Best Economics News Story of the Year: Dickens Meets Hayek in a Mumbai Slum

My one-man committee has met and made a decision: The award for best economics news story of the year goes to Jim Yardley of The New York Times for an article titled “In One Slum, Misery, Work, Politics and Hope,” published in the December 29 issue.
It is a story about Dharavi, Mumbai’s most famous slum, a seething hive where perhaps as many as a million people live in 60,000 structures on an area smaller than central park. Not surprisingly, in every alley, there are scenes of appalling poverty: Read more>>>

Choral Singing, Malpractice, Italy: More Links for Your Classroom

• Most economists are familiar with the distinction between coordination via spontaneous order and coordination via hierarchy. (See, e.g., discussion in Ch. 1 of my textbook.) In the real world, coordination often involves a mix of the two. This post from Lynne Kiesling of The Knowledege Problem  illustrates the coordination issue with the example of choral singing. If you scroll down the comments, you will see one I have added.
• The euro crisis is not about tiny Greece, Ireland, or Portugal; it is about Italy. Italy is not only too big to fail, it is too big to rescue. In this post from Economonitor Ed Hugh digs deep into the Italian problem and explains why the euro's ultimate fate will depend on whether Italy can pull itself out of the very deep hole it is in. Hint: Government finance is only part of the story.
• Everyone agrees it would be good to slow the runaway growth of medical costs, but where to attack the problem? Conservatives often single out the need to reign in excessive medical malpractice suits. Others dismiss malpractice as a minor problem, citing data that malpractice legal costs and awards amount to only 2.4 percent of medical spending. This interesting post from the NY Times by Pauline W. Chen, M.C., a practicing physician, explains that the damage done to the medical system by excessive malpractice suits may be far greater than the measured 2.4 percent if one takes into account the way doctors respond to the fear of malpractice claims.

US GDP: Can We Blame the Grinch for Yet Another Downward Revision of Growth?

The third estimate of US real GDP for Q3 2011 brought yet another downward revision. Can we blame the Grinch who Stole Christmas?

GDP is now reported to have grown at an estimated 1.8% annual rate in Q3 2011, less than the 2.0% second estimate released in November and less still than the 2.5% preliminary estimate reported in October Although slowing, the July-September 2011 quarter was the 9th consecutive quarter of growth since the end of the recession that lasted from Dec 2007 to Jun 2009.

Even after the revision, Q3 GDP was still above its pre-recession peak reached in Q4 2007, although only by a razor-thin 0.04%. According to standard business cycle terminology, the recession phase of the business cycle is the downward movement of GDP from its previous peak. The recovery phase is the upward movement from the trough (low point) of the recession and continues until GDP again reaches its previous peak. Once GDP moves above its previous peak, the expansion phase begins. The revised Q3 data still suggest that after a recovery of 2 years duration, the expansion phase has now begun.

Consumption was revised downward but still accounted for much of the growth in Q3. Investment was revised up to weakly positive compared with the negative number in last month’s second estimate. Federal government defense spending grew but was offset by continued decline of federal nondefense spending and state and local government spending. Exports grew even more strongly than previously reported, but they were offset by an upward revision of imports (a negative entry in the GDP accounts).

The revised growth of nominal GDP (NGDP) was 3.9% in Q3. NGDP growth consisted of 1.8% real growth and 2.1% inflation. An increasing number of economists focus on NGDP growth as a key policy target. Over the long run, NGDP growth of about 4.5% would allow real GDP to track its potential level with about 2% inflation. The Q3 NGDP growth of 3.9% suggests that the gap between actual and potential GDP that opened during the recession continued to widen.

Follow this link to view or download a classroom-ready slideshow presentation of the latest GDP data

Linking Keystone XL to the Payroll Tax Only Shows Why we Need a Real Energy Policy

The administration is coming under increasing pressure to accelerate approval of the Keystone XL pipeline, designed to carry increased U.S. imports of bitumen from Canadian oil sands. The latest form of pressure is a Senate bill that would fast-track KXL in exchange for a two-month extension of the payroll tax cut and other items. After some resistance, it now appears the House will go along with the proposal. It is a bad idea. READ MORE>>>

Latest Price Data Show US on Brink of Deflation as World Economy Slows

The most widely watched U.S. inflation indicator, the seasonally adjusted all-items CPI for urban consumers, fell in November at an annual rate of 0.23 percent. The decrease was small enough that it will hit the headlines as no change, based on the rounded monthly data reported in the press release from the Bureau of Labor Statistics. (All inflation data in this post are month-to-month changes stated as annual rates, based on the three-decimal version of the data released by the Cleveland Fed.) November marked the second consecutive month of negative inflation, following a decrease of 0.96 percent in October. >>>Read more

Follow this link to view or download the latest inflation charts and data in slideshow format

Huger Rises in American Cities and Other Links for Your Econ Classroom

• The US Conference of Mayors has released a new report that shows increased hunger and homelessness in U.S. cities. Unemployment is the leading cause of both, but many hungry and some homeless are employed. (For more on the relationship between poverty and labor market conditions, type "poverty" in the search box on this blog)
• It's hard to keep up with the fast-changing situation in Europe, so now and then I like to give a link to a piece that summarizes the situation well for those who can't read everything. Tim Duy's post in today's Economonitor fits that pattern. Duy explains why the euro has deep-rooted structural problems that are not addressed by the latest Franco-German plan. "I don't see where this ends well," concludes Duy. (BTW, Duy also spikes the rumor that the Fed is about to rescue European banks.)
• While the crisis in Europe has attracted the most attention, China is having its problems, too. Here are two good posts to keep up to date on the China scene. In the first, Michael Pettis explains just how we know that China is overinvesting. In this next one, Patrick Chovanec provides the latest data on the collapse of China's housing bubble.

What do the Russian Protesters Want? One Observer’s View of Problems and Needed Reforms

Commentators have compared the recent Russian protests to those of Tahrir Square and Occupy Wall Street. There are differences, of course, but certain similarities stand out. For one thing, these recent movements differ from, say, Ukraine’s Orange Revolution, in that none of them has a clear leader. Instead, they have coalesced around negatives: Egypt without Mubarek, Russian without Putin, America without Wall Street. They all see the existing political system as corrupt, but they are much less specific about what should replace it.

Although these movements may lack leaders, they do not lack thinkers and opinion makers whose writings provide useful insights into what the protesters want. This post looks at the views of one Russian opposition figure, the journalist and writer Yulia Latynina, as expressed in a recent essay titled “Russian Baker, or Ownerocracy.” READ MORE>>>

Can New Fiscal Rules Save the Euro? Three Details to Watch For

Yesterday  Angela Merkel and Nicolas Sarkozy announced a new set of fiscal rules, their latest idea to save the euro.  The new rules would replace the unworkable Stability and Growth Pact (SGP), which mandates a deficit of no more than 3 percent of GDP and debt of no more than 60 percent of GDP. Yesterday’s announcement was short on specifics, but here are three crucial things to watch for that will determine whether the new rules will have any chance of working. READ MORE>>>

China is Overinvesting in Electric Cars and Other Links to Eliven Your Econ Course

• The US government has been roundly criticized for its investment in Solyndra's failed solar panel venture, yet many people think the Chinese government is oh-so-clever when it pours money into "economy of the future" investments of its own. Think again. Governments everywhere are prone to pouring money into the sand. This excellent long post by Michael Pettis explains how the Chinese government has overinvested in the electric car industry and in other sectors as well.
• Defender's of Wall Street often defend princely salaries by arguing that a highly efficient U.S. financial sector is adding hugely to the strength of the economy. This nice piece of research by NYU's Thomas Phillippon blows that argument out of the water. It argues that financial sector costs are rising faster than its output, and that the resulting loss of productivity is a drag on the economy at large, not a boost. The comparison of productivity-enhancing IT investment in retail trade with productivity-sapping IT investment in the financial sector is especially interesting.
• Last week the stock market got a boost when the Fed announced it would lower the interest rate charged to loan dollars to European banks. Every wonder why European banks need dollars? This report by Binyamin Appelbaum of the New York Times explains some of the reasons.

US Employment Data: Stronger November Report Shows Economy Struggling to Resist Global Weakness

The latest employment report from the Bureau of Labor Statistics shows stronger, but still moderate, job growth for November. The unemployment rate fell to 8.6 percent, its lowest since March 2009. On the whole, the report shows a U.S. economy struggling to resist being dragged down by even weaker economies in Europe and Japan, and by a still strong but slowing China.

The economy added 120,000 payroll jobs in November. At the same time, figures for the previous four months were revised upward by a total of 114,000. Service jobs, led by retail trade, accounted for all the gains. Producers of goods lost 6,000 jobs and government lost another 20,000, continuing a steady decline. Local governments shed the most jobs last month,

The unemployment rate, which dropped to 8.6 percent in November, is the ratio of unemployed persons to the labor force. The labor force, in turn, includes both employed and unemployed persons. The number of unemployed decreased by 594,000 in November, of which 279,000 found jobs and 315,000 withdrew from the labor force.


The BLS also pubishes a broader measure of unemployment called U-6. The numerator of U-6 includes unemployed persons, marginally attached persons who would like to work but are not looking because they think there are no jobs, and part-time workers who would prefer full-time work but can’t find it. The denominator includes the labor force plus marginally attached workers. U-6 fell to to 15.6 percent in November. As with the official unemployment rate, that was the lowest level since March 2009.

The employment to population ratio ticked up to 58.5 percent, its fourth monthly increase after reaching an all-time low in July. The long-term downward trend in this ratio reflects several factors: Slow job growth, more discouraged workers, who do not look for jobs because they think none are available, more retired persons as the population ages. 

Follow this link to view a classroom-ready slideshow presentation of the latest labor market data.

Afghanistan's Economic Future, Aid, and the Curse of Riches

We hear a lot about the future of Afghanistan after NATO withdrawal in 2014. Most of the speculation focuses on security and politics. Too little of it concerns economics. A pair of new reports, one from the World Bank and the other from the IMF, help fill the gap. If you thought the security and political prognosis was problematic, wait until you read what lies ahead for the country’s economy. READ MORE>>>

Ed Hugh on the Euro and Other Links to Enliven Your Econ Course

If you don't have time to read everything about the teetering euro, read Ed Hugh's excellent summary in "Last Days of Pompeii" from Economonitor. Hugh shows that many countries share the problems of the euro (excessive public and private debt, aging populations, competition from emerging economies), but the euro is getting hit first and worst.

All of us want to work behavioral economics into our courses these days. Here's a great behavioral econ reading list from Cheap Talk that will help.

If you want to get a good discussion going on consumerism and the environment, show your students this ad from Patagonia, "Don't Buy This Jacket," and the commentary by Mark Gunther.

Follow me on Twitter @dolanecon to get more links like these to enliven your econ courses.

US GDP Data: Downward Revision of Q3 GDP Strengthens Case for Stimulus

The second estimate of U.S. GDP for the third quarter of 2011 shows a downward revision, making the real growth rate 2 percent rather than the 2.5 percent reported in last month’s preliminary estimate. The slowing growth rate makes the expansion look weaker than before and strengthens the case for new stimulus. >>>READ MORE

Follow this link to view or download the latest GDP charts ready for classroom presentation

Thoma on Taxing the Rich vs. Growth and Other Links to Enliven Your Econ Course

Mark Thoma offers his opinion as to Why America Should Spread the Wealth: "If those at the top of the income distribution receive far more than the value of what they create, and those at lower income levels receive less, then one way to correct this, at least in part, is to increase taxes at the upper end of the income distribution and use the proceeds to protect important social programs that benefit working-class households, programs that are currently threatened by budget deficits." He acknowledges, however, that beyond a point, there may be a tradeoff between achieving greater equality through taxation, on the one hand, and stimulating growth, on the other. My thought: Greater emphasis should be placed on the difference between raising marginal tax rates on the rich (for example, by letting the Bush tax cuts expire) and undertaking true tax reform. The latter would eliminate loopholes and cut tax rates in a way that simultaneously raised average tax rates on upper-income households while cutting their marginal tax rates. Such a policy could promote both growth and equality, while achieving fiscal consolidation at the same time. (For more on growth-friendly fiscal consolidation, see this earlier post.)

In a recent post on Economonitor, Paolo Manasse and Giulio Trigilia provide evidence that markets are now perceiving a general euro risk rather than confining the perception of risks to just a few countries. They argue that Italy's weak fundamentals, which cannot be cured by a simple change of government, lie behind the emergence of generalized euro risk.

Scott Sumner, drawing on work by Timothy Taylor, calculates that the Transport Safety Administration is killing 100 people (equivalent to the crash of a medium-sized airliner) every month. That happens because longer waiting times at airport security since 9/11 divert a large amount of traffic to the highways, where fatalities per passenger mile are far higher than for commercial air travel.

Follow me on Twitter @dolanecon to get more links like these to enliven your econ courses.

On Technical Barriers to Leaving the Euro and Learning from Others’ Experience

When discussion turns to the possibility that some country might leave the euro, much is often made of the technical difficulties of introducing a new currency, especially of the months, even years, of planning that went into launching the euro in the first place. Sample: “Computers will have to be reprogrammed. Vending machines will have to be modified. Payment machines will have to be serviced to prevent motorists from being trapped in subterranean parking garages. Notes and coins will have to be positioned around the country.” (Joshua Chaffin in the Financial Times, quoting a 2007 paper by Barry Eichengreen.)

Yes, there would be technical difficulties. Still, lots of countries have switched currencies in the past. Sometimes the process has been planned and orderly, sometimes messy and chaotic. One way or another, the job gets done. Anyone who thinks technical problems pose insurmountable barriers needs to look at the imaginative, pragmatic devices that other countries have used to ease the transition from one currency to another. Here are three lessons from other countries’ experiences  that would be relevant to anyone now making plans to leave the euro. READ MORE>>>

US Inflation Data: Moderate October CPI Data Give Fed Room to Maneuver in Face of Euro Crisis

US inflation pressures continued to ease in October, according to the latest data from the Bureau of Labor Statistics. With the struggling US economy facing headwinds from the euro crisis, low inflation gives the Fed a welcome extra bit of room to maneuver.

The headline CPI actually fell at a 1 percent rate during October.  (All inflation rates given in this post are seasonally adjusted monthly changes stated as annual rates.)  Energy prices were the main factor driving headline inflation downward. Negative inflation is unlikely to persist, however, given that world oil prices have already pushed back over $100 a barrel this week.

Core inflation remained moderate in October, rising just slightly to a 1.7 percent annual rate. Apparel prices and prices of medical goods and services helped pull the core rate up a bit from September’s 0.6 percent, which was the low for the year. READ MORE>>>

Follow this link to view or download a classroom-ready slideshow including the latest inflation charts and analysis.

Understanding the New View of Poverty (2): What Helps and What Hurts

Last week, the Census Bureau published a new Supplemental Poverty Measure (SPM) that changes our understanding of poverty in America. The first installment of this post looked at the way it erodes our stereotypes of who is poor, especially by showing that there are more poor white, working-age, home-owning Americans than we thought. No matter what population group or political party you belong too, it is now harder to dismiss income insecurity as something that threatens only people who are not like you. This installment turns to the issue of which government policies help reduce poverty and which policies may be making the problem worse. READ MORE>>>

Understanding the New View of Poverty (1): The Erosion of Stereotypes

We all thought we knew who is poor in America. Children, especially in one-parent households. Racial minorities. Families who aren't able to participate in the great American dream of home ownership. Really? The Census Bureau's new Supplementary Poverty Measure (SPM) erodes all of these stereotypes. They still contain some truth, but less than it seemed. No matter who you are, you cannot dismiss income insecurity as a problem that doesn't threaten people just like you.

The news does not come without warning. The official 2010 poverty figures, released in September, already showed a record high poverty rate for working-age Americans—some 13.7 percent, up from 12.9 percent in 2009, itself a record. Now the new SPM shows that official figures understate the problem. Why, and what does it mean? READ MORE >>>>

US Employment Data: October Job Growth Still Slow but Details Hold a Bit of Good News

The Bureau of Labor Statistics reported only 80,000 new payroll jobs in October, still a very slow tempo. However, there was a bit of good news hidden in the revisions for earlier months. The August payroll job figure, originally reported as a shockingly bad zero gain, was revised upward to a more respectable 104,000. September's job growth, in turn, was revised upward from 103,000 to 158,000. Some observers believe that upward revisions are typical of a job market that is beginning to turn the corner toward growth. Optimists can hope this month's 80,000 will eventually be revised up, as well. >>>Read more

Follow this link to view or download a slideshow with the latest unemployment charts and graphs, ready for your classroom or business presentation

NGDP Targeting is the Natural Heir to Monetarism

In a recent post, Daniel Alpert enlists Milton Friedman as an ally against the newly popular (but not new) idea of targeting nominal GDP. On the contrary, I see NGDP targeting as the natural heir to monetarist policy prescriptions of the 1960s and 70s.

If we look at the textbook version of monetarism, the point is almost trivial. Textbook monetarism begins from the equation of exchange, MV=PQ, where M is money (M1, back in the day), V is velocity, P is the price level, Q is real GDP, and PQ is NGDP. Next it adds the simplifying assumption that velocity is constant. It follows that targeting a steady rate of money growth is identical to targeting a steady rate of NGDP growth.

Of course, Friedman himself propounded a more sophisticated monetarism, one in which the linkage between monetary policy and NGDP was not so tight. He saw two sources of slippage as potential problems for a monetary growth target. READ MORE>>>

Can Spaceship Earth Carry Seven Billion Passengers, and More to Come?

According to the United Nations, the world population will reach 7 billion people this week. No one really knows the exact date, but the announcement has sparked a round of commentary, most of it pessimistic. The doubling of the world’s population over the past 50 years is the most rapid in history. Demographers expect another 3 billion at least before global population finally peaks early in the next century and begins a gradual decline. Can we make it until then? Or will our overburdened spaceship earth suffer environmental collapse?

Population growth poses real challenges for environmental policy. The more people, the more important it is to get things right in the relationship between people and the planet. At least three issues require even closer attention as the population grows than they would with a constant population. READ MORE>>>

US GDP Data: Growth Stronger in Q3 as Economy Enters Expansion

There was a bit of joy in yesterday’s advance estimate of U.S. Q3 GDP both for traditionalists who focus on the real value of output (RGDP) and for the growing number of economists who track the nominal value (NGDP).

Real output was reported to have grown by 2.5 percent in the quarter, a bit stronger than analysts’ expectations. That was up significantly from 1.3 percent in Q2. RGDP passed a key psychological threshold as it edged above its previous peak, which it had reached all the way back in Q4 2007. After almost two years of recession and two years of slow recovery, the economy has finally entered its expansion phase. READ MORE>>>

Only Economists Can Save the Planet

Gernot Wagner’s But Will the Planet Notice? is the book I would like to get my neighbors to read. The ones who use canvas shopping bags, take short showers, recycle, and think that is enough. The ones who think “environmental economics” is an oxymoron. The ones who think concepts like markets, incentives, and property are the roots of our planetary problems, not the keys to solving it.

Wagner can speak to these people as a member of the same club. He is careful to point out that he, too, pays his dues—no plastic bags, no meat, no car, and a day job with the Environmental Defense Fund. But he also has a Ph.D. in environmental economics. That means that even though he may live like your average green progressive, he thinks differently. He thinks recycling is nice, but not enough, and that only economists can save the planet. READ MORE>>>

US Inflation Data: Scant Fuel for Inflation Fears in September CPI Report

Although some observers still think the Fed's easy monetary policy risks a rise in the US inflation rate, there was scant fuel for their fears in the September inflation report from the Bureau of Labor Statistics. The all-items CPI for urban consumers rose at a seasonally adjusted annual rate of 3.7% in September, down almost a point from the August rate of 4.6%.

Food and energy prices are highly volatile and account for much of the month to month variation in the CPI. Their effect can be removed by taking food and energy out of the CPI. The result is called the core inflation rate, which fell to just 0.6% in September (monthly change stated as annual rate), the slowest for the year. Because food and energy prices contributed more than their share to inflation, as they have for most of the year, the core inflation rate was below the all-items rate.

Another way to remove volatility from the CPI is the 16% trimmed mean CPI, published by the Federal Reserve Bank of Cleveland. The trimmed mean CPI removes the 8% of prices that increase most and the 8% that increase least in each month, whether they are food, energy, or something else. In September, trimmed mean inflation slowed significantly, although it remained above the core inflation rate.

No one measure of inflation is best. The all-items CPI gives the most accurate picture of current changes in the cost of living for urban consumers. The core CPI and trimmed mean CPI give more accurate pictures of underlying trends. Economists at the Fed look closely at the core and trimmed mean CPIs to judge the effect of monetary policy. They pay less attention to the all-items CPI, which includes food and energy prices that are set on world markets, beyond direct control of monetary policy.

The Fed, unlike many central banks, does not set an explicit target for the rate of inflation. However, it has made it clear that it considers an inflation rate of around 2 percent, over a medium-term time horizon, to be consistent with its mandate to maintain price stability. Although inflation has increased from its extremely low levels of 2010, the September inflation data, on the whole, fall within a range that the Fed should not find alarming.

Follow this link to view or download a short slideshow with charts of the September data.

The Senate’s Currency Manipulation Bill is Not Only Bad Policy, but Unnecessary

China's currency manipulation is bad policy. So is the Senate's latest crackdown on it. The bill passed yesterday is not only bad policy, but unnecessary. Here's why.

First of all, before we get hysterical about Chinese policy, we should recognize that currency manipulation is the global norm, not the exception. By a recent count, only 14 percent of the IMF's member nations allow their exchange rates to float freely. Some 58 percent manipulate their exchange rates by holding them above or below the level to which the market would move them. READ MORE>>>

US Labor Market Data: Job Growth Moderate, Unemployment Steady in September

The latest data from the Bureau of Labor Statistics show that the U.S. economy added 103,000 payroll jobs in September. That was the best number in five months, but is still well below the rates of job growth earlier in the recovery.

The service sector provided nearly all of the new jobs, with health care and temporary work leading the way. Goods producing sectors added just 18,000 jobs and manufacturing jobs actually fell in the month. Government jobs decreased by 34,000, continuing a steady decline.

A separate household survey that includes farm jobs and the self-employed showed that the labor force, which includes both employed and unemployed persons, grew by 423,000. Of these, 398,000 found jobs and 25,000 joined the ranks of the unemployed as soon as they started to look for work. The unemployment rate, which is the ratio of unemployed persons to the labor force, remained unchanged at 9.1 percent for the third month in a row.

The BLS also calculates a broader measure of unemployment called U-6. The numerator of U-6 includes the officially unemployed, plus persons marginally attached to the labor force who would like to work but are not looking because they think there is no work, plus part-time workers who would prefer full-time work, but can't find it. The denominator includes the labor force plus the marginally attached. U-6 increased from 16.2 to 16.5 percent in September, its fifth increase in the past six months.

Another important labor market indicator, the employment-population ratio, increased slightly in September, but remained just above its all-time low reached in July. The long decline in the employment-population ratio primarily reflects an aging population, but cyclical factors, like more discouraged workers, have also kept this indicator at a low level.

Follow this link to view or download a short classroom-ready slideshow with graphical presentations of the main employment indicators.

What the Wall Street Protesters Want: An Economic Commentary on the "Contract for the American Dream."

Nearly every news story I read about the occupation of Wall Street begins by saying that the protesters are vague about what they want. Even Paul Krugman, who is supportive of the demonstrations, complains in today's New York TImes about a lack of specific policy demands. Maybe that is a valid critique of individual protestors, but if you look instead at what some of their sponsoring organizations say the protest is about, you get a different picture—one that is not only more specific but often makes surprisingly good economic sense. READ MORE>>>

How Gordon Brown Saved Britain from the Euro and Why that Makes him a Hero

In his new book, Alistair Darling describes Gordon Brown's political style as "appalling," "volcanic," and "brutal." He should know. The two men sat together in the cabinet for years while Brown was chancellor. Darling then served as chancellor himself when Brown finally became prime minister. Now that Brown is out of office, it seems he has few political friends left. Still, his successors should erect a statue to him, for one accomplishment if nothing else: He saved Britain from the euro. Here's why that makes him a hero.

The story starts back in 1997, when Tony Blair was new to the job of prime minister. The euro was still three years away from realization, but already Blair was an enthusiast. Brown was skeptical, but he had a problem. Political solidarity required him to support the euro in principle, but his stronger sense of economic reality made him realize that it was a bad idea for the UK. His solution was to endorse the euro subject to the following five tests, which together were vague enough and tough enough that they could never be fully met: >>>READ MORE

US GDP Data: Growth for Q2 2011 Revised Upward, But Still Weak

U.S. GDP growth for the second quarter of 2011 was revised upward to a 1.3 percent annual rate from the 1.0 percent second estimate reported last month. The upward revision, which returned GDP growth to the same rate as the advance estimate released in July, was a relief to some observers, even though it was still very weak . About 2.5 percent growth is generally considered necessary to keep unemployment from rising, when growth of the labor force is taken into account.

Although a recovery has been underway for two years, the level of U.S. real GDP has not yet reached its peak level of mid-2007, before the recession. When GDP finally reaches its previous peak, the economy will have been considered to make the transition from the recovery phase of the business cycle to the expansion phase.

Investment remained a relative bright spot in the GDP data, accounting for .79 percentage points of the 1.3 percent growth in the quarter. Business fixed investment was relatively strong while housing investment remained weak. Consumption grew by about 0.49 percentage points, with personal expenditures on healthcare services leading the way. The government sector contracted. Federal defense expenditures rose, but they were more than offset by decreases in federal nondefense spending and in state and local government purchases. Net exports performed better than previously estimated. Exports were revised upward and imports downward compared with the August report.

Follow this link to view or download a set of classroom-ready slides with graphical presentations of the latest GDP estimates.

Natural Gas Flaring, Carbon Taxes, and the Risk of Alien Invasion

To an alien orbiting Earth in a flying saucer, natural gas flares would be one of the most visible signs of human life on earth. Notice I said "human life," not "intelligent life."

Flaring is the practice of burning off the natural gas that is produced in association with oil rather than piping it to market, using it at the wellhead, or reinjecting into the ground. Flaring was once common, but in more recent times, it has largely been limited to places like Russia and Nigeria. Now, though, it is becoming a big source of controversy in the United States. According to a recent New York Times article, some 30 percent of natural gas produced from rapidly expanding North Dakota oil fields will be flared this year—more than enough to heat every home in North Dakota through the state's harsh winters. Elsewhere in this country, less than one percent of gas is flared. READ MORE>>>

For more environmental topics, check out my new book, TANSTAAFL: A Libertarian Perspective on Environmental Economics.

The UBS-Adoboli Scandal Shows the Problem of Negatively-Skewed Risk is Still With Us

In my banking courses, I point to negatively skewed trading strategies as a key cause of the crash of 2008. The recent loss of more than $2 billion attributed to rogue trades by Kweku Adoboli at Swiss banking giant UBS shows that the problem of negatively skewed risk is still with us. It is an old story, but with a new twist.

The problem of negatively skewed risk arises from the way incentives change when you gamble with someone else's money. >>>Read more

US Inflation Data: Headline CPI Inflation Slows, Core Inflation Up a Bit in August

The Consumer Price Index for all items purchased by U.S. urban consumers rose at a seasonally adjusted annual rate of 4.6 percent in August, somewhat slower than the July rate of 6.2%. Gasoline and food prices added significantly to inflation in August, as in the previous month.

Food and energy prices are highly volatile and account for much of the month-to month variation in the CPI. Their effect can be removed by taking the food and energy components out of the CPI. The result,  called the core inflation rate, was 2.97 in August, slightly faster than in July.

Another way to remove volatility from the CPI series is the 16 percent trimmed mean CPI published by the Cleveland Fed. That index removes the 8 percent of prices that increase most and the 8 percent that increase least each month, whether they are energy, food, or something else. In July trimmed-mean inflation rose slightly. At 3.6 percent, it remained slightly above core inflation, as it has for most of the year.

There is no "right" and "wrong" way to measure inflation. Each index answers a somewhat different question. Economists often look at the core or trimmed mean measures to judge the effects of monetary policy. The all-items CPI includes food and energy prices that are set in global markets, beyond direct control of domestic policy.

Although inflation is beginning to rise, it is not yet a great cause for concern. The Fed does not set an explicit target rate for inflation, but it tends to view 2 percent inflation as consistent with prudent monetary policy in the long run. After slowing to a crawl during the recession, headline inflation is now running about 3 percent on a year-on-year basis, while core measures have not yet reached the 2 percent threshold.

Follow this link to view or download a set of classroom-ready slides with graphical presentation of inflation data.

US Working-Age Poverty Hits a Record High: What it Means for the Budget Debate

Adding to the gloom from recent labor market data, the Census Bureau reported today that the poverty rate among working-age Americans hit a record high in 2010. Last year some 13.7 percent of the U.S. population aged 18-64 years fell below the poverty threshold of $22,314 for a family of four. That was up from 12.9 percent in 2009, also a record. The Bureau has reported working-age poverty figures since 1966, at which time the rate was 10.5 percent. Read the full post>>>

The Truth About Taxes: What are Our Choices?

This post is an abbreviated version of a recent presentation to the League of Women Voters of San Juan County, Washington. You will find a link to the slideshow version at the end of the post.
The question we most often hear about taxes is, are they too high, or too low? The answer to both questions is YES. How can that be?

Taxes are too high in the sense that they distort the decisions made by households and businesses. At the same time, they are too low in the sense that they do not bring in enough revenue to pay for government as we know it. We cannot continue to operate the government that way.
Economists measure the sustainability of the federal budget in terms of the cyclically adjusted primary balance (CAPB). That is the deficit or surplus averaged over the business cycle, without including interest payments. To be sustainable, the CAPB should be near zero, or slightly in surplus.

As of 2011 the United States has a CAPB of -6.8 percent, the largest deficit of any developed country. That means we need to cut nearly 7% from the deficit, through spending cuts or tax increases, to achieve sustainability. Failing to do so will cause the government debt to grow out of control. We will inevitably end up like Greece, or worse. Not tomorrow maybe, but not in the far distant future, either.

Where to start? The first choice we have to make is, how big a government do we want? Opinions differ. Some people are happy with the size of federal government we have now. At 23 percent of GDP (cyclically adjusted), it is about the same size relative to the economy as in the 1980s, although it is larger than it was in that lucky period between the end of the cold war and the start of the wars in Iraq and Afghanistan. Others would like to cap total federal spending at 18% of GDP, about where it was in the last year of the Eisenhower administration. Economists can't answer the question of how big the government should be; only voters can.

Once we decide how big a government we want, we need a tax system that can pay for it. Our current tax system cannot do the job. Its tax rates are too high. They distort the decisons of consumers, savers, employers, producers, everyone.

What we need is tax reform that lowers tax rates and broadens the tax base.

One approach to tax reform is to lower marginal tax rates for everyone while eliminating loopholes. There are lots and lots of loopholes.

Another approach to tax reform is to replace existing taxes like payroll taxes and the corporate income tax that distort incentives, while replacing the lost revenue with broad-based taxes like energy taxes or value added taxes.

The bottom line: Tax reform is a must. It is good for liberals, it is good for conservatives. It should not be hard to find a compromise. Remember, continuing business as usual is NOT a viable option.

Follow this link to view or download the slideshow version of this presentation.

Why Rolling Back Environmental Protection is the Wrong Fix for Jobs

Originally published on Economonitor.com.

Just when it seemed nothing could do it, persistently high U.S. unemployment has produced bipartisan agreement in Washington—agreement to roll back environmental protection in an attempt to save jobs and create new ones.

The White House, shrugging off off environmentalist opposition, has quashed a major EPA initiative that would have strengthened ozone regulations and is reportedly leaning toward endorsement of the Keystone XL pipeline to carry petroleum from Canadian oil sands. Republicans have applauded and issued their own list of proposals, including rollbacks of regulations for coal ash, farm dust, greenhouse gasses, and cement plants, among others.

None of this is good news, either for the environment or the economy. Rolling back environmental regulations is the wrong way to fix the jobs problem. Here's why.

Jobs are created when businesses hire workers, combine their labor with capital and natural resources, and use them to produce goods or services. If the products that come out are worth more than the inputs that are used up, the process adds value to the economy. Businesses make profits, workers get jobs, and consumers get goods or services that enhance their standard of living.
Right now, though, not enough jobs are being created that way to bring the unemployment rate down. High unemployment is creating a lot of pressure on the government to force-feed the job creation process. But how to do it?

One approach would a program of federally financed infrastructure investment. As discussed in an earlier post, there is reason to think there are plenty of projects, from repairing dams and sewers to modernizing the electric grid, that would both create jobs and add value to the economy. The Obama administration's new jobs initiative includes some of them. Many independent economists endorse immediate infrastructure spending, paired with a credible commitment to medium-term deficit reduction, as components of a sensible fiscal strategy.

Unfortunately, the costs of infrastructure projects are highly visible. They must either be covered by borrowing or by raising new revenue, but right now too many politicians have sworn to do neither. That is why the search is on for programs that would create jobs—or at least appear to do so—while hiding the costs.

Rollbacks of environmental regulations are a perfect vehicle for that purpose. The jobs they save or create are highly visible. Without regulatory relief, jobs would be lost at cement plants that might have to close, utilities that would sell less power if they couldn't keep costs artificially low, and farms that could export less if they had to worry about environmental compliance. The costs of rollbacks are less visible. They take the form of damages to health, property, or other environmental values that are collectively large but widely spread in space and time. Furthermore, if rollbacks, although saving some jobs, cause others to be lost—for example, jobs that would have been created to produce pollution control equipment or energy from alternative sources—those would-have-been jobs, too, are less visible. Taken together, it easy to exaggerate the net job creation from any given reversal of environmental protection.

The trouble is, when producers are allowed to capture the benefits of increased output of cement, energy, crops, or whatever while shifting the costs to others, they produce too much. They expand production up to the point where the value of additional output is just equal to the visible cost of production (the internal costs, to use the economic term), but not enough to cover the invisible (external) costs. That means that even if they create net jobs, rolling back environmental regulations subtracts value from the economy, rather than adding it. Not a good idea.

In fact, if creating jobs by subtracting value and shifting costs were a good idea, we would have no jobs problem. Job creation would be easy, at zero cost the federal budget. Here are three suggestions:

• For unemployed urban youths, a Licensed Shoplifter Corps. LSC members would have immunity from prosecution for theft. They could appropriate cell phones, Levis, and canned goods from local stores and sell them at discounted prices in special neighborhood shops. Jobs would be created both for LSC members and for workers who resold the stolen goods.
• For unemployed rural youths, a Biofuel Expansion Initiative. BFI participants would be given permits to cut trees (without paying for them) on anyone's property, or any public land, and chop them up for firewood. Jobs would be created not just in harvesting the trees, but in hauling them, making chainsaws and wood splitters, and other steps in the supply chain.
• For properly qualified unemployed professionals, a designation of Certified Public Embezzler. CPE members would receive immunity to hack into people's bank and credit card accounts and divert funds to their own purposes. As self-employed professionals, CPE members would disappear from the unemployment statistics, and, in addition, would create jobs in subsidiary markets for computer services and hardware.

Absurd? Why is licensing people to shoplift, poach firewood, or embezzle money any more absurd than licensing them to poison the air, pollute waterways, or add to the pace of climate change? If jobs are the goal, it is never hard to create jobs at someone else's expense. The trouble is, when the hidden costs are added to the visible ones, such jobs end up costing more in the long run than real, value-adding jobs do. There Ain't No Such Thing As A Free Lunch.*

Originally published on Economonitor.com. 
*Follow this link to get a copy of my new book TANSTAAFL: A Libertarian Perspective on Environmental Policy

Data for the Classroom: No New Payroll Jobs in August

Private payroll job growth for August was zero, the worst showing since since September 2010. Adding to the gloom, the job growth numbers for May and June were revised downward by a total of 52,000 jobs. Private nonfarm jobs increased by a slim 17,000 but that gain was offset by a loss of 17,000 government jobs.

The labor force, which includes both employed and unemployed persons, grew by 366,000. Of these 331,000 found jobs and 35,000 were added to the officially unemployed as soon as they started looking for work. The unemployment rate, which is the ratio of unemployed persons to the labor force, remained unchanged at 9.1 percent.
The unemployment rate is based on a survey of households. It uses a different methodology than the payroll job report, which is based on a survey of employers. Among other things, the household survey includes farm workers and self-employed persons. It is not unusual for the two surveys to point in different directions in any given month, as was the case in August.

The government also calculates a broader measure of unemployment called U-6. The numerator of U-6 includes unemployed persons, marginally attached persons who would like to work but are not looking because they think there are no jobs, and part-time workers who would prefer full-time work but can’t find it. The denominator includes the labor force plus the marginally attached. A shorter average work week led to an increase in involuntary part-time workers and caused U-6 to rise in August.

The employment to population ratio ticked up to 58.2 percent, just above the all-time low reached in July. The long decline in the ratio reflects several factors, including slow job growth; more discouraged workers, who do not look for jobs because they think none are available; and more retired persons as the population ages. For a full discussion of the trend in the employment to population ration, see this earlier post.





Follow this link to view or download a set of classroom-ready slides with graphical presentation of the latest unemployment data.

How Germany Free-Rides on the Euro

For years, I have warned my European students of the fiscal free-rider problem built into the structure of the euro area. My examples have always been fiscally undisciplined peripheral governments seeking political gain by running budget deficits at the expense of their euro partners. Now, though, as the debate unfolds over measures to cope with the European sovereign debt crisis, it is becoming increasingly apparent that Germany, the long-time locomotive of the euro, is also, in its own way, free-riding on the common currency.

The free-rider problem arises whenever someone is able to capture the full benefits of an action while shifting all or part of the the costs to others. I introduce the concept to my students with the example of ten friends eating dinner in a restaurant. If they know they will get separate checks at the end of the meal, they all order hamburgers and beer. If they know there will be one check, to be split equally among everyone at the table, they order steak and champagne.

In the case of  deficit-prone peripheral members of the euro, individual governments capture the full economic and political benefits of fiscal stimulus while shifting part of the costs to other euro members. This happens in two ways. Read more>>>

Already Weak, US GDP Growth in Q2 2011 is Revised Downward

U.S. GDP growth for the second quarter of 2011 was revised downward to a 1 percent annual rate from the 1.3 percent advance estimate reported last month. The downward revision disappointed many observers. About 2.5 percent growth is generally considered necessary to keep unemployment from rising, when growth of the labor force is taken into account.

Although a recovery has been underway for two years, the level of U.S. real GDP has not yet reached its peak level of mid-2007, before the recession. When GDP finally reaches its previous peak, the economy will have been considered to make the transition from the recovery phase of the business cycle to the expansion phase.

About three-quarters of the growth of GDP was attributable to investment, mostly business fixed investment. Housing investment remained weak. Consumption grew by about 0.3 percentage points. The government sector contracted, with slight growth of federal government activity more than offset by falling state and local government purchases. Net exports barely edged up, with moderately strong export growth almost fully offset by growth of imports.

Follow this link to view or download a set of classroom-ready slides with graphical presentations of the latest GDP estimates.

Why Rick Perry's Position on Climate Change Makes Him a True Conservative

Rick Perry is a climate-change skeptic. Sure, he says, the world is getting warmer, but the climate has often changed. He doesn't buy in to the idea that human activity has an effect on the current warming trend. Friedrich Hayek would say that makes him a true conservative.
Hayek liked to view the political spectrum not as a left-to-right line with socialist and conservative poles, but as a triangle. Conservatives were at one corner, socialists at another, and liberals at the third. The terminology has changed a little since Hayek's time. Conservatives are still conservatives, but, at least in the United States, those on the left now prefer to identify themselves as progressives rather than socialists. Most of those who, in Hayek's time and before, called themselves liberals, today prefer to identify themselves as libertarians, or sometimes, classical liberals.
In a famous essay "Why I Am Not  Conservative," Hayek identified a number of characteristic tenets of conservatism, including:

• Habitual resistance to change, hence the term “conservative."


• A claim to self-arrogated superior wisdom in place of rational argument.


• A propensity to reject scientific knowledge because of the consequences that seem to follow from it.


• Use of state authority to protect established privileges against the forces of economic and social change.

All of these tenets feed into Perry's views on climate change. He resists any change to an American path of economic development based on cheap, carbon-intensive energy; a path economists sometimes call extensive as opposed to intensive growth. He proudly claims superiority of faith-based wisdom over rational argument. And, especially in the case of climate change, he is quick to reject scientific knowledge. Read more >>>

US Employment-Population Ratio Hits a New Low: Why It Matters for the Budget Debate

By and large, U.S. media have spun the July employment report as more positive than negative. The 117,000 new payroll jobs created last month and the upward revisions for May and June were a relief after two months of very bad data. The downtick in the unemployment rate, although slight, was also welcome. One indicator that rarely makes the headlines told a different story, however. The employment-population ratio fell to a new low of 58.1 percent. What does it mean? Why should we care?

We should care, because the sinking employment-population ratio has big implications for the budget debate. The cuts-only faction of budget balancers are demanding a cap on federal government spending at 18% of GDP. They tout that as a level we lived with happily in the past, and should therefore be happy to live with in the future. The trouble is, the future isn't going to be like the past. The smaller the fraction of the population that is working, the harder it becomes to put the country's fiscal affairs in order. That becomes even clearer if we take a closer look at the reasons the ratio is falling. Read More >>>

Data for the Classroom: US Labor Market Shows Slight Improvement in July

The U.S. labor market showed a slight improvement in July, if only in comparison to the very dismal June numbers.

The closely-watched figure for non-farm payroll employment showed a gain of 117,000 jobs. Private sector jobs increased across a broad range of sectors, but those gains were offset by continued declines in the state and local governments, which lost 37,000 jobs in the month. There was some good news in the form of an upward revision of very weak preliminary numbers reported earlier for May and June. May job gains were revised upward from 25,000 to 53,000 and June from 18,000 to 46,000.

A separate household survey that includes farm jobs and self-employed showed a loss of 38,000 jobs for the month, along with a decrease in unemployment (by 156,000), and in the size of the labor force (by 196,000). Because the unemployment rate is calculated as the ratio of unemployed persons to the labor force, the paradoxical result was that the unemployment rate fell (from 9.2 to 9.1) despite the decrease in employment. Because the decrease in the unemployment rate was largely the result of the exit of discouraged workers from the labor force, it is really more of a negative than a positive development.

The Labor Department also publishes a broader measure of unemployment, called U-6, which is based on the sum of officially unemployed persons, plus marginally attached persons who would like to work but are not looking for work because they think there are no jobs, plus persons who are working part time but would prefer full-time work. That measure also fell in July, from 16.2 percent to 1.1 percent.

An even broader labor market indicator is the employment to population ratio. It fell to 58.1 percent in July, and all-time low.

Follow this link to view or download a set of classroom-ready slides with charts showing the evolution of the labor market situation.

Data for the Classroom: Weak Q2 GDP Growth, Downward Revisions

It is hard to find a good way to spin the latest US GDP data. The economy grew at an estimated 1.3% annual rate in Q2 2011. Although the January-March 2011 quarter was the 8th consecutive quarter of growth since the end of the recession that lasted from Dec 2007 to Jun 2009, the growth rate of 1.3% disappointed many observers. About 2.5% is needed to keep unemployment from rising, when increases in the labor force and productivity are taken into account.
Q1 growth was revised sharply downward to just 0.4 % from 1.8%. Revised 2008 and 2009 data show that the recession was much deeper than previously thought. After the latest revisions, it now appears US real GDP has not yet reached its pre-recession peak (Q3 2007).

Looking at the report line by line, consumption barely grew in Q2 2011. Investment grew at 0.87%, with strong business fixed investment helping to make up for weak residential investment. Federal government spending grew slightly but was more than offset by continued decline of state and local government spending. Net exports grew strongly on good export growth and slowing growth of imports.

Follow this link to view or download a classroom-ready slideshow with charts of the latest US GDP data.

How Smart Fiscal Rules Keep Sweden's Budget in Balance

Almost three decades ago, Herbert Stein, the former Chairman of Nixon's Council of Economic Advisors, lamented that the United States had no long-run budget policy—no policy for the size of deficits and for the rate of growth of the public debt over a period of years. He pointed out that Congress makes annual budget decisions that are wholly inconsistent with professed long-term goals, hoping that something will happen before a point of crisis is reached. He might have added that when the crisis does arrive, it is resolved by a combination of hasty, one-off measures; the making of promises that are rarely kept; and the appointment of special commissions whose advice is rarely heeded.


What Stein said then remains true today. The rational way out of this destructive cycle of irresponsibility and crisis is to establish long-term fiscal policy rules and stick to them. There is at least a vague recognition among some members of Congress of the need to do so. The problem is that the rules they actually propose are primitive and counterproductive. The debt ceiling itself, which Congress routinely sets at levels that are inconsistent with its own spending and taxing decisions, is one such rule. The balanced budget amendment championed by many fiscal conservatives is also deeply flawed, for reasons detailed in this earlier post.

Instead of these "dumb" fiscal policy rules, we need to be looking at what can be learned from countries that have faced the same problems and introduced smarter rules to overcome them. Last week's post examined how intelligent budget rules have helped Chile prosper. Today we look at the smart fiscal rules that have put Sweden's budget on a sustainable path and made that country's economy one of the strongest in Europe. READ MORE>>>

How Intelligent Budget Rules Help Chile Prosper: Lessons for the US

As everyone knows who has followed the current budget debate, U.S. fiscal policy needs more than a quick fix. It needs budget rules to put the debt and deficit on trajectories that are sustainable in the long run. Where better to look for workable rules than to countries that have done things right? Chile, which has managed to prosper under an intelligent set of budget rules, is a good place to start. READ MORE>>>

Is a 56.2 MPG Fuel Economy Standard Really a Good Idea?

According to news reports, the Obama administration is talking to automakers about raising the Corporate Average Fuel Economy standard for passenger cars to 56.2 miles per gallon by 2025, more than double the  27.5 MPG in force for the 20 years up to 2010. Economists, even those like myself who favor policies to reduce fuel use, have argued that CAFE standards are a bad idea. Has anything changed to make stricter fuel economy standards look better now than in the past? Read the full post >>>

Yes, the US Needs Budget Rules, but Not Hatch-Lee

Sometimes the United States is slow to join a global trend. Fiscal policy rules are a case in point. Economists love the idea of rules that decouple tax and spending policies from short-term politics and focus instead on long-term growth and sustainability. Such rules used to be rare; as recently as 1990, they were in effect in only 7 countries, according to an IMF survey. By 2009, the number had grown to 90. Aside from failed attempts like the Gramm-Rudman-Hollings Act of 1985, the United States has been missing from the list.

It won't be missing for long if Utah Senators Orin Hatch and Mike Lee have their way. They are pushing a set of budget rules in their Hatch-Lee Balanced Budget Amendment, which was introduced on March 31 with the backing of the entire Senate Republican delegation. Just this week, Senator Lee gave it added momentum by including it in his Cap, Cut and Balance Act. That new proposal would require the Hatch-Lee amendment to be passed, along with a set of short-term cuts and caps, before the debt ceiling could be raised.

Linking long-term rules to a short-term increase in the budget ceiling is an excellent idea. The IMF cites several examples, from Sweden to Bulgaria to New Zealand, where a fiscal crisis provided the impetus for the adoption of successful budget rules. But is Hatch-Lee the right kind of rule? Unfortunately it is not.

Follow this link to read the full post on Ed Dolan's Econ Blog at Economonitor.com
 

Data for the Classroom: US Unemployment Rises in June

 U.S. job growth slowed again in June. Although total payroll jobs increased for the ninth straight month, the Bureau of Labor Statistics reported a disappointing total increase of just 18,000. At the same time, the May figure was revised down from 54,000 new jobs to just 25,000. An increase of 57,000 private nonfarm jobs was offset by a loss of 39,000 government jobs. Jobs decreased at all levels of government, federal, state and local.

The unemployment rate, based on a separate survey of households, edged up by 0.4 percent to 9.2 percent, its highest level since December 2010. The unemployment rate is the ratio of unemployed persons (those looking for work but unable to find it) to the labor force. Unemployed persons increased by 173,000 in the month, and at the same time, 272,000 discouraged workers stopped looking for work and left the labor force. All in all, the household survey showed a net loss of just under 445,000 jobs.

The government also calculates a broader measure of unemployment called U-6. The numerator of U-6 includes unemployed persons, discouraged workers who would like to work but are not looking for jobs because they do not think there are any to be found, and persons working part time who would prefer full-time work, but can't find it. U-6 rose to 16.4 percent in June, its highest rate in half a year.

One final measure of the job situation is the employment-population ratio. The numerator consists of people who are officially employed, while the denominator includes the entire population. The employment to population ratio has decreased not just because of the poor job situation, but also because of the increased number of retired persons in an aging population. The ratio fell to 52.8 percent in June, equaling its lowest level of the recession.

Follow this link to view or download a brief, classroom-ready slideshow with graphs of the June employment situation.

If QE2 Was Price-Level Targeting, It is Starting to Work

Has QE2 worked? Some say yes, some say no. The answer depends on what you wanted it to do.
If you wanted a quick revival of the housing market, a boost to GDP growth, and rapid job creation, it's easy to say QE2 has failed. None of those indicators look good. On the other hand, if you thought the purpose of QE2 was to save the country from deflation, then it looks better, especially if you are a fan of price level targeting.

Follow this link to read the full post on Ed Dolan's Econ Blog at Economonitor.com

One Year Later, How Much Has China's Yuan Appreciated?

A year ago this week China announced a major change in its exchange rate policy. After holding the yuan-dollar exchange rate fixed for almost two years during the global crisis, the country's central bank, the People's Bank of China (PBoC) announced that the yuan would once again be allowed to float, albeit in a highly controlled way. The yuan began appreciating against the dollar immediately, touching off intense speculation about how far it would be allowed to move. A year later, what has happened?

Follow this link to read the full post on Ed Dolan's Econ Blog at Economonitor.com

Data for the Classroom: US Unemployment for May 2011

Latest data from the Bureau of Labor Statistics shows a very weak job US job market in May, 2011.

Payroll employment increased for the 8th straight month of job growth in May, but the pace of job growth slowed to a weak 54,000, the slowest September 2010. An increase of 83,000 in private nonfarm jobs was offset by a decrease of 23,000 in state and local government jobs. A separate survey of households, which includes farm jobs and self-employment, showed an increase of 105,000 jobs.

The unemployment rate edged upward to 9.1 percent, its highest level since December 2010. The number of unemployed persons increased by 167,000. The labor force, which includes both employed and unemployed persons, increased by 272,000.

The unemployment rate would have been even higher if not for the fact that many people have dropped out of the labor force because of the weak job market. The employment to population ratio dropped slightly in May to a level close to its lowest point during the current downturn.

Follow this link to view or download a set of classroom-ready slides with highlights from the May 2011 employment situation report.

Data for the Classroom: US GDP First Quarter 2011

US GDP grew at an estimated 1.8% annual rate in Q1 2011, according to the latest data from the Bureau of Economic Analysis. The January-March 2011 quarter was the 7th consecutive quarter of growth since the end of the recession that lasted from Dec 2007 to Jun 2009. The growth rate of 1.8 percent disappointed many observers. Growth is expected to recover somewhat later in the year, but the recovery remains weak.


Consumption was the fastest growing GDP component, but slower than in Q4 2010. Investment grew at 1.45%, with strong business equipment purchases offsetting weak residential investment. Federal, state, and local government spending all declined, led by a drop in defense spending. Net exports were almost unchanged, as strong export growth was slightly more than offset by rising imports.


Follow this link to view or download a classroom-ready slideshow presenting highlights of the Q1 2011 GDP data.

Failure of Austerity in Europe? What Does the Latvian Exception Prove?

Writing in The New York Times this week, Paul Krugman argues that austerity has failed in Europe. Budget cuts and tax increases were supposed to provide the confidence needed to get troubled EU economies back on track, but the "confidence fairy" hasn't shown up. Austerity has not just failed to work, says Krugman—it has made matters worse. He shares the view, held almost universally outside official circles, that doubling down on austerity will not save Greece, Ireland and Portugal from eventual default in one form or another.

Meanwhile, there is the case of Latvia, where a stringent austerity program, supported by the EU and the IMF, predates those of Greece, Ireland, and Portugal. Austerity brought on a stunning 18 percent drop in Latvian GDP in 2009, but now the country is returning to growth. Unemployment and the budget deficit are still high, but falling. Is Latvia the exception that proves that austerity is a good idea after all?

→Read the full post on Ed Dolan's Econ Blog at Economonitor.com

Will Shifting Political Winds Finally Kill Ethanol Subsidies?

As recently as last December, the coalition backing U.S. ethanol subsidies appeared to be alive and well, despite the fact that everyone knew they were bad for the environment, bad for energy efficiency, and bad for the budget. The largest subsidy, a tax credit for blending ethanol into gasoline, was set to expire at the end of 2010. At the last minute, though, ethanol's friends rallied to slip a little-noticed one-year renewal of the subsidy into a bill extending the Bush tax cuts and benefits for the long-term unemployed. As I blogged at the time, it looked like ethanol subsidies were a classic case of a bad policy that refused to die.

Now ethanol subsidies are back in the news, and this time they may be on the way out. One piece of legislation, introduced by Senators Tom Coburn (R-OK) and Dianne Feinstein (D-CA), would not only end the 45-cent per gallon tax credit, but also eliminate the 54-cent per gallon tariff on imported ethanol. To understand what has changed, we need to look at the economics behind the shifting pro- and anti-ethanol coalitions.

One shift is that environmentalist support for ethanol has pretty much evaporated. Environmentalists originally joined the ethanol coalition in the belief that using more ethanol, a renewable biofuel, would reduce greenhouse gas emissions. Years of study, however, have shown that corn-based ethanol, over its full life cycle, does little to reduce carbon emissions and may actually increase them. Late last year even Al Gore, long an ethanol booster, reversed his position. While serving as vice-president, Gore had cast a critical tie-breaking Senate vote to secure support for corn-based fuel. Now he admits that there are no environmental benefits, and that his original support was motivated, in part, by the hope of getting Iowa caucus votes in a later run for president.

Environmentalists are not the only ones to fall away from ethanol. As time has gone by, it has proved easier than once thought to find fault lines in the seemingly solid ethanol coalition. At first glance, it might appear that subsidies would find strong support all along the supply chain, from landowners to corn growers to ethanol distillers to fuel suppliers who blend ethanol with gasoline. However, closer economic analysis has shown that benefits are not distributed equally among the parties.

An interesting paper by Farzad Taheripour and Wallace Tyner of the Purdue University Department of Agricultural Economics analyzes the way subsidies are distributed by looking at elasticity of substitution between ethanol and gasoline as a motor fuel, and at the elasticity of supply at various points along the supply chain. (Elasticity means the percentage by which one variable, like quantity supplied, changes in response to a one percent change in another variable, like price.) The authors reach two conclusions that are relevant to the politics of ethanol.

One is that ethanol distillers and corn growers are engaged in a tug-of-war over the benefits of the subsidies. Who wins the biggest share depends partly on government policies that encourage blending of ethanol with gasoline and partly on the supply elasticity of corn. The authors find that over time, as the share of total corn production that goes to ethanol increases, corn farmers can be expected to capture more of the subsidy, leaving less for blenders and distillers. According to USDA data, the percentage of the U.S. corn crop going to ethanol increased from about 7 percent in 2001 to almost 40 percent by 2010. The predictable result would be for ethanol producers to become less attached to the subsidy, and farmers to become more attached.

A second conclusion is that farmers, in turn, are driven by market forces to pass much of the benefit of the subsidy along to landowners. That happens because land suited to growing corn is in less elastic supply than farm inputs of labor and capital. The pass-through to landowners, too, tends to splinter the ethanol coalition. Farmers who own their own land and landowners who lease to corn farmers remain solidly in favor of ethanol subsidies, but farmers who grow corn on leased land gain little or nothing.

Still another factor behind shifting pro- and anti-ethanol coalitions is the effect of corn ethanol subsidies on food prices. A paper by economist Bruce Gardner of the University of Maryland explains how the effect on food prices helps farmers capture a larger share of ethanol subsidies. The gain comes because demand for corn as food is less elastic than the demand for corn as an ethanol feedstock. If corn were used only for ethanol, distillers and blenders would capture a large part of the subsidy. Instead, though, farmers lose part of the benefits of the subsidy to ethanol producers but they more than gain it back when diversion of corn to ethanol drives up the price of corn as food.

When it comes to coalition building, the effect on food prices cuts both ways. Although higher corn prices increase the tenacity with which landowners cling to subsidies, they generate opposition from corn consumers. Those include both domestic consumers of everything from cornflakes to corn-fed beef, and people who are concerned about the effects of high corn prices on consumers in poorer countries.

All of the above suggests a paradox: Subsidies have succeeded in increasing the percentage of the corn crop that goes to ethanol, but that very success has narrowed the originally broad pro-ethanol coalition. Too much of the benefit goes to too small a group, landowners, and others in the supply chain have too small a stake. The Coburn-Feinstein proposal further splits ethanol producers from downstream users by removing the tariff on imports. Fuel suppliers would be quite happy to blend in tariff-free imported ethanol in place of subsidized domestic ethanol.

The final blow is likely to come less in the form of defections from the pro-ethanol camp than from a powerful addition to the anti-ethanol forces, namely, Congressional deficit hawks. True, ethanol subsidies, estimated to cost the budget about $6 billion a year, are chump change beside the trillions needed to close the federal budget gap. Still, everything helps. Many fiscal conservatives—at least those who do not plan to participate in next year's Iowa caucuses—know that farm subsidies must be cut back across the board, ethanol included.

The present relationship of the deficit to ethanol subsidies is a little like that of inflation to transportation regulation during the Carter administration. At that time, captive regulatory agencies had long propped up cartels in trucking, airlines, and railroads, and the cartels, in turn, were keeping prices high. Realistically, inflation was mostly a macroeconomic problem. The effect of the cartels on inflation was small. Still, the effect was there, and it was enough to allow free-marketeers, who favored deregulation as a matter of principle, to bring inflation hawks into their coalition. The outcome: the transportation cartels were busted once and for all. (Disclosure: I myself played a bit part in the deregulation drive as a transportation analyst for the Department of Justice and later the Interstate Commerce Commission.)

The bottom line: Ethanol subsidies may not be dead yet, but they are breathing their last. A symptom of their weakened position is that pro-ethanol forces are no longer trying to maintain the status quo. Instead, the counterproposal to Coburn and Feinstein's ethanol legislation is a bill being pushed by Sen. Chuck Grassley (R-IA) that would phase the subsidies out gradually rather than ending them cold turkey. The only remaining element of suspense is whether ethanol subsidies will go before the firing squad as part of current negotiations over the debt ceiling, or will instead be left to expire peacefully at midnight on December 31.

Are Financial Regulators Flying Blind? Could Better Risk Topography Help?

Data on the capital and liquidity of banks are the navigation aids that regulators depend on to avoid another financial crash. Improvements to these indicators, adopted last year by the Basel Committee on Bank Supervision, are among the most heralded regulatory reforms since the 2008 crisis. But what if the instruments are faulty, even in their upgraded form? If so, regulators are flying blind, and our chances of avoiding another crash are slim. What can be done?

A recent paper by three prominent financial economists suggests one possible answer: a sort of Manhattan project that would map out a "risk topography" of the financial system. The authors are Markus K. Brunnermeier of Princeton, Gary Gorton of Yale, and Arvind Krishnamurthy of Northwestern. All three are also affiliated with the National Bureau of Economics Research. ( I will refer to the team in what follows as BG&K.)

Their work on risk topography is part of a growing literature on macroprudential regulation of the financial system. Traditional microprudential regulation focused on the safety and soundness of individual institutions. It operated on the implicit premise that if each institution was sound, then the system as a whole would be sound, too. Macroprudential regulation, in contrast, recognizes that interactions among disparate institutions—commercial banks, investment banks, hedge funds, derivatives markets, and all the rest—may pose threats to the system as a whole even when each firm taken separately appears sound. The need for better macroprudential regulation was recognized in last year's Dodd-Frank Act, which created an interagency Financial Stability Oversight Council (FSOC) to deal with systemic risks. It was the subject of an important speech that Fed Chairman Ben Bernanke gave in Chicago last week.

The problem, say BG&K, is that as things now stand, macroprudential regulation cannot be effectively implemented because the FSOC lacks the data needed to measure systemic risk. BG&K compare the situation to that faced by Presidents Hoover and Roosevelt in the early years of the Great Depression. Because national income accounts did not then exist, those presidents and their advisors struggled to develop stabilization policy using fragmentary data like factory output and boxcar loadings.

Some people have reacted to the data deficit by throwing up their hands in surrender. For example, in a recent Financial Times op ed, Former Fed Chairman Alan Greenspan argued that modern financial markets are "unredeemably opaque," and that neither regulators nor anyone else can ever "get more than a glimpse" of their internal workings. If so, attempts at macroprudential regulation would not just be doomed to failure, but would have harmful unintended consequences.

BG&K are not willing to accept the opacity of financial markets as irremediable. Instead, they propose developing a whole new system of reporting and measurement, no less ambitious in its scope than the national income accounts. It is hard to summarize the breadth of their proposal in a few words, but some key ideas will give an idea of their general approach.

First, BG&K point out that in assessing systemic risk, it is not enough simply to look at balance sheet measures during periods of calm. Instead, regulators need to know where pockets of risks are building up within the system in ways that are not revealed by existing balance-sheet based measurements of liquidity and capital adequacy. Instead, they propose requiring financial firms to report, on a regular basis, their sensitivity to a list of specified scenarios. For example, firms might be asked to estimate their dollar gain or loss if house prices rise or fall by 5, 10, or 15 percent, and also how such events would affect their liquidity position. Sensitivity estimates like these are already required as part of stress tests that regulators conduct from time to time, but BG&K propose gathering the data more frequently and from more institutions.

The BG&K approach also focuses on feedback mechanisms between problems of capital adequacy and problems of liquidity. They are particularly concerned with "liquidity spirals" that begin when firms that use short-term funding to finance longer-term investments experience runs or have trouble rolling over short-term borrowing. They are then forced into sales of illiquid assets at fire-sale prices. Those sales, in turn reduce capital and lead to further funding problems. When liquidity spirals, off-balance sheet positions, derivatives, and collateral requirements are taken into account, concepts like leverage and liquidity, which are well-defined in simple, stylized models, become fuzzy and hard to measure on the basis of data derived solely from balance sheets.

Cross scenarios that involve interactive exposure to two or more different risks are the third problem addressed by the BG&K proposal. Their paper uses the example of a U.S. bank that buys Spanish mortgage backed securities, denominated in euros, leaving it exposed both to the risk of falling Spanish housing prices and that of euro depreciation. If both risks materialize simultaneously, the impact on the bank may be greater than the sum of the events taken individually, and may not be adequately revealed by anything the bank would be required to report under the current system.

The end product of the required reporting would be a multidimensionl "risk map" of the financial system that would make visible all manner of risk pockets, sinkholes, pitfalls, soft spots, and other hazards, not only as they exist at the moment, but as they would shift and grow with changes in interest rates, exchange rates, asset prices, and so on.

A final key feature of the BG&K proposal is to make the resulting risk map of the financial system publicly available, just like the national income accounts and the Fed's flow of funds accounts. Public availability of the data would do more than just increase transparency. More importantly, availability of the new data would stimulate the development of macroeconomic models that better incorporate the financial sector than today's models do. The authors point out that when national income accounts and flow of funds accounts were first introduced, no one really knew how to use them. Their full value became apparent only over time as models based on them were developed.

Is this ambitious risk topography project feasible? I can see two kinds of barriers to its effective implementation.

First, the very complexity and novelty of the project would make it expensive and time-consuming to implement. True, as BG&K point out, many building blocks of a risk mapping system already exist. Past experience with stress testing of financial institutions provides one building block. Another is provided by the internal risk models already in use by the financial firms for their own purposes. Presumably, well-run firms are already equipped, at the click of a mouse, to answer questions about the impact on their operations of changes in asset prices and exchange rates. Even so, figuring out just what scenarios should be explored, how to assemble the resulting data, and how to ensure its integrity would be enormous tasks. One imagines a long process of sampling, beta-testing, and revision before the system would be up and running. Even then, by its very nature, we would not know whether the whole exercise was worthwhile until it was tested in a real-world crisis.

Second, we can be pretty certain that a large-scale risk mapping project would run into political resistance. BG&K rightly point out that the Dodd-Frank Act already provides the needed legal framework. The Act calls for establishment of an Office of Financial Research (OFR) within the Treasury Department, which, in turn, is tasked with providing research and information to the Financial Stability Oversight Council. The OFR even has subpoena power to require financial institutions to produce the data that it requests.

Legal authority or no, there would be resistance to the idea of using the OFR to undertake the vast task that BG&K propose. Given the tight-fistedness of the current Congress, just coming up with the money needed to staff and operate the exercise would be hard enough. Furthermore, not all of the component institutions of our financial system are as deeply in love with transparency as are critics in academia. One can easily imagine that every appointment and authorization would give rise to the same kind of trench warfare currently being waged over the Bureau of Consumer Financial Protection. That agency, also authorized by the Dodd-Frank Act, may very well end up stillborn, or if not, extensively re-engineered before it sees the light of day. The same thing could happen to the OFR if it were given too large an assignment.

Still, despite the technical and political hazards of a large scale risk mapping project, to give up on the idea in advance would be to admit that the financial system is in fact "unredeemably opaque." If so, the alternatives are bleak. Regulators would then either have to abandon the concept of macroprudential regulation altogether and passively await the next crisis, or they would run a severely heightened risk that their regulatory initiatives would have harmful unintended consequences.