Comments on economics, mystery fiction, drama, and art.

Friday, February 27, 2009

Another round of bad news seems to be upon us

So let's start off with the "good" news. One of the primary reasons that the revised measure of the change in GDP (down at a 6.2% annnual rate in the fourth quarter, instead of the preliminary -3.4%) is that inventories shrank more rapidly than the BEA originally thought. So businesses now probably have less in the way of excess inventories, and they may--may--begin buying for inventory accumulation purposes sooner.

You can read the BEA press release here. Which components of GDP took the largest hits?

Personal Consumption Expenditures on durable goods, down 22.1% on an annual basis. This is not a surprise. Spending on durable goods is fairly easily postponable, and we already knew that new car sales have fallen off the table. [Overall, consumption spending was down only (well, "only" is a relative term; this would usually be considered a sharp decline) 4.3%.]

Gross Private Domestic Investment, down 20.8% on an annnual basis.

Exports fell 23.6%, with exports of goods down 33.6%. On a somewhat cheerful note, exports of services rose 3.5%. (Imports also fell, by 16%.)

All in all, an even more depressing quarter to end 2008 on than we had thought.

And--next Friday, we get the employment report for February, which, from all indications, will be, um, not good.

Additional commentary by Felix Salmon, Brad DeLong, Mark Thoma, Paul Krugman, and Calculated Risk. The New York Times story is here.

Thursday, February 19, 2009

Extraordinary events in financial markets

A colleague and I are working on an op-ed piece for a local paper on the economics of the financial crisis. here's where we are, so far.
In the last six months, the Federal Reserve has taken unprecedented steps to deal with a meltdown of the U.S. (and global) financial markets. Triggered by falling home prices, financial markets had to deal with collapsing values of mortgage-backed securities; this crisis almost immediately bled over into the entire collateralized debt obligations market. The balance sheets of banks, investment banking firms like Goldman, Sachs and Lehman Bros., and other financial firms saw their assets shrinking, while their liabilities remained. They were faced with at least temporary insolvency, and financial markets hit a wall of lack of liquidity—no one wanted to lend, especially not to other financial firms.

The Fed began by taking what can only be called a traditional response to a liquidity crisis—it tried to add to the liquidity of financial firms, so as to encourage them to resume lending, financing not only financial market activities, but also inventories and capital equipment purchases of firms across the breadth of the economic landscape. The Fed adds to liquidity by buying securities in the open market (these are called “Open Market Operations”), and when the Fed does this, the composition of the Fed’s balance sheet changes—it adds both to its assets (the securities it buys) and to its liabilities (the reserve accounts that banks maintain at the Federal Reserve banks).

And the Fed did a lot of this. Between the end of August, when the Fed held assets worth about $985 billion, and February 12, when the Fed’s assets totaled about $1,882 billion, it nearly doubled its asset holdings. What effect does this have? Almost directly and almost immediately, increases in the Fed’s asset holdings add to reserves held by commercial banks in the U.S.

Banks hold reserves for, essentially, three reasons. First, because the Fed requires then to hold reserves equal to (approximately) 10% of their checking account balances. Second, to be able to meet ordinary banking needs—to clear checks, to have cash available for customers who want it. And, third, to be prepared for extraordinary financial events. In the ordinary run of things, banks hold little or no reserves for the third reason. And they hold as little as possible for the other two reasons, simply because reserve holdings have historically been, for banks, idle balances on which they earn no income. To earn income, they need to use their reserves to make loans, or to buy other financial assets.

So in the ordinary course of business, banks would have responded to this influx of bank reserves by making new loans, or buying corporate or government bonds. This time, they did not. Bank reserves, which were $44 billion on August 1, 2008 soared to $861 billion on January 1, 2009—an increase of 1800%. (Between January 1, 1959 and August 1, 2008, bank reserves grew by only 133%, in total—over 49+ years.) Of the roughly $900 billion that the Fed added to its balance sheet, banks added more than 90% to their reserves—they reacted by hoarding reserves, not by making loans. Bank’s excess reserves—the amount of reserves they held in excess of those that the Fed requires them to hold—rose from $1.9 billion on August 1 to $798 billion on January 1.

In other words, banks used this extraordinary, unprecedented increase in bank reserves not to make loans, but to protect themselves against some extraordinary financial event. And, as a result, the nation’s money supply, although it grew quite rapidly between August 2007 and January 2009, did not grow at anything approaching the growth in the liquidity that the Fed was throwing at the financial system.

One measure of the money supply, M1 (consisting of currency in circulation plus checking account deposits), grew by about 13% during this period. A broader definition of money, M2 (everything in M1, plus essentially certificates of deposit and savings accounts), grew by only 7.6%.

Still, this is exceptional growth in the money supply over a five-month period. For M1, the only faster five-month growth occurred from July 2008 to December 2008, when it grew by 16%. For M2, this is the fastest five-month growth ever recorded. (Both these statements refer to the period beginning in January 1959, which is when the available data series begin.) In ordinary times, our strongest fear right now would be not a recession, not a cataclysm like the Great Depression, but out-of-control inflation.

And there is no inflation. Using the Consumer Price Index, we see a declining general level of prices for the past five months (through December 2008; the January 2009 CPI has yet to be released), with prices as of December 4% below their July level.

How can this be? Economists use a concept called the “velocity of money,” that measures, essentially, how quickly we “turn over,” or spend, the money available to us. If velocity gets larger, then people are spending money faster, and a given money supply will support more spending. If velocity slows down, then people are spending money more slowly, and a given quantity of money will support less spending.

And velocity has slowed down. Using M1 as our measure of money, velocity has slowed down by 10% in 2008, and we don’t have the data yet for the fourth quarter. Using M2, velocity has slowed by 7%. In short, the increases in the money supply have been essentially totally offset by slower spending. Just as banks are hoarding reserves, businesses and consumers are hoarding money.

With the financial system still in shock and awaiting the next crisis, and with consumers and businesses cutting back as fast as they can, what is to be done?

Wednesday, February 18, 2009

Keynes speaks

"The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately. "

John Maynard Keynes, from The End of Laissez-Faire
(from a posting on the Society for the History of Economics website by Sumitra Shah of York University, Toronto, Canada)

Thursday, February 12, 2009

Fun monetary facts

M1 (coin and currency in circulation plus checking account deposits) is now less than the monetary base...or, checking account deposits are now less than bank reserves at the Federal Reserve...

That's scary.

Textbook prices and other delights

There's a wonderful discussion over at Crooked Timber about the economics of textbooks, which is worth a read if you're in the higher ed biz. The issues are real, but the solutions are not obvious.

Over the past 40 years or so (since I entered college), textbooks have changed a lot. My textbook for introductory economics, written by Jay Wiley and published by Richard D. Irwin (now a piece of the McGraw-Hill octopus) had about a dozen graphs and maybe two dozen tables. In the mid-1960s, including graphs and tables in a text was quite expensive; you needed a graphic artist to do the graphs and special typesetting for the tables. It also meant that getting a grip on the meaning of something like the marginal product of labor in a Cobb-Douglas production function was a bit tricky.

Wiley's book came with no study guide and, of course, with no on-line study materials. For the instructor, there were no teaching materials (including no test banks; personally I don't use test banks, because I don't like the questions. They can be valuable, however, in suggesting things to write questions about). While the study guides can be sold, all the rest of that, which are now commonplace pieces of a textbook package, is usually some form of free...but it's not costless.

Some of the comments at Crooked Timber point our, correctly, that reading a textbook is different from reading other materials, and may work less well on line than ofther forms of text. I think that's true. Another comment (Marcus Pivato, comment #42) points out how difficult it is to prepare a finished textbook. Having written a study guide, I can certainly agree with that. The first draft was pretty painless, maybe 10 - 15 hours per chapter for a 16-chapter book. But the rewites-and-edit took forever, easily 25 - 30 hours per chapter. And this was for a book without any interactive features, without anything much in the way of graphics. A textbook takes exponentially more time. (I have some colleagues who have written textbooks. All of them say it was the most difficut, most time consuming, and least rewarding thing they have ever done professionally.)

Anyone who thinks it'd be easy to put together a textbook online or as a .pdf is mistaken. It's a job, it's difficult, and at all the places I've taught, it gets you relatively little credit (or money, inthe form of salary increases). You have to do it because it's something you feel is important. And then you hve to hope it makes a difference.

Sunday, February 08, 2009

Stimulus priorities

One of the local newspapers asked me last week what my priorities would be for a stimulus package. Here's what I suggested:

These are not necessarily in order of importance, although 1, 2, and 3 are the things I would place at the head of the list.

1. Increased spending on infrastructure projects. There’s generally a number of these that are pretty much ready to roll. In northwest Indiana, these could include speeding up highway repair and maintenance projects, work on the existing South Shore lines, and extending the South Shore to serve more of the region.

2. Increased federal assistance to state and local governments. Unlike the federal government, state and local governments mostly have to present balanced budgets. In recessions, this can mean cutting state and local government spending, and laying workers off, at the worst possible time. A temporary Increase in federal support for state and local government can help avert this.

3. A temporary extension of unemployment insurance benefits for laid-off workers. Expanded unemployment insurance benefits to help laid-off workers pay for health care insurance under the current COBRA provisions.

4. A serious effort to mitigate foreclosures on residential mortgages. Returning to the “old” bankruptcy standards that allow bankruptcy judges to adjust mortgage debt. (This used to be legal, but was made illegal in the bankruptcy “reforms” enacted a few year back. Oddly, the new law disallows such adjustments for a primary residence, but does allow them for vacation or secondary residences.)

5. A temporary reduction in payroll tax rates, especially unemployment insurance and worker’s compensation tax rates, with the foregone revenue made up from the general revenues of the federal government. Both these programs are federal mandates, but the revenues come from state tax levies. Reducing those levies now will provide some tax relief to businesses, but the revenues will have to be made up to allow the programs to continue to operate.

6. A temporary increase in federally-funded student financial aid for higher education. Many people have lost jobs, and many more are likely to do so in the coming months. Temporarily increasing student aid, including, perhaps, stipends for living expenses (as were provided, for example, under the GI Bill after World War II), would make it easier for people who have lost their jobs to enhance their skills, develop new skills, and prepare for the changes the economy is certain to go through in the future.

You will doubtless note the absence of cuts in federal personal income taxes or federal business income taxes or federal capital gains taxes. I don’t think those are likely to be especially effective in combating the recession. You will also note that I specify that much of this be temporary. We’re trying to solve a temporary problem, so the remedies should be temporary.

Saturday, February 07, 2009

Some (more) evidence for the proposition that monetary policy is currently pushing on a string

The velocity of money measures the "speed" with which money turns over. When velocity falls, then people are holding on to money longer, spending a given quantity of money less rapidly, and total spending falls. If this is happening, then expanding the quantity of money is less effective at providing a boost to spending. (Velocity is calculated as nominal GDP divided by the money stock.)

And recently, the velocity of money, regardless of how one measures it, has declined sharply.

The M2 velocity of money peaked during the second quarter of 2006 at 1.934. In the fourth quarter of 2008, it had declined to 1.780, a decline of 7.9%. That's the largest decline in M2 velocity over a 10-quarter period since late 2002/early 2003, and the fifth largest since 1959.

The M1 velocity of money continued to rise (erratically) until the second quarter of 2008, when it reached 10.380. By the fourth quarter of 2008, it had declined by 10.3%, to 9.310. This is the largest decline in M! velocity over a 2-quarter period at least since 1959 (which is far back as my M1 series goes).

So in addition to having no further room to cut discount rates, the Fed faces a public that is, increasingly, holding on to the money it has. No wonder a lot of economists think we've hit a liquidity trap.

Friday, February 06, 2009

About what we were expecting, actually

The BLS has pubished its report on the employment situation in January, and it is, I think, in line with expectations.

Unfortunately, we were expecting bad things. And we got them. Establishment employment, done 598,000 from December 2008, and about 3.5 million since January 2008. Over the past year, that's about a 2.5% drop in total employment. Aggregate hours worked are down about 3.5% over the past year as well.

Two industries of particular importance to where I live and work, are motor vehicles and parts, and steel. Employment in the manufacture of motor vehicles and parts is down about 30,000 from December (about 4%) and nearly 200,000 (about 22%) since January 2008.

Not surprisingly (motor vehicle manufacturing is, of course, a major customer for the steel industry), employment in iron and steel mills has also experienced significant employment declines. Data are not available for January, but the December 2007 to December 2008 decline is more than 5%; I will be extremely surprised if employment in iron and steel mills does not fall significantly in the next few months. (Data for primary metals manufacturing is available; it fell by about 2% between December 2008 and January 2009, and is down by about 9% since January 2008.)

The overall unemployment rate rose about as expected, from 7.2% in December to 7.6% in January. Here are the changes (January 2008 to January 2009) in the Labor Force Participation Rate, the Employment-Population Ratio, and the Unemployment Rate, for adult men (white, African-American, and Asian separately) and for adult women (for the same ethnic groups:

Adult Men
..............LFPR, down from 76.4% to 75.4%
..............EPR, down from 73.5% to 70.2%
..............UR, up from 3.9% to 6.8%

..............LFPR, down from 71.3% to 70.7%
..............EPR, down from 65.4% to 60.7%
..............UR, up from 8.3% to 14.1%%

..............LFPR, down from 79.2% to 77.9%
..............EPR, down from 76.5% to 72.5%
..............UR, up from 3.5% to 6.9%

Adult Women:
..............LFPR, up from 60.2% to 60.4%

..............EPR, down from 57.9% to 56.9%
..............UR, up from 3.8% to 5.8%

..............LFPR, down from 64.4% to 64.1%

..............EPR, down from 59.7% to 58.2%
..............UR, up from 7.4% to 9.2%

..............LFPR, down from 61.6% to 59.7%
..............EPR, down from 59.9% to 56.8%
..............UR, up from 2.8% to 4.9%

Thursday, February 05, 2009

The bad news (so far) in February

And it's only February 5...the employment report hits tomorrow...

January 2009 retail trade news here.

To say nothing of the much larger than expected decline in factory orders.

And the catastrophic (January 2009) auto sales reports here. 40% lower than January 2008.