By roughly the five-year mark after the launch of the euro in 1999, enough data had accumulated to allow an analysis of the early effects of the euro on European trade patterns. Studies include Micco, Ordoñez and Stein (2003), Bun and Klaassen (2002), Flam and Nordström (2006), Berger and Nitsch (2005), De Nardis and Vicarelli (2003, 2008), and Chintrakarn (2008). The general finding was that bilateral trade among euro members had indeed increased significantly, but that the effect was far less than the one that had earlier been estimated by Rose and others on the larger data set of smaller countries. Overall, the central tendency of these estimates seems to be a trade effect in the first few years on the order of 10-15%. None came anywhere near the tripling estimates of Rose (2000), or the doubling estimates (in a time series context) of Glick and Rose (2002).

There are three leading explanations for the discrepancy between the estimates of the euro’s effects (10-15% increase in trade among members) and those from historical estimates (doubling or tripling). (more…)

January 1, 2009, is the tenth birthday of the euro.  On this occasion, everyone has been taking stock.   The record of the euro shows both pluses and minuses. Looking back, the euro has in many ways been more successful than predicted by the skeptics — many of them American economists.  (The Europeans love to quote Martin Feldstein as having predicted that EMU could lead to civil war.)  The historic transition to a monetary union among 11 countries in 1999 went smoothly; the euro instantly became the world’s number two international currency; and the officials of the European Central Bank (ECB) have from the beginning worked as citizens of Europe rather than as representatives of home constituencies.  After a rocky start, the euro has achieved a strong value; the ECB has achieved a strong reputation (the tradition of the Bundesbank has not been diluted as feared); and new members to the East have achieved membership in the club.  Slovakia becomes the 16th country to join, on January 1.

At the same time, however, some of the skeptics’ warnings have come to pass:   shocks have hit members asymmetrically; cushions such as US-type labor mobility have not developed; and the Stability and Growth Pact has proven unenforceable.    Furthermore, the popularity of the project with the elites does not extend to the public, many of whom are convinced that when the euro came to their country, higher prices came with it.

One of the most interesting questions at the inception of the euro was whether the elimination of currency risk and of foreign exchange transactions costs would promote trade among members.   Facilitating trade had been one of the most important of the original motivations of founders.  Prior to 1999, however, most economists believed that the effects of currency barriers between countries, if even greater than zero, were small — small, for example, relative to trade barriers.

In 2000, Andrew Rose published in Economic Policy what turned out to be one of the most influential empirical papers of the decade:  “One Money, One Market…”   Applying the gravity model to a data set that was sufficiently large to encompass a number of currency unions led to an eye-opening finding:    members of currency unions traded with each an estimated three times as much as with otherwise-similar trading partners.   Many found the tripling estimate implausibly large.  No sooner had Rose written his paper than the brigade to “shrink the Rose effect” (the phrase is from Richard Baldwin)  – or to make it disappear altogether — descended en masse.  But their plausible methodological critiques can be answered. Authors tended to replicate the finding with a twist. Although they came away denting the magnitude of the estimate, few studies, if any, managed to shrink the estimated effect of currency barriers below the estimated effect of trade barriers.

 This research was of course motivated by the coming of the euro in 1999, even though estimates were necessarily based on historical data from (much smaller) countries who had adopted (or left) currency unions in the past.    But now, 10 years later, we have enough data to see the extent to which the trade-promoting effect that currency unions have showed among smaller countries also carries over to European countries.    This will be the subject of my next post to follow.

The Yale Book of Quotations provides a useful service: It tabulates well-known sound-bites, but tries to get the exact quote and citation right, which is rare.    (P.T. Barnum in fact never said “There is a sucker born every minute.”    Richard Nixon never said “But it would be wrong.” Etc.)  The editor also compiles an annual list of Top Ten Quotes of the Year.   In the second week of December he released the list for 2008.  Number 1, for example, is “I can see Russia from my house” (carefully attributed to the Tina Fey parody rather than precisely what Sarah Palin originally said).

The good news is that the title line in my blogpost of July 17 was chosen as one of the top ten quotes of 2008 (tied for tenth place, it is true).    The sentence is: “If there are no atheists in foxholes, there are no libertarians in financial crises.”     The bad news is that the quote was attributed to Paul Krugman, who had used it subsequently on the Bill Maher Show.   I had originally written it in 2007 as the first line of an article in a Cato Journal issue devoted to financial crises.  Among the others who picked up on the line after my blogpost were Ben Bernanke,  Mark Shields, Bloomberg,  WSJ.com, Brad deLong, and Tom Keene – generally with attribution, when the format permitted.

The list of Top Ten Quotations of 2008 went out over AP on December 15 as it was, and appeared in lots of newspaper stories and TV broadcasts.  Krugman immediately set the record straight on his blog, as I knew he would.   AP sent out a correction on December 22.    It should be obvious that this is not a scandal of any sort and that Krugman is just as quotable as he ever was.
  

But there are some other, more interesting, aspects.

One is an illustration of how tough is the world in which highly visible columnists like Krugman live.   There are lots of Krugman-haters out there.  Of course the phenomenon originates in the fact that he consistently has been liberal and anti-Bush (not precisely the same thing).  But the antipathy goes very deep.    The Yale/AP list was originally called to my attention by one Joel West.   I told him I was indebted to him for pointing out the misattribution.   But I also told him that I was sure that there had been no desire on Paul’s part to steal my line:  TV shows like Bill Maher don’t customarily allow their guests to display footnotes.     But Mr.West must be one of the Krugman-haters, because his subsequent blogpost accused Krugman of dishonesty.   As had another Krugman-hating blogpost before that.   These people are eager for ammunition against someone of a different ideological persuasion and are not sufficiently discriminating about what they use.

Ironically, of the other two soundbites that share tenth place on the Yale/AP list with the atheists-libertarians quote, one is something else attributed to Krugman (“Cash for trash”), and the third is from the all-time champion Krugman-hater, Donald Luskin.   Luskin earned the Top Ten honor when quoted as saying “Anyone who says we’re in a recession, or heading into one — especially the worst one since the Great Depression — is making up his own private definition of “`recession’”  in the Washington Post, September 14.    This was of course after a huge fraction of economic commentators and the public had already decided that the country was probably in recession, as now turns out indeed to have been the case.   (I myself took a bit of grief on various blogs both for saying the “R word” too early and also for saying it too late.  But I have also gotten credit.)

The atheists-and-libertarians line itself has also drawn some grief from some atheists and libertarians, on various blogsites.   I don’t mean to put these two philosophies together (although that would be an interesting essay question on some exam).  Nor is it the case that either group is objecting to being associated with the other.   But both have pointed out that the statement is not literally true.   They are entirely correct:  There are plenty of atheists in the military;  and there are plenty of libertarians in a financial crisis.  But of course the statement did not literally mean there are no atheists in foxholes or libertarians in financial crises.  The claims are, rather, that on average:  (i) soldiers under fire tend suddenly to grow more religious in outlook, and (ii) policy-makers facing a financial crisis tend suddenly to grow more interventionist in outlook.    But, yes, there really are conscientious atheists in foxholes.   They are a minority, but a substantial one.   And yes there really are thoughtful libertarians in financial crises.  Again a minority, but not to be dismissed.   If anything, I admire the intellectual consistency of those who have thought through their views well enough ahead of time that they do not change them under pressure from events that, even if calamitous, were predictable. 

 
Every two years, Harvard Kennedy School hosts the newly elected Members of Congress for a three-day “briefing” on a wide variety of topics.   We had an excellent turnout this week: 40 of the 50 new congresspeople, from both parties.    I participated in a panel titled “Understanding the Economic Crisis,”  along with Greg Mankiw, Elizabeth Warren and Robert Lawrence  (on video).    

Trying to explain the origins of the financial crisis and recession in ten minutes, even to the extent any of us understands it, was a tall order.    But I tried to cram it all into a single slide.     Here it is: 

The National Bureau of Economic Research today announced that its Business Cycle Dating Committee had officially determined a peak in economic activity at December 2007, which signals the start of the recession.    I am a member of the committee.    Though I speak only for myself, not the committee, I offer my views on two questions of possible interest: 

(1)   Who needs the NBER Business Cycle Dating Committee (BCDC) anyway?

(2)   Why did we pick December 2007 as the starting month of the recession?

(1) We sometimes hear the question “Who needs the NBER Committee anyway?”   This question most often comes in one of two forms:

(1a)  Everyone in the real world has known that the economy has been in a recession for some time.   In past cycles, media reports have sometimes taken the line “Ivy Tower Eggheads Finally Figure Out What Everybody Else Has Known All Along.”    The implicit critique is that the committee takes too long after the event – typically almost a year — to make its declaration.   One short answer is that our job is to be definitive, authoritative, but not fast.  We don’t want to have to revise our dating of the peaks and troughs later, in part because it would sow confusion among those who rely on them (from econometric researchers to political speechwriters).   GDP and other official statistics are often revised after the fact, for example.  We leave it to others  –pundits, forecasters, consulting companies, financial newsletters, and so on – to try to get there first.   We deliberately get there last.

(1b)  The other form taken by the question “Who needs the NBER committee?” runs as follows: “The rule of thumb is simple:  two consecutive negative quarters of GDP growth.   Why complicate things?”    The Frequently Asked Questions segment of the BCDC announcement answers this in detail.     For now, observe simply that questions (1a) and (1b) are inconsistent with each other.    As of December 1, 2008, the US economy has not yet experienced two consecutive negative quarters.    So an argument that we should wait for two consecutive quarters (critique 1b) is the opposite of the critique that we should have acknowledged a recession before now (critique 1a).

(2) The more important question is:  Why did we pick December 2007 as the start of the recession?    As is the case surprisingly often, different economic indicators give very different answers to the date of the peak.

            Of the monthly indicators to which the BCDC gives primary attention, the most important is jobs, more specifically Payroll Employment (from the Labor Department’s Bureau of Labor Statistics).   It peaked in December 2007, and has been declining ever since.   My personal favorite indicator is Total Hours Worked (which is closely related, because it is number of people employed times the average number of hours per worker).    Hours Worked also peaked in December, as shown in the graph below.

            Of the quarterly indicators, the most important is aggregate economic activity, more specifically, Output.   The Commerce Department’s Bureau of Economic Analysis computes two measures of output:   Gross Domestic Product (GDP) and Gross National Income (GNI).  The two should be the same in theory, but differ in practice due to measurement errors.   GDP receives far more public attention – in part because its advance estimate comes out first — but in fact has no claim to be a more accurate measure of output than does National Income.    The statistics currently available show that GNI peaked in Quarter 3 of 2007, whereas GDP peaked in Quarter 2 of 2008.    A simple-minded average of the two peak dates would seem to  point to midnight of New Year’s Eve, December 2007, as the peak.    Another (comparably unsatisfactory) way of forcing the output data to cough up a precise month is to look at Personal Income, which is available monthly.   The BCDC’s computed measure of real personal income less transfers peaked in December 2007.  

      It would be wrong to claim that all roads arrive at the same destination, December 2007.   Other indicators point to other dates, some earlier, some later.  If we are very lucky, revisions that the BEA makes in July 2009 will help resolve the discrepancy between the GDP and GDI measures somewhere in the middle.  But perhaps the best characterization of the output measures is that they show a rough plateau from the fall of 2007 to the summer of 2008.   That the employment statistics speak more clearly allows them to have the predominant say.

Over the last 24 hours, President-Elect Obama has announced five top members of his new economic team.   What do they have in common?   

• Retreads from the Clinton Administration?    Rubin protégés?   No, not all.                    

• Scholars from leading universities?     No, not all.                    

• Friends of mine?    Well, yes, though that is not my point.    As it happens, they have been friends, for 12-to-30 years.    (god forgive me.   There are few greater turnoffs than a columnist who thinks it’s “all about me.”    On the other hand, this isn’t a newspaper column.   It’s just my personal blog.  So what the hell.)    Here is the list:

• Yesterday, President-elect Obama formally introduced Larry Summers as his choice for Chair of the National Economic Council and Tim Geithner as his choice for Treasury Secretary.  Both of these excellent choices held positions in the Clinton Treasury.

• At the same time, to my delight, our new president introduced Prof. Christina Romer as his choice for Chair of the Council of Economic Advisers.    Christie was my colleague for 10 years in the Economics Department at the University of California, Berkeley (1988-1997).  She and her husband David Romer form a team who were my favorite daily lunch companions during that period.   (David would be a great pick for one of the open Governor slots on the Federal Reserve Board.)    They have also been my colleagues on the Business Cycle Dating Committee of the NBER.    The Harvard Economics Department voted to hire Christie last year (and the Harvard Kennnedy School voted to hire David), but unfortunately in the end it did not work out.   Although the CEA position is Christie’s first major government job, she is another excellent choice for the team.   She is smart, well-organized, and even-keeled.  Christie together with Fed Chairman Ben Bernanke have the added bonus of being among the world’s top experts in the monetary history of the Great Depression, an expertise that is of unexpected benefit at the current juncture.

• Today, Obama also announced Peter Orszag as his choice for Director of the Office of Management and Budget.   In 1996, when I arrived at the Council of Economic Advisers, Peter was a Senior Staff Economist at CEA, working on international economics.  Even then his extraordinary abilities had made him indispensable to top officials.   He was the sort of person who rises very quickly in a merit-oriented government:  not just extraordinarily smart, but able to get lots of things done very fast and very well.  When Peter returned from a quick spell at the London School of Economics (finishing his doctoral degree), he moved to a key position on the National Economic Council staff.    More recently, he has been director of the Congressional Budget Office.  This position at the Capitol Hill end of Pennsylvania Avenue is the counterpart to the OMB Director job at the White House;  thus Orszag will on January 20 truly “hit the ground running” with respect to the budget, in the same way that Geithner will with respect to the financial crisis.   

 Irrelevant gossip:    At the height of the East Asia crisis in 1998, I hosted a party in honor of Peter Orszag.    The party is mentioned in Paul Blustein’s The Chastening  (which remains the best blow-by-blow account of the East Asia crisis), because Joe Stiglitz took Stanley Fischer outside on the doorstep to voice in person the critiques of the IMF’s management of the crisis that he had been making in public.    The reason they went outside was so that Larry Summers, who had been managing the crisis from the Treasury, could not hear them inside.

• No, Obama did not choose this team because they are Clintonites or top scholars or my friends.   He did not choose them because economists (leaving aside, as always, the far left and the far right) consider this a dream team.   He chose them because they are The Best and Brightest and The Least Arrogant.     As the President-elect says, the American people want effective leaders, not primadonnas.

• The phrase “The Best and the Brightest” comes readily to mind because their IQs are so high.    After 8 years of the current President and his appointees, I hope that the American public, despite anti-elitist suspicions, understands that intelligence and ability do actually matter.  

• But IQ in an academic sense, by itself, is a very incomplete qualification for higher office.  Many university professors are famous for lacking social skills, managerial competence, personal organization, ability to communicate, unflappability, openness, and humility.  These other skills are just as important in policy making as is intelligence.   Indeed, the phrase “The Best and the Brightest” comes from the famous book by David Halberstam, where the title was meant ironically since the orignal Kennedy brain trust screwed up so badly in Vietnam.   The Bundys and McNamaras were arrogant in the same sense as the Cheneys and Rumsfelds:  when reality diverged from their pre-conceptions (whether in Asian wars or other policy areas), they were too sure of themselves to process the discrepancy mentally and too stubborn to adjust course.   But the Obama team is different.   It is The Best, the Brightest, and the Least Arrogant.    With one possible exception, these people have no ego, no sharp elbows, no rough edges.   They are not close-minded or stubborn.   They are not ideologues.  They will scoop up facts and arguments, on all sides of a policy question, before making a recommendation; and even after a decision has been made, they will monitor new information as the situation develops and adjust course when necessary.    These traits, more than anything, have been missing from government in recent years.
  • Many will object to this description of the team with the observation that Larry Summers is famous for being arrogant.   Summers’ arrogance is a little overdone, compared to some others I could name.  But it is true that Larry’s personality is not ideally suited for the traditional job description of the Chair of the National Economic Council, which is to be an “honest broker,” in the classic phrase of Roger Porter’s early description of the proto-position.   The NEC manages the decision-making process in the White House.  It must make sure that every agency feels that its views have been heard and fairly represented to the president.  (“Agencies” here means not just cabinet departments like Treasury, State, Commerce, Labor, Agriculture, HHS, etc., but also White House agencies such as CEA, OMB, NSC, etc.)  It is evident that Larry was given the title of NEC Director so that he could have the status of Principal, which means he gets a seat at the table in cabinet-level meetings, as opposed to having to sit in the row behind, where the principals’ top aides sit.   I am sure that Obama wanted direct access to Larry’s views because he is off-the-charts smart  (“one of the great economic minds of our time”).  I am also sure that Obama realizes that Larry is not perfectly suited to the honest broker role.   (The same was true of Larry Lindsay, who was fired from the NEC Director position by George W. Bush — not just, as often reported, because he correctly forecast that the cost of the Iraq war would be much higher than the official line.   He did not have a lot of interest in running the policy process, and was rather more interested in expressing his own views to the President, as compared to his more bureaucratically inclined successors.)  
  • Not to worry.    The Wall Street Journal has evidently reported that the NEC will have Jason Furman as Deputy Director.  Jason, who has been Obama’s Economic Policy Director during the national campaign, could not possibly be better suited to the job of running the policy process as an honest broker.   He is a young version of the others:   brilliant, tireless, non-ideological; no ego, no rough edges, a team player.   I know.  He worked for the CEA in 1996-97.

• There you have it.   The Best, The Brightest and the Least Arrogant.   Current conditions are so bad it would be foolish to make an optimistic prediction about economic performance over the coming years.  But I will make the prediction that this team will function like clock-work, and give the country the most capable economic policy making it has had in many a decade.

News services reported today that Tim Geithner, currently President of the Federal Reserve Bank of New York, was President-elect Obama’s choice to be Secretary of the Treasury. The fiancial markets reacted very positively to the news. This presumably captures both relief that some policy uncertainty has been resolved at this critical juncture and approval that Geithner is the man chosen.   I share the pleasure at this appointment.

Tim Geithner is refreshingly straightforward and personable, and doesn’t “stand on ceremony.”  At the same time, he is cool and unflappable. By coincidence, the Economic Advisory Panel to the NY Fed President, of which I am a member, met today. Unusually, Geithner excused himself at two points in the four-hour meeting to take short phone calls. Given the timing, it seems very likely that one of the phone calls was Senator Obama offering him the Treasury position. These Panel meetings are off the record, but I think I am not betraying any confidences to report that Geithner betrayed no sign to us of what had just happened. No change in demeanor, no change in the substantive flow of the discussion. This is a guy who does not lose his cool.  Just what the country needs.

Most sensationally, Summers is said to be tainted by his time as President of Harvard.    Too much has already been said about this.   But I will make just a couple of observations.    First, although Summers may not be Mr. Personality, and he will never be elected to high office nor chosen to head offices for women’s rights or the environment, he has all the most important qualities for the Treasury job.   Despite a tendency to say what he thinks, I don’t think he committed any true faux pas or became involved in any mini-scandals during 8 years in the government — no easy feat.   (The closest he came to a faux pas, or what counts for one in the media, was a statement that the argument that was then being made for abolition of the estate tax was based on greed alone rather than efficiency.   He quickly retracted the statement without bothering to try to explain what he had meant, having already by then become familiar with the rules of political brouhahas.)    In his time in Washington, he learned how to get along with politicians across the spectrum, from socialists to the far right.   It’s true that he wasn’t able subsequently to get along with the full range of faculty in the Harvard English Department, but that is a tougher task.  

Finally, I continue to be surprised at how the press describes Summers’ ill-fated and ill-considered (but “off the record”) remarks regarding explanations for the lack of women in academic science departments.  He is most often reported as having suggested that women generally have less aptitude for science than men.   Memories of these remarks in some quarters probably accounts for the recent decline of Summers in the betting odds, though he also has defenders among women with whom he has worked.   I link to the text of what he actually said here,  and urge readers to make up their minds for themselves.   But I don’t read his speculative remarks about the various hypotheses quite the way most people have assumed.   To me the most outrageous line in the remarks was, rather, the suggestion (made to illustrate the penalities for being out of the academic workforce for a couple of years) “that no economist who had gone to work at the President’s Council of Economic Advisers for two years had done highly important academic work after they returned” !  

Is the United States in recession?   If one looked solely at the adverse shocks that have hit the economy over the last year, one would infer an unusually high probability of a recession.    If one consulted some of the most import economic measures over the last year, one would say the country clearly entered a recession last January.  If one gauged the popular mood, one would hear, “Of course we are in recession !” 

The one criterion that has been missing is the one criterion that people most commonly have in their minds as the definition of a recession:   two consecutive quarters of negative growth.   This morning, October 30, the Commerce Department released the advance estimate of GDP for the 3^rd quarter.   It showed a decline.   The decline was small:  just 0.3 per cent at an annual rate; and it is only one quarter, not yet two.    But at this point there can be little doubt that we are really truly in recession. 

The adverse shocks include the most severe housing bust in more than 70 years, an oil shock as big as those of the 1970s, the greatest financial crisis since the Great Depression, and the worst fiscal outlook ever.    Any one of these developments would normally be enough to send an economy into recession.   Leading economists from Martin Feldstein to Larry Summers have been warning since the start of the year that the downturn has indeed arrived, not to mention Nouriel Roubini who forecast it far ahead of time.

And sure enough, many of the most reliable statistical indicators have suggested all year that we are in recession. 

The most important statistical criterion besides GDP is employment.   Jobs peaked in December 2007 and have declined steadily ever since.  The cumulative loss is 760 thousand (or 0.55%) as of September.    My personal favorite among indicators is Total Hours Worked in the economy, because it combines both employment (number of people working) and average length of workweek (are they working 40 hours a week? Overtime?  Part-time?).    Total Hours Worked shows a similar pattern as employment, but with an even steeper decline since December: 1.4%.  (The Bureau of Labor Statistics is the agency that releases these numbers, on the first Friday of the subsequent month.)

The index of Leading Economic Indicators, which is designed to try to warn of turning points in advance, turned down more than a year ago.   Not only that, but also the index of Coincident Economic Indicators, which is supposed to move contemporaneously with the real economy, appears clearly to indicate that a recession started toward the end of 2007.  

Housing prices as of August are down 27%, relative to their peak in July 2006 (Case-Shiller composite of 20 cities).   Consumer confidence, another important determinant of household spending, fell to an all-time low in September, according to the October 28 release from the Conference Board.  The version collected by the University of Michigan is also looking quite bleak.   Indeed, retail sales are down, especially autos.  The worse news in the Commerce Department report is that consumer spending took a steeper plunge in the third quarter than at any time in the last 28 years.   The trend in industrial production has been negative for a year, and accelerated in August and September.  Corporate profits are down too.

But it is still not yet officially a recession !  Why not?   The most important criterion for dating business cycles is real growth.    The rate of change of real GDP, surprisingly, was above zero in the first quarter of 2008, and was even moderately strong in the second quarter: 2.8%.   (The revised “final” estimate of GDP in the fourth quarter of 2007 did turn out to be below zero, but just barely.)     It is quite a mystery why output pointed up during the first half of the year, while everything else pointed down.  

Clearly the demand for US goods received some boost in the 2nd quarter from tax rebates and exports.   Exports continued to help growth in the third quarter (together with inventory investment, which probably includes some goods sitting on shelves that firms were unable to sell, and defense spending).    Net exports have been carrying the economy for the year, as one can readily tell by noting that real domestic purchases have been in decline.  Exports are unlikely to continue this role in the future, because our trading partners have slowed down more than we have and because the depreciation of the dollar has recently stopped.

But perhaps there is some measurement problem with GDP.   Gross National Income (GNI) has as much claim to measure growth as Gross National Product does.  In theory the two are supposed to be virtually the same: the value of goods and services sold is conceptually the same as the value of income earned.    Real GNI did in fact turn down in the 4th quarter of 2007 and the first quarter of 2008, though it rebounded in the third quarter as real output did.   Real personal income – one of the indicators that the NBER Business Cycle Dating Committee looks at – has been declining almost throughout the year. Real personal disposable income fell especially sharply in this morning’s release for the 3rd quarter.

The weight of evidence is now overwhelming:   we are currently in recession.

Did it start at the end of 2007, when employment and the other indicators peaked?     Or was the stimulus from the government and from exports enough to postpone the turning point, and did the recession thus only start towards the end of the summer, when the financial crisis intensified very sharply?   I am afraid that we need to wait for some more data and some more (regularly scheduled) revisions before we will know.

[For anyone wishing to comment on this post, I suggest you go to the RGE version.]