Wednesday, December 30, 2009

Not Your Father's Recession

Copyright, The New York Times Company
Our recession predictably continues to be one in which real gross domestic product and spending outperform the labor market. This pattern differs from the 1980-82 recession and suggests that public policy could be doing a better job this time of raising employment.

At this time a year ago, with the three quarters of G.D.P. data that was available, I explained how this recession had followed a pattern described decades ago by Paul Douglas, the senator and economics professor.

Professor Douglas said that a labor crisis would hurt spending but only in a ratio of 7 to 10. That is, for every 10 percentage points that employment and hours worked fell, total output and spending would fall 7 percentage points. Equivalently, one side effect of a labor crisis would be to raise employee productivity and real hourly wages, because productivity is the ratio of output to labor.

Since then, four more quarters of data have become available to further test this theory. From the fourth quarter of 2007 to the third quarter of 2009 (the most recent quarter with data available, and some say the trough of the recession), employment and hours worked fell 8.6 percent, while real spending and output declined 5.8 percent (both relative to trends).

The declines are almost exactly in the proportions predicted by Professor Douglas decades ago (an earlier discussion of this approach can be found here.)

By definition, the fact that real G.D.P. performed better than labor means that productivity rose. As a result, we expect hourly labor costs (that is, the amount employers spend on payroll and benefits for each hour that employees work) to have risen too.

The chart below displays private sector productivity and real wage series for this recession. Both rose a couple of percentage points, especially over the last year.

Many readers of last year’s article thought that it was only obvious that real G.D.P. should fall less than employment — employers, they said, would force more work upon the workers who kept their jobs. Employers may in fact be acting this way (although why are they paying more per hour?), but this pattern is not found in all recessions. During the 1980-82 recession, which has often been compared to this one, real G.D.P. and spending fell significantly more than employment and hours.

Many economists would agree that the causes of the current recession are different than in 1980-82, and that some of the differences can be seen in the productivity data. Some would say that high real wages are part of the problem — that employers would be hiring more if labor were cheaper. If that’s right, public policy so far in this recession seems to have gone in exactly the wrong direction by raising the minimum wage and otherwise increasing employment costs.

Wednesday, December 23, 2009

Are Layoffs "The Problem"?

Copyright, The New York Times Company

Job hires have been low in recent months, but that does not necessarily mean that spurring hiring at small businesses is the best way out of this recession.

It is sometimes said that helping large employers can prevent mass layoffs, whereas helping small employers can stimulate new hires. If so, it might be important to know whether the job losses during this recession have come from a surge in layoffs or a collapse of new hires.

The chart below displays monthly new hires and job separations from January 2007 to the latest month available, October. New hires indicate the number of people newly employed with their employers; promotions and transfers are not included. Job separations indicate quits, layoffs, retirements and deaths.

The monthly flows into and out of employment are large: Millions of people find a job every month, and millions lose a job. The fact that separations have consistently exceeded hires for over a year explains why total employment has fallen by seven million since the recession began.

Job separations have been lower during this recession than they were before the recession began, as was the case in the 2001 recession. Employment has dropped because new hires have fallen even more. For this reason, some have argued that the key step to raising total employment is to spur job creation by small business, because layoffs are not the problem.

But if you look at the individual components of separations, you will see that a couple of other conclusions are also credible.

The chart below displays two of the major components of “total separations:” quits and layoffs. Layoffs have surged during this recession, but this surge is not visible in total separations because it is more than offset by a reduction in quits:

Thus, a surge of layoffs — rather than a collapse in hiring — could well have made this recession as bad as it ultimately was.

Moreover, the collapse of hires need not have been the driving force over the last year or two.

The chart above shows how quits collapsed. To the extent that many new hires occur in order to replace workers who had quit, the collapse of new hires shown in the first chart could well be a response to the collapse in quits shown in the second.

The fact is that the various job flows are all interdependent on one another: Quits create hires and prevent layoffs, the prospect of new hires can motivate people to quit, and prior quits and layoffs can create new hires as more labor becomes available for firms aspiring to grow.

Although public policies that support small business may help end this recession, the case for such policies cannot be made from the job flows data alone.

Friday, December 18, 2009

Hunting with PK

If you think it's dangerous to hunt with DC, read this story:

Smithie Adams has been a recreational hunter: the occasional deer, duck, or rabbit. His basic approach has been to aim his rifle at the intended target, shoot, and hope his hand was steady enough.

This season he went hunting with PK, rumored to be a world expert. PK offered this advice.

"Today is the third Friday of the hunting season, in a year with that is a prime number minus two.

On such Friday's, betweeen 11:15 and 11:30 Greenwich time, you cannot hit your prey by aiming your rifle at the target.

You will hit your target by aiming your rifle at yourself!"

How does this story end?
  • Smithie Adams aims at himself and fires?
  • Smithie Adams says, "I'll take a break from hunting until after 1130."
  • Smithie Adams laughs and says "PK, clearly you have another agenda!"

Thursday, December 17, 2009

Paternalism on Campus

Professor Mankiw emailed me:

"I have no recollection of the events you recount. One thing I am sure
about is that I have always encouraged motivated undergraduates to take
the 2010 sequence. (I took the equivalent courses when I was an
undergraduate at Princeton.) It is possible that a student who
refused to do problem sets, etc., would seem insufficiently motivated to
me. But I cannot recall ever ejecting, or even trying to eject, an
undergraduate on those grounds.

On libertarianism and paternalism: I think there are some situations in
which paternalism is called for. Indeed, when students come to Harvard,
they are voluntarily subjecting themselves to the rules set by the Harvard
faculty. If I did not impose some rules as a faculty member, I would
not be doing my job.

There are schools with fewer rules--that is, less paternalism. Brown
comes to mind. Harvard has more rules. My guess is that you knew that
when you chose to come to Harvard. By coming, you agreed to a particular
set of rule, and we agreed to impose them. So paternalism within the
university is just our living up to a voluntarily agreed contract. The
same argument does not apply to governments, especially centralized
governments. (You might apply the argument to local governments, as it
is easy to move from town to town.)


PS Feel free to post this if you wish."

I totally agree with Professor Mankiw's thinking about competing groups. People voluntary join groups that impose rules, and have the option to join some other group with an alternate set of rules. For example, I chose to become a grad student at the Univ of Chicago instead of a grad student at Harvard.

But I guess we remember 1989 a little differently.

Father Mankiw

I read today how Professor Mankiw will not share his lecture notes with because "he didn’t want to make it easier for students to cut class. 'Listening to lectures and taking your own notes is part of the educational process.'"

That reminds me of my own enrollment in his Ec2010c course in Autumn 1989: he tried to expel me! Ec2010c is a graduate course, and I was the only undergraduate there. Early on I learned about structure of the course, grading, etc., and determined that I did not need to complete all of the problem sets, should not participate in any of the "study groups," and might even skip a lecture or two (not many -- attending was quite productive). I would hone in on the material in December and early January, in preparation for the mid-January exam (and perhaps along the way object to some of the dubious conclusions of New Keynesian economics).

Professor Mankiw knew nothing about me, but decided that my approach (whispered to him by then TA Susanto Basu) was harmful to me and perhaps even the other students, so that for the common good I should be expelled from the course.

His reaction always puzzled me, because he's a friendly person and usually appears to be libertarian. But now I see that he does take a paternalistic role toward the students.

By the way, I was not expelled from the course because the other TA (Xavier Sala-i-Martin) and the other Prof (Barro) requested that I be allowed to remain. Among about 50 grad students, I got the second highest grade on the final (and only) exam in the course. Since 1989, it has been more common for a couple of eager undergrads each year to enroll in 2010c.

[please also see Professor Mankiw's reaction]

Gullible New Keynesians? Or Tax Collector Windfall?

Incentives Matter, Period
Long before Adam Smith, people learned that incentives matter. If a person cannot keep enough of the fruits of his efforts, he will not put forth the effort in the first place.

Kings, emperors, sharecropper landlords, treasury secretaries, slave owners, and many others over the ages understood that they maximize their tax collections by limiting their tax rate to something less than 100 percent. Even the so-called Communist Chinese government appreciates this. An economy with excessive tax rates will necessarily be an economy that produces far less than its potential, and ultimately produces little revenue for its tax collectors.

This impeccable logic, supported by centuries of experience around the world, includes nothing about “interest rates,” nothing about the “Federal Reserve,” and nothing about the “zero lower bound.” In the grand scope of human experience, the Federal Reserve (a U.S. institution that was absent for most of its history) is at most a minor footnote.

Yet now a few New Keynesian economists are telling us that hiking tax rates raises income and labor usage (sic). Their logic hinges critically on an esoteric theory of the Federal Reserve. Without evidence, they believe, and would have you believe, that the Federal Reserve’s situation can turn the impeccable logic of incentives on its head.

[Hereafter, for brevity I refer to those making this argument as “New Keynesians”, but please recognize that many New Keynesians such as Professor Mankiw are not so gullible as to conclude that incentives don’t matter. For now, I am not naming the gullible, in order to give them more time to pause and see the big picture].

Incentives from the (Usual) Macro Perspective
That incentives matter is not just a microeconomics point. If you have a large group of people (members of a kibbutz, citizens of the Soviet Union, etc.), each of whom has little incentive to work, the aggregate result for the group will be low output and low living standards.

The point that incentives matter in the aggregate seems so obvious, but the recent debate about them requires that we revisit each of the logical steps.

Suppose that something happens at the individual level to reduce the supply of labor. An increase in personal income tax rates, or an increase in unemployment benefits, are examples. New Keynesians agree with me that, say, an unemployed individual enjoying higher unemployment benefits will be less willing to accept a low paying job. Or that the substitution effect of a higher personal income tax rate is to cause people to put forth less of the effort that produces that income, unless the rate hike were offset by higher pre-tax pay.

As each individual supplies less labor, wages rise as employers compete for the smaller labor pool.

We usually say that the prices of the goods produced by those employers would rise with wages, or that employers would take other steps (suspending advertising, sales, discounts, reducing product quality, etc.) to reduce the volume of goods they deliver to customers (after all, the wage increase is reducing the profit they earn from delivering each unit). This process may not be exactly as in the undergrad textbook – that is, volume may react a bit less (or a bit more) than it would if prices increased one-for-one with wages – but the basic point is that higher costs ultimately and significantly reduce production and sales.

So the macro story, as most economists understand it, ends with less labor usage and output. And the basic conclusion that higher costs reduce production has been supported by decades of experience and economic measurement.

The New Keynesian Miracle
Nevertheless, the New Keynesians depart from me at this point. They say that, in response to higher wage costs, employers/producers will do essentially nothing in the short term to raise prices or otherwise reduce their production and sales. In the longer term, employers/producers will pass on their wage costs to costumers, and those costumers understand that they must buy now before the producers can adjust. This extra spending by the customers actually induces employers to produce more in the short run, and thereby employ more in the short run.

Thus we have quite a miracle. A greater tax on personal income increases aggregate income (even if the revenue from that tax is given back to taxpayers), because they have an individual incentive to earn less!

A tax rate cut would reduce income. The logic is the same: tax cut --> more labor supply --> lower costs and anticipation of lower prices --> less spending --> less production and labor usage.

Putting the Federal Reserve in the Picture
Like encounters with aliens, the New Keynesian miracle is said to occur in only specific situations when the skeptics happen to be looking elsewhere. Normally, they say, the Federal Reserve would respond to the labor supply shock by adjusting the nominal interest rate. When something reduced labor supply at the individual level, the Federal Reserve would normally raise the nominal interest rate to choke off the additional spending that would otherwise appear in the New Keynesian story.

When something increased labor supply at the individual level, the Federal Reserve would reduce the nominal interest rate to encourage the spending that (in the New Keynesian story) consumers would otherwise hold back until prices fell. That’s where the “zero lower bound” comes in – it supposedly prevents the Federal Reserve from reacting in this last step.

For this theory, it doesn’t matter whether the interest rate were stuck at zero, one, two, or ten. Nor is the “reason” for the interest rate’s being stuck relevant. The critical assumption is that nominal interest rates do not adjust in reaction to a shift in labor supply.

Tax Collectors’ Dream Come True
To recap, New Keynesians tell us that income and labor usage increase when something reduces labor supply at the individual level, as long as the nominal interest rate does not adjust upward.

This miracle is exactly what centuries of tax collectors have dreamed about. They could take a larger share of the economic pie and in doing so make the pie grow! All they have to do is make sure that the nominal interest rate cannot adjust upward.

That leaves us with the question. Is it a great misfortune of history that the New Keynesian miracle was not discovered until 2009?

Or have tax collectors over the years understood what New Keynesians do not: incentives matter, regardless of whether there’s a Federal Reserve, and regardless of the details of how nominal interest rates adjust?

Wednesday, December 16, 2009

No News Housing Starts

Some people thought they saw a trend toward less construction in the October housing construction data. Now that the November housing data is out, we can revisit that claim.

I don't detect a trend.

Who Studies Near-Zero Interest Rate Economies?

Professor Krugman has repeatedly emphasized that little of what we understand from past business cycles applies today, because (so he says) interest rates are near zero today. He concludes that the only useful studies are those of other eras of near-zero interest rates, and as a result one can ignore what Professor Barro, Mankiw and I (and anyone else who uses "traditional" economics) say about government policy.

First of all, he has presented no evidence that a low-interest rate economy responds differently to fiscal and regulatory policy, while we have plenty of evidence that fiscal and regulatory policy are having very much the same effects as they always do.

Professor Krugman's remarks contrast starkly with my JPE paper "Extensive Margins and the Demand for Money at Low Interest Rates", which empirically examines the extent to which "normal" economies respond to shocks differently than low-interest-rate economies, rather than assuming that low interest rates necessarily transform those responses.

Even if we accept on faith that only low-interest rate economies must be studied, then one has to pay more attention to Barro's and Mulligan's studies, rather than less, because those studies have been conducted on economies with nominal interest rates at least as low as today's.

The chart below shows the yield on 3-month Treasury Bills by year 1937-47 and 2005-15. Year is measured vertically and nominal yields are measured horizontally. Thus, near zero yields are seen on the left border of the chart.

As you can see, yields were at least as low during the episodes studied by Barro and me as they are today. For example, the average yield in 2009 was about the same (just a bit higher; shown by the red curve) as the average yield in 1941 (shown by the blue curve).

For years, Professor Barro's Macro textbook has used World War II to estimate a government spending multiplier. (He and Charles Redlick have recently revisited WWII, and other U.S. defense spending episodes). I have looked at the labor market during World War II. Both of us looked at the expansion of government circa 1941-42 and the contraction of government 1946-47.

Interestingly, Professor Barro and I have done vastly more work on low interest rate economies than he has, despite the fact that he is the one so fascinated by them. I guess the conscience of a liberal is not without its inconvenient truths.

A 'Paradox of Toil'?

Copyright, The New York Times Company

Some economists have been recently discussing a “paradox of toil,” meaning that an increased willingness to work actually depresses the economy. But evidence from this recession clearly shows that the paradox of toil is of little practical importance.

Paul Krugman explained Monday on his blog:

when you’re in a liquidity trap … If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment. [emphasis added]

This paradox of toil is of interest because it turns standard economics on its head, and helps rationalize the view that active fiscal policy can boost the economy even while it reduces incentives to work. Professor Krugman and other fiscal stimulus advocates tell us that the paradox of toil describes our economy during this recession.

Fortunately, the relevance of the paradox does not have to be taken on faith, but can be examined with data from 2008 and 2009.

For example, if the paradox described this recession, then the expansion of labor supply that occurs at the beginning of every summer as students become available to work would lead to lower employment. Or on the other hand, an increase in the minimum wage would increase employment as it raises prices and costs and leads to inflation.

In fact, the 2009 labor market reacted to these events in the conventional way, with no paradox.

When school let out for the summer of 2009, teenage employment increased by over a million, and total employment increased by about 700,000 (these May-July comparisons are necessarily seasonally unadjusted, because the school year is part of the seasonal cycle). The expansion in labor supply did not reduce total employment, as Professor Krugman would have us believe would have happened in a “paradoxical” year like 2009. Total employment expanded seasonally as it did in previous years.

The federal minimum hourly wage was increased from $6.55 to $7.25 at the end of July 2009. It did not have the stimulating effect that Professor Krugman assumes.

Teenage employment fell 1.5 million after that increase, as compared to the 1 million that teenage employment typically falls at the end of summers that do not have minimum-wage increases. Total employment also fell more than the usual seasonal patterns would suggest.

The evidence shows that the laws of economics remain in full force, despite the present “liquidity trap.”

Wednesday, December 9, 2009

What Happens Next? Part II

I have now run my version of the real business cycle model (some of my academic papers on it are here and here, and I began applying it to this recession about a year ago, such as here and here) for a partial recovery over the next two years. (compare to my previous post of no recovery -- they can look pretty similar, depending on what people expect about the future of productivity growth).

My model has no adverse productivity shocks, no shocks to capital markets (these variables just react to events in the labor market), no monetary policy, and no fiscal stimulus. Simply put: I view this as a one (type of) shock recession, and the labor market is ground zero for that shock.

This version of the model has a labor market distortion that gets progressively worse for two years (2008 & 2009), at which point it partly reverses itself, although never getting back to pre-recession levels.

The model and data are shown below. Note that latest 12 months (4 quarters) of the data were not available when I first began writing about this model.

[APL is real GDP per hour worked -- labor productivity -- which in the model is in fixed proportions to the marginal product of labor]

Approaching a Tax Milestone

Copyright, The New York Times Company

On Thursday, the United States Treasury releases its monthly statement of receipts and outlays. If not tomorrow, the report may soon show that the payroll tax has, for the first time in history, become the single largest federal tax.

For decades, the individual income tax has been the federal government’s single biggest tax. It is a (complicated) function of each family’s income from wages, investments and other sources, and is summarized every April with our filing of the infamous “Form 1040.”

Although officially known as a “contribution,” the Social Security tax brings in almost as much revenue as the individual income tax, and is catching up. The chart below shows Treasury collections of the two taxes (in order to adjust for seasonality, the chart shows the sum over the previous 12 months).

Since the recession began, individual income tax collections have fallen to $890 billion from $1,186 billion, whereas Social Security tax collections (inclusive of the Medicare tax) have increased to $848 billion from $837 billion. Thus, personal income tax collections have been rapidly falling down to the amount collected in payroll tax.

All of this has happened despite the fact that the Social Security tax is levied at relatively low rates: It has just two brackets of about 15 percent and 3 percent (inclusive of the “employer contribution”). For this reason, many economists consider the payroll tax to be the quintessential “flat tax.”

European countries have long been familiar with having the payroll tax as their primary tax. France, Germany and Greece — to name a few — collect significantly more in their payroll taxes than they do with personal and corporate income taxes combined.

Several western European countries are (deservedly, or not) known for their generous safety nets and heavy tax burdens, but they have no monopoly on payroll-tax primacy. The Czech Republic’s government is known for its free-market orientation, and it collects almost twice as much from payroll taxation as it does from personal and corporate income taxation combined.

That raises an interesting question for the United States as it considers a larger, and perhaps European-like, role for its government.

Will it be Democrats who first harness the revenue-collection power of the payroll tax? Or will Republicans appreciate its favorable incentives?

Friday, December 4, 2009

Women's Share of Payrolls

Women were 49.86% of payroll employment in October. Total October payroll employment was over 131 million (a revision of last month's report -- I said total employment had to get below 131 million before women's share passes 50.0%).

Both the household and establishment surveys shows total employment flat. I found the household survey result interesting because it had dropped so much in just a few months -- now it seems that we can rule out the possibility that Sep or Oct were aberrant -- seasonally adjusted household survey employment really was down over 1.5 million from the summer.

Teen employment was flat -- another reason to believe that their very steep drop from summer to fall was real.

Thursday, December 3, 2009

Why are Durable Goods Suddenly So Expensive?

The graph below shows monthly price indices for capital equipment and consumer durables, though Oct 2009.

Economists know well that these goods have steady gotten cheaper over time. The mystery to me is that, beginning last September, they stopped getting cheaper and even got more expensive (note that the consumer durable price is on a different scale -- it has tended to decline a lot over time -- so the lack of decline is more remarkable there).

While you try to solve the mystery, please note:
  1. volumes produced of these goods are obviously down, but that has been true in previous (ITC-less) recessions and those recessions did not have such price increases (note that my graph includes the 2001 recession). So I don't think the high prices can be blamed on the low volumes alone.
  2. For some items, one might be concerned that the price indices are based on "list prices" and those list prices have (perhaps) been discounted more heavily than usual. I am dubious of a significant "list price" bias because the increases are across broad categories of consumer durable goods, including things like cars, college textbooks, jewelry, and telephones where this bias is either less of an issue OR the BLS is measuring actual transaction prices by acting as would-be purchasers themselves).
  3. Also note that most of the measured sub-index increases are nominal -- I doubt that manufacturers sought to discount their goods by first hiking their list prices.

The ITC is known as the "Investment Tax Credit" -- a credit going to the purchaser of a new durable good. The federal government used it in some of the 1960s and 1970s recessions, but not in the 1980s and 1990s. Professor Goolsbee has convincingly shown that the short run effect of the ITC is to make durables goods more expensive, rather than encouraging investment in them.

"Cash for Clunkers" was a kind of ITC -- a subsidy going to purchases of new cars.

I have warned for a while now that investors may be rationally expecting further ITCs.

I raise all of this because the expectation of future ITCs may explain the price pattern in the chart: producers of durable goods are holding back production until those credits are in place?

Anyway, the point of this post is to hear your ideas, not to insist on the ITC interpretation.

Wednesday, December 2, 2009

Recession Creates a Captive Audience of Taxpayers

Copyright, The New York Times Company

Recent experience with municipal sales and income taxation serves as a reminder that competition among governments benefits their “customers” — us.

Thanks to a County Board vote in early 2008 that doubled the Cook County portion of Chicago’s sales tax, Chicago attained the highest sales tax rate in the United States — 10.25 percent, passing up Memphis with its 9.25 percent rate. (The total sales tax in New York City is now 8.875 percent, after a half-percentage-point increase over the summer.)

The Cook County Board’s president, Todd H. Stroger, told voters that the county badly needed the revenue. Republicans attributed the increase to county government control by “tax and spend” Democrats, but both explanations raise the real question: Why was 2008 suddenly the time to have such a high sales-tax rate?
Governments almost always “need” more revenue, and Democrats have dominated county politics for a long time. For some reason, the board president and his supporters once thought that a sales-tax rate less than 10 percent for Chicago was O.K.

Changing migration patterns are part of the explanation. Over the years, Cook County had been competing with nearby areas for citizens. Joliet, Naperville and Aurora are each less than 50 miles away and have grown toward a combined one-half million people. Since 2006, however, the rate of migration out of Cook County has dropped 17 percent.

The recent migration pattern is quite different from what it was during the 1980-82 recession, when Cook County lost population at a particularly high rate.

This recession’s housing crisis has created a significant obstacle to those who might move out of Cook County and other large metropolitan areas: It’s difficult to sell a house. Until housing markets get significantly better, it looks as if Cook County will have a captive audience.

With a captive audience, governments can tax at higher rates with less concern for an exodus by taxpayers, and that’s why Chicago’s 10.25 percent tax has not been created the out-migration that it would have five years ago.

The sales tax is not the only public policy that responds to competition among government institutions.

Suburban public schools are thought to be more efficient because they are compared by parents and homeowners with schools in nearby districts (see the Stanford professor Caroline Hoxby’s research on school competition and school efficiency). Perhaps the data will someday show that the housing crisis was associated with worse results from public schools, too, thanks to this same audience captivity.

It appears that yet another legacy of this recession may be to render municipal taxpayers as second-class citizens.

Tuesday, December 1, 2009

Nonresidential Investment

Nonresidential capital and employment are "complements" -- when people are working they need a place to work and equipment to work with efficiently.

When our workforce was 138 million, we needed more investment in the non-residential capital stock, which had been starved thanks to the housing boom. But with employment down almost to 130 million, that situation is changed. How low non-residential investment gets depends on how low employment gets.

Thus, this morning's news that non-residential construction is down yet again I take as a reliable indicator that employment is not coming back soon.

Sunday, November 29, 2009

Tantalized by Panel Data

Much conventional wisdom among econometricians and applied economists extols the virtue of "panel data": data that follows individuals or regions over time. State panel data -- data that follows each of the 50 states over time, is thought to be especially virtuous because there's never a problem with losing track of one of the states (unlike panels of individuals, from which members can nonrandomly drop). Especially lauded is the practice of including so-called "time effects" in the model, which means that changes over time are NOT examined except to the extent they occur differently among the individuals or regions.

One interesting question in industrial organization and public economics is the "incidence" of excise taxes -- that is, whether a tax on the sales of specific items will reduce what manufacturers receive for making the item, or increase what consumers pay for it. Cigarettes are an important instance of this, because the taxes are large, and policy-makers are concerned about the harmful health effects of smoking. Because the effects of taxes are determined by the interaction of supply and demand, knowledge of cigarette tax incidence would tell us about the nature of pricing in the cigarette industry, as well as effects of federal cigarette taxation on health and state revenues.

Cigarette tax incidence has usually been studied with state panel data. After all, states differ widely in terms of their use of their taxes, and the dates at which they change their rates. The state panel studies usually find that each penny of cigarette tax raises retail cigarette prices by almost exactly a penny, with little effect on the price per unit received by manufacturers.

By this logic, the $0.62 per pack federal excise tax hike this April would raise retail cigarette prices by almost exactly $0.62 per pack, reduce cigarette smoking in an amount commensurate with the $0.62, and have little effect on the amount cigarette manufacturers receive per pack shipped to U.S. retailers.

I have long been dubious of state panel data for this purpose, because the supply curve across states is very different than the national supply curve. Wholesalers in one state can pretty easily ship cigarettes to a wholesaler in a state with a different tax situation, and this possibility requires wholesale cigarette prices to be essentially the same in each state at a point in time. National pricing is very different because nothing requires the wholesale price in, say, 2006 to be the same as it is in 2009 (I'm told that cigarettes do not store well over long time periods).

We have enough data now to check whether I'm right. I found a monthly Consumer Price Index for cigarettes at The CPI is an index, telling us percentage changes in retail prices from one month to the next, but do not tell us what a pack actually costs. The aforementioned literature often gets annual (measured in November) cigarette prices from the "Tax Burden on Tobacco", so I used that to pin down the level of national average cigarette prices in Nov 2007 ($4.20 per pack; see also this article that puts average prices at $4.10 in early 2009), and then used the monthly CPI to measure retail prices for all other months Jan 2007 - Oct 2009.

The chart below displays the results. Notice that the vertical axis is scaled so that each tick is $0.62/pack -- if the state-panel studies could be used to project federal tax effects, then prices would go up by exactly one tick.

Instead, cigarette prices increased a lot more than 62 cents: more like $1. The state-panel results wildly underestimate the effect of the tax on retail prices, and thereby wildly underestimate the effect of the federal tax on smoking and excise tax revenues received by the states.

[The vast majority of states kept their excise tax rates constant during the first half of 2009. Exceptions are Arkansas, Kentucky, Mississippi, and Rhode Island.]

Saturday, November 28, 2009

Are Banks Undermining Loan Modification?

This article claims that they are:

If the terrible government loan modification program is in fact broken, let's leave it that way!

Friday, November 27, 2009

Prescott and Mulligan: Same Song, Different Verse

I just found this interesting July 2009 presentation by Professor Edward Prescott. He says that the anticipation of future taxes/bad incentives is depressing the economy. I say that the bad incentives are already here.

Now is not the time to quibble: what we both say is vastly different from the conventional wisdom, and we both recommend that government refrain from making it worse.

Wednesday, November 25, 2009

One Minimum Wage Increase With a Side of Fries, Please

Copyright, The New York Times Company

Economists have debated the employment effects of the minimum wage. A recent study of obesity now weighs in on this debate.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among people who are likely to work in minimum wage jobs like teenagers and restaurant workers.

However, inspired by a study of a 1992 minimum wage increase in New Jersey, some economists have suggested that minimum wages can increase employment, by helping to cure pre-existing problems in the labor market. In their view, a higher minimum wage could increase employment and output at employers of low-wage workers, and a lower minimum wage would reduce them.

The typical example is a fast-food restaurant.

The minimum-wage-cures-labor-markets view says that a higher wage level causes fast-food restaurants (like other employers of low-wage workers) to hire more workers, produce more fast food and sell more fast food.

More fast food sold also probably means more obesity. Thus, if the minimum-wage-cures-labor-markets view was correct, a higher minimum wage would, all things being equal, probably result in higher obesity rates.

More conservative economists would argue, though, that high minimum wages restrict employment by fast-food restaurants, which means less fast food produced, which means less obesity.

In other words, the traditional economics view implies a lower minimum wage would, all things being equal, result in more obesity.

As you may know, Americans have indeed been getting more obese over the last couple of decades, with increased consumption of fast foods contributing to that enlargement. During most of that period, the inflation-adjusted federal minimum wage had been falling.

A recent study by the researchers David Meltzer from the University of Chicago and Zhuo Chen from the Centers for Disease Control and Prevention now finds that low inflation-adjusted minimum wages are partly to blame for increased obesity.

If their study is correct, it suggests that a higher minimum wage indeed reduces employment and output at fast-food restaurants, and makes it a bit easier for Americans to adopt healthier eating habits.

As with any new study, time is needed to digest the methodology and results, and integrate them with the previous literature. But expect the fight against obesity to weigh in on the debate about low-wage labor markets.

Tuesday, November 24, 2009

What Does It Cost to Buy a Recession?

By Oct 2009, U.S. labor usage was more than 10 percent below trend. Even if it returned to trend by the end of 2010, that would put labor usage about 20 year x percentage points below trend (i.e., an average 6-7 percentage points below trend for each of three years). A year's labor income is about $10 trillion, so that's $2 trillion that labor income has been reduced over the three years.

How to Purchase a Recession
Suppose for the moment you had a lot of $ to bribe people not to work, or employers not to hire. What method of allocating the bribes would reduce employment the most? How much would it cost you to purchase a recession like this one?

If you simply paid people not to work, shrinking the labor usage by that much might cost about $3 trillion.

It can be a $3 trillion task because people who would not work anyway may take you up on your offer not to work. If you could target your bribes, you would want to target them to the weakest employment relationships -- those for which supply is closest to demand. With very well chosen targets, you could make a recession like this for a mere $100 billion.

But do not expect that you could target so well in practice, because it's difficult to know which employment relationships are the weakest, and once you started paying people for what appeared to you to be weak employment relationships, others might put on the appearance. But at least you could try to target the types of people who are generally expected to be working soon, such as persons searching for jobs (interestingly, that's what unemployment insurance does).

All together, you would be hard pressed to make a recession like this for less than $1 trillion.

UI is an Illustration, but not the Major Force
Unemployment insurance (UI) reduces the employment rate, by increasing the pay someone can earn while not being employment, and reducing the after-tax pay earned while employed. But I raised the question above to demonstrate that UI cannot be the only, or even a major, reason why employment is so low.

Recall that UI benefits are voluntary: nobody forces you to take them. Thus, even if UI had the purpose of reducing employment (which it is not), it could not be much more effective per dollar of expenditure than the hypothetical "recession purchase" discussed above.

UI will spend something like $300 billion for 2008-10, and obviously that $300 billion is not for the PURPOSE of minimizing employment. To make this recession by itself, UI would probably have had to spend more than $1 trillion. (this is the same argument I made in "Public Policies as Specification Errors" for why UI was not a major factor in the Great Depression, either).

Mortgage modification is almost a big enough operation by itself to make this kind of dent in the labor market (whether it actually does is another question). For example, if the Obama Administration achieved its goal of modifying 9,000,000 mortgages and each mortgage were written down an average of $75,000, that would be a total of $675 billion.

If you took the combination of mortgage modification, UI, big parts of the "stimulus" law, and other anti-employment policies, we probably are looking at over $1 trillion worth of spending that encourages people to have lower labor incomes.

Bottom Line
Although it's easy, and at least partly appropriate, to say that government spending of various sorts has reduced employment over the past couple of years, note that buying a recession is no cheap enterprise, and buying a recession of this size may be beyond even what governments can afford.

Investment and Housing Prices Among Various Data Released Today

A couple of housing price indices, plus national accounts revisions were released today. Much of the new data is not newsworthy, but I did notice that real nonresidential investment was even lower in Q3 than it was in Q2 -- another indicator that employment is not coming back soon.

I also noticed that the BEA price index for residential structures investment was (marginally) lower for the seventh quarter in a row. Here is a comparison of quarterly Case-Shiller, OFHEO, and BEA (all expressed relative to the PPI for housing construction).

Monday, November 23, 2009

Question About Deflation

Robert asks
"In our industry, the manufacturers claim to be holding prices, but are quietly making all kinds of deals to "help" us be more competitive.

Our competitors are taking those incentives and chasing prospects with what appears to the dealer to be lower prices across the board.

This is new behavior. For the past 8 years, no one really asked what the price was. Currently it's the prime topic.

Then I went online and ordered a pizza from pizzahut Friday. Suddenly every pizza is $10, half the price of the past few years. If that's a short term promotion were ok. If that's the new reality, are we in trouble?"

Let me rephrase Robert's post as three questions:

(1) Is deflation -- that is, a general decline of all prices (both the prices at which we buy, and those at which we sell) -- a problem? Theoretically, it is not a big problem, but just redistributes wealth from those with dollar-denominated liabilities to those with dollar denominated assets. However, this recession arguably got going because of the "underwater mortgages/foreclosure" problem -- a problem that get's better with inflation and worse with deflation. For more on this, see "Inflation, we need you!".

(2) Is there deflation right now, or will there be in the near future? I think we have a bit of inflation right now, and expect more inflation in the next couple of years (see here). It's always a bit difficult to know the inflation/deflation rate precisely, because a lot of price changes can be pretty subtle, as with the promotional discounts indicated in Robert's post. But the Bureau of Economic Analysis and the Dept of Labor have enough serious ways of measuring it that, together with the recent commodity price inflation, I am confident that we do have inflation.

(3) If not general deflation, what is Robert supposed to make of his observations? It's no surprise that various manufacturing prices have been falling a bit over 2009, after falling significantly at the end of 2008. If he's seeing more drops than a "bit" then that's some bad news for his segment of manufacturing.

(4) The pizza bargains may indicate that his region's economy is tougher than the national average, or merely that Robert hasn't purchased a pizza for a year or two (maybe the case -- that's about the time frame he wedded his lovely bride!!).

Friday, November 20, 2009

Bears Fan

Does this picture explain why I blame a large fraction of public policy mistakes (bank bailout, mortgage modification, min wage hike, etc.) on the previous administration?

Wednesday, November 18, 2009

No News Housing Construction Report

I don't see much news here:

The Minimum Wage and Teenage Jobs

Copyright, The New York Times Company

Teenage employment has fallen sharply since July. The most recent minimum wage hike may be an important factor.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among those who are likely to work in minimum-wage jobs, like teenagers and restaurant workers.

In July 2007, the federal minimum hourly wage was increased for the first time in 10 years, from $5.15 to $5.85. It was increased again a year later to $6.55, and increased yet again this July to $7.25.

Because the minimum-wage law still permits employers to pay more than the minimum, economists agree that a low minimum wage has smaller effects than a high minimum wage. The inflation-adjusted federal minimum wage had gotten to its lowest in decades by early 2007, so the July 2007 increase should have had the smallest effects of the three.

The July 2009 increase should have the largest effect, because the combination of the two previous hikes and some deflation ($6.55 bought more in June 2009 than it did the previous summer) had already gotten the inflation-adjusted minimum wage relatively high.

The chart below shows a seasonally adjusted index of the percentage of 16- to 19-year-olds with jobs. That group is especially likely to be affected by minimum-wage legislation. Of course, this is a recession period in which employment has been falling for essentially all groups, so for reference the teenage percentage has been converted to an index by dividing by the percentage for all people, with July 2009 set as the benchmark (i.e., the teenage employment rate that month has been set to 100).

The chart shows teenage employment index values greater than 100 early in the recession, which means that employment rates fell in greater percentages for teenagers even before the July 2009 increase, as it did in prior recessions (even recessions without minimum-wage increases). With the index falling somewhat less than 1 percent a month before July 2009, we would expect the index to be somewhat below 100 after July 2009 even if the minimum wage hike had no effect.

But the teenage employment after July 2009 seems sharply lower. By October 2009, the index had fallen to 92.1 — a drop of about 8 percent in just three months — whereas the prior 8 percent drop had taken more than a year. This suggests that the 2009 minimum-wage increase did significantly reduce teenage employment.

Before this recession, economists hotly debated the employment effects of the minimum wage, with special attention to a 1992 minimum-wage increase in New Jersey (this book got it started, and this book is a good source for the opposing view).

More work is needed to determine whether the 2009 experience is fundamentally different from the earlier episodes that have been studied, but next week I will describe a new study that “weighs in” on those episodes.

Tuesday, November 17, 2009

PPI For Housing Construction

The housing PPI looks pretty flat over the last six months. That is one indicator that housing prices will be flat, which means that mortgages will not be going further underwater.

The bad news is that the housing PPI in the last six months has not participated in the moderate inflation seen in the wider economy over the last six months, which suggests that housing prices have not yet participated in that inflation.

Monday, November 16, 2009

Minimum Wage Regrets?

A couple of years ago, a number of "leading economists" endorsed the federal minimum wage law that legislated the current minimum of $7.25/hr:

Henry Aaron The Brookings Institution
Kenneth Arrow Stanford University
William Baumol Princeton University and New York University
Rebecca Blank University of Michigan
Alan Blinder Princeton University
Peter Diamond Massachusetts Institute of Technology
Ronald Ehrenberg, Cornell University
Clive Granger University of California, San Diego
Lawrence Katz Harvard University (AEA Executive Committee)
Lawrence Klein University of Pennsylvania
Frank Levy Massachusetts Institute of Technology
Lawrence Mishel Economic Policy Institute
Alice Rivlin The Brookings Institution (former Vice Chair of the
Federal Reserve and Director of the Office of Management and Budget)
Robert Solow Massachusetts Institute of Technology
Joseph Stiglitz Columbia University

[read the longer list here. Interestingly, the University of Chicago does not appear on the list.]

They all said: "we believe the Fair Minimum Wage Act of 2005’s proposed phased-in increase in the federal minimum wage to $7.25 falls well within the range of options where the benefits to the labor market, workers, and the overall economy would be positive."


"the weight of the evidence suggests that modest increases in the minimum wage have had very little or no effect on employment."

An ambitious journalist might ask them whether they still believe these things, and in particular whether that they believe this July's increase had "positive" effects.

Thursday, November 12, 2009

Why is Employment Falling? How to Turn it Around?

Debated on The Kudlow Report tonight:

Welcome Kudlow Viewers!

Below are my posts on the fiscal stimulus. See also my list of reasons why government policy has been reducing employment, not raising it.

To see my posts on other economics subjects, please click on "all posts" above.

I also blog weekly at the New York Times www (one of my favorites is here).

Kudlow Show Tonight

I will be on CNBC's Kudlow Show Tonight, sometime between 7 and 730p eastern time.

What Happens Next?

I'm not sure. My version of the real business cycle model (some of my academic papers on it are here and here, and I began applying it to this recession about a year ago, such as here and here) does not give a definite answer, but it does drastically narrow the possibilities.

My model has no adverse productivity shocks, no shocks to capital markets (these variables just react to events in the labor market), no monetary policy, and no fiscal stimulus. Simply put: I view this as a one (type of) shock recession, and the labor market is ground zero for that shock.

One version of the model has a labor market distortion that gets progressively worse for two years, at which point it remains at that higher distortion forever. Specifically, the average marginal tax rate ultimately increases about 10-15 percentage points (more accurately, the after tax share is cut by 22 percent), but it takes 2 years for the full marginal tax rate hike to occur.

The model and data are shown below. Note that latest 12 months (4 quarters) of the data were not available when I first began writing about this model.

[APL is real GDP per hour worked -- labor productivity -- which in the model is in fixed proportions to the marginal product of labor]

The good news from this first scenario is that the labor market will stop getting worse in 2010 (ie, employment and hours will stop falling further below trend). The bad news is that aggregate hours will never return to that previous trend, even part way. Consumption will ultimately be further below trend than it is now.

I am still working on it, but I think there's another version of the model that would fit the same data: the labor market gets even worse for a couple of more years, but eventually will be closer to the previous trend than we are now. The bad news from this second scenario is that the labor market will not stop getting worse until beyond 2010. The good news is that consumption and aggregate hours will eventually return to their previous trends, at least most of the way.

Either way, the inference I am making from consumption behavior -- it has fallen a lot by historical standards, but far less than labor has fallen -- is that the present value of lost labor is great, but much of that loss labor has not yet occurred. Whether the remaining lost labor is spread over the infinite future (the first scenario above), or concentrated in the next couple of years (the second scenario above), I do not know.

Wednesday, November 11, 2009

A Jobless Recovery

Copyright, The New York Times Company
The Bureau of Economic Analysis recently confirmed what everyone suspected, that real spending and incomes grew again from the second to the third quarters of this year. Yet we also learned on Friday that employment still fell in October, as it had in previous months. Although employment will someday turn upward, I suspect that this divergent pattern for spending and employment will continue for a while.

One bit of conventional wisdom about this recession is that it was caused, or at least significantly worsened, by a paradox of thrift: Consumers suddenly ceased to be willing or able to spend as they once did. But I have argued against that conventional wisdom, based in part on the fact that work hours and employment have fallen much more than either consumer spending or personal incomes have.

Indeed, real personal consumption expenditure was higher in September 2009 than it was a year earlier (as was real personal disposable income), while work hours had fallen 7 percent. This recession cannot be understood merely as the consequence of low spending.

A variety of models can help explain the recession so far, and to predict where it may be going, but here I’d like to focus on the two variables emphasized in my own research: productivity, and what are known as labor market distortions.

Productivity is the amount produced per hour worked. If productivity grows, it means that output can grow faster than employment, as it did from the second to the third quarter.

During several previous recessions, productivity was falling. Yet this recession has been different, with productivity throughout 2008 and 2009 being higher than it was when the recession got started.

Productivity growth has been especially strong during the last two quarters, perhaps in part a recovery from somewhat slower (but still positive) productivity growth at the end of 2008. Productivity could surge a bit more — maybe for another quarter — without exceeding the long-term trend. If so, inflation-adjusted output would continue to grow faster than employment and hours over the next couple of quarters.

Labor market distortions are a collection of factors that hold back employment, even when employees are creating a lot of value.

These distortions include difficulties in job search, income taxes, minimum-wage laws and incentives that are eroded by means-tested government benefits (determining whether someone should receive benefits based on things like the person’s income). These factors can be difficult to quantify individually, but we know from the poor employment results that at least some of them are important.

Labor market distortions have gotten progressively worse during this recession. The federal minimum wage, for example, was increased once shortly before the recession began, a second time in the summer of 2008, and yet again this summer. The housing collapse has also had multiple harmful effects, such as impeding families who might want to move out of some of the hardest-hit regions toward areas where the economy is doing better.

These types of factors can make a bad labor market much worse.

Some of the labor market distortions will stop getting worse over the next couple of months, as housing prices stabilize and the federal minimum wage stays put, but that does not mean that labor market problems will reverse themselves.

According to my measures, labor market distortions have been getting worse at the same rate over the past couple of months as they have throughout the overall recession. Moreover, Congress appears poised to further erode incentives to earn income as an accidental byproduct of its plans reforming health care. Nor do consumers seem to be spending in anticipation of a grand employment recovery.

Thus, my humble prediction for the next several months is that real incomes and spending will continue to grow, although likely at an annual pace less than the 3.5 percent estimated a couple of weeks ago. In other words, as many have feared, this part of the recovery will be “jobless,” in the sense that employment and hours will not rise significantly, and may continue to fall.

Tuesday, November 10, 2009

Is "Fresh Water Macro" Off Track?

[Economists' Voice invited me to write this, and indicated that they liked it, but nonetheless it has languished in the editorial process, so the article premiers here. The Economists' Voice version will have the footnotes. For further, but still not exhaustive, recitation of economics errors in Professor Krugman's Sunday Magazine article, see here.]

Should macroeconomists begin again, particularly those at Chicago, Minnesota, Rochester and other freshwater schools? These days, commentators tell us that we should scrap all that we hold dear – neoclassical growth models, asset pricing models, and the efficient market hypothesis alike.

And not just run-of-the-mill journalists. No less than the Nobel Laureate Paul Krugman argued this September in the New York Sunday Magazine that we are “mistaking beauty for truth,” dismissing “the Keynesian vision of what recessions are all about,” falling “in love with the vision of perfect markets,” and blaming entire recessions on laziness.

Krugman and others are getting carried away. Allow me to defend neoclassical growth models, by providing some examples of the application of these models to the current recession, and to previous recessions. The reader can then evaluate whether Krugman’s accusations are at all accurate.

The Neoclassical Growth Model
The neoclassical growth model is an aggregate model with two basic tradeoffs: (1) current versus future and (2) market versus non-market allocations of labor. Resources are allocated over time via decisions to accumulate a homogeneous capital good, rather than consuming in the current period. People allocate their time between the market and non-market sectors via employment and hours decisions.

The model has a few equilibrium conditions. Three conditions denoted (Y), (L), and (K) relate to current consumption and work: (Y) output is produced according to capital and labor inputs, (L) the supply of labor equals its demand, and (K) the supply of capital (consumption foregone) equals its demand. The remaining two conditions are versions of (Y) and (L) for the future period.

Stated this way, the model seems to be based on the assumption that markets always clear. But twenty years of applying the model has not exactly been a love affair with perfect markets. My practice and others is to include a residual in each of the conditions: a “productivity shock” in condition (Y), a “labor market distortion” in condition (L), and an “investment” or “capital market distortion” in condition (K), which means that I expect there may be significant market imperfections or other unpredictabilities. The not-so-subtle truth is that we often suspect that markets are not functioning efficiently: one of my papers on the topic has the title “A Century of Labor-Leisure Distortions”.

Three Diagnostics
In its most basic form, the neoclassical growth model has neither money nor fiscal policy. Nevertheless, it provides some diagnostics as to how public policy variables might be affecting the private sector.

In this approach, the first step uses the macroeconomic data to suggest which of the conditions – (Y) or (L) or (K) – has the most variable residual. Much like microeconomists ask “was it supply or demand?”, as Lawrence Katz and Kevin Murphy have done with changes in relative wages, we users of the neoclassical growth model ask “Was it productivity? Labor supply? Labor demand? Capital supply? Or Capital demand?” We doubt that the complexity of the larger economy will ever be understood without some means of compartmentalizing the various behaviors, and the three “equilibrium conditions” are our means of doing so.

While a variety of tools would be appropriate for understanding the roles of monetary and fiscal policy, the neoclassical growth model’s decomposition offers some suggestions as to which approaches might help the most. For example, we might think differently about monetary policy if it depressed the labor market by inadvertently raising real wages, rather than depressing capital accumulation by adding frictions to capital markets.

Not All Recessions are the Same
Well before the current recession began, this approach led to the conclusion that recessions have various causes, and therefore that no one government policy could fix all recessions, or be blamed for all of them.

I have long been of the opinion that the labor supply residual, rather than productivity or investment shocks, was the most important of the three residuals in the Great Depression. Despite the current recession’s capital market theatrics, it again seems that much of the action is with the labor supply residual.

For both 1929-33 and 2008-9, labor supply residuals seem key because employment was low while total factor productivity and real pre-tax wages were high (or, in 1929-33, at least not commensurately low): my story, then, is not so different from the business cycle described by General-Theory-Keynes himself.

In this regard, results like mine, and those in recent papers by Lee Ohanian, Robert Shimer, and Robert Hall are quite consistent with “the Keynesian vision of what recessions are all about:” something made real wages high and employment low. But long ago we recognized that many other recessions cannot be characterized that way: real wages and employment frequently cycle together as Mark Bils has found. In these other cases, the “productivity shock” – the shock emphasized in the seminal work of Fin Kydland and Edward Prescott – seems to be pretty important. There was a good reason why old-time Keynesian models fell into disrepute soon after the 1970s stagflation.

Examination of Incentives
Given the recent time series for real wages and productivity, I doubt many of us are looking for an adverse productivity shock. But we do ask how individual incentives might be consistent with those patterns. It’s this type of reasoning that led Lee Ohanian to blame some of the Great Depression on Hoover’s industrial policy.

When it came to this recession, the neoclassical decomposition quickly led me to look further at public policies – absent from some of the other recessions – that might have caused the supply of labor to shift relative to its demand. Like others, I noticed that the federal minimum wage was hiked three consecutive times. I also turned up a major policy (the Treasury and FDIC plans for modifying mortgages) that creates marginal income tax rates in excess of 100 percent. Much research remains to be done, and undoubtedly other users of the neoclassical growth model will make convincing cases for the roles of monetary and other factors.

Paul Krugman’s scorn is all we have to suggest that marginal tax rates in excess of 100 percent are not worthy of attention, and that today’s low employment is not even partly a consequence of public policy. But, regardless of how economists ultimately interpret today’s recession, it will be notable for the basic fact that total factor productivity advanced while employment fell, and for the initial reception suffered by the basic facts in a politicized marketplace for ideas.


Barro, Robert J. and Robert G. King. “Time Separable Preferences and Intertemporal Substitution Models of Business Cycles.” Quarterly Journal of Economics. 99(4), November 1984: 817-39.

Bils, Mark. “Real Wages over the Business Cycle; Evidence from Panel Data.” Journal of Political Economy. 93(4), August 1985: 666-89.

Chari, V. V., Patrick J. Kehoe, and Ellen R. McGrattan. “Business Cycle Accounting.” Econometrica. 75(3), April 2007: 781-836.

Cole, Harold L. and Lee E. Ohanian. “The Great Depression in the United States from a Neoclassical Perspective.” Federal Reserve Bank of Minneapolis Quarterly Review. 23(1), Winter 1999: 2-24.

Cole, Harold L. and Lee E. Ohanian. “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis.” Journal of Political Economy. 112(4), August 2004: 779-816.

Gali, Jordi, Mark Gertler, and J. David Lopez-Salido. “Markups, Gaps, and the Welfare Costs of Business Fluctuations.” Review of Economics and Statistics. 89, February 2007: 44-59.

Hall, Robert E. “Macroeconomic Fluctuations and the Allocation of Time.” Journal of Labor Economics. 15(1), Part 2 January 1997: S223-50.

Hall, Robert E. “Reconciling Cyclical Movements in the Marginal Value of Time and the Marginal Product of Labor.” Journal of Political Economy. 117(2), April 2009: 281-323.

Katz, Lawrence F. and Kevin M. Murphy. “Changes in Relative Wages, 1963-1987: Supply and Demand Factors.” Quarterly Journal of Economics. 107(1), February 1992: 35-78.

Kehoe, Timothy J. and Edward C. Prescott. Great Depressions of the Twentieth Century. Minneapolis, MN: Federal Reserve Bank of Minneapolis, 2007.

Keynes, John Maynard. The General Theory of Employment, Interest, and Money. London: Macmillan, 1936. (Diagnosing at p. 17 the 1929-33 period in a way similar to my own diagnosis)

Kydland, Finn and Edward C. Prescott. “Time to Build and Aggregate Fluctuations.” Econometrica. 50(6), November 1982: 1345-70.

Mulligan, Casey B. “A Century of Labor-Leisure Distortions.” NBER working paper no. 8774, February 2002.

Mulligan, Casey B. “Public Policies as Specification Errors.” Review of Economic Dynamics. 8(4), October 2005: 902-926.

Mulligan, Casey B. “A Depressing Scenario: Mortgage Debt Becomes Unemployment Insurance.” NBER working paper no. 14514, November 2008.

Mulligan, Casey B. “What Caused the Recession of 2008? Hints from Labor Productivity.” NBER working paper no. 14729, February 2009a.

Mulligan, Casey B. “Means-tested Mortgage Modification: Homes Saved or Income Destroyed.” NBER working paper no. 15821, August 2009b.
Ohanian, Lee E. “What – or Who – Start the Great Depression?” forthcoming, Journal of Economic Theory. 2009.

Parkin, Michael. “A Method for Determining Whether Parameters in Aggregative Models are Structural.” in Karl Brunner and Bennett T. McCallum, eds. Money, Cycles, and Exchange Rates: Essays in Honor of Allan H. Meltzer. Carnegie-Rochester Conference Series on Public Policy, 29, Autumn 1988: 215-52.

Prescott, Edward C. “Some Observations on the Great Depression.” Federal Reserve Bank of Minneapolis Quarterly Review. 23(1), Winter 1999: 25-31.

Shimer, Robert. Labor Markets and Business Cycles. Forthcoming, Princeton University Press, 2009.

Friday, November 6, 2009

Where's the Spending Disaster? Or the Income Disaster?

Lehman failed in September 2008, and that started the panic that got the world's attention.

So a year later, in September 2009, after living through a year of "disaster," how did real consumption expenditure (one economists' favorite measures of living standards) compare to what it was in September 2008?

What about real disposable personal incomes: the amount of income households have on hand to spend?

Both of these are HIGHER in September 2009 than they were a year earlier.

Of course, we cannot say the same thing about employment, but nobody seems to acknowledge that this recession is much more about the labor market than about drops in real incomes or spending. [prediction: leftie bloggers will ignore this sentence (and 100 other posts I've had on the labor market), and have you believe that I claim that employment also has no perceptible decline]

[The BEA may revise the September 2009 income and spending numbers, up or down, so it is possible that the revisions show real income and or spending to be slightly lower 9-09 than 9-08. Undoubtably one could find other tweaks to the series to change a slight increase into a slight decline, or vice versa. But the fact that the BEA's measurement updates and other tweaks are first order considerations when characterizing the changes is proof itself that no spending or income collapse occurred since Lehman failed. A collapse should be obvious even when viewed with blurry glasses!]

Household Survey Shows Labor Market Continuing Swiftly Down

From Aug to Oct 2009, the Household Survey shows employment falling 1.4 million (sic).

This is one of the largest two month drops during this recession. That measure of employment hasn't been this low in six years (back when the population was significantly less).

Why Employment is Continuing Down

I mentioned earlier this week that, despite the fact that GDP and consumer spending turned around months ago, employment would probably continue down. Today it was reported that October payroll employment was almost 200,000 less than it was in September.

For those who think that employment is just a reaction to consumer spending, that may come as a surprise. But, as I suggested on Wednesday, the "paradox of thrift" has been a symptom, not a cause, of this recessinon.

Your Government Is Selling Puts, Putting Your Money at Risk

The Congressional Oversight Panel has reported that the Treasury Department leveraged limited bailout money to insure assets worth many times more. These guarantees could have, and implicit guarantees may still, cost the taxpayers trillions.

Thursday, November 5, 2009

Today's Productivity Data Fed into Distortion Model

Today I was able to use the BLS productivity release to update of Figure 7 from my NBER working paper.

Of particular interest is the fact that the labor market distortion shows no signs of getting better in Q3. Until that happens, employment could continue down while real GDP rises.

Wednesday, November 4, 2009

The Recession and the ‘Paradox of Thrift’

Copyright, The New York Times Company
One bit of conventional wisdom about this recession is that it was caused, or at least significantly worsened, by a “ paradox of thrift”: Consumers suddenly ceased to be willing or able to spend like they once did. An alternative interpretation puts the labor market at ground zero, and sees the spending decline merely as a reaction to the labor market.

Was spending or the labor market the fundamental driver in this recession? Causality is always hard to disentangle, but one fact is worth noting: Consumer spending fell much less than did the labor market.

The chart below displays inflation-adjusted private consumer spending, alongside hours worked in the labor market (the product of employment and hours worked per employee), for each month of this recession.

Each series is displayed as an index, with its value at the start of the recession (December 2007) set to 100. Consumer spending normally trends up more than employment does, so I have adjusted for that by removing prior trends from consumer spending and work hours.

For example, a value of 95 for real consumer spending in September 2009 means that inflation-adjusted consumer spending in September 2009 was 5 percent below what it would have been had it continued its previous trend since December 2007.

Consumer spending fell significantly during the months of 2008, a drop that sorely hurt manufacturing and other industries. But labor fell at least as much for the first nine months of 2008, and fell a lot more since then.

Through September 2009, work hours were 11 percent below trend, while consumer spending was “only” 5 percent below trend.

The economic news first started getting widespread attention in September 2009 when Lehman failed and credit markets froze. Since that time, consumer spending only fell only two percentage points further below its trend while labor fell another eight.

While it is conceivable that a few percentage points’ decline in consumption could cause a many-fold reduction in work hours, it seems more likely that the reduced consumer spending was mainly a reaction to layoffs and hours cuts. The roots of this recession go a lot deeper than the paradox of thrift.

Tuesday, November 3, 2009

Residential and NonResidential Construction Through September

Residential construction spending was higher in September than in August, which was itself higher than in July, which was itself higher than in June.

Interestingly, I predicted last December that the housing market would turn around in the summer of 2009. By now, we have seen enough housing price and construction data to see that prediction was correct.

My prediction was based on the assumption that a credit crunch would not be an housing important factor. In other words, I expected any significant credit market restraint of the housing market to cause the market to turn around later than summer 2009. That's not to say that credit is flowing easily -- just that credit conditions are reacting to the housing market (in particular, its new and lower levels of price and construction) rather than the other way around.

But look at nonresidential construction: it's fallen significantly since spring. Why?
  • Credit crunch?
  • housing construction crowding out non-residential construction?
  • an expectation that labor will remain low for a while to come.

I am skeptical that a credit crunch is all that important -- certainly not the entire story (if it were, why did the housing market turn around as quickly as I predicted?). Housing construction right is now not significant enough to crowd out much non-residential construction. Thus, the bad news is that non-residential investment spending may be indicating more tough times for the labor market. I'm going to write more about that tomorrow on

Monday, November 2, 2009

Update on Labor Market Decomposition

Here is an update of Figure 7 from my NBER working paper.

Of particular interest is the fact that the labor market distortion shows no signs of getting better in Q3. Until that happens, employment could continue down while real GDP rises.

More than 100,000 Mortgage Modifications per Month

I found this graph on the Huffington Post.

It appears to be for Home Affordable Modification Program, and therefore omits modifications under Home Affordable Refinance Program and under the FDIC's Streamlined Modification.

Friday, October 30, 2009

Must Mortgages be Modified According to Treasury or FDIC formulas?

Mortgages held by Freddie and Fannie must. So do mortgages held by banks taken over by the FDIC. It appears that Citi agreed to follow the FDIC guidelines with its mortgages as part of the terms of its November 2008 bailout.

For those that are left, participation is voluntary. But we cannot conclude that voluntary participation is equivalent to an endorsement of the FDIC guidelines, because servicers may follow those guidelines merely to partake in the significant Treasury subsidy that goes along with following those guidelines. Treasury has budgeted $75 billion for the HAMP program, which it expects to reach 3-4 million mortgages. That's more than $20,000 of subsidy per mortgage!

The table below summarizes reports by Treasury, FDIC, and the Congressional Oversight Panel as to the type and amount of various subsidies. This list is not exhaustive, but I think the largest part of the subsidy is that Treasury pays half of the amount of a borrower's mortgage payment that causes it to be 38% percent of that borrower's income rather than 31%. For example, if borrower annual income was $50K and unmodified annual housing payments were were $20K, the Treasury would in effect be paying $1,750 per year for five years toward the borrower's mortgage.

Mortgage Modification: Mostly by Reduced Interest Payments

I have summarized reports by Treasury, FDIC, and the Congressional Oversight Panel in the Table below. Pooling and service agreements do not permit term extensions beyond a few months, because each mortgage in the pool is supposed to mature at about the same time. Very little of the monthly payment is principal, so there is not much scope for reducing monthly payments by reducing principal. In practice, the principal balance is a actually bit higher after modification because arrearages are added to the previously scheduled principal.

Thus, modifications reduce interest in order to reduce monthly payments to 31% of AGI. As explained in my papers, this creates a marginal income tax rate in excess of 100%.

Thursday, October 29, 2009

Treasury Concerned that Borrowers May "Game" Mortgage Modification Formulas

I agree. The Treasury's only solution has been to make the modification formula secret (see Congressional Oversight Panel, October 2009, p. 47: the secret is about the exact location of the allocation W0 in this diagram).

What about changing the formula to get the implicit marginal income tax rate down below 100%? Or even down to 0%?