My response:

I am astounded by claims that fiscal stimulus under recession circumstances doesn’t create jobs. Or at least I am astounded when such claims come even from some reputable economists.  Do they think that a construction job on a road-building project doesn’t count as a real job if the funding comes from the government?   More likely, they think that the increase in demand doesn’t raise output in the aggregate, because the federal debt crowds out private production and so someone else somewhere loses his or her job?  But that would be hard to believe, at a time when the Fed is keeping interest rates at zero, long-term interest rates are also quite low, and capacity is lying idle.  Moreover, Republican lectures to Democrats about the evils of the national debt take real chutzpah, after Presidents Reagan, Bush I and Bush II increased the debt ten-fold during periods when no national emergency required it.

Yes, the effort to identify specific jobs saved is more a political exercise than an economics exercise; but the true number of jobs saved, relative to what would otherwise have happened , is greater than the 650,000 number. It is legitimate as a communications strategy for the White House to make the benefits concrete by pointing to the many individual teachers who would have been laid off by fiscally devastated state and local governments in the absence of federal government money. But there are several difficulties with using this job count as a way to evaluate the impact of the fiscal stimulus.  One problem is that the exercise doesn’t count the indirect effects of most of the spending and tax cuts, where it is hopeless to try to pinpoint whose job was saved.

The biggest problem, of course, is that one cannot estimate accurately, let alone prove to the skeptics, what would have happened in the absence of the stimulus package. Claims by Republican congressmen that one should judge Obamanomics by looking at whether employment is greater now than before February are nonsense. If there hadn’t been a severe recession underway (starting on the predecessor’s watch, if you want to get political about it), there would have been no need for the stimulus. None of us claims that fiscal stimulus creates a lot of jobs on net when the economy is already expanding strongly. The increased government spending that occurred during the terms of Presidents Reagan and Bush after the recessions of their respective first terms had already ended, for example, did not create a lot of jobs.  But without the recent stimulus, the recession would have been worse.

The appropriate way to estimate the stimulus impacts is by means of a standard macroeconomic model with fiscal multipliers in it. But if you believe philosophically that fiscal multipliers are zero, even in a severe recession, then neither a standard macroeconomic model nor anything else will convince you.

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 French President Nicolas Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi.  Nobel-Prize winners abound. The Commission believes that we have been focusing too much on market-measured 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 single concept that factors in these other measures of the health, inequality, the environment, etc.    GDP is a comprehensive measure of market output, 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 measurement problem is the reason for the myriad errors our national policy makers have made in recent years (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 have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some 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 of 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 recessions, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one value 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 regarding the science, would think that the output loss outweighs the climate benefit by far. 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,” but, rather, a gain in welfare.  It would then logically follow that any policy decisions that got us into this situation (whether attributable to incomplete information about banking activity or inequality or anything else), were good, not bad!

Source: US Energy Information Agency

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          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)

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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.

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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.

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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.)

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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.    

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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)

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