Alan Krueger, Assistant Secretary of the Treasury for Economic Affairs, suggested in a speech in October a useful metaphor to distinguish different kinds of economic indicators. Some indicators are like the gauges on the dashboard of the car — industrial production, unemployment, inflation and so on.  They give the latest bits of information on the business cycle outlook, for businesspeople , government policy-makers, economic forecasters, and anyone else who wishes to follow such developments at high frequency. Many of these numbers are typically collected on a monthly basis. Other statistics are like the results of 10,000 mile checkups – the poverty rate, infant mortality, life expectancy, carbon emissions, natural resource depletion, the crime rate, traffic congestion, leisure surveys, and other measures of inequality, health, the environment and the quality of life.  They are needed to supplement market-measured output in order to get a comprehensive feel for welfare and the longer term sustainability of the economy. This second category of statistics is more often collected on an annual basis.

GDP is the single indicator that gets the most attention. Lately much of that attention has been very critical. In late September, the most recent in a long line of critics weighed in. This group was weighty indeed: the Commission on the Measurement of Economic Performance and Social Progress was created by President Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi, with Nobel-Prize winners abound. The Commission apparently believes that we have been focusing too much on market-measures output “By their reckoning, much of the contemporary economic disaster owes to the misbegotten assumption that policy makers simply had to focus on nurturing growth, trusting that this would maximize prosperity for all. “What you measure affects what you do,” Mr. Stiglitz said…”If you don’t measure the right thing you don’t do the right thing.” (New York Times, Sept. 23, 2009.)

I certainly agree that the non-market variables are important, both in the sense that they should be measured well and in the sense that policy-makers should put some priority on them as objectives. But I question whether the measurement issue and the objective issue are as closely linked as many would have it. I especially question any claims that the role of GDP should be in practice be replaced with a concept that factors in these other measures of environment, inequality, health etc. GDP is a comprehensive measure of market output, and is available quarterly, and belongs on the dashboard. The other variables are typically available only annually, and there is no way to know how to aggregate them into a single number, let alone to aggregate them together with the standard economic measures. By all means, take the 10,000 mile checkups seriously. But don’t remove GDP from the dashboard.

I am not sure I see the claim that the reason for the myriad errors our national policy makers have made in recent years is the measurement problem (notwithstanding the Bush Administration’s notorious downgrading of science). We have perfectly good tools for helping to make decisions about environmental regulation, for example, in the form of cost benefit analysis. GDP measurement issues simply have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some genuine environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some genuine economic costs at zero or abandon cost benefit analysis entirely. Yes, that would have a big effect on the policy decision. But what does any of it have to do with GDP?

In the same newspaper reporting Joe’s comments, I read a report about a development that has received mysteriously little attention: according to numbers from the Energy Information Agency, greenhouse gas emissions fell sharply in 2008 (by more than 2 ½ %), are falling even more in 2009 (about 6%), and in the next few years are almost certain to remain easily below the levels of 2005.   (See the chart below.)  The oil price spike in 2008 deserves some credit. Some might wish to try to give some credit to policy too. But there can be no doubt that the main reason for the sharp fall in emissions is the recession. A simple statistic for the unitiated: although CO2 emissions in an average year rise by 0.8%, they fell that much in both 1991 and 2001, the last two recession years, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one weigh a 9 percent fall in emissions against a 3.8% fall in real GDP (from the 2007Q4 peak to the 2009Q2 apparent-trough)? I strongly suspect that a majority of Americans, no matter how well-informed, would think that the output loss far more than outweighs the climate benefit. A minority, in favor of very drastic action on climate change, might implicitly choose the other way. (I myself am in favor of pretty serious action, but not in favor of policies that impose huge economic costs, either because they are too drastic or are designed in an inefficient way. And of course engineering a recession would be a very inefficient way to do it.) Are Joe Stiglitz and Amartya Sen among those who think we are better off on balance? I have no idea. To ask the question is to help illuminate why attempts to sum everything up into a single number, such as “Green GDP,” fail.

Incidentally, if Joe does think that the estimated 9 percent fall in emissions outweighs the 4% loss in GDP, then he doesn’t think that our current situation constitutes a “contemporary economic disaster.” It would then logically follow that any policy decisions that got us into this situation were good (whether or not attributable to incomplete on false information about banking activity or inequality or anything else)!

So9urce: US EIA

          Numbers newly reported from the IMF’s COFER data base show that in the most recent quarter, the spring of 2009, the share of central banks’ foreign exchange reserve holdings that they allocate to dollars resumed its downward trend.   The dollar share has been gradually sliding since the beginning of the decade – perhaps because of the birth of a possible rival, the euro, in 1999, or perhaps because of the long-term path of tremendous fiscal and monetary expansion on which the United States embarked in 2001.   

          During the four quarters preceding the most recent one, the share of the aggregate portfolio that the world’s central banks allocated to dollars had temporarily reversed its downward direction.  Arithmetically, the main source of this increase in the dollar’s share was its appreciation against other currencies.   But another source was the action of central banks in industrialized countries, acquiring dollars more rapidly than other currencies.   The movement of the raw quantity shares can be seen in the first graph below, and the movement in the shares properly valued at current exchange rates in the second graph.   (I am grateful to Ted Truman and Dan Xie, both of the Petersen Institute for International Economics, for these graphs.)   

          Whether the temporary reversal from Q2 of 2007 to Q1 of 2008 is measured in quantity terms or in valuation terms, the phenomenon was presumably a (surprisingly strong) safe-haven reaction to the global financial crisis.  Apparently the recent easing of risk and liquidity concerns has now mitigated the flight into dollars.  The central banks that had shifted into dollars have begun to shift back a bit, into euros in particular.

          The gradual downward trend of the dollar’s share during the past decade is a continuation of the trend that began after the end of the Bretton Woods system: from the late 1970s until 1991.  The dollar’s share recovered from 1992 to 2000.  That temporary halt in the longer run trend may have been in part a result of the deficit reduction path that began with George H.W. Bush’s unpopular fiscal reversal and continued through the time of Bill Clinton achievement of fiscal surpluses, until George W. Bush took office and reinstated the chronic deficits.

          The usual response to worries that US macroeconomic profligacy will eventually end the dollar’s privileged position as lead international currency has always been that no asset constitutes a credible alternative for central banks to hold in their portfolios.   I have argued that, since 1999, the euro has constituted a credible alternative.   Based on econometric estimates of the determinants of central banks’ reserve holdings in research with Menzie Chinn, we have even gone so far as to report simulations that show the euro overtaking the dollar by 2022.  Many, like Truman, consider such speculation exaggerated.  They may be right.

           But the euro is not the only alternative to the dollar.  The yen, pound and Swiss franc remain viable alternatives for national authorities to put some of their reserves.  Furthermore, 2009 has seen the resurrection of two international reserve assets that had previously been written off as dead:  the SDR and gold.  My forecast is that we are gradually moving from the dollar standard to a global monetary system that features multiple reserve assets.

Share of central banks foreign exchange reserves allocated to dollars, 1999 QI – 2009 QII       (among industrial countries, among developing countries, and overall)

[Readers wishing to post comments are referred to the SeekingAlpha version.]

National leaders are meeting at the United Nations in New York today, to discuss the climate change negotiations.    Talks will continue at the G-20 meeting in Pittsburgh later in the week.   But hopes look very bleak for progress sufficient to produce at Copenhagen in December a successor treaty to the Kyoto Protocol.   The biggest roadblock is the familiar game of “After you, Alphonse.”  The United States will not accept quantitative emission targets unless China, India and other developing countries do the same, at the same time.    But the developing countries will not cut their emissions below the Business as Usual path (BAU) unless the rich countries go first. 

My own proposal for how to break the deadlock is a plan that tries in a politically realistic way to assign emission targets, leaving no country feeling it is being asked to incur an economic cost that is unfair or too large.    The targets are derived from a family of formulas   The specific detailed example of the plan that I have given in the past attained an environmental target by the year 2100 of CO2 concentrations equal to 500 ppm.  It did so without violating the political constraints, which included the constraint that no country is asked to accept an ex ante target that costs it more than 1% of income in present value, or more than 5% of income in any single budget period.

The G-7 leaders, meeting in Italy in June 2009, set a more aggressive collective goal, corresponding approximately to concentrations of 380 PPM.   I have recently been trying to hit that goal, working with Valentina Bosetti, within the same political constraints and framework of formulas.    To achieve the more aggressive environmental goal, we advance the dates at which some countries are asked to begin cutting below BAU.  We also tinker with the values for the parameters in the formulas (parameters that govern the extent of progressivity and equity, and the speed with which latecomers must eventually catch up).   The resulting target paths for emissions are run through the WITCH model to find their economic and environmental effects.   We find that it is not possible to attain the 380 ppm goal, subject strictly to our political constraints.  We are, however, able to attain a concentration goal of 460 ppm with somewhat looser political constraints. 

Some may conclude from these results that the more aggressive environmental goals are not attainable in practice, and that our earlier proposal for how to attain 500ppm is the better plan.   We take no position on which environmental goal is best overall.   Rather, we submit that, whatever the goal, our approach will give targets that are more practical economically and politically than approaches that have been proposed by others.

[Readers wishing to post comments are referred to the SeekingAlpha version.]

The field of International Monetary Economics is not without its own cycles and fads.

In a speech at the European Central Bank over the summer, “On Global Currencies,” I identified eight concepts that I saw as having recently “peaked” and eight more that I saw as newly rising in relevance. Those that I viewed as losing traction were: the G-7, global savings glut, corners hypothesis, proliferating currency unions, inflation targeting (narrowly defined), exorbitant privilege, Bretton Woods II, and currency manipulation. Those that I saw as receiving increased emphasis now and in the future were: the G-20, the IMF, SDR, credit cycle, reserves, intermediate exchange rate regimes, commodity currencies, and multiple international currency system.

A condensed version appears this month in Finance and Development, from the IMF, titled “What’s ‘In’ and What’s ‘Out’ in Global Money.”  I boil the list down to five concepts that I pronounce “on the way out” and five more that I see as replacing them:

• The G-7 has been rendered largely obsolete by its lack of representation of developing countries, and thus in the course of 2009 has been overtaken by the G-20.

• The corners hypothesis had become conventional wisdom by the end of the 1990s. This was the idea that all countries were or should be abandoning intermediate exchange rate regimes (bands, baskets, crawling pegs, adjustable pegs, and heavily managed floats) in favor of either the floating corner or the institutionally fixed corner (currency boards, dollarization, or monetary union). Since 2001 the tide has turned against the corners hypothesis, and far fewer economists would now assert it as a sweeping generalization.  Certainly a huge fraction of the members of the IMF continue to follow intermediate regimes.

• The language of “unfair currency manipulation,” has been in US law since 1988 and the IMF Articles of Agreement for longer. China during the years 2004-2008 was pretty much the first large country to face charges of unfairly manipulating its currency to keep it undervalued. But US Congressmen who have for years urged China to abandon its link to the dollar could well live to regret it, if they were to get their way and the People’s Bank of China did in fact stop buying US treasury bills. It is finally beginning to sink in among Americans that having China as its largest creditor carries with it some new constraints.  What concept is “on its way in,” to replace the idea that intervening to prevent one’s currency from appreciating is anathema?   Reserves.  Two short years ago, Western economists were lecturing surplus countries that they were acquiring too many reserves.  Today we see that the developing countries that have weathered the 2007-09 crisis the best are countries that had previously piled up the most reserves, other things equal.

• Most controversially, I assert that Inflation Targeting — narrowly defined, I hasten to add — has seen its best days. The definition of IT I have in mind is the proposition that the monetary authorities should set a target range for the increase in the CPI each year, and then should focus all their efforts on hitting it. This orthodoxy says that the central bankers should pay no attention to asset prices, the exchange rate, or commodity prices, except to the extent that they carry implications for the CPI. For large rich countries, it has become clear since 2007 that Alan Greenspan was wrong when he (plausibly) abjured all attempts to identify or discourage bubbles in real estate and stock markets. As a result, the credit cycle view of monetary policy has been resurrected , after a long period when only inflation was thought to matter. For smaller and developing countries, I would also argue that volatility in commodity prices has made it clear that monetary policy should let currencies depreciate, at least somewhat, when the terms of trade worsen, rather than the opposite as is implied by a strict interpretation of CPI targeting. For them, I would propose replacing the CPI target with a more production-oriented price index, such as a target for the PPI or even an export price index.

• The United States has benefited throughout the post-war period by an unlimited ability to borrow in dollars. A popular view two years ago, supported by some of the best scholars, was that the US had earned the dollar privilege by establishing a unique comparative advantage in supplying a saving-glut world with high-quality assets. Then the sub-prime mortgage crisis in 2007 revealed that US assets were not so high-quality after all. The dollar did retain the benefit of being the safe haven currency in 2008, as an exorbitant privilege — contrary to the predictions of those of us who had predicted that the unsustainable current account deficit would lead to a large depreciation. Nevertheless, some developments in the course of 2009 have suggested a global movement away from the unipolar dollar standard, and toward a new multiple international reserve system. These events include the gradual rise of the euro as an international currency to rival the dollar, the sudden and unexpected resurrection of the SDR from near-death, new interest in the yen and gold as safe haven assets (including among central banks), and the very first glimmerings of an international role for the RMB.

[Any readers wishing to post comments are referred to the Seeking Alpha version.]

The Queen of England during the summer asked economists why no one had predicted the credit crunch and recession.   Paul Krugman points out that, inasmuch as economists can almost never predict the timing of recessions (and don’t claim to be able to), the real questions are worse.  The real questions are, rather how macroeconomists (most) could have gotten it so wrong as to believe that:
(i) a severe recession was not even looming ahead as a potential danger, and
(ii) a breakdown of many of the world’s most liquid financial markets, in New York and London, was impossible to imagine.

To anyone wondering about these questions, I recommend Krugman’s essay in the New York Times Sunday magazine, September 6:  “How Did Economists Get it So Wrong?” .
I think his diagnosis of the state of macroeconomic theory for the last 30 years has it right. 

I would only add that he is modest in skipping over one point:  during Japan’s lost decade of growth in the 1990s Paul himself forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy – a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory.   But macroeconomics went on as before.   (Likewise with the stock market correction of 1987, the LTCM crisis of 1998, and the dotcom bust of 2000-01.   I do think, however, that our field did a better job with the emerging market crises of 1994-2001, in part because it was considered permissible to argue that financial markets in this case were highly imperfect.)

The list of scholarly economists who in my view deserve kudos for getting important parts of the crisis right ahead of time also includes, among others:

• Robert Shiller – for declaring most visibly that the housing boom was a bubble,
• Ned Gramlich — for pointing out most assiduously that families were being persuaded to take out mortgages that weren’t good for them,
• Ragu Rajan — for diagnosing most accurately the problems of excessive leverage in the financial system,
• Claudio Borio and Bill White at the BIS — for seeing most presciently the dangers of a monetary policy that ignored asset bubbles, and
• Nouriel Roubini – for warning most fortissimo how serious a future meltdown was likely to be.

Returning to Krugman’s NYT article, even the caricature drawings are good…  except that I have never seen Olivier Blanchard in a double-breasted suit.    But Robert Lucas definitely merits a place there as a leader of the orthodoxy:   When given one page in a recent  Economist essay to defend “freshwater” economic theorists regarding the crisis, he actually thought it was a useful rebuttal to point out that critics are repeating arguments they have made before.  And he also thought it was useful to explain:  “The term “efficient” as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.”  — As if it is not the latter question that the public is wondering about.

(For other economists’ reactions to the Krugman piece, see the National Journal site.)

 [Any reader wishing to make comments on this post is referred to the RGE version.]

A year ago, it occurred to me that if the popular blood lust against the financial sector was to be given vent, one could do worse than adopt a small (but global) tax on financial transactions.    On August 27 it was reported that Adair Turner, head of the UK Financial Services Authority, had come out in support of just such an idea, arguing that the financial sector is too large.   The Financial Times editorializes against the proposal, pointing out the importance of the sector to Britain, and arguing that ”bonus-bashing is a distraction.”  Willem Buiter is with Turner in believing that the financial sector is too large, but views the transactions tax as the wrong policy tool for the job.

It is worth recalling that more of the original goals of the bailout packages of a year ago have been attained than most commentators expected.    First, the goal of preventing a depression in the general economy has apparently been accomplished — and without nationalization of the large banks.    The Administration and the Fed always said that helping some undeserving financiers would be an undesirable but necessary side effect of the rescue plan   You don’t punish someone who has been smoking in bed by allowing the resultant fire to burn down the block.   Second, the goal of recouping a substantial share of the bailout costs has also begun to be realized – contrary to many cynical predictions – as banks repay loans to the Treasury and to the Federal Reserve, often at a profit to the taxpayer.

Nevertheless, it is indeed irksome that the banks have continued to pay out huge bonuses to their top employees, and to oppose the creation of a new US agency for financial consumer protection.   So the public’s anger is understandable.   Perhaps the transactions tax is indeed the right way to go.  Our Treasury and others’ could really use the revenue, especially if they don’t recover full value on the money that has been put into rescuing financial institutions.  Furthermore, the idea of shrinking the volume of transactions in financial markets nowadays looks much less likely to damage economic efficiency than we once believed.    

[Anyone wishing to comment is referred to the Seeking Alpha  or RGE Monitor versions of this post.]

In the July employment report released by the BLS this morning, August 7, the labor market shows its first encouraging signs. Most commentators will focus on the jobs numbers, which show a decline of less than half the rate that the economy experienced in the “freefall period” of late 2008 and early 2009.

Employment tends to lag behind production. For this reason, as readers of this blog will know, my preferred indicator is total hours worked. The latest numbers show that the length of the workweek has begun to rebound from its record low of two months ago. As a result, the BLS reports that total hours worked in the economy did not decline at all in July, for the first time since the financial meltdown of last September.

One never wants to read too much into a single report, especially one subject to revision. But when today’s labor news is combined with a variety of other data, it looks likely that the economy is finally at or near the turning point.

Hours Worked  (Changes) from the Current Employment Statistics survey,
Bureau of Labor Statistics, Aug. 7, 2009

Year       Jan   Feb   Mar     Apr   May   Jun                    Jul   Aug   Sep     Oct  Nov  Dec
2007    -0.5   0.0   0.6    -0.3   0.5   0.1                   -0.2 -0.1   0.1      0.2   0.2   0.1
2008    -0.3  0.1 -0.1     -0.1 -0.5 -0.5                    -0.2  0.2  -0.6   -0.8 -0.9 -0.9
2009    -0.7 -0.6 -1.2    -0.6 -0.3 -0.7(P)                0.0(P)

 [Readers wishing to comment are encouraged to go the version of this post at Seeking Alpha or RGE Monitor.]

Friday marks 200 days in office for President Obama.   “How has he done?” asks Fortune.

The first thing to say is that Barack Obama took over the presidency at an extremely difficult time. A variety of analogies suggest themselves: He is Harry Houdini who has been thrown in the river, in a straitjacket, with chains wrapped around him. Or he has taken over as the captain of a ship with a rotting hull, while the ship is under attack in a hurricane. To capture the state of the economy, perhaps the best metaphor is that Obama took over as pilot of an airplane in the middle of a steep dive. For a president precedent, he is Lincoln, who takes office as the South secedes. Or he is Roosevelt, who takes office at the depth of the Great Depression.

In any case, in light of the difficult circumstances, I think Obama has done amazingly well.

The financial markets were in free-fall six months ago. Bank spreads were at historic highs (a good indicator of just how outside-the-box this financial crisis was). GDP contracted at an annual rate of about 6 % in the last quarter of 2008 and the first quarter of this year.

Since then, the airplane has begun to level off. Those bank spreads are down to more normal levels. GDP declined at an annual rate of “only” 1% according to last Friday’s advance estimate; if I had to guess, we will see a bottom in the second half of the year and could see some positive growth. I give a lot of credit to the fiscal stimulus, to the monetary stimulus, and to the financial repair measures, as messy as those inevitably were.

At the time our new president took office in January, there was a danger that this could be not only the worst of the post-war recessions, but as bad as Japan in the 1990s. I think we have now avoided that. We have learned from mistakes in the past, particularly the mistakes of the Depression – those made by the Federal Reserve, Hoover, and also Roosevelt. Obama has the advantage of the lessons of the 1930s to learn from.   But he has the disadvantage of having inherited an exploding path of debt (unnecessarily incurred by this predecessor).    The debt is the rotting hull of the ship of state.

Regarding February’s stimulus package, some commentators said it was too small, some said it was too large.  In truth, it was both.   It was too small by itself to return us to full employment, to knock out the recession.   In order to bring us back to full employment, we would  need a boost to spending several times as big.  And yet, at the same time, it was too large to guarantee that we avoid losing the confidence of our international creditors.   If they stop buying our bonds, US long-term interest rates could rise sharply.   (China — the largest holder of US Treasuiy securities — has already begun to ask questions about the value of US debt.)     But the Administration struck an appropriate balance between these two competing concerns. 

People are angry about the big bonuses that are still being paid to those in the financial sector who got us into this problem. Entirely understandable. But don’t forget that, from the beginning, the goal was to prevent a depression in the general economy. That has been accomplished. You don’t punish someone who has been smoking in bed by allowing the resultant fire to burn down the block. The Administration and the Fed always admitted freely that helping some undeserving financiers would be an undesirable but necessary side effect of the rescue plan. And do you remember all the pundits who warned that the rescue could not work unless the banks were temporarily nationalized? Or all the cynics who dismissed claims that the Treasury would recoup a share of the budget costs as firms like Goldman Sachs repaid their loans with interest?

In my view, overall, Obama has gotten far more things right than wrong. He has bravely proposed things that most sensible economists — whether Republican or Democrat — have long favored. Proposing is not always the same as enacting; there is the matter of Congress. But he has tried to get them passed, and has tried to do it in a bipartisan way.  (That bipartisanship constraint is one of the Houdini chains.)

Washington has always been stymied by the political constraints of what can pass Congress.  Often presidents figure that special interest groups will block sensible reforms, so why waste political capital trying? But an example, which I find extremely encouraging, including symbolically, is that (with the help of Defense Secretary Robert Gates), Obama proposed to end spending on the F22 fighter. The F22 is probably the most egregious example in the defense budget of spending on hugely expensive weapons systems that the Pentagon doesn’t want because they are not useful for today’s national security needs. To my surprise, Obama actually prevailed  on this.

I can also name two areas where he proposed very sensible legislation that a heavy majority of economists of both parties would support, and yet where he has lost in Congress (at least so far). One is cutting agricultural subsidies to agribusiness and rich farmers. Another is auctioning off most of the greenhouse gas emission permits in any plan like the Waxman-Markey Bill, rather than giving them away to industry.  (Obama’s proposal was to use the proceeds of the auctions to reduce the marginal tax rate on low-income workers, to “Make Work Pay,” which would have been an excellent use of the funds.)

But the fact that he is trying, and that he is winning some of the battles, is important.  He is willing to fight the fight, while yet compromising when politically necessary. It is tremendously important that the public take notice of these details. There are always particular interest groups that stand to lose from any given reform such as farm supports,  military procurement or emission permit auctions; if the general public pays no attention to the details and does not support the President on them, it means special interests will triumph over the general good as so often in the past.

If I had to find one mistake that the White House has made, the initial economic forecasts were too optimistic, at least with respect to the unemployment rate. It was an honest mistake, but a mistake nonetheless… not just with respect to the economics: politically, Obama would have been better to recognize the severity of the recession from day one.

Regarding the health plan, we as yet have no idea what the outcome will be. The big questions, of course, are how to reduce costs and how to pay for getting everybody insured. Instead of proposing an income surcharge on the wealthy, I would have preferred eliminating non-taxability of employer-provided health benefits— that’s what McCain was for in the campaign, and most economists as well. The non-taxability could have been retained for workers in lower income brackets if the White House felt this was essential.  At the least, Senator Kerry’s astute version, which is aimed at curbing the effective taxpayer subsidy in the cases of the most egregiously expensive health care insurers, should be politically saleable.   You can call Obama’s failure, so far, to move in this direction a second mistake. But, since Fortune asked my opinion of how much the President has done right versus wrong, I put the score at 98 to 2. 

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Personal saving rose again in the second quarter. “Does this mean the stimulus tax cut has failed, as the 2008 tax cut stimulus did?”, asks The National Journal.

My answer:

Martin Feldstein and others predicted that the tax-cut component of the 2009 fiscal stimulus package would have substantially less expansionary bang-for-the-buck than the spending component of the package, because much of the tax cut would be saved, as had been the case with the 2008 tax cut.  (“Bang for the buck” in this case could be defined as demand stimulus divided by budget cost.)   We knew this from Milton Friedman’s permanent income hypothesis, or even from good old Keynesian multiplier theory.

But in February President Obama had to get those last three (Republican) votes to pass the stimulus bill in the Senate, and those three Senators insisted on raising the tax cut component of the stimulus package a bit and lowering the spending component. Their motivation presumably was to mollify their fellow Republicans, many of whom still claim that ONLY tax cuts provide stimulus, and that spending does not (and perhaps even has a negative effect) — which is even more extreme than the claim that a tax cut creates stimulus equal to spending. After the failures of the Bush tax cuts (and Reagan’s before him), I don’t know if any economists still cling to such “supply sider” notions — or indeed if these congressmen would be able to state their logic. Regardless, I think the Feldstein prediction has been borne out since then.   Talk about irony!   The Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03 were both explicitly designed to boost saving — hence their focus on capital income and higher income brackets — and yet in both cases private saving fell in their aftermath.   The tax cuts of January 2008 and February 2009 were both explicitly designed to boost consumption; yet private saving rose in their aftermath !   

Fortunately, the majority of the Obama stimulus package took the form of increased spending, much of which has yet to come.

None of this is to deny that efficiency is an important consideration, and cost-benefit calculations should always enter into the choice of both what kind of tax cuts to adopt and what kind of spending increases to adopt. But if it is short-term demand stimulus we are after, and we are, then government spending gives more bang for the buck than tax cuts.

[Any readers wishing to post a comment are encouraged to go to the versions on Seeking Alpha or RGE Monitor.]

On July 31, the Department of Commerce’s BEA (Bureau of Economic Analysis) released an important set of numbers regarding GDP.  Of most immediate interest, the advance estimate of GDP growth for the second quarter, April-June, 2009, was a very moderate -1 per cent per annum.  The small magnitude of this negative number confirms an inflection point in the second quarter.   As most of us had already thought, the economy is no longer in the free-fall of October 2008 to March 2009 — when the rate of output contraction was approximately 6% per annum – but, rather, is beginning to level out.     

Furthermore, the figures reveal large depletion of inventories in the second quarter, which offers good grounds for hope that firms will begin to produce more in the second half of the year.  In other words, the economy is probably bottoming out even as we speak.

But even if it turns out that the NBER Business Cycle Dating Committee eventually puts the trough sometime in the 2nd half of 2009, it will not make that decision until all the facts are in, which will be a long time.    A major reason is that government statistics, especially for GDP, are always revised subsequently.   That brings us to the other big component of the BEA release on Friday:  comprehensive revisions to the GDP numbers going back many years.    The BEA does a comprehensive revision generally every five years.  In this case the statistics were substantially affected, especially those over the last dozen years, as the results of a number of permanent changes in methodology (such as how natural disasters are treated in the accounts).   

These revisions produced two interesting implications for the current recession, quite aside from the question whether it is now ending.  

First, the recession turns out to have been worse than the previous GDP numbers indicated.  During the course of 2008, the economy apparently contracted 1.9%, more than double the previous estimate of 0.8%.      The cumulative decline through the 2009 Q-I now appears to have been 2.8% (as compared to the previously reported 1.8%).    Add in the latest quarter, and the 3% cumulative decline cements the claim of this recession to be the worst since the 1930s.

Second, that revision includes a conversion of the +0.9% that was previously reported for the first quarter of 2008 to the new estimate for that quarter:  -0.7%.

That is important from the viewpoint of the NBER Business Cycle Dating Committee.   Why?     All through 2008 it was difficult to tell whether a recession had started at the end of 2007.   On the one hand, some measures such as employment and real income had peaked then,  but on the other hand it appeared that GDP had continued to grow in early 2008.     Even after the accelerated deterioration in the autumn of 2008, when it could no longer be doubted that the economy was in recession, the signals as to the date of its beginning still conflicted.     

The Committee ended up, on December 1, 2008, declaring that the peak had occurred in December 2007.    As always, there were critics.   Some didn’t see how we could declare that a recession had begun six months before GDP growth turned negative.   “Everybody knows that a recession is defined as two consecutive negative quarters”     (More common, as usual, was the precisely opposite critique:   “The NBER is just now saying what has long been obvious to everyone but them.”)

The new report from the BEA that the first quarter of 2008 was negative after all is thus another piece of evidence that validates the choice of end-2007 as the business cycle peak.   Similarly, it validates the decision by the Committee to have made the call in December, rather than waiting for the BEA revisions of July 31, 2009.  

The bottom line of all of this?    We are less at sea than we had feared.   The data now tell a story that is fairly well delineated, the story of a recession that, though upsettingly severe in amplitude, appears familiarly sinusoidal in shape.

(This post does not necessarily represent the views of the NBER Business Cycle Dating Committee or its members.  Nor of the BEA or its Advisory Committee members.)

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                                                              I 06   II 06 III 06  IV 06                          I 07  II 07 III 07     IV 07                            I 08    II 08      III 08       IV 08                 I 09

Newly reported GDP        5.4    1.4     .1    3.0               1.2    3.2    3.6    2.1                    -.7    1.5       -2.7     -5.4           -6.4       

Previously published.      4.8    2.7     .8    1.5                 .1    4.8    4.8    -.2                    +.9      2.8       -.5       -6.3         -5.5

 

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