to draw two lines, one at four months and another at six months. If price changes for a particular CPI component occur on average every four months or more frequently, we called that component a "flexible" price good and, if changes occurred less often than every six months, we labeled it a "sticky" price good. (We have called goods that change prices somewhere between every four and six months "semiflexible" and are generally ignoring them in this particular exercise.)

Second, since we're dealing with considerably fewer spending categories than Bils and Klenow did, we could only imperfectly match our data set to their results, so admittedly some art was applied in instances where sticky price goods and flexible price goods coexisted in the same spending category.

Those cautions aside, here's what we came up with, looking at data between 1998 and 2009.


Figure 1 shows the weighted distribution of the CPI market basket on the basis of its degree of price stickiness. In terms of the overall, or "headline" CPI, we judge that a little more than 50 percent of the index is composed of sticky price goods, 40 percent of the index is made up of flexible price goods, and the remainder is somewhere in between.

So, what do these measures tell us? Figure 2 below shows the four-month percent change in the sticky CPI and the flexible CPI, with the headline and the traditional core CPI included as dotted lines for reference.


Clearly the sticky-price CPI exhibits relatively smooth patterns, very similar to that exhibited by the traditional core CPI, while the flexible price CPI behaves in a way more consistent with the headline CPI. Such a correspondence between the core measure and the sticky-price measure isn't very surprising since food and energy items are heavily (though not exclusively) flexible price goods (see again figure 1).

So we also produced "core" measures of the sticky and flexible CPI (the sticky and flexible price CPI measures less food and energy), and these data are shown in figure 3.


One observation from this calculation is that sticky prices have tended to rise at a pace above the core flexible prices for a considerable period of time. Obviously something more than degree of price flexibility distinguishes these two price measures. But as an exercise in reading the incoming price data, the sharp drop in the flexible component of the core CPI is another clear indication of the strong disinflationary pressure on retail prices in recent months. Over the past four months, the core flexible CPI has fallen at a 2.6 percent pace, just a shade more than what we saw during the disinflation of 2003. And the sticky price core CPI? Well, it hasn't moved much—it's sticky. But the longer the disinflationary pressures on the economy persist, the more these prices will likely become unstuck as they too begin to reflect the price adjustments being reflected elsewhere in the consumer's market basket.

By Michael Bryan, Federal Reserve Bank of Atlanta, and Brent Meyer, Federal Reserve Bank of Cleveland

March 3, 2009 in Data Releases, Inflation | Permalink


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I'd like to know whether or not the shelter cost -- rental and oer-- are included in the sticky components; and if so, what's their share? As BLS uses a 6-month moving avearge for inflation in these components, my conjecture is that it's likely they are in the sticky components.

Posted by: yuer | March 04, 2009 at 04:25 PM

This study has an interesting concept, but there are two things that I would change:

1) Define price change as a certain percentage change instead of an absolute change. Car prices probably change every month, but perhaps not significantly.

2) Going back to 1998 isn't enough to draw conclusions. Going back further (to the 1960s or earlier) is warranted.

Posted by: Paul | March 06, 2009 at 12:47 AM

I agree with Paul - can't make conclusions about predictability without going into a period of significant changing inflation - late 1970's and early 1980's.

Great study!

Posted by: Trate | March 06, 2009 at 03:56 PM

Can you tell us what were the largest items in the sticky-core category?

Posted by: Bob_in_MA | March 08, 2009 at 06:03 PM

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