Fiscal Stimulus

I participated in a discussion on the Oregon economy and the government's fiscal stimulus plan this morning on OPB's "Think Out Loud" program so I thought a post that summarizes my thoughts would be appropriate.

The fiscal stimulus plan being proposed by the federal government is based on good old Keynesian theory that in a temporary down turn in the economy, fiscal policy can have a role in stimulating the economy and lessening the blow. Keynesian theory underwent a withering attack from the rational expectations revolution in macroeconomics which suggested that fiscal policy is ineffective as agents in the economy understand that any fiscal spending today has to be paid back in the future so behaviors will adjust immediately. However, assuming this is true, economies do not adjust immediately to behavioral changes - there is wage and price 'stickiness' - which means that, in the short-run, fiscal policy can still be effective. The key with fiscal policy as opposed to monetary policy is that if it appears that consumer confidence is low and present and future consumer spending is and will be low then firms react my lowering investment and employment and wages suffer - further enhancing the low consumer confidence and spending. This leads to the downward spiral that can enhance and lengthen recessions. Cash transfers to those that are likely to spend it will cause a temporary shock in this cycle which, it is hoped will lead to new investment and job recovery - further stimulating consumption - and lessen the extent of the economic downturn.

So two pertinent questions are: does the current situation look like the one I have described, and what is the catch to such a policy?

First, it is not entirely clear that we are in such a cycle and that this is the appropriate policy response and the main reason I say this is that it is not clear we are seeing the big effect on investment and jobs probably due to the very strong export market thanks to the weak dollar. But it is hard to know exactly as data lag the present. I am weakly in favor of the plan broadly conceived (but I think we could do a lot better targeting benefits to those most likely to spend them) - largely because the risk of a severe downturn is real and recessions hurt the most vulnerable hardest, so I generally err on the side of caution.

Second, the catch is that short term stimulus increases the debt which will be a drag on the economy when it returns to sustained positive growth. So, once again, there is no free lunch.

What does this all mean to Oregon? Well, there are two competing facts: one, Oregon has traditionally be a high unemployment state and was hit particularly hard by the last recession, and two, Oregon's housing market is is good shape (so far) relative to other parts of the country. Local conditions matter only partly for the economy so any national recession will be shared by Oregon, but I do think we will not be exceptional like last time. Exports are strong (10% of Oregon GDP), house values have not crashed and there is a chance that tourism (generally down when incomes fall) will remain healthy in Oregon as people substitute Oregon vacations for overseas ones due to the dollar. So I remain cautiously optimistic. The wood products industry and construction industry are already being hit hard by the slump in construction, however, and demand for Oregon's manufactured goods within the US is falling. So, only time will tell.

Econ Job Market: Another Note

Here is a new innovation that did not exist when I was on the market: an econ job market wiki site. This reveals information to both sides of the market which is fantastic - as an economist I generally believe the more information available in markets, the more efficient the outcome.

The Economist's Job Market

I have been a bit lax in posting lately and for that I apologize. One look at the department's seminars list will explain my absence from the blog-o-sphere. The ones in 2008 are all the department's job market candidates that we invited to visit the OSU campus after an initial interview in New Orleans. It is very hard to predict, when you are a job candidate, which institutions are particularly interested in you and way. Each department is made up of a group of faculty members each with idiosyncratic preferences and the department (especially smaller ones like ours) may have particular needs that the new hire is supposed to address. Thus you never really know as a candidate what is going on behind the scenes. The single most important thing a job candidate does is their "job talk," the presentation of the main research paper from their dissertation. This has to go well - a bad job talk can sink a candidate. Amazing, eh, perhaps a lifetime employment opportunity can me made or broken with a 90 minute presentation. The pressure is, therefore, enormous.

[A note: Economics dissertations in the US have almost completely become a bundle of 3-4 separate research papers sometimes having little relation to each other. Mine was exactly like this. This is in response to the incentives of the academic market and publication lags in economics. In economics the name of the game is journal publications and a publishable paper is usually about 30 pages long. Books, book chapters, etc. are almost worthless for getting tenure. So students start trying to write papers for journals from the outset. Also, publication lags in economics are becoming so bad (you often have to wait over a year just to get an initial response from a journal to a submission and it is quite common for a paper to take 3-4 years to 'stick' somewhere) that to get enough research published for tenure in a typical 6 year tenure clock, you have to get papers out even before you leave grad school. Thus the new style dissertations. A friend who is finishing up his dissertation at an august British institution is being forced to do an 'old style' dissertation (in the UK old is often thought of as necessarily better) and this really hurts him - he has to write an entire dissertation on a single subject with parts that are not suitable for journals.]

Anyway, imagine now that a candidate has a fly-out and does well at a place she has never seen in a part of the US she has never been. If she is lucky, she may have been given a quick stroll around the campus, perhaps driven quickly around a few parts of town, but in 24 hours really hasn't had a chance to see much of anything. Then the job offer comes through and it is common to have only about a week to respond (in my earlier post I mentioned how fast the market clears, so departments can't wait for a candidate to decide for fear of losing any chance to hire anyone at all). So here she is back at home, perhaps with a significant other and maybe even kids and she has to decide about coming to an institution and a town she may know nothing about but may end up being her home for the rest of her life in a week. The significant other usually does not get to see anything. Fortunately, the stress is reduced a tiny bit by the fact that the economics job market is pretty robust so movement from position to position is quite common, but you can't count on that. So now you see the plight of the poor graduate student in economics. That said, I am keenly aware that what I am describing probably sounds like nirvana to people in other disciplines where jobs are so scarce that a tenure track faculty position seems like an impossible dream, so I don't complain too much.

If you are interested in how the sausage gets made, the job candidate's seminars are open to the public, so come join us ... and introduce yourself.

Econ 101: The Prisoner's Dilemma

[This post was motivated by a question in the comments to my post on self-fulfilling expectations]

One of the most canonical examples in all of modern economics is the game theory story of the prisoner’s dilemma. The reason this has become so well-known and almost always used as the very first example of game theory in economics classes is because of the power of the result. It very simply and elegantly shows how, in strategic situations, the basic efficiency of free markets fails.

A little background: in economics perhaps the most powerful result of all is what is known as the first welfare theorem. The first welfare theorem states that when markets are free and complete (which is a technical term but actually implies some fairly strong conditions), the resulting equilibrium is efficient. This is also related to the invisible hand which states that economic agents, by solely pursuing their own self-interest, will maximize social welfare. Now, there are lots of things that make this not true in reality, the most common are the existence of externalities, public goods and asymmetric information. But, the prisoner’s dilemma shows us that it is also not true in strategic situations. Strategic situations are where the actions of one player determine the ‘payoffs’ of the other players. (NB: you can think of this as a type of externality, but a in a specific and complicated way – more complicated than the standard externality stories) To give a simple example if we are roommates and you are considering purchasing a new iPhone, the joy you get from that purchase may depend on you being the first to own one and show it off to our friends. If I buy one before you, then the enjoyment you get from yours diminishes. So my actions have affected your payoffs from the purchase of an iPhone. We are now no longer in the pure free market case which assumes that others decisions have no affect on your costs or benefits from market transactions.

The Game: there are infinite variations on the same story but they all follow similar lines. Suppose that two people are arrested of a crime. The police put them in two separate interrogation rooms where they cannot see or talk to each other. The police have enough evidence to get convictions only for a lesser charge which would lead to 1 year jail terms, but if one confesses to the crime they can convict the other of the more serious crime and in this case the confessor gets probation only (o years in jail) and the other person gets a 5 year jail sentence. If they both confess then they both get convicted and sentenced to 3 years in jail. It is assumed that they both know all of this and they know the other person knows as well (and technically each knows that the other knows that the other knows, and on, and on, and on…). They also have to make their final decision without knowing what the other has done.

So now consider the choices of each person. If they decide to not confess they get: 1 year in jail if the other does not confess and 5 years if the other confesses. If they decide to confess then they get 0 years in jail if the other does not confess and 3 years if the other confesses. So no matter what one person thinks the other person will do, confess is always the better choice. So they both confess and the result is that they both spend 3 years in jail.

Note, however, that there is a better out come for both, the one where both don’t confess and get only 1 year in jail. So the result of the prisoner’s dilemma game is sub-optimal because both could be made better off by not confessing. But acting in their own self-interest leads to this poor outcome – contrary to the invisible hand in free and complete markets.

So you see the power of the story: in strategic situations, all the efficiencies of free markets are no longer guaranteed. You could easily change the story to my iPhone story or any other more standard market stories and motivate this more obviously, but the essence is always the same.

Economist's Notebook: Getting it Right on Home Prices

This from the pet peeve department. The Oregonian this morning has a front page headline:

"Portland Home Values Tick Up"

But this is an inaccurate statement. It should read "Portland Home Transaction Values Tick Up." You see, median home sales prices don't necessarily tell you anything about appreciation of home values. It does give some information about market conditions - the median value of a home transaction - but that is all. This could decline due to deprecation of home values OR simply because more lower priced homes are being sold relative to more expensive ones than before. This is why the Case-Shiller index is so good, they track same-home sales to track the appreciation of home values. In other words, they look at houses that have sold multiple times, adjust for improvements, and see if prices have increased or decreased.

The first sentence in the article is even worse: "Portland-area homeowners saw modest growth in home values in December..." NO! You cannot draw this conclusion from median home sales data.

The Oregonian is not alone in this, almost every newspaper makes this same mistake. Editors should insist on accuracy.

Evidence on Sales and Income Taxes on State Economic Growth

A while back I clipped this quote from a survey of academic papers on state taxes:

“The Effect of Personal Income Tax Rates on Individual and Business Decisions - A Review of the Evidence”
By Mark Rider

Andrew Young School of Policy Studies
International Studies Program Working Paper 6-15

“…there is a large body of evidence that high state [personal income tax] rates have a negative effect on business and individual decisions and thus slow the growth of state employment and personal income. Consequently, states must use care in setting state [personal income tax] rates to make sure they are not out of line with those of their neighbors and other competitor states.” (page iv)

This was quite intriguing and so I started a process of tracking down that papers cited to support that claim. I was left a bit disappointed in the results. This argument seems to be based on an assumed causal link that is speculative: high personal income taxes cause higher wages to compensate, higher wages deter new investment and dissuade businesses to locate there, and finally this causes slower growth. Overall, I found the claims in the paper not always accurate or reliable. An example of one dubious claim is this: "Helms (1985) reports evidence that state tax burdens significantly reduce state growth rates." This is not correct. Helms finds this to be true only when states use tax revenues to fund transfer payments, it is not true when states use tax revenues to fund public services.

In general there is a consensus that overall tax burdens matter somewhat to state growth, but the degree to which growth is sensitive to overall tax burden is a matter of some debate, mostly because the problems of really testing this in a meaningful way. Two careful papers, the Helms paper referenced above and a subsequent paper from two U of O economists suggest that when tax revenues are spend on public investment the negative effect of state taxes disappear or even reverses ( Mofidi and Stone, 1990). But what really matters to the discussion about Oregon is the evidence on the composition of state taxes on growth. Here the evidence is scant and scattered. for the purposes of this post I will present a few snippets of what I have found so far from my survey of the literature on state taxes and growth. One paper that is a little old but intriguing tests whether specific taxes (corporate, personal income and sales) has an affect on subsequent employment growth. There are some methodological issues, but the results are provocative:

"JOBS AND TAXES: THE EFFECT OF BUSINESS CLIMATE ON
STATES' EMPLOYMENT GROWTH RATES"

by MICHAEL WASYLENKO AND THERESE McGUIRE

National Tax Journal, Dec85, Vol. 38 Issue 4, pp. 497-511.

"The results here confirm that for the wholesale trade, retail trade and finance industries the size of the personal income tax may have an important indirect effect on employment growth. Moreover, the coefficient on wages is also statistically significant in these three industries. If part of the higher income taxes is borne by firms in the form of higher wages, these personal income tax rates also have a direct effect on employment growth in these three industries." (p. 506)

They also find that corporate and sales taxes have no measurable affect except for sales on employment in wholesale trade.

Three related papers by Carroll, Holtz-Eakin, Rider and Rosen investigate the effect of personal income taxes on entrepreneurship activity in the US, using the 1986 Tax Reform Act as a natural experiment and find that higher personal income taxes suppress investment and employment by entrepreneurial firms. However, this is done in isolation, so again does not specifically address the mix of taxes.

Finally, evidence on out-migration and personal income taxes shows little of what I would consider strong evidence positive correlation, but there does seem to be strong evidence that higher wages compensate for higher tax burdens and there is very good evidence that business location decisions and foreign direct investment decisions are sensitive to local wages.

So what is a lay reader of my blog to conclude? Sadly the received evidence does not say anything too clear about the effect of tax composition. Person income taxes appear to have perhaps a slightly higher correlation with employment growth and lower entrepreneurial activity and less investment from outside the state and country. The extent to which shifting a chunk of that burden to sales taxes would ameliorate the problem is still far from clear. Still, I think there is enough evidence to suggest that we may not be doing ourselves any favors by being an exceptionally high income tax state.

Tax Poll

Just a note: Since I have been lax in posting on taxes, I am extending the poll closing date until the end of the month.

Getting Back to Taxes

Before I get started, apparently Mike Huckabee has a national tax plan that is interesting in that it proposes replacing the national income tax with a national sales tax. Some economists think this is a good idea in theoretical terms. My readers, I think, are already more well-informed about the evidence than is Mr. Landsburg, but he makes an interesting and sometimes very curious argument - one with a lot of holes in my opinion. I am not the only one. This is the same economist who claimed he bawled out a elementary school teacher for suggesting to his child that recycling is a good thing, claiming that he taught his kids not to recycle because he loved trees. His argument was that recycling lowered demand for trees and thus we should expect fewer trees - forgetting perhaps that what most people care about are not commercial tree farms but old-growth and wilderness areas, but I digress. Safe to say that I am not part of the Steven Landsberg fan club - I think he is an extraordinarily lazy thinker.

Now, getting back to my old posts on a state sales tax. I understand that sales taxes may be as volatile in the short-run as income, but income taxes are still more sensitive in the long-run. Does the long-run matter? I argued before that it does, but now I would like to take that a step further and bring in a stylized fact: Oregon is a high unemployment state. Here is a graph from the Oregon Employment Department.



Not only do we see Oregon as a high unemployment state but notice how much worse the downturn of 2001 - 2004 was on Oregon's Unemployment than the national average. So if we are worried about significant and sustained shortfalls in the revenues of the state government - you can see clearly why relying so heavily on an income tax was so costly for the state, and why I am pressing the long-run elasticity as a very significant number.

The related question also becomes: how much does Oregon's high income tax rate contribute to this high unemployment rate? I don't know the answer, but I am sure it is not zero. It may well be not terribly significant, but I am a bit worried about the connection and the data suggest a correlation at least. (Remember to be careful about this kind of evidence though, it could be that high taxes come about as a result of poor economic performance as states struggle to fund essential services) I will leave you all with some interesting maps from the Bureau of Labor Statistics. These are Unemployment rates by state, 2000-2006. Darker shading means a higher unemployment rate. Notice something about Oregon? It had higher unemployment, and took longer to recover than almost every other state. This could be purely coincidental, but it is worth further investigation.

Economist's Notebook: Self-Fufilling Expectations

As I was standing in line at security at PDX on my way out to New Orleans, I happened to see Steve Novick, Democratic candidate for the US Senate seat currently held by Gordon Smith, in line ahead of me. I immediately noticed him because of the fact that he is very, very short. Now, we all know intuitively that height has absolutely nothing to do with the ability to be a good senator - or does it? Steve is obviously extremely intelligent, personable and hard working, so I would argue there is nothing innate about his height that lessens his ability to be an effective senator. But suppose I was worried about his ability to be elected not because of any prejudice I had about his height, but because I thought others might worry about the effect of his height. If everyone in Oregon were like me, personally not worried about his height but worried about others holding his height against him, notice what happens: my initial worry would be confirmed. No one would vote for him because of his height, not because they believed it made him less able but because they believed it would make him unelectable, and they would all have been proven right ex post. This is what in economics are known as self-fulfilling expectations: you expect his height to be a problem, so you act that way, and by such action you cause it to be true.

You can make a similar argument about his effectiveness once in the senate. A senator who is considering supporting him on some legislation he is proposing, might worry about his ability to drum up support among other senators, so decides not to - not because of his own ability, but because of how this senator believes others will act towards Novick. This worry causes the senator not to support Novick and thus causes his own worry to be shown to be correct.

So the punch line is that you can quite legitimately be worried about his height without believing that it has any effect on innate ability. But should you be? Notice that if everyone chose not to worry about what others might do, another equilibrium would result. An equilibrium where height played no role either in the election or in the senate. So what is a voter to do with such economic insight? Well, which equilibrium results really depends on how much you think other voters and senators will be influenced by height. Any one voter's marginal contribution to this is so small it is virtually meaningless, so an individual decision to disregard these concerns is not that meaningful in terms of outcomes, but may be meaningful in terms of one's own utility.

Note to the AEA: Don't Schedule the ASSA Meetings the Same Weekend of the National Championship Game

It was a bit amusing when the fans started rolling in, but not anymore. It is hard to move. After the last interview today, I had a hard time getting out of the hotel because the LSU marching band was streaming in. Note to the Oregon State Economics Department: maybe it is not such a good idea to make the interview room in a hotel on Bourbon street. Ooops. Luckily I am no where near, so I will sleep tonight. New Orleans is not unprepared for this, here is a (bad) picture of one of several mobile elevated observation and command posts they set up all around Bourbon street.



Next is a (bad) picture of Ohio State and LSU fans waiting for the street car. Most interactions have been friendly, but things were getting a little edgy when I was walking by about 9pm.



Normally I would go to sessions where new research is presented, but I simply had no time. It is a shame. But I learned a TON about cutting edge macro research and it is really fascinating. When I had macro theory in grad school it was a bit of a bad time and some new innovations (now old but new to me) - heterogeneous agents models, learning, policy rules and new Keynesian theory has really made it quite an exciting field again, in my opinion. Plus, there is no other field where cutting edge academic research has an immediate impact on actual policy. The Fed system has a huge research agenda and is always interacting with academics. Anyway, I can report that a lot of smart creative people are doing macro these days and, for that, we can all be thankful.

Other notes from the big easy: I was recommended and tried Albita Turbodog. Not impressed: dull and watery. They claim to use Willamette hops, I couldn't tell. The AndyGator was worse. Fortunately, the same restaurant has Sierra Nevada Celebration. Now that is a beer. My evening was rescued. Should have thought to ask if they had Rogue. You never know where you will find Rogue. Vic Tremblay had an Anchor Steam and we got into a discussion about whether Anchor was the first microbrewery. Apparently since Fritz Maytag purchased an established brewery some think he does not deserve the title of first. I say, who cares and enjoy the beer - Vic Agreed. But perhaps if you really care about reducing energy consumption, one should not buy beer that has been shipped half way across the country. But I just could not take another Turbodog.

Supply and demand: guy on street offered me a ticket for the championship game, I asked price. Answer: $1000 (but I think he knew I wasn't serious). Hotel rooms tonight going for double and triple regular price. Thought about subletting. Decided sleep was worth more.

Final note: when a horde of people in purple start yelling GO (or more accurately, GEAUX) at you, the proper response is: TIGERS. Now you know.

The ASSA Meetings: Notes from the new PhD job market

So somehow I found myself on the macroeconomics search committee and have spend the last two days in a hotel room for 11 hours both days interviewing job seekers. I am tired. But not as tired when I was on the other side of the room as a new PhD myself, running from hotel to hotel, interview to interview not knowing anything about my future (would I get any job offers at all, will I have any choice, will I WANT to live in any place I am offered a job?). These were huge worries and huge implications for the rest of my life - all from a series of 30 minute interviews that barely scratch the surface of who I am. Anyway, I am glad that is all over.

So now I have to sit in judgement of others, come to quick conclusions about them and most particularly how well they fit the specific needs of the department. This is what is so frustrating for job seekers, in my opinion, because you have no control over that and generally have little specific knowledge of what these needs are. So how do you know if you did a poor job impressing of if you did a good job but are just not quite as good a fit as the next one? You don't. I have already seen many very impressive new PhDs but quite a few I already know we won't go after because of fit. I wish I had ten jobs to offer.

But I digress. What strikes me the most after two days is that macro, which is divided into a number of different 'camps' based on different specific topics in terms of research, seems to have this division now in the graduate core theory classes. I am surprised how little these students know about the other areas of macro. I think this is reflective of the incentives of the academic economics profession: it pays to start working in a specific niche and now this has reached the training itself. Why? Well I think it may have a lot to do with the increasing publication lags in economics. These days in economics it can easily take over a year to hear back from a journal after you submit a paper. If lucky you may get an opportunity to revise the paper and resubmit it which may take another year until acceptance (or eventual rejection). More commonly it takes 2 or 3 rounds of submission to get a revise and resubmit offer. So if you have a paper it may take easily 3 to 5 years to publish it. Considering the fact that most tenure clocks are 6 years in length (meaning you have to go up for tenure in your 6th year on the job), and tenure expectations are often at least 5 or 6 publications, it is becoming more and more important to start this process while still a graduate student. These publication lags are much, much worse than 20 years ago apparently. So you can see why now, graduate students specialize earlier - because specialization means you can 'master' the material easier, you can make a name for yourself easier, and you can become known to the community of researchers that will end up 'refereeing' your papers. But I think in macro it has gone too far. Many students just don't know the 'field' and are thus very constrained by this and have a hard time commenting about other lines of research. I can't imagine what it will be like in 10 years when all of these people are leading the macro profession.

Other notes: there are a TON of football fans here now all decked out in purple and red. And they are all very, very drunk. Generally the interaction is quite friendly (much to the amazement of my English friend who is used to a bit more partisanship found in English football). But I find this all very amusing: hordes of straight laced economists (many in suits and sporting name tags) and hordes of drunken football fans comingling in the streets. The economists are definitely the ones out of place. Sigh. We are so uncool - Freakonomics or not.

Beeronomics: Cereal Boxes and the Honest Pint

Brewers are not the only ones facing higher ingredient prices these days - cereal manufacturers are too. So what to do? Well, you can raise prices or you can shrink the box and hope that consumers won't notice. Cereal manufacturers seem to be successfully doing the latter. So will brewers be tempted to start shrinking servings of beer at their pubs? Would you know if they did? Maybe it is time to get on board with the honest pint.

By the way, anyone know any good brew pubs in New Orleans?

Strike Up the Band

Lousy cell phone picture, but here is a New Orleans Jazz Band playing in the baggage claim area of Louis Armstrong International Airport tonight to welcome thousands of economists to the Big Easy. Note the logo on the Tuba (see below).

I am staying just off Canal, close to the French Quarter and didn't think I would notice any difference here from when I was last here in 2001. Boy was I wrong. Half the buildings and storefronts here are vacant - in the center of New Orleans. I haven't been over to the French Quarter yet, but I suspect it will be better there. Sad.

Oh, and apparently there is something going on here on Monday that has brought in a bunch of Ohio State and LSU fans. Good thing I am out of here on Monday morning.