Bond spreads

Here's an interesting piece of information--the spread between BAA and AAA bond rates, from 1919 to 2008. Note that the spikes tend to occur in severe recessions (the Great Depression, the recession of 1937/38, the 1974/75 recession, the 1980/82 recessions, and our current unpleasantness. I think the best explanation of the spikes is an increase in the risk premium during serious economic downturns. That is, it's another indication of a "flight to quality"--although how much faith we can place right now in an AAA bond rating is not so clear to me.

Aggregation in The General Theory

Tyler Cowen is blogging his way through Keynes's The General Theory of Employment, Interest, and Money, and he's just done Chapter 7. (Chapter 1; Chapter 2; Chapter 3; Chapter 4; Chapter 5; Chapter 6). One of his conclusions about Chapter 7 is this: "The last two paragraphs of this chapter are a nice statement of what macroeconomics is all about." So what are the last two paragraphs of Chapter 7, and why are they so important? (Actually, I think it's the last three paragraphs, so I'll add that one.)

"The reconciliation of the identify between savings and investment with the apparent "free-will" of the individual to save what he chooses irrespective of what he or others may be investing, essentially depends on saving being, like spending, a two-sided affair. For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.

"The above is closely analogous with the proposition which harmonizes the liberty, which every individual possesses, to change, whenever he chooses, the amount of money he holds, with the necessity for the total amount of money, which individual balances add up to, to be exactly equal to the amount of cash which the banking system has created. In this latter case the equality is brought about by the fact that the amount of money which people choose to hold is not independent of their incomes or of the prices of the things (primarily securities), the purchase of which is the natural alternative to holding money. Thus incomes and such prices change until the aggregate amounts of money which individuals choose to hold at the new levels of incomes and prices thus brought about has come to equality with the amount of money created by the banking system. This, indeed, is the fundamental proposition of monetary theory.

"Both these propositions follow merely from the fact that there cannot be a buyer without a seller, or a seller without a buyer. Though an individual whose transactions are small in relation to the market can safely neglect the fact that demand is not a one-sided transaction, it makes nonsense to neglect it when it comes to aggregate demand. This is the vital difference between the theory of the economic behaviour of the aggregate and the theory of the behaviour of the individual unit, in which we assume that changes in the individual's own demand do not affect his income."

The first of these three paragraphs is a statement of the paradox of thrift. The second notes the interdenpedence of actions. And the third invokes the aggregation problem, arguing that aggregation of individual actions can lead to outcomes that are not the same as simply the individual actions writ large. We teach this, in introductory economics, by invoking the Fallacy of Composition; Keynes's insight here, in Chapter 7, was to recogninze the importance of the Fallacy of Composition for the operation of the aggregate economy, and to propose a theoretical structure that took it into account

A pricing puzzle

I collect art, mostly prints. I collect prints for a couple of reasons. First, I understand the process of printmaking better than I do the processes of painting or sculpture. Second, because prints come in editions (multiples), there's typically somewhat better price information available than there is for unique pieces. (I should add that the web makes collecting art all too easy, especially if you find galleries that are reliable. Unfortunately, or maybe fortunately, I have.)

I recently found a print that I like a lot, by an artist whose work in general I like a lot, and I found it at three online galleries. I've purchased from two of these galleries in the past. My experience has been that, when I find the same print in multiple galleries, the prices are usually almost the same. (In the price range in which I buy things, that means a variation of 2% to 3% between galleries.)

For this print, though, the three prices were (a) $650, (b) $975, and (c) $1200. Based on the decstiptions of the individual prints, and from additional information I requested, the price differences do not appear to be based on differences in the condition of the prints (but I think I will find out--I bought the $650 version). In some colloquy with the owner of the gallery with the $975 price, I received this explanation of the price variation: "The variation is usually determined by how much you pay for the print and how important the artist is in the art world."

Now, frankly, part of this makes no sense. Who the artist is (reputation, pricing history) clearly matters. But in this case, that's not a variable. What's left is the price that the gallery paid for the print. To an economist, however, this cannot provide an adequate explanation. Here we have three apparently identical items, with a mean offer price of about $940 and a standard deviation of about $275 (yeah, I know that the sample size is vanishingly small). And these prices are easy to find. How could either of the higher-priced galleries make a sale, at least until the lowest-priced print had been sold?

The only plausible answers I can come up with is that these gallery didn't do their homework, or that the owners galleries (b) and (c) have a much lower rate of time preference than does the owner of gallery (a).

And things get worse in the labor market

Today, the BLS released its report on the Employment Situation for December 2008. If you really want the details, click through and read it. The lowlights:

*The unemployment rate jumped from 6.8% to 7.2%, its highest level since January 1993. It's worth noting that, in both of the most recent recessions, the unemployment rate continued to rise even after the economy began to recover. I don't think anyone thinks we're at the trough yet.

*Employment, measured by the household survey, fell by 806,000 between November and December. It's now down by about 3 million since its cyclical peak in January 2008.

*Employment, measured by the establishment survey, fell by 524,000 between November and December, and is down by about 1.9 million over the past 4 months. Establishment employment has now declined for 12 consecutive months and is about 2.5 million below its cyclical peak in December 2007.

(And I'd like to thank Brad Delong for reminding us that these data are now nearly a month old...things have clearly not improved since early-to-mid December.)

Of additional interest is a report on the number of workers who are employed only part time as a result of what the BLS refers to as "economic reasons;" this is often called involuntary part-time employment. Here's the lead: "In November 2008, 7.3 million persons were employed part time for economic reasons, up by 3.4 million from a recent low of 3.9 million in April 2006." But the reality is worse than that. Looking at Chart 1 in the report, it appears that involuntary part-time employment has increased from about 4.5 million at the beginning of 2008 to 7.3 million in November--an increase of over 60%. In other words, almost all of the increase in involuntary part-time employment has occurred since the current recession began.

This is one of the facts that lead some observors to argue that the unemployment rate does not provide as accurate a measure of labor market distress as we might like. And, in fact, involuntary part-time employment generally rises sharply in recessions. In the 2001 recession, it rose by 12% or so; in the 1990-91 recession, by about 40%; in the 1980-82 recessions, by40%; and in the 1974-75 recession, by about 33%. So, in this recession, the rise in involuntary part-time employment has been, as usual large--but, compared to recent recessions, much larger than average.

This does lend support to the conclusion that this recession is deeper than the increase in unemployment and in the unemployment rate have suggested. Comparisons to the 1980-82 recessions look more and more appropriate.

And now, a word or two on the rate of inflation

Beginning in about October 2007, one could have begun to worry about the rate of inflation. Here are the annual rates of inflation, beginning in October 2007, calculated monthly as the percentage change in the CPI from one year earlier:

October 2007...............3.5%
November 2007...........4.4%
December 2007...........4.1%
January 2008...............4.4%
February 2008.............4.1%
March 2008..................4.0%
April 2008.....................3.9%
May 2008......................4.1%
June 2008.....................4.9%
July 2008......................5.5%
August 2008..................5.4%
September 2008............4.9%
October 2008.................3.7%

And, then, November 2007 to November 2008:
November 2008.............1.0%

In fact in the last four months, the CPI has declined from the prior month. A December decline of the same magnitude as the October-to-November one will result in a fall in the CPI from December 2007 to December 2008. So despite everything that the Federal Reserve has done to inject liquidity into the economy, inflationary pressures have, essentially, vanished, and vanished rather abruptly--annualizing the monthly increase in the CPI from June 2008 to July 2008 gives us a 9% annualized rate of inflation. From July 2008 to August 2008? -1.6%. October to November? A staggering -19%.

A Little Good News Would Be Nice

But apparently we don't have any yet.

Automobile sales in December fell again, and by startingly large percentages, compared with December 2007.

Chrysler's sales were down 53% in December, compared with December 2007.
Toyota's sales fell 37%.
Honda? Down 35%.
Ford--down 32%.
GM's sales were off 31%, as were Nissan's.

And here's Ford's senior economic analyst, Emily Kolinski Morris:"We expect the first few months of 2009 to feel much like last three months of 2008."

The current estimate is that sales for 2008 as a whole will be down 18% (to about 13 million vehicles) from 2007; one source--Global Insight--projects 2009 sales at 10.3 million, or about 20% below the 2008 level. Sales haven't been that low, on an annual basis, since 1982.

And, of course, the decline in motor vehicle sales (and production) and the collapse in construction spending have consequences, not least on the steel industry, where we find that "[t]hrough August, steel production was actually up slightly for the year. The decline came slowly at first, and then with a rush in November and December. By late December, output was down to 1.02 million tons a week from 2.1 million tons on Aug. 30, the American Iron and Steel Institute reported. The price of a ton of steel is also down by half since late summer."

Doesn't this all make you feel better?