The economic outlook for 2010 and beyond

Most economists are forecasting very sluggish growth for 2010 - in the 2.5 to 3.5 percent range - which would keep unemployment around 9.5-10 percent. Meanwhile I, under the spell of Bob Barbera, have been arguing that growth is likely to be much higher than that, with the result that the unemployment rate could fall by much more by the end of the year. How much more? Bob and I are working on an op-ed piece that suggests that 8.5% is a reasonably conservative guess for end-of-2010 unemployment.

The high-frequency data seem to bear out our rosy forecasts. Consumer spending high this Christmas season, the housing market struggling to life, inventories bouncing back pretty dramatically. But the recovery skeptics have some strong arguments to make for slower growth in 2010. What are my counterarguments? Why do I believe what I (think I) believe?

I've been scratching my head over this question and I think the answer is, I don't have a strong case to make for why we should expect strong growth. I can't pinpoint one sector of the economy that is poised for takeoff. Instead, my argument is that the US economy has always in the past recovered strongly from deep recessions. 1975 and 1983 are the most recent examples, but the post-1933 recovery from the Great Depression was not shabby either. The burden of proof, it seems to me, is on those who would argue that this recession is different. Their arguments seem to me not persuasive. A partial listing of these arguments includes:

Everyone's forecasting slow growth. But everyone is always wrong at business cycle turning points. The conventional wisdom missed the 2007-09 recession as well as the 1975 and 1983 recoveries.

The banking system is a mess, consumer finances are a shambles, there's a looming foreclosure crisis, state and local governments are going to be cutting budgets this year, etc. All true. But these problems are always with us at the trough of a recession (though they're clearly more severe this time around than they have been in the past). Economic growth makes these problems much less severe. Give me 3 million jobs in 2010, and I'll give you a much lower rate of foreclosures than you forecast.

With interest rates at zero, there's no way for the Fed to stimulate our way out of this one as it has in the past. It turns out this is untrue on several counts. First, the Fed has found ways to stimulate the economy despite the "zero bound." Second, if we use interest rates on risky assets like BAA corporate bounds as our measure of whether monetary policy is tight or loose, we find that the actions the Fed has taken in the last year have had a tremendous loosening effect - BAA bond rates are at normal recession levels now, down from sheer panic levels a year ago. Third, it turns out not to be true that the Fed looses during recoveries. The loosening tends to occur before recovery begins, tightening during the period of recovery. Today the Fed is maintaining a loose policy into the period of recovery. Finally, if we combine fiscal and monetary policy, I think we can argue that never in the history of the US has macroeconomic policy been as stimulative as it is today.

Are there any positive reasons to expect strong recovery? I would point to extraordinarily strong monetary and fiscal stimulus, a return to normalcy by many indicators (risk spreads are at normal recession levels, housing inventories are nearing mid-2000 levels); pent up demand for things like automobiles; and the effects of a depreciating dollar. Further out, it's possible that green energy will be the next investment boom, especially if Congress gets its act together and passes cap-and-trade. But such things are impossible to predict with any accuracy. How many people in 1993 were predicting the dot-com boom?

For 2011 and beyond, I see possibilities but no proof positive of strong growth. The main drag on growth will be sluggish consumption spending. We can't continue on a path in which consumption is 70 percent of GDP. It has to fall to something more like 65 percent. What sector will pick up the shortfall? I don't think we can expect investment spending to increase very much from its historic average. Government spending on infrastructure, education, energy research and development should rise somewhat. But the biggest compensating movement will have to come from net exports. We need to reduce the structural current account deficit from the 5-6 percent range to something more like 2 percent. That will require a reduction in the value of the dollar. If that happens, then it's not hard to imagine a period of reasonably strong growth fueled by a revival of manufacturing and a switch in the composition of spending from tradeable to nontradeable goods.

But getting a depreciation will be difficult, because the value of the dollar is determined not by US policy but by the central bank of China. Macroeconomic policy coordination with China will, I think, be the central sticking point in the next five years. Solve that and we've got a chance for a strong, sustained period of recovery and growth. Screw that up, and we've got a world of problems.

ARRA and growth in 2010

Menzie Chinn and Paul Krugman comment on a Deutsche Bank study showing that while ARRA (the fiscal stimulus package passed last February) should increase the level of GDP in 2010 relative to what it would have been without ARRA, it subtracts from economic growth in the 2nd half of the year.

This is not evidence that ARRA is doing more harm than good. The reason ARRA subtracts from growth in the second half of 2010 is that spending under the program starts declining at that point from its peak in 2010Q2. To use Krugman's numbers, if stimulus spending is $125 billion in 2010Q2 and $120 billion in 2010Q3, and if government spending is 15 percent of GDP, then the $5 billion decline in spending would contribute (5/125)x.15 = .006 (6/10 of 1 percent) in that quarter.

The lesson is not that we would be better off in 2010H2 without the stimulus: as the graph above shows, GDP is still 2% higher than it would be otherwise. Repealing ARRA would be tantamount to accelerating the phaseout, which would increase the negative contribution to growth.

Krugman wishes we had built in more stimulus in 2010H2 - the phaseout should occur in 2011 or later. This makes sense if you believe that growth apart from the stimulus will be sluggish in 2010H2. If on the other hand you believe that the economy is poised for a strong rebound in 2010, then phasing out the stimulus in the second half, at a time when the rest of the economy has a full head of steam, is perfectly appropriate.

More employment forecasts

My simple VAR forecasting model (unemployment and continuing claims; employment and initial claims) tells me that December's employment situation will not be much improved over November's: Change in employment = -9000, unemployment rate = 9.9 percent. It shows strong growth in employment starting in January.

Every fiber of my being, however, tells me the employment number will be in positive territory. It's been rising by 70,000 or so every month, so let's say +60,000. That would certainly be consistent with recent economic releases that suggest a quickening pace to recovery. The unemployment rate is dicier: the labor force participation rate has fallen dramatically in this recession, meaning there are a lot of people out there who would ordinarily be working but aren't, and aren't counted as unemployed either. Strong growth in jobs could draw these people back into the labor force while not having a significant effect on the unemployment rate.

Republican faithful misfire

TPM reports of a distressed caller to CSPAN worried that his prayer for Robert Byrd's death may have struck Jim Inhofe instead:

"Our small tea bag group here in Waycross, we got our vigil together and took Dr. Coburn's instructions and prayed real hard that Sen. Byrd would either die or couldn't show up at the vote the other night," the caller said.

"How hard did you pray because I see one of our members was missing this morning. Did it backfire on us? One of our members died? How hard did you pray senator? Did you pray hard enough?" he continued, his voice breaking.

Fortunately, it appears that both Sens. Byrd and Inhofe survived the prayer assault.

Senate health bill is better than nothing

Considerably better, according to Jonathan Cohn. Here's how it benefits middle-income families, according to health economist Jonathan Gruber:

Kinda hard to read. Look at the original article.

Public option vs. individual mandate

The Democrats' health reform plan(s) has a grand bargain at its core: insurance companies lose the right to cherry-pick their customers through higher rates for people with pre-existing conditions and lifetime caps; in exchange, everyone is required to buy health insurance. The individual mandate is necessary because without it the market for health insurance is subject to an adverse selection problem: healthy people opt out, which raises the cost of serving the average person in the pool, which causes insurers to raise rates, which causes more healthy people to drop out, etc.

But there is a political danger in the individual mandate: how do you tell a person struggling to raise a family on $40,000 per year that he/she needs to pony up $10,000 for health insurance? Well, you subsidize the purchase, bring it down to a manageable number - $5000? $3000? But the subsidies are expensive; if insurance premiums keep rising at the rate they have in recent years the program becomes unsustainable. Enter the public option: a strong public option can help control costs and make generous subsidies feasible. At the least, allowing people the option of buying a public plan keeps them from feeling like the government is forcing them into the arms of the rapacious private health insurance companies.

But the insurance companies and their lackeys in Congress have fought the public option tooth and nail, and probably have killed it. Now liberals have to ask themselves, is the bill palatable without the public option? It's not just a matter of good policy, it's a matter of political survival for many Democrats.

Matt Steinglass argues that liberals must honor the original bargain - insurance reform for the individual mandate - and try to fix the mandate before it takes effect in 2013. That's a reasonable argument, but there's another equally reasonable one: drop the mandate, keep the reforms, and screw the insurance industry. Then put the onus on the insurance industry and its lackeys to fix the system before 2013. If they want an individual mandate, they'll have to give something - a public option, stricter regulation, generous subsidies, something. I look forward to the reception the Lieberman-Nelson Health Insurance Reform bill gets in Congress.

Still waiting to hear about this tenure case

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Batshit crazy 9-09.pdf (323 KB)

Posted via email from Maynard

Odd coincidences

I taught two courses this semester with 24 and 30 students enrolled. In each course the last student listed alphabetically had a last name beginning with T. In each course the two students listed alphabetically just above the last student withdrew from the course; each of these students had a name beginning with S. In each course the student at the 25th percentile (arranged alphabetically) withdrew from the course. In each course students arranged close to each other on the alphabetical list were more likely to work together on assignments than students far away from each other on the alphabetical list.

We've turned the downward sparrow!

That's what my students tell me on their last written assignment of the semester: "Many economic indicators have shown us that we have turned the downward sparrow and started the recovery slowly."

I'm not sure what that means literally, but I'm going to start using it.

Fourth quarter GDP forecasts

The WSJ reports that a number of forecasting firms have increased their projections of fourth-quarter GDP growth, from an average (across 7 forecasting firms) of 3.1% to 3.9%. Economic forecasters have adaptive expectations. In the early stages of recovery forecasters are pessimistic because recent data has been pessimistic. As their pessimistic forecasts are proved wrong, they revise them upward to keep up with events (with a lag, of course). It works the same way on the down swing: in early 2008 forecasters were predicting at worst a mild recession because growth had been slowing mildly in recent quarters. Only when the bottom actually fell out did the forecasts catch up with reality. On the basis of this logic, I'm going to say, add 1% to the consensus forecast: fourth-quarter growth in the 4-5% range.

Good news, bad news

Paul Krugman says anyone who calls the -11,000 jobs number for November good news is nuts. Obviously if the economy lost 11,000 jobs a month on average for a long period of time we'd be in bad shape. -11,000 is good news because it shows the economy is turning, not because it's where we want to be. We were in an eighteen wheeler whose brakes had gone out, hurtling towards a cliff. After heroic effort, inches before the precipice, we have turned the truck so we are running along, not toward the cliff. With continued effort we can look forward to turning the truck around completely; and that will be good news.

Krugman's benchmark for good economic news is +300,000 jobs per month. That's sensible. At the current pace of improvement we'll be there by April.

Windfall bonus tax

Krishna Guha of the Financial Times asks, A Windfall Tax in the US? He gives a 14 point argument in favor of the proposition, then asks "well, what do you think?" I think - yes, absolutely. Also, make them all parade naked down Wall Street while we throw fruit at them.

Ah, now it all makes perfect sense to me

This is the Afghanistan war plan devised by PA Consulting, via TPM. No wonder it took so long for Obama to approve it.

The Economist has another explanation. "Why did it take Obama so long to approve the Pentagon's Afghanistan war plans? Because they had to be translated from the original Russian."

Public option bait and switch

Apparently the Senate is now considering an alternative to the public option under which people aged 55-65 could buy into Medicare instead of buying private insurance. This sounds to me like an ingenious bait and switch; I can't believe liberals could be this clever:

1. Liberals want single-payer universal coverage - Medicare for Everyone.
2. But that won't fly politically, so they push a "public option" instead.
3. The public option is whittled down in negotiations to a mere shadow of its desired self, off-limits to the 85% of Americans who currently have insurance.
4. But for Republicans and key conservative Democrats, even the emasculated public option is too much. The Democrats threaten a filibuster if the public option stays.
5. Meanwhile, John McCain and other Republicans take to the floor of the Senate to defend Medicare against the Democrats' promised cuts. Don't throw Granny under the bus, they cry, she loves her Medicare so!
6. So Harry Reid comes back at them: all right, we'll ditch the public option and cover the uninsured through Medicare instead. What, Medicare is socialism? But you're on record extolling its virtues - so Medicare is good enough for Granny but not good enough for her 55 year old son?
7. Befuddled, the wavering Democrats accept Medicare for Everyone (55-65 years old) in place of the public option - the liberals win! Next up: Medicare for those aged 45-55.

A spirited debate over the climategate scandal

Thanks Ralph. The last three seconds do indeed tell the story.

James Hansen should stick to climate research

His economics is pathetic. Paul Krugman has the complete takedown. I'll just point out two howling bad arguments:

Because cap and trade is enforced through the selling and trading of permits, it actually perpetuates the pollution it is supposed to eliminate. If every polluter’s emissions fell below the incrementally lowered cap, then the price of pollution credits would collapse and the economic rationale to keep reducing pollution would disappear.

In other words, if we solve the problem, there's no incentive to keep trying to solve the problem. Ee gads.

Still need more convincing? Consider the perverse effect cap and trade has on altruistic actions. Say you decide to buy a small, high-efficiency car. That reduces your emissions, but not your country’s. Instead it allows somebody else to buy a bigger S.U.V. — because the total emissions are set by the cap.

Oif. Suppose there's a $2 a gallon tax on gasoline. Suppose I give up my SUV for altruistic reasons. What happens in the market for gasoline? The price falls, and someone else takes advantage of the lower price by driving more. How is Hansen's proposal any better than cap and trade?

The bottom line is that cap and trade is the best we're going to do. Anyone who cares about global warming ought to get behind it and work to iron out the imperfections rather than holding out for the "perfect" solution.

Live at student senate

I presented the alternative curriculum proposal to the Student Senate tonight. Interesting reactions. One student wanted to know the name of this shadowy cabal that is causing so much trouble. People are calling it the Char Weise Group, which would be great if I played sax but otherwise not so much. Twenty Tenured Professors doesn't have much of a ring to it (again, that would make a great name for a swing band). Since the final details were hammered out over Guinesses at Garyowen's, I'm going to propose "The Coalition of the Swilling."

Urban Institute report on the "public option"

This report argues that the virtue of a public health insurance option is that it offers a plan that can offer reasonable rates to customers because it can impose low reimbursement rates on health care providers. In other words, it uses the government's market power to offset the market power of hospitals. The authors warn that a weak public option (one that negotiates rather than imposes rates) will be in no better position to negotiate favorable rates than private plans, and therefore not achieve much by way of savings. Ditching the public option, on the other hand, will ensure that rates continue to rise at an unsustainable rate:

The outcome is likely to be that costs will continue to spiral upward. In effect, the nation would be relying on the range of promising pilot approaches to cost containment that would take some time to be successful. If they are not, we may be left with increasingly regulatory approaches, such as rate setting or utilization controls that apply to all payers. This would mean much more government involvement than giving people a choice of a low-cost public option that would be required to compete with private insurers.

Liberals might offer those who oppose the public option this alternative: either a strong public option, or treat hospitals and insurance companies like public utilities and regulate their rates directly. I think the regulatory approach would actually be more effective than the public option and would be happy to go that route.

But Fed forecasts are as wrong as everyone else's!

The employment report is great news, right? Not according to many prominent commentators. Here's Paul Krugman:

Good news is bad news

Today’s unemployment report was good news. But in a real sense good news is bad news, because this month’s not-too-bad number deflates the sense of urgency.

The fact remains that realistic projections show unemployment staying disastrously high for many years. The chart above is from the minutes of the Fed’s Open Market Committee. Unemployment above 8 percent in the fourth quarter of 2011; above 7 percent in the fourth quarter of 2012.

That's fallacy #2 in my taxonomy (see post below). The Fed's forecasts are liable to be as wrong as everyone else's. Let's examine, for example, the Fed's forecasts from October 2007, two months before the start of the recession.



GDP growth of 1.8-2.5% in 2008 and 2.3-2.7% in 2009; unemployment averaging 4.8-4.9 percent in both years. Um, how did that work out? And should I bring up the Fed's embarrassing forecasts in October 2008 - after the collapse of Lehman Brothers, when the bottom was falling completely out of the economy? Here's what the Fed's consensus forecasts were for 2009:

GDP: -0.2-1.1%
Unemployment: 7.1-7.6%

Oog!

Happy days are here again (you can tell by the smile!)

Just a few comments:

1. We're in much better shape than we thought we were. The BLS revised the job loss numbers down 79,000 in October and 80,000 in September. The labor market does not seem to have stalled in the third quarter, it kept improving at the pace it began in the spring.

2. Average improvement in the job loss numbers since February = +73,000 per month. If this trend continues, job growth will be +208,000 by February 2010. That would be phenomenal.

3. Several commentators have cautioned that this month's data will be revised, so we can't take it at face value. Yes, revisions are possible. But repeat Bob's mantra: at business cycle turning points, "revisions are in the direction of the inflection." That is, we're more likely to see an upward revision than a downward one.

As a reminder, this is what I wrote on Nov. 25:

Ok, very quickly, then I'm headed on the road. I just ran two vector autoregressions: one with initial unemployment claims and payroll employment and another with continuing claims and the unemployment rate. I used the VARs to forecast November's unemployment and payroll employment numbers. Then I tookdata for unemployment claims in the second week of November(big drop in both numbers - pretty remarkable, and good news for the labor market), used the historical correlation between surprise changes in those numbers and surprise changes in unemployment and payroll employment, and I get the following predictions:

November unemployment rate: 10.0%.
November change in payroll employment: -10,795.

I don't know whether to believe those numbers or not. The standard error of those point estimates is very large, and the models may be misspecified to begin with. But let's let those predictions stand and see what is reported a week from Friday. If the numbers look that good, there are going to be a lot of people scrambling to figure out how they could have been so wrong about predictions for a jobless recovery!

BINGO!

BLS report on November employment situation:

Unemployment rate = 10.0%

Change in payroll employment = -11,000

I believe I called this one.*

* I will now claim to have been confident in the forecast I made a week and a half ago. Those hesitations you detected in more recent posts were figments of your imagination.

Another forecast for payroll employment

In an earlier post I half-suggested that the employment figures to be released tomorrow could show unexpectedly strong growth, by which I meant a job loss of only about 10,000. Today's ADP employment services report says 169,000 jobs were lost in the private sector, a bit more than expected. This would suggest a much more pessimistic overall jobs report tomorrow. Still, the ADP report continues to suggest that the labor market is stabilizing slowly - job losses fell for the eighth consecutive month.

The consensus forecast for tomorrow's payroll employment number is -130,000, down from -190,000 in October. A 60,000 job improvement every month is consistent with the trend begun in early 2009. If this trend holds, job growth will follow the green line in the graph below. We get positive employment changes in February, and by June the economy is humming along at close to +300,000 per month.

The last two months, however, the improvement in job losses has slowed to an average of +29,000 per month. If that trend continues, we get the red line: job losses continue to April, and even by June we're still at an anemic +42,000 per month. This is the Goldman-Sachs scenario.

I continue to think the green line scenario is the more likely of the two, with a chance that growth will be even stronger.

Speaking of pessimists!

Goldman Sachs is really pessimistic. Here's their forecast for economic growth in various countries, via the WSJ's blog:


If you believe that US GDP growth is going to be 2.1% in 2010 and 2.4% in 2011, then you believe that the unemployment rate is still going to be above 10% at the end of 2011. You should not believe that. That is unbelievable.

Paul Krugman's economic pessimism

Let me stipulate up front that a year or two from now we may look back at the state of the macroeconomy in 2009 and 2010 and see that Paul Krugman's dire forecasts were exactly on target, and we should never have paid attention to that Char Weise fellow and his rosy scenarios. And you'd be crazy to put more faith in an obscure macroeconomist at a small liberal arts college than a Nobel Prize winning Princeton economist. Yet more and more I'm convinced that Krugman is wrong, dead wrong in his gloomy economic forecasts. And the Brad DeLongs and Mark Thoma's of the blogosphere who echo his views are not giving enough credence to the case for a strong recovery. I've given some reasons for optimism in previous posts; let me devote this one to itemizing the fallacies that Krugman and other doom-and-gloomers have been committing in the past few months.

Fallacy #1: Paying too much attention to high frequency data. In his most recent post, Krugman worries about the decline in construction employment and the latest downturn in the ISM manufacturing index. On the former issue - it's winter, 'nuf said. On the latter issue: though the ISM index fell from 55.7 in October to 53.6 in November (above 50 means expansion), it's still higher than it's been since May 2006. And the trajectory is up, sharply: it was 32.9 last December. Squiggles happen, it's crazy to put much stock in every one.

Fallacy #2: Paying too much attention to economic forecasts. Krugman frets that professional forecasters are predicting sustained high unemployment through 2012. But professional forecasters always get these things wrong. As I noted in a previous post, the professional forecasters vastly underestimated the strength of the post-1975 and post-1982 recoveries, and completely missed the current recession. They were right about the recoveries that began in 1991 and 2001, but overall their track record is not impressive.

Fallacy #3: Forgetting about data revisions. Unemployment is what it is, it's never revised dramatically. It's also an unreliable barometer of the state of the labor market because it is affected by flows into and out of the labor force. But payroll employment - we have no idea what payroll employment is right now. This number is always revised, and tends to be revised upward in the early stages of recovery. Ditto GDP. I believe the economy lost jobs in the third quarter and probably also in the fourth quarter. I believe the economy will gain jobs in the first quarter of 2010. We won't know for sure until we see the revised data, a couple of years from now. Until then, month-to-month declines in payroll employment cannot be taken as concrete evidence of a "jobless recovery."

Fallacy #4: Seeing monsters under every bed. Mortgage delinquencies, commercial real estate, state budgets: all of these are seen as impediments to a strong recovery. But at every business cycle trough there are going to be signs of weakness in the economy - that's why you're at a trough! These things are endogenous variables. A strong recovery raises household income, improves corporate balance sheets, increases state tax revenue, and all of a sudden things that seemed like barriers to growth don't look so bad after all. Case in point: last fall, Krugman, Roubini and others argued that the banking system was insolvent and needed to be nationalized. Why? Because many of the assets they held were virtually worthless. But guess what: in a financial panic, assets are priced way below their fundamental values. When the panic subsides, asset prices rise and balance sheets don't look so bad after all. The US government has pumped money like mad into the banking system. The money has had the effect of quelling the panic and restoring asset prices to reasonable (recession, not panic) levels. This has improved bank balance sheets to the point where most of them have been able to repay the government loans. Nine out of ten of the banks that were identified as susceptible to further economic downturn in the Treasury's stress tests have raised the required amount of capital from private sources. Bank stocks have risen dramatically. The banking system is not, it turns out, insolvent: it was illiquid, and the government was able to deal with this problem without having to nationalize the whole mishagosh.

So I think Krugman is wrong about the weakness of the recovery. I hope he's wrong. Because there's a chance that he's not, it still makes sense for the government to do many of the things Krugman recommends: the Fed needs to keep interest rates low, there needs to be another round of fiscal stimulus focusing on jobs and state budgets. But there's no need to go all Chicken Little with every new data release.

Christmas spirit

Ah, it warms the heart to reflect on the magnanimity of American charities during the Christmas season. The Houston Chronicle reports (thanks to Matthew Yglesias) that charities in the Houston area doing toy drives are making parents prove that they or their children are citizens before they get presents.

The Salvation Army and a charity affiliated with the Houston Fire Department are among those that consider immigration status, asking for birth certificates or Social Security cards for the children.

The point isn't to punish the children but to ensure that their parents are either citizens, legal immigrants or working to become legal residents, said Lorugene Young, whose Outreach Program Inc. is one of three groups that distribute toys collected by firefighters.

“It's not our desire to turn anyone down,” she said. “Those kids are not responsible if they are here illegally. It is the parents' responsibility.”

Warms the cockles, it really does.