Economic Reporting Review
September 24, 2001

By Dean Baker, co-Director of the Center for Economic and Policy Research

OUTSTANDING STORIES OF THE WEEK

Roadblocks Cited In Efforts to Trace Bin Laden's Money
Time Weiner and David Cay Johnston
New York Times, September 20, 2001, page A1

This article examines the ways in which Osama bin Laden's network may
have been able to transfer large amounts of money without being
detected. It notes that the Bush Administration is now supporting
measures that would make money laundering more difficult, after
previously opposing them.

Continental: Risky Deals and Insider Sales Precede Crisis
Floyd Norris
New York Times, September 20, 2001, page A1

This article examines how two major shareholders in Continental
managed, through their control of the company, to make tens of
millions of dollars off the company's stock, even as the airline was
falling into bankruptcy. As the article points out, Continental's
cash flow crisis preceded last Tuesday's attack, although the attack
certainly worsened the prospects for a recovery.

A Los Angeles Commuter Group Sees Discrimination in Transit Policies
James Sterngold
New York Times, September 16, 2001, Section 1 page 25

This article reports on the efforts of a community group in Los
Angeles to steer more of the region's public transportation money
towards its bus system. In recent years, the region's transit
authority has spent billions of dollars to construct a subway system
which will mainly serve affluent suburbanites. At the same time it
has been cutting back bus routes and raising fares. Buses are
primarily used by lower income and minority populations.


The Terrorist Attack and the Economy

I.M.F. Bankers Get Ready To Give Pakistan a Loan
Joseph Kahn
New York Times, September 20, 2001, page B4

This article reports on the I.M.F.'s decision to extend new loans to
Pakistan. At one point it discusses the I.M.F.'s latest assessment of
the world economy, which is relatively optimistic. It reports that
this optimism rests in large part on the fact that "few leading
economies now have large budget deficits or high inflation."

This was also true during the Great Depression. Most countries were
actually experiencing deflation during the Depression and budget
deficits were generally small relative to the size of national
economies. Low budget deficits and low inflation are clearly not
sufficient to guarantee strong growth.

Bush Signals Support for New Tax Cut
Glenn Kessler and Mike Allen
Washington Post, September 18, 2001, Page A17

This article reports on proposals being considered by the Bush
Administration to help stimulate the economy. At one point it refers
to the impact of the $300 rebate checks that were sent to most
taxpayers. It refers to this tax cut as "the president's
well-publicized $40 billion in tax rebates."

Actually, this portion of the tax cut package was not proposed by
President Bush. It originated with Congressional Democrats. The
President accepted the rebate plan in order to gain support for the
rest of his tax cut proposal.

Investors Should Expect Continued Turbulence
Steven Pearlstein
Washington Post, September 18, 2001, Page A18

This article presents a set of questions and answers
pertaining to the stock market and the economy in the wake of the
terrorist attack the prior week. At one point it comments that before
the attack many investors "held stocks on the theory that the
slowdown in the U.S. economy had pretty much run its course, and that
production and profits would revive by the end of the year."

Even with the earlier declines in stock prices, price to earnings
ratios prior to the attack were still close to 25 to 1, more than 60
percent above their historic average of 15 to 1. Since the
Congressional Budget Office (CBO) projects that real profit growth
will average just 1.0 percent annually over the course of the decade,
a recovery to the profit growth track projected by CBO would not have
provided sufficient justification for investors to hold stock. These
investors must have believed that not only would the economy recover
quickly, but that profits would grow far more rapidly than CBO had
projected. (CBO's projections are generally viewed as the standard
basis for budget and economic analyses.)

This article also asserts that "many forecasters now predict a short,
mild recession, with things beginning to turn around by next spring."
Since it now seems all but certain that the economy will experience a
recession, this statement is the most optimistic assessment of the
economy that can be made. The Post has consistently printed forecasts
about the economy in the last year that have been proven by
subsequent events to be overly optimistic. For example, when the
economy first began to slow last fall, many articles included
projections that the economy would begin to grow strongly again in
the second quarter. When this projection was no longer plausible, the
date at which strong growth would resume was pushed into the third
quarter, and eventually the fourth quarter. Now that it is clear that
the economy will not be experiencing strong growth in the fourth
quarter, the projection is for a return to growth in the spring. (For
example, see "Economy Gains As Consumers Keep Spending," Washington
Post, July 14, 2001, Page E1 and ERR 7-23-01; "Economic Reports Show
Gains," Washington Post, June 27, 2001, Page E1 and ERR 7-2-01;
"Economy Beats Expectations," Washington Post, April 28, 2001, Page
A1 and ERR 5-7-01; and "Reports Offer Positive Economic News,"
Washington Post, April 3, 2001, page E1 and ERR 4-9-01.)

The fact that Post articles have consistently relied on projections
that have been proven to be overly optimistic suggests that a broader
array of sources is necessary. There were economists who had
anticipated this downturn, for example Wynne Godley at the Levy
Institute. It would be appropriate to occasionally turn to an expert
who was not surprised by the economic downturn.

No Surefire Fixes in Sight for Battered U.S. Economy
Steven Pearlstein
Washington Post, September 20, 2001, Page E1

This article examines the economy's prospects in the aftermath of
last Tuesday's attack. At one point the article asserts that "over
the last few trading days, the bond market has responded to the
prospect of runaway budget deficits." There is nothing in the text of
the article that provides any basis for believing that the nation is
facing "runaway budget deficits." Even with a $100 billion stimulus
package, the largest one mentioned in the article, the overall budget
would be close to balanced. Even excluding the Social Security
surplus, the deficit would still be under 2.0 percent of GDP. A
deficit of this size is low by historic standards and could be
sustained indefinitely.

The article also asserts that the stimulus provided by deficit
spending could be offset by the drag on investment that would result
from higher interest rates. A large body of economic research shows
that interest rates have a very modest effect on investment,
especially during an economic downturn. The investment that is
induced by the increased demand created by a stimulus is likely to be
larger than the investment crowded out by higher interest rates (e.g.
Steve Fazzari, "Investment and U.S. Fiscal Policy in the 1990s,"
Economic Policy Institute, 1993).

The impact of budget deficits on long-term interest rates is
relatively small. At the peak of the last business cycle in 1989, the
government had a budget deficit that was equal to 3 percent of GDP.
The budget surplus for 2000 was more than 2.0 percent of GDP.
However, this massive shift from deficit to surplus of 5 percentage
points of GDP (more than $500 billion at present), led to a fall in
the real interest on home mortgages of approximately 1.5 percentage
points. The drop in the real interest rate of Aaa corporate bonds was
less than 1.0 percentage point. This implies that likely effect on
interest rates of the stimulus packages currently being discussed,
would be probably be too small to even be measured accurately.

The article includes a quote from an economist asserting that
consumers are not short of funds. It is worth noting that the ratio
of consumer debt to disposable income is considerably higher than at
any point in the past, especially if car leasing arrangements are
treated as equivalent to car loans. (The Federal Reserve Board's data
on consumer credit does not count a car lease as debt, even though
the lease relationship is very similar from the consumer's
perspective to buying a car with a loan. Until the nineties, leasing
was unusual, as most cars were purchased outright.)

At one point the article presents a comment from an economist at the
Urban Institute, which it identifies as "liberal." The Urban
Institute can probably be more accurately identified as "centrist,"
since it has staff has a wide range of political views.

Stocks Fall for 4th Straight Day
Greg Schneider and Carol Vinzant
Washington Post, September 21, 2001, Page E1

This article reports on the stock market's plunge in the wake of the
terrorist attack. At one point it presents a comment from a market
analyst that "under ordinary circumstances you would expect to be
very excited about the market prospects for the next 12 months. But
these aren't ordinary circumstances."

There is no explanation given for this analyst's assessment, but the
implicit basis for optimism about the market appears to be that it
has declined by a large amount in the last year and a half. This is
not a reason for believing the market will rise significantly in the
future. By historical standards, the market is still over-valued,
with its price to earning ratio still close to 30 percent above its
historic average. With profit growth over the next decade projected
to be much slower than the historical average, it would be expected
that the price to earnings ratio should be even lower than its
historic average, other things being equal.


The Stock Market

Bush's Man on Wall St. Pushed for Reopening
Joseph Kahn
New York Times, September 21, 2001, page C6

This article reports on the debate over the timing of the reopening
of the financial markets after last Tuesday's terrorist attack. The
article notes that many practical considerations, such as the
potential interference with the rescue efforts and damaged computer
systems, necessitated a delay in reopening the markets. It is worth
noting that the options markets in Chicago remained closed during
this period, even though there were no comparable obstacles to
trading stock options there. This decision to close these markets
must have been motivated by a concern over the instability that would
result from an early reopening of the market.


Japan

Grim Global Outlook Looms Over Japan
Clay Chandler
Washington Post, September 18, 2001, Page E2

This article reports on the negative impact that the downturn in the
United States is having on Japan's already weak economy. At one point
the article notes that Japan's Prime Minister Junichiro Koizumi is
planning a supplementary budget in order to help stimulate the
economy and prevent further job loss. In commenting on this fact, the
article asserts that Koizumi "has surrendered a bit of the moral high
ground." The article does not explain its moral characterization of
fiscal policy.


Poland

Ex-Communists Poised for Victory in Poland
Edmund L. Andrews
New York Times, September 21, 2001, page A3

This article discusses the current economic and political situation
in Poland, which is expected to result in an election victory on
Sunday for the reconstituted Communist Party. The article notes that
Poland is suffering from high unemployment, commenting: "largely
because of rigid work rules and high taxes, job growth has
consistently lagged behind economic growth. Economists and government
officials say Poland needs to grow by 5 percent annually, a rate that
most countries would consider spectacular, in order to achieve any
reduction in joblessness."

The difference between economic growth and job growth is productivity
growth. Economists view productivity growth as the main long-run
determinant of living standards. The fact that Poland has a large gap
between its rate of economic growth and employment growth implies
that it is experiencing rapid productivity growth. If this is
attributable to rigid work rules and high taxes, as the article
claims, then it would be a strong argument in favor of rigid work
rules and high taxes.

It is also worth noting that 5 percent is not an especially
impressive rate of growth for a developing nation, like Poland. In
the period from 1960 to1980, the average rate of growth among
developing nations exceeded 5 percent.


The Airline Industry

Airline Aid Plan Gains; Layoffs Near 86,000
Greg Schneider, Glenn Kessler, and Keith L. Alexander
Washington Post, September 20, 2001, Page A1

This article examines the problems facing the airline industry in the
wake of the terrorist attack and Congressional proposals for a
bailout. At one point the article asserts that "high labor and fuel
costs made the [airlines'] situation worse." The article does not
indicate how it has determined that the labor costs faced by the
airlines are "high." Obviously the airlines, like all businesses,
would make more profit if they could pay their workers less, but the
article does not present any evidence to indicate that the industry
is paying its workers above market wages.


Argentina and Brazil

Feeling the American Aftershock
Jennifer L. Rich
New York Times, September 18, 2001, page W1

This article examines the economic fallout from the September 11th
terrorist attacks on the economies of Argentina and Brazil. It
discusses at some length Argentina's efforts to balance its budget --
a condition that the I.M.F. imposed in order for Argentina to receive
a new set of loans.

At one point the article refers to this effort as a "pledge to live
within its means." Later, it refers to it as "fiscal discipline."
Argentina is currently in the third year of a recession. There is no
obvious reason that a nation cannot or should not run modest budget
deficits -- like the one recently experienced by Argentina -- during
a recession.

Prior to taking steps to reduce its deficit, Argentina was projected
to have a deficit that was approximately equal to 2.3 percent of its
GDP. By contrast, the federal budget deficit in the United States hit
a peak of 4.7 percent GDP in the last recession and 6.0 percent of
GDP in the early eighties recession. It is also worth noting that
Argentina's ratio of government debt to GDP ratio is actually lower
than the ratio in the United States in the early nineties, therefore,
there is no obvious sense in which its deficits could be said to be
unaffordable.

Budgets inevitably move toward deficit in an economic downturn as tax
collections fall and transfer payments for programs such as
unemployment insurance increase. Economists generally view this
dynamic as being positive, since the increase in demand created by
the deficit helps to offset the downturn.

The demand by the I.M.F. that Argentina cut its deficit, even while
it is in the middle of a recession, would be predicted to lead to a
further decline in output and rise in unemployment. While the I.M.F.
may be in a position to force Argentina to follow this policy in
spite of its economic consequences, it is not apparent that it should
be characterized as "fiscal discipline."

Later, the article characterizes Brazil as having a "chronic current
account deficit." Actually, developing nations often do run current
account deficits. It is usually expected that there will be an inflow
of capital from industrialized nations -- which will help to finance
the construction of factories and infrastructure in developing
nations. This situation has been reversed in recent years, as the
United States has become a massive borrower of capital and some
developing nations, such as China, South Korea, and Malaysia have
begun to run massive current account surpluses.

The article also asserts that "to keep inflation from growing out of
hand, the country will probably have to aggravate its own recession,
by cutting spending sharply and tightening monetary policy." No
source or evidence is given for this assertion.

It is worth noting that the I.M.F. has consistently warned about the
possibility of inflation getting out of control in Brazil. For
example, it insisted that the country maintain an over-valued
currency in 1998 for this reason. When the country eventually was
forced to devalue in 1999, inflation remained relatively mild.