The Commerce Department this morning announced its advance estimate of last quarter’s real GDP. As expected, the estimate shows that GDP fell in the first quarter of 2009 — by a hefty 6.1 per cent at an annual rate. An implication is that the current recession has just tied the post-war record for longevity.

The previous record-holders were the recessions of 1973-75 and 1981-82, each of them five quarters in length according to the official NBER chronology.  In the current downturn, the NBER’s Business Cycle Data Committee determined that the economy peaked in the 4th quarter of 2007. Although the Committee won’t declare the trough of the recession until well after the fact, and the trough could well be a ways off, a negative 1st quarter of 2009 almost certainly means that the five-quarter benchmark has now been attained.  (The Commerce Department often revises its GDP figures substantially between the advance estimate and the final number, and we are due for major backward-looking revisions in July.  Indeed that is one reason why the NBER always waits so long to issue its findings.  In the past, the size of the average revision has been just over 1 percentage point, whether up or down.   It is highly unlikely that future revisions will change this morning’s negative number into a positive one.)

The NBER also keeps a more precise monthly chronology. The postwar record is 16 months, again shared by the 1973-75 and 1981-82 recessions. To match this monthly benchmark, the current downturn would have to have continued into April. Our best single indicator as to whether it did so will be the employment number to be released by the Bureau of Labor Statistics next Friday, May 8. It almost certainly will show that there were further job losses in April. If so, it will further confirm the dismal conclusion: one would have to go back 80 years, to the disaster of 1929-1933, to find a longer recession.

[Readers who wish to post comments are advised to go to the posting at Seeking Alpha.]

          We often hear the question “isn’t this economic crisis becoming as bad as the Great Depression?” Economists can offer a variety of reassurances, but each of them is quite circumscribed:
(more…)

It is unfortunate that much of the congressional debate regarding the stimulus package is phrased in terms of a summary statistic: what fraction of the stimulus is to be increased spending and what fraction is to be tax cuts. It currently looks to be about 70-30, but the Republicans say they want more in tax cuts and the Democratic holdouts say they want more in spending.

To judge the merits, one has to go into greater detail. (more…)

 
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.

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.]

The members of the G-20 are meeting in Washington on November 15 to discuss reform of the global financial system.  The first thing to say about the calls for a “new Bretton Woods” is that they overreach, in the sense that it is very unlikely that any changes in the structure of the international monetary or financial system will or should, at this point in history, come out of multilateral discussions that are big enough to merit comparison with the first Bretton Woods. Certainly we are not talking about fixing exchange rates, as the 1944 meeting did.

Detour for an anecdote.  In mid-1998, when the crisis that originated in Southeast Asia had reached its one-year anniversary without abating, President Bill Clinton decided to give two important speeches.   He wanted to call for a new Bretton Woods.   His economic advisers (including both at Treasury and in the White House) advised him against this, on the grounds that one should not call for something as portentous as a new Bretton Woods when one was not likely to have proposals substantive enough to merit the name.   Soon after the (successful) speeches, British PM Tony Blair called for a new Bretton Woods.    Clinton asked his advisers, “How come Blair got to call for a new Bretton Woods when you wouldn’t let me do it?”    Our answer was along the lines, “Blair’s Treasury Secretary, Gordon Brown, doe s not necessarily have his interests aligned with his boss, in the way that Bob Rubin does.   So Brown had less incentive to stop Blair from saying something foolish.”   The big irony of the story is that Brown today is himself leading the move for a “new Bretton Woods.”

Even though the effort is virtually certain to fall short of a true “Bretton Woods 2,” it is worth taking the opportunity to consider what changes – whether more ambitious or less — might be made at the multilateral level to improve the functioning of the system.

Changes in government policy at the national level have already been radical in many countries, compared to anything that would have been imagined a short time ago:
• central banks’ extension of credit to institutions and under terms not contemplated in the past,
• governments’ buying up bad assets and recapitalizing, taking over,, or otherwise transforming troubled banks and financial institutions),
• agencies guaranteeing deposits (without limit) and money market funds, and so on.

Some of these steps can be done at the purely domestic level (US takeover of Fannie Mae and Freddie Mac); others require cooperation between a small number of countries (rescue of Fortis by Benelux countries); but others arguably require multilateral agreement, and thus are candidates for a modest “Bretton Woods.”

•  The International Monetary Fund has been given the task of outlining what a new Bretton Woods would look like – appropriate since the IMF is one of the original Bretton Woods institutions (along with the World Bank).
      o An Early Warning system is almost certain to be high on its list. But it already developed early warning indicators, after the East Asia crisis of 1997-98, and they haven’t been much help.
      o Now that the financial crisis is spreading to small economies like Iceland, transition economies in easternmost Europe, and poor countries like Pakistan, the IMF country rescue programs will get back in the saddle.
           This time around, however, the Fund has more competition (including from the ECB, the Gulf countries, China, and Sovereign Wealth Funds), and partly for that reason will probably demand less conditionality from the borrowing countries.    Also the Fund will have to turn to newly-wealthy countries like China to help finance  new facilities and programs.
              • Bill Rhodes has proposed that the Fund facilitate expansion of currency swap arrangements, to allow emerging markets to have the same access that has been made available to developing countries.
              • Michael Bordo and Harold James have suggested that the Fund could manage reserve assets of the new surplus countries; but it is not clear why the latter should want it to.
          The Contingent Credit Lines (CCL) – which were launched by the IMF with some fanfare in the aftermath of the 1997-98 East Asian crisis but were never attractive enough to attract a single client country — are back now, in the form of  new Short-Term Lending Facility.  The idea has always been that countries that have followed blameless policy (or as far as we can come to that in the real world), as judged by pre-crisis criteria, should be able to borrow large amounts from the Fund very quickly when faced with global contagion, without the usual conditionality.    Brazil and Korea look like two countries that had done most things right in recent years (flexible exchange rates, high level of reserves…) and have nevertheless since September seen international investors disappear.    The IMF has responded appropriately, with CCL-type loans that are multiples of country quotas.  
          Only a small number of countries qualify for having followed “blameless policy.”  Morris Goldstein suggests that the larger class of countries that have now been hit by forces beyond their control — the US-originating financial crisis — be helped by a revival of a long-ago IMF loan window, the Compensatory Financing Facility.
• The problem is that the money that the IMF is now able to offer is not only small relative to global capital markets (the IMF has long been used to that circumstance), but also small relative to the countries’ own reserves or to the no-condition funds that the Federal Reserve has now offered them through swap lines.   To expand such facilities, the IMF needs more funding.  Where will it come from?  Sovereign Wealth Funds and central banks in East Asia and Gulf countries.   But that in turn requires giving these countries much greater political representation than they currently have in the Fund.
              o There has been a loose one-year campaign to suggest guidelines for the operations of Sovereign Wealth Funds themselves, to “regulate” them.  But benefits of the SWFs may be more widely appreciated now than a year ago, in the context of the current crisis.   
              o The IMF, just as all the multilateral economic institutions, has moved far too slowly to give added representation to the newly important developing countries such as China, Brazil, Korea, India and Mexico – representation at least in proportion to their economic role, to say nothing of population.
                  A big part of the problem is that larger quotas and voting shares for these countries would have to come to a substantial extent out of Europe’s share.
                  In a fair world, Europe would also give up its stranglehold on the Managing Directorship (especially after the performance of the recent incumbents, who have appeared less interested in their jobs than in domestic politics back in their home countries or in putting new meaning into the phrase “foreign affairs”).  The same goes for the U.S with respect to the World Bank presidency.

•  The G-8 has been increasingly handicapped in recent years by virtue of its obsolete membership.
      o The G-7 still retains some relevance, in its role as self-appointed steering committee for world governance. After all, this financial crisis did not start in the developing countries, as it did those of 1982, 1997 and 2001.
     o But the G-7 cannot discuss the spread of the crisis to developing countries without Korea, Brazil, Turkey, India and Mexico at the table.  It cannot discuss central topics such as global current account imbalances, or the need for exchange rate adjustments, or coordinated global fiscal expansion, or requests that surplus countries fund rescue programs,  without China and Saudi Arabia at the table.     Thus it is appropriate that the G-20 is the group that has been invited to to the November 15 summit in Washington to discuss the new Bretton Woods.   
     o  Coordinated fiscal expansion is the most likely substantive macroeconomic policy outcome of the G-20 meeting.
      
• A probable substantive structural outcome from talk of the need for a bold new multilateral initiative is that there could be a “Basel III” to replace the “Basel II” agreement.
      o It would make capital requirements on banks countercyclical, rather than what has turned out to be procyclical, i.e., destabilizing, under Basel II. (Ironically economists at the BIS in Basel probably deserve credit for being the observers, in addition to Charles Goodhart, who most accurately warned of the procyclicality before the crisis.)
      o A Basel III could also replace the option of self-regulation of banks (under which they could choose their own Value At Risk models) with external regulation.    Dan Tarullo, who could have a  major role on the Obama team, offers some ideas .
      o The highly capable chairman of the Financial Stabilty Forum, Mario Draghi, assures us that already this year substantial progress has been made in such important areas as reducing conflict of interest on the part of credit-rating agencies.
      o International guidelines for guaranteeing deposits (possibly reinstating a ceiling, such as $100,000, after the crisis has passed) should perhaps be coordinated, to avoid flight of the sort that Ireland’s European partners experienced.

• Other possibilities:
      o A more ambitious reform would be to try to agree on guidelines to extend prudential regulation from international banks to non-bank financial institutions, since the latter were such a serious part of the problem in 2008 that many either failed or were bailed out, against all expectations.
      o More radically, regulation of this sort not just agreed multilaterally but carried out multilaterally, rather than at the national level, by the BIS (which now includes major emerging market countries) or a new agency.
      o The IMF, Financial Stability Forum, and other institutions will vie to lead the effort.
      o Other proposals, many of which could be attempted at the national level, but would optimally be coordinated internationally:
           A securities transactions tax, harmonized internationally, to raise revenue in a way that satisfies the public’s understandable feeling that the financial sector, which created this financial crisis, should not benefit from the solution.
           Executive compensation reform (especially in the financial sector).   Options-based bonuses have not been implemented in the incentive-compatible way that the corporate finance theorists anticipate  d, and have instead encouraged inordinate risk-taking.  One possible solution is to discourage compensation by options, in favor of restricted stock.    Another is to regulate corporate governance so as to insure that the CEO’s buddies don’t comprise the committee that determines his or her compensation.
         Regulation of the “originate to distribute” model of mortgage lending. Mortgage-Backed Securities were a useful innovation, but were carried too far.  The banks or mortgage brokers that originate a mortgage loan should be required to reattain a certain slice of each one (some have suggested 1/5), before selling the rest on, so that they have an incentive to monitor the creditworthiness of the borrower.  
           Regulation of Collateralized Debt Obligations.   Perhaps it is enough to raise capital requirement on the holders.  Perhaps something more drastic is required. 
           Regulation of certain derivatives, particularly Credit Default Swaps.  Perhaps it would be enough to standardize CDSs and set up a central clearing house, as many observers have suggested.
           But there is a danger that derivatives regulation could do more harm than good, e.g., a ban on futures markets or short-selling.
  o At the other end of the spectrum, one should consider the possibility that doing nothing might in the end be better than undertaking fundamental reforms in the international financial system, if the latter were driven by clumsy politics.

[To anyone wishing to post a comment:  I recommend you go to the RGE version of this post.]

When the Treasury came out with its $750 bailout plan on September 22, I  thought it lacked so many necessary ingredients that it deserved a thumbs down.  (Many others had similar objections, including George Soros.)

But in the negotiations between the Treasury and Congressional leaders over the course of last week, most of the missing ingredients were inserted.    Starting with the additions that were most necessary on the merits, and moving toward the ones where the necessity was more political, they were:

·        Institutionalized oversight of the Treasury, which had previously been startlingly absent.

·        Provisions so that the taxpayer would share in the upside potential of banks and other financial institutions, rather than just socializing the losses.  These provisions should allow the possibility that the government could recoup most or all of its short-term losses as has often ultimately been true in past unpopular bailouts.

o       First, by giving the government equity stakes in the banks that sell their bad loans to the Treasury.

o       Second, by having the president in five years submit legislation to recoup the cost from the financial sector if the taxpayer is still in the red at that point.

·        Limits on executive compensation, especially golden parachutes, at banks taking advantage of the opportunity to dump their bad loans on the Treasury.

·        Dividing the $750 billion into three slices over time, which at least offers the congressional negotiators a little bit of cover.

·        A provision for possible government insurance of mortgages instead of acquisition of them.   This was a bone thrown to the Congressional Republicans who had blocked the plan several days ago; I don’t know why they would want this provision, but at least it can’t do much harm.

Some other proposed provisions, from both the right and left, were left out, and for good reason in most cases.

The plan (TARP for Troubled Asset Recovery Plan) would still be unprecedented in magnitude and in the discretion it gives the Treasury Secretary.   Even if the Congress had passed it today, it would not have guaranteed an end to the financial crisis, let alone averting the recession that is probably already inevitable at this point.   Furthermore it does little to begin the reforms in regulation that our financial system now clearly needs.

Nevertheless, and as distasteful as it is to be “bailing out” Wall Street, or even bailing out those homeowners who took out loans that they shouldn’t have, let alone bailing out policymakers who were asleep at the switch, my view is that the program is necessary.   It is better than the alternatives:   

• better than the Treasury proposal of 9/22,
• much better than the proposal we would have gotten from a pre-Paulson Bush Administration,
• better than the alternative that the House Republicans are offering, and (most important of all) 
• better than the alternative of doing nothing, which would (will?) quite likely mean a severe recession.

I suppose it is not surprising that Congressmen facing elections in 5 weeks don’t want to go on record supporting something so unpopular.   What will happen now that the House rejected the deal in its vote today?   Most likely the stock market and real economy will plummet, until the pain gets so bad that a bailout package like this one accumulates more support.

I expressed my views this morning on the NPR radio show On Point.

[To any readers who wish to post comments: I suggest you go to the RGE version of this post.]