Economic Recovery: Good News / Bad News

Data released by the fed today suggest that the recovery, while slow, is starting to get some traction as industrial production rose 0.8 percent in November. The graphic above shows recent history. This is good news. However, data from New York state showed a strong contraction from recent trends in manufacturing. This is bad news.

Tempering that somewhat we much higher than expected producer price inflation. This can be written off as a energy cost created spike, but if it keeps up the fed will have to reconsider its loose monetary policy. That said, I don't think this by itself will cause that much concern in the Fed - the recovery is still much too weak. So this is not bad news yet, but could become bad if it keeps up.



All in all, more signs of an economy struggling to get real traction in the face of high unemployment and a still weak housing market. Graphics from the Reuters wire story.

Crisis Watch: Good News Friday

I have been trying to find some areas of optimism and this is a big one, from MarketWatch:

U.S. Sept. industrial production up 0.7%

WASHINGTON (MarketWatch) -- Led by a rebound in autos, metals, and high-tech, U.S. industrial production increased at an annual rate of 5.2% in the third quarter, the fastest growth in four years and the first quarterly increase since the recession began in late 2007, the Federal Reserve reported Friday. Output of the nation's factories, mines and utilities rose 0.7% in September after an upwardly revised 1.2% gain in August and a 0.9% increase in July, the Fed said. The 0.7% increase in output in September was stronger than the 0.4% gain expected by economists surveyed by MarketWatch. Manufacturing output rose 0.9% in September. Capacity utilization rose to 70.5% in September from a revised 69.9% in August.

Here is a nice picture from Calculated Risk showing the increase in capacity utilization in perspective:



This is also a nice illustration of a little economics riddle: how can there be so much underutilized capacity just sitting around? One answer is the liquidity trap which may well describe where we are - no one wants to lend at any interest rate so we are all just sitting on our hands. But it is this picture essentially that leads the few optimists among us to think that we may be in for a robust recovery. So much capacity tha could ramp up in a very short time period...

What Was the Failure of Economics?

Macroeconomists have been taking a lot of heat for the failure of the sub-discipline to forecast and/or forestall the crisis. This has often been enlarged to suggest that there is something wrong with the economics discipline as a whole.

This suggests an attitude that I am increasingly running into when I identify myself as a professor of economics: that somehow 'economists' run the economy. Ummm, no. The most important thing to understand is that the economy exists as a natural artifact of human interaction. We don't create it, pull the levers, etc. What we strive to do is understand it, and through this understanding, help governments manage it better.

And here there was a failure. However, I don't think it was with macroeconomics in general, but in the failure of the IO principal-agent and contracting folks to interact enough with the finance and macro types. In other words, there was a trust of the internal incentives of the firm (in this case banks) on the part of finance/macro types that was misplaced. It shouldn't have been: there is a lot of research on incentive problems in CEO compensation, in principal-agent contracts and the like. But macro-types that set policy ignored the lessons of this literature in pushing too far on bank deregulation, trusing the internal incentives to do the trick.

Alan Blinder says something similar in an op-ed in the Wall Street Journal but he blames the corporate boards. But again, we know the incentives were/are skewed there too. Still, his answer is along the same lines, get the incentives right through increased regulation.

Shameless Cross-Posting on a Busy Day: Weekly Unemployment Claims Fall

Busy as heck these days, but I just had the happy duty to confer a PhD degree on one of our grad students who is off to a tenure-track faculty position in PA.  Good work!  Since I am so busy in general I am going to let Kelly Evans of the Wall Street Journal's 'Economics Blog' cover one little sign that the light at the end of the tunnel may be piercing the darkness:

Another week and another encouraging sign: The Labor Department’s tally of new claims for U.S. unemployment benefits, released this morning, fell by 14,000 last week to a level of 631,000. This is still a high level, of course, but the four-week average of new claims — which smoothes out weekly volatility — also declined, to 637,250.

The four-week average is being very closely watched by economists right now, given this simple series has historically had impressive power for predicting when recessions are coming to an end. As we noted a couple weeks ago, Robert J. Gordon, an economics professor at Northwestern University who sits on the committee tasked with dating recessions, is one who finds enormous value in this series. Going back to the late 1960s, he has found that the four-week average of new claims peaks about a month before the declared end of recessions with remarkable accuracy.

As of right now, the four-week average claims series peaked at a level of 659,500 in the week ended April 4. If that number holds, based on the series’ past performance it would mean the recession ended somewhere between late March and early May — a far more optimistic read on the economy than any consensus forecast (the latest WSJ survey of economists shows on average they expect the recession to end in September). “The end of the tunnel may only be weeks away,” says Mr. Gordon.

Of course, the length and depth of this recession — which began in December 2007 — could mean the series doesn’t have as much predictive power this time around. It also won’t be clear for many months when the recession actually has ended, because even if signals coming from the data improve, theNational Bureau of Economic Research’s dating committee, of which Mr. Gordon is a member, likely won’t declare an “official” end for quite some time. For example, the committee didn’t pinpoint December 2007 as the starting date of the current recession until a full year later.

And meanwhile, the government’s data also contained an increasingly worrisome piece of information: The total number of workers receiving jobless benefits jumped to nearly 6.3 million for the week ended April 18, a far higher figure than has been previously recorded by the Labor Department. With such high levels of workers on jobless rolls, it could keep a lid on any hopes for a recovery, particularly as the unemployment rate, now 8.5%, is expected to hit double digits.

I'll just say that it is the last paragraph that I find myself agreeing with. It is too far early to call the end of the recession - I think we are in for a rough rest of 2009. Also, we should expect some uptick in industrial activity (and thus employment) as inventories have been depleted, but this does not mean demand has recovered.

How Bad is the Current Crisis?

From Menzie Chinn at Econbrowser comes this graphic lifted from the IMF's latest World Economic Outlook. Menzie makes two points that I have made as well: a recession is bad enough but a recession with a credit crisis is worse and a recession with a credit crisis and a worldwide downturn is even worse.



The answer: really, really bad.

Portland's Economic Malaise as Seen by The New York Times

Peter S. Goodman of The New York Times brings us this article about how the economic downturn is affecting Portland and he does a nice job tracing through some of the interconnections that characterize the economy.

I think he overstates the demand side, however, people can only withhold spending so much and for so long -  which is why the initial fall into recession can be quite steep, but recovery can too.   But for a recovery to be relatively quick and robust, we must have a well functioning credit market.  Hopefully Geithner's plan will pay quick dividends - I am skeptical, but am willing to give it a chance.

Oregon's Revenue Woes

Uh-oh...

Is Investing in Weatherization a Good Stimulus Plan?

An editorial in The Oregonian this morning touts a plan proposed by Joe Cortright to invest in weatherization of private homes as a way to stimulate the economy.  But is this really such a good idea?

Sure weatherization is good: saving money on energy costs and dependence on fossil fuels, reducing the carbon footprint of the state and injecting money into the economy in a downturn are all noble pursuits.  But is this plan the best way to address the very serious economic crisis in the state of Oregon?

The problem with this proposal is that the public goods aspect of this plan is minimal at best.  These are investments in which the costs and benefits are almost all private and thus there is not much justification for governmental involvement.  By contrast, investments in transportation infrastructure, education, and creating an infrastructure for a sustainable energy industry all have very strong public good aspects, the benefits are enjoyed by everyone, not just (in the case of weatherization) the private home owners.  The difference between something that basically replaces private investment and one that adds new public investment is precisely the difference in real stimulus versus little to no stimulus. In economic terms, the multiplier effect of this type of spending, on something that replaces private investment, is likely to be low.   By way of contrast, the governor's proposal to attack deferred maintenance at public colleges and universities has the same attributes of being quick to implement and a strong potential to suck up excess labor supply in construction, but it also represents a large and lasting public goods investment.    

Sure there is a social cost to the use of fossil fuel based energy and this is a problem.  But if you want private home owners to make these kinds of investments there are much more effective ways to do it - tax incentives, for example, or, even better in my view, a carbon tax on fossil fuel-based energy.  It is important not to confuse other goals with the immediate problem of fiscal stimulus in a horrendous downturn in the economy.  There is a way to align the two goals - like the aforementioned investment in sustainable energy infrastructure - but just because something is easy and sounds good, does not make it good economic policy and The Oregonian does itself no favors by not asking the hard questions when analyzing a proposal like this. I am actually fairly surprised that an economist has proposed this because in my view it does not survive the economics litmus test.

What troubles me most is that this is exactly the type of kind of nice sounding policy that becomes politically popular but that is actually damaging in that it stands in the way of better policy options and has the potential of, therefore, prolonging our misery in this terrible economic crisis.

Slow Economic News Day

Blogging hampered by school closures caused by weather these last two days and looks like tomorrow might be worse. No matter, not much going in the economy these days.

Oh, there are a few notes. First look at this excellent graphic from The Oregonian.
This really reveals the sequence of the contraction in Oregon. Starts with construction and then brings down financial activities (makes sense - mortgages, etc.) and manufacturing and high tech (manufacturing first, now high tech is crashing). Then comes the steep declines in trade, retail, leisure and hospitality.

Here are the rest of today's headlines:

Here it comes: deflation.

Oregon's housing market is wallowing.

And finally the Fed hits the zero interest rate bound.

Like I said, not much happening today, perhaps tomorrow will be a bit more interesting...

Income Tax and the Current Economic Crisis

A while back I engaged in a whole series of blogs that tried to investigate the question: should Oregon have a sales tax? I learned a lot from that exercise. But due the particular quirks of the current economic crisis it just may be that we are very lucky to have what we have.

I have heard it stated, by no less than Oregon's Chief Economist Tom Potiowsky, that currently Oregon's revenues are in good shape relative to other states thanks to our reliance on income taxes. Contrast this with Washington which relies on sales taxes and is resorting to fairly draconian measures to deal with their budget crisis.

The basic theory is this: right now consumers are retrenching and consumption spending has dropped dramatically, aided in part by falling home values. Unemployment is rising, but not by nearly as much as consumption is falling. So, this time at least, we are fortunate to rely on income taxes and not sales taxes.

Is this theory supported by the facts? Perhaps. The BEAs national figures seems to support it - personal income is stagnating but consumption is plunging.

Of course, new data out today show Oregon's unemployment surging to 7.3% so this trend might not last for long. I don't think state personal income figures are out yet, so we'll have to wait and see.

Of course time can change everything as well, as we recover from this recession it may be that consumption spending picks up faster than incomes. But given the nature of the bubble that burst, it is hard to say. Also, if federal stimulus includes lots of job creation, Oregon might again be well positioned.

Food for thought. Comments?

What's So Bad About Deflation?

Economists are starting to freak out about the possibility of price deflation. The October CPI showed a 1% drop in price level from the previous month. This, in itself, is no big deal and might give consumers a little confidence to spend a bit more, but it can become problematic if it persists and starts seeping into expectations. What we are worried about now is exactly this - expected deflation. But why is this a problem?

When businesses expect prices to be lower in the future, they pull back on investment and output and this leads to lowering employment and (where possible) wages. This will, of course, decrease demand which will put further downward pressure on prices. This becomes a downward spiral and the very scary part is that it is not clear how to make it stop. Generally, to manage inflation the Fed changes its target federal funds rate and if it wants to spark inflation they lower the federal funds rate. But right now the Fed is not really able to do this. Though the target rate is at 1% the demand for treasuries is so high that the effective rate on T-bills is already close to zero. In essence, what the Fed wants is for people to take dollars and use them and is offering a very low price of borrowing, but right now people are so freaked out that they don't want to borrow at any price, in fact they are close to PAYING the US government to keep their dollars safe. Yikes.

There is another aspect of deflation that fuels the spiral: loans (like mortgages) are generally in nominal terms so deflation actually increases the real interest rates on outstanding debt. In other words you give up more consumption of everything else. This leads to lower consumption as well.

So what level of inflation is good? Well, most central bankers like the 1 to 2 percent range.

Should Detroit Declare Bankruptcy?

I own a GM car.  It is a 21st Century beast however, built in Sweden on a platform that is shared by Chevrolet, Saturn, Opel and others.  It is a good car, I have no complaints, well designed, fairly well built (though a far cry from the quality that Japanese car manufacturer's produce) and wonderfully fuel efficient yet with plenty of zip thanks to a smallish four cylinder engine that is turbocharged.  In short, it should be a pretty darn good car for toady's marketplace.  But sales of my car in the US have been abysmal.  And herein lies the problem with GM in my view.  Too many brands, too many dealers, too many cars - all leading to not enough focus on a core set of cars and research supporting new innovation.  

It is tempting to blame the relics of the strong labor movement for GMs downfall, as I have seen done many times in the last few days in the press, but closer scrutiny reveals that this is more a function of the past labor contracts and not the current labor contracts that are pretty much in-line with those of foreign manufacturers that are doing business in the US (though the effect of these contracts is still lagged). So don't blame labor for this mess.  GM's web site lists 13 brands!?!  Apparently they have over 7000 dealers to Toyotas 1000, this is just too many irons in the fire, no wonder they have not been able to remain dynamic and competitive.

Many observers are saying that Detroit's problems are of its own making and the cure is Chapter 11 bankruptcy.  This would allow them to renegotiate union contracts, get out of pension obligations (at great expense to the US taxpayer presumably), and renegotiate with creditors.   I was of this opinion at first blush.  The problem with this solution is that the traditional device of this type of bankruptcy is the ability (under chapter 11 protection) to secure commercial credit, and this type of credit is not now available - meaning that chapter 11 would quickly turn into chapter 7 and the liquidation would begin.  Perhaps this is all for the best, but in a time when the economy is in a deep, deep nosedive and shedding jobs like crazy the hit that this would deliver may just be a knock-out blow.    I am fairly well persuaded by this line of thought.

But maybe there is a middle way.  Perhaps a government bailout of GM, for example, could be a part of a chapter 11 filing, in the form of a credit guarantee.  Or perhaps some of the provisions of chapter 11 could be imposed on a bailout (insisting on a renegotiation of labor contracts and pensions, for example).  Why must it be a $25 billion hand out or a potentially disastrous chapter 11?  Let's provide them the opportunity to shed dealers, discontinue brands (which is hard with outstanding dealer contracts) and refocus on a core set of products.  

I believe preventing the collapse of Detroit is vital to our efforts to dampen the blow of the economic crisis right now, but lets do it in a way that leaves Detroit dynamic and competitive when it is all over.

Goodbye TARP

Today, Secretary of the Treasury Hank Paulson announced that they are scrapping the plan to buy troubled assets from banks. It appears that they started to realized three things. One, the ability to come up with a true value for the assets was going to be very hard and take a long time (and speed is of the essence). Two, the amount of leverage used to buy these assets meant that the affect on banks balance sheets was going to be minimal. Three, these banks have not been using the government money they have received so far and instead have been hoarding it - this would likely be even worse if they bought the assets. Other problems included the incentive for banks to only sell their worst assets, the problem of a huge and costly program needed to resell the assets and the continued deterioration of the housing market on which these assets are based.

[By the way, to give credit where it is due, I was on OPB with Earl Blumenauer right after the TARP was first announced and his opposition to it was partly based on the amount of time it would take to do it. Off air, I disagreed arguing that the announcement itself would be enough to restore enough confidence to get markets unstuck. He was right, I was wrong. I have been consistently too optimistic about the crisis until recently...and now I am just depressed.]

Injecting cash into banks directly through the purchase of preferred stock is a better solution for all three problems - but there needs to be more than persuasion used to get banks to not sit on the money they get, something the government realizes and is trying to address. It is also a very good idea to exert more effort to stem the erosion of the housing market which is both at the heart of the crisis and where most less-affluent Americans are having serious trouble as well as shore up consumer credit where things like the drying up of funds for student loans is both immediately troublesome but also exceedingly worrisome for the future if students are being prevented from getting a college degree.

Free Fall

The Bureau of Labor Statistics released its latest jobs report and the news is grim, grim , grim. Above is the unemployment rate over the last ten years for the US. I believe that we will get to and quite possibly surpass 8% before this crisis is done with. I wouldn't be surprised if we approached 10%. The US has lost over 500,000 jobs in the last two months. Keep in mind we need to add upwards of 100,000 jobs a month to keep up with population growth. Unemployment is especially bad among Hispanic and Black populations and average weekly wages have plummeted as well - so those that work are doing so for less. There is a spike in the number of underemployed - part time workers looking for full-time work - and job losses in manufacturing are especially large and troubling (manufacturing jobs tend to be a bit slow to recover).

I think two things are called for and quickly: fiscal stimulus in the form of increased unemployment insurance and a transfer of federal funds to states for investments in infrastructure and other such projects. We have to let go of our conventional thoughts about how best to manage an economy and immediately come to terms with the fact that we are in full-blown crisis and every day that we delay we risk risk extending the crisis by months. Also troubling are the potential effects on the more serious long-term challenges that face the world: climate change. Willingness to address these problems will wane in the face of economic hardship across the world. This is why yesterday I argued for an alignment of the spending on infrastructure and on things that will improve our energy consumption: in other words invest in mass transit, not roads. Many economists, myself included, have been quite astonished at how quickly this deterioration in the economy has happened. For my part, I have generally more focused on long term challenges like education and the environment and less focused in short term challenges. But everyone now understands how serious a situation we are in and we simply must act immediately, failure to do so threatens sending us in to a real depression.