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Final Demand and the Inventory Cycle Print
Friday, 30 July 2010 15:17

Economics seems to be the science of forgetting. All the great truths that were pounded into our heads when we grad students, or even undergrads, seem to be missing from the thinking of those making pronouncements on the economy and economic policy.

For example, the housing wealth effect, a well-established economic doctrine firmly rooted in the center of the discipline, seems to have disappeared from most discussion of consumer spending patterns. The basic point -- that a dollar of additional housing wealth leads to 5-7 cents in additional consumption each year -- explains both the consumption boom at the peak of the bubble and the falloff in consumption in the wake of its collapse. Instead of noting the huge amount of lost housing wealth and recognizing the drop in the consumption and rise in the saving rate are permanent, economists and economics reporters are looking at consumer attitudes and hoping that greater optimism will lead to a new spending boom.

In the same vein, it is remarkable how little attention a very classic inventory cycle has received in explaining the changes in GDP over the last five quarters. The basic story is that firms were shedding inventory as fast as they could in the 4th quarter of 2008, with the rate of decline increasing into the first quarter of 2008. Although inventories continued to decline in the second quarter, they declined at a slower rate, which meant that inventories added to growth. Eventually firms stopped cutting inventories and began rebuilding. In the most recent quarter they were adding inventories at a very rapid pace, $85.9 billion a year.

With the latest figure, the inventory cycle has come to an end. I don't have a crystal ball telling me the rate of inventory accumulation in the next few quarters, but it is unlikely that it will be much higher than the current rate. This means that inventories will provide little boost to growth in future quarters, making GDP growth look like final demand growth and that is not very good.

While GDP growth has been erratic over the last four quarters, final demand growth has been much less so. It has been consistently weak, averaging just 1.2 percent. In the most recent quarter it was 1.3 percent. So unless we have some good reason for final demand growth increasing (state and local cutbacks, the end of the housing tax credit, and the phasing down of the stimulus all push the other way), we can expect very slow GDP growth for the next several quarters and rising unemployment.

gdp-final_demand_28123_image001

 

 
It’s Friday Morning; That Means It’s Time to Beat Up David Brooks Print
Friday, 30 July 2010 11:14
Normal 0

As we all know, there are two types of people in the world: those who say that there are two types of people in the world, and those who don’t. David Brooks tells us today that he is in the former category.

 

He etches out two fundamental positions in economic policy debates. On the one hand are the Obama liberals who believe in an expanded role for government in directing the economy. Brooks’ Obama liberals believe that the government has to rein in business and protect the citizenry.

 

His other pole is the Paul Ryan conservative. Paul Ryan conservatives believe in unleashing the power of individual entrepreneurs. They want to get the government out of the way by privatizing Social Security, Medicare, and other programs currently provided by the government.

 

The David Brooks categorization gives us a great fairy tale about the battle of big government liberals versus market-oriented conservatives. But, suppose we step back to the real world for a moment. Let’s imagine that we want to structure the government and market to provide services in the most efficient way and don’t particularly care about whether that means big or small government, which are not well-defined concepts in any case. Outside of David Brooksland, there are many people who hold this view.

 

When we consider a program like Social Security, we would ask how to carry through its purpose – ensuring workers a core retirement income— at the least possible cost. Any serious analysis would almost certainly show that some public Social Security type program fits the bill.

 

The administrative costs of the Social Security program are approximately 0.6 percent of what is paid out in benefits each year. By contrast, the administrative costs of privatized systems like the ones in Chile and the U.K. are on the order of 15-20 percent of the benefits paid out annually.

 

Furthermore, these privatized systems do not allow individuals to do what they want with their money. They threaten them with jail if they don’t turn over a fraction of their earnings to the financial industry each year. So the commitment to a privatized Social Security system seems more like a commitment to force people to give money to Merrill Lynch than a commitment to individual freedom.

 

The same applies to privatizing Medicare. We can hand people vouchers and tell them to buy the health care they want. However, this would require a massive array of laws and bureaucracy to ensure that the providers accepting these vouchers were not gaming the system and ripping off beneficiaries and the government. This approach can increase profits for insurers and providers but there is no evidence whatsoever to suggest that it would make it possible to provide the elderly with health care at a lower cost.

 

We can take steps to lower costs and reduce the role of government that will send David Brooks’ small government types fleeing in horror. Suppose that we got rid of government patent monopolies and allowed all prescription drugs to be sold at generic prices in a competitive market. Free market types should love this one. Instead of drugs selling for hundreds, or even thousands, of dollars per prescription, they could be bought at chain drug stores for five or ten bucks.

 

The research could be supported by government research grants awarded through competitive contracts. The government already spends $30 billion a year on biomedical research through the National Institutes of Health. If this sum was doubled, then it would probably be sufficient to replace the industry’s funding; especially if a requirement of getting grants was that all research findings would be posted on the Internet where they would be freely available to other researchers.

 

We could also try a variation of the Paul Ryan approach to Medicare vouchers. Instead of creating an incredibly burdensome task of policing a privatized system in the United States, we can allow beneficiaries the option to buy into the much more efficient systems in Europe, Canada and elsewhere. Free market types should love this win-win situation where giving beneficiaries a choice will allow taxpayers to save money on Medicare and put large sums of money (more than $10,000 a year in many cases) into the pockets of our retired workers. But, this voucher system means less money for the insurers, the drug companies and other providers, so Paul Ryan would not support it.

 

There are many other cases where smaller government can be used to accomplish the progressive goals of providing basic needs and limiting inequality[CSN]. But Paul Ryan and his friends are not likely to be interested in these policies. This might suggest that, in spite of what David Brooks tells us, Mr. Ryan’s concern is not reducing the size of government, but rather redistributing income upward.

 

Of course, upward redistribution of income is not a very good political platform since there are many more people who end up losers in this story than winners. And, in a democracy, politicians are unlikely to win elections if they promise to take money out of most voters’ pockets.

 

So, Mr. Ryan and David Brooks come up with stories about how conservatives want to limit government and unleash individual entrepreneurs. The story might have little basis in reality, but that doesn’t mean that you can’t get it in the NYT and persuade lots of people to take it seriously.   

 
New Economic Study: If People Don't Eat Chicken, They Will Starve to Death Print
Thursday, 29 July 2010 17:21

This surprising result -- that the failure to eat chicken leads to starvation -- would be shown true using the same methodology of a new study on the impact of the TARP. The study, by Princeton University Professor Alan Blinder and Mark Zandi, the chief economist at Moody's Analytics, examines the impact of the TARP and the stimulus on economic growth and unemployment. It finds that GDP would be 11.5 percent lower in 2010 had it not been for these two policies, with about three quarters of the benefits attributable to the TARP and various Fed/Treasury/FDIC policies that provides aid to the financial sector.

While the analysis of the stimulus is pretty standard and very much in keeping with other estimates, this is not the case with the analysis of the financial sector policies. The problem with the study is the implicit counterfactual. It effectively assumes that if we did not do the TARP and related policies, that we would have done nothing even as the financial sector melted down.

This is comparable to doing an analysis of the benefits of eating chicken where the counterfactual is that people eat nothing. Needless to say, we would find very large benefits to eating chicken in such a study.

Suppose as an alternative counterfactual, we let the market do its work. Citigroup, Goldman Sachs, Bank of America, Morgan Stanley would be out of business, with their highly paid CEOs walking the unemployment lines. Rather than doing nothing, we could have the Fed flooding the system with liquidity (much as it did), without having to worry about money being siphoned off by bonuses for the honchos who led these banks to ruin.

It would be difficult to fully flesh out the counterfactual in this scenario, but it is certainly more plausible than the one described by Blinder and Zandi. If we need a study to make us feel good about the fact that the Wall Street is rich while the rest of the country is poor, it fits the bill, but it is not serious analysis and the media should not treat it as such.

 
Fits and Starts Are Not Common in the Early Stages of a Recovery Following a Steep Downturn Print
Thursday, 29 July 2010 13:24

The Post noted the weak economic data in recent weeks and then told readers:

"fits and starts are common during early stages of economic expansion."

This is not true for recoveries from steep downturns like the one the U.S. has just experienced. In the first four quarters of recovery following the 1974-75 recession the economy grew 3.1 percent, 6.9 percent, 5.3 percent and 9.4 percent. In the first five quarters following the 1981-82 recession the economy grew by 5.3 percent, 9.3 percent, 8.1 percent, 8.5 percent, and 8.0 percent.

We should be seeing robust economic growth right now based on past patterns. It is a very bad sign that we are not.

 
Economists Still Have Not Heard of the Housing Bubble Print
Wednesday, 28 July 2010 06:12

It is incredible that economists and economic reporters still focus on consumer confidence. Consumers are actually spending at a relatively high rate. (The savings rate is well below historic levels.) The problem is that they lost $8 trillion in housing wealth. The housing wealth effect on consumption is something that economists have known about for more than 60 years. It's too bad that they seem to have forgotten and so have the reporters who cover this issue.

The problem is not confidence. It is a lack of money. That is why consumers are not spending more and will not anytime soon regardless of how happy they are.

 
The Fed Could Try Talking About Bubbles Print
Tuesday, 27 July 2010 07:04

The Washington Post had an article discussing the debate over how central banks can prevent future economic collapses like the current one. As is its practice, the Post relied exclusively on economists who were not able to see the crisis coming. As a result, it fundamentally misrepresents the crisis as being primarily financial in nature.

In fact, the main problem was that the housing bubble was driving the economy, generating $1.2 trillion in annual demand through construction and housing equity driven consumption. There is no easy mechanism through the economy can replace this much lost demand. That would be the case whether or not the collapse of the bubble was associated with a financial crisis.

The article also fails to list one of the most simple and obvious ways that central banks can combat a bubble: talk. During the run-up of the housing bubble, Federal Reserve Board Chairman Alan Greenspan repeatedly said that everything was fine in the housing market, as did Ben Bernanke, who was a governor at the Fed for most of the period. This helped undermine the case of those who were warning of the bubble.

By contrast, if Greenspan had explicitly warned of the bubble and documented its existance and potential dangers with extensive research from the Fed staff, it may have been effective in containing its growth. The financial industry cannot simply ignore research from the Fed and there was no serious response to the evidence that the Fed could have presented.

There is no reason the Fed and other central banks cannot use the full capabilities of their research staff to attempt to counter dangerous financial bubbles. There is a virtually costless strategy with enormous potential payoffs.

 
If House Members Who Voted for Energy Bill Are Out on a Limb, It is Only Because of Bad Reporting Print
Tuesday, 27 July 2010 06:57
The Washington Post reported that House Democrats who voted for the energy bill are worried that it will hurt them in the election because their opponents have labeled it as a job killer. It would have been worth noting that there is no reason to believe that the bill would have led to a substantial loss of jobs. If opponents of the bill are able to score political points by describing the bill as a job killer it is only because the media have done a poor job in describing its impact.
 
Goldman's AIG Exposure Print
Tuesday, 27 July 2010 04:53

The NYT notes that recent documents suggest that Goldman Sachs was largely hedged against a potential AIG bankruptcy and that it had taken collateral from AIG and other counter-parties that would have almost fully compensated for any losses.

It is not clear that Goldman was as hedged as the documents suggest since, as the article mentions in passing, a bankruptcy court may not have clawed back some of the collateral posted. The other issue that would have been worth mentioning in this piece is that the government and Goldman resisted the release of documents at every point in this process. For 6 months after the initial bailout of AIG the government provided no information whatsoever about the counter-parties who had been paid with the money.

 
Why Did David Brooks' Pro-Growth Heros All Support the Policies that Gave Us the Economic Crisis? Print
Tuesday, 27 July 2010 04:39
I'm just asking. By the way, what measure is he using that shows that the United States has declining human capital? All the data with which I am familiar shows the workforce is getting more educated through time.
 
Is There a Shortage or Glut of Freight Shipping Capacity? Print
Tuesday, 27 July 2010 04:30

That is what readers of an NYT article on higher shipping fees for faster service must be wondering. The article tells readers that shippers now have a shortage of space because:

"With little demand for shipping, ocean carriers took ships out of service: more than 11 percent of the global shipping fleet was idle in spring 2009, according to AXS-Alphaliner, an industry consultant."

Okay, so we are seeing a big run-up in prices and, "fighting for freight, retailers are outbidding each other to score scarce cargo space on ships, paying two to three times last year’s freight rates — in some cases."

ummm, what happened to the 11 percent of shipping fleet that is now idle? The article does make a brief reference to this idle capacity later, noting that firms are reluctant to bring it back on line. This sounds a bit like a case of collusion to keep prices high. It might make for a good article by an enterprising reporter.

(I'm back from the DC power failure - 32 hours in my hood.)

 
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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