Month: August 2011

Here is my latest column, some of it will sound familiar to readers of TGS:

One bias in the economic statistics — which never shows up in published revisions — is embedded in the health care sector, where third-party payments, subsidies and care quality are hard to monitor and measure. A result is that a dollar spent on health care does not necessarily mean a true dollar’s worth of value added. The United States spends more per capita on health care than any other country, yet without producing measurably superior results. To the extent that some of these expenditures are wasteful, the gross domestic product and productivity numbers overstate economic growth.

Here’s another problem: Expenditures on the military and domestic security have risen since 9/11, but those investments are intended to neutralize external threats. Even if you agree with this spending, it generally doesn’t produce useful goods and services that raise our standard of living.

One of the most commonly cited productivity numbers describes per-hour labor productivity, but this, too, has intrinsic flaws. Labor force participation has been falling for more than a decade, and low-skilled workers are leaving the work force in disproportionate numbers. Taking some lower-paying jobs out of the mix will raise the measure for average productivity, which is hardly the same as increasing the economic gains from a given set of workers or, for that matter, from putting more people to work by making them more productive.

There is more at the link, including points which do not appear in TGS.

Let’s say the U.S. becomes another Japan or for that matter let’s say Japan has become Japan.  Still, we all know that capital depreciates.  That raises the return on replenishing and rebuilding the capital stock.  Even though wealth is falling, it raises the marginal rate of return on investment.  Which in turn should spur aggregate demand and also credit creation.  At some point you have to get the roof fixed.  If alien invasion can work, what about a slower rotting away of the same output?

That’s a slow, ugly and painful way to end a downturn, but the deeper question is whether it will work at all.  It doesn’t seem to have worked in Japan and they’ve had enough time for a lot of capital to rot away. This paper measures depreciation rates (for America) and estimates that physical capital, without repair, has an average survival time of thirteen to sixteen years.

Why has it not worked in Japan?  I see (at least) two options:

1. The boost to aggregate demand has to be based on sustainable increases in real wealth, rather than deteriorations in wealth.  Maybe so, but then monetary and fiscal policy won’t work either, or more accurately the fiscal policy will work only if the resulting outputs are fairly valuable.  Keynesian pyramids won’t do the trick.  Of course, people who stress “the broken window fallacy” will likely side with this response.

2. As the capital stock depreciates, it is repaired slowly but steadily, enough to keep the MP of K from rising very much and thus there is enough capital replacement to thwart recovery.  (People who stress “the broken window fallacy fallacy” may prefer this option!)  That sounds plausible, but if I think about it long enough my worries multiply.

The argument implies that the real problem is low and enduring real rates of return, and not simply that a monetary trick is distorting those rates of return.  The marginal real rate of return keeps on creeping up and the decisions of investors keep on pushing it back down, but only so much; apparently the economy wants to stay in this low output, low rate of return corridor.  That’s closer to a TGS story than to a “we can fix this with AD” story.  (Alternatively, do you wish to argue that there is a collective action problem with the slow accretion of the “investment of repair” and that we should tax it and save it all up for one big bang of recovery?  I can see the model but does anyone actually believe this?)

Does the argument imply a funny non-linearity?  It implies that, say, a stimulus of $2 trillion will be more than twice as effective as a stimulus of $1 trillion.  Bombs falling are better than slow rot, and so on.  That could be true, but I see a lot of hand-waving on the issue.  It would seem to boil down to psychology and multiple equilibria (“the confidence fairy”?) and thus I am suspicious of very definite predictions along this particular dimension.  Of course, sometimes bombs really wreck a place; ever been to Bosnia?

It is worth pondering our views on capital depreciation and whether they are consistent with our other beliefs about macroeconomics and also about Japan and why it has remained in its downturn so long.

By the way, measured private investment has not really risen since 1998.

Timeshare Backyard is a grass lot in Manhattan’s Lower East Side that is rentable for $50 per hour (see a Reuters report on the project). Renters can specify added cost options like a slip-n-slide, barbecue grill, or live band–though they’ll have to act quickly as the backyard is almost fully booked through August 28, when the endeavor comes to an end. Timeshare Backyard is a project by The Participation Agency, a rather mysterious New York City brand consultancy.

Here is the link, with a good photo (very enticing), a barbecue grill is extra, and for the pointer I thank Selena M.  After August 28, the rental offer goes away.

That is a new paper by Isil Erel, Taylor D. Nadauld, and Rene M. Stulz, and it is one of the more instructive papers on the financial crisis:

We estimate holdings of highly-rated tranches of mortgage securitizations of American deposit-taking banks ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. We find that holdings of highly-rated tranches were economically trivial for the typical bank, but banks with greater holdings performed more poorly during the crisis. Though univariate comparisons show that banks with large trading books had greater holdings, the holdings of highly-rated tranches are not higher for banks with large trading books in regressions that control for bank size. The ratio of highly-rated tranches holdings to assets increases with bank assets, but not for banks with more than $50 billion of assets. This evidence is inconsistent with explanations for holdings of highly-rated tranches that emphasize the incentives of banks deemed “too-big-to-fail”. Further, the evidence does not provide support for “bad incentives” theories of holdings of highly-rated tranches. We find, however, that banks active in securitization held more highly-rated tranches. Such a result can be consistent with regulatory arbitrage as well as with securitizing banks holding highly-rated tranches to convince investors of the quality of these securities. Our evidence supports the latter hypothesis.

In other words, it was not “too big to fail moral hazard” and it also was not venal corporate incentives.  It was possibly some regulatory arbitrage but also just plain, flat stupidity and complacency.

Mulligan writes:

There is still no evidence to confirm the fundamental Keynesian proposition that supply doesn’t matter.

Oddly, for all of his apparent skepticism of Paul Krugman, Mulligan is completely suckered on this one.  This is Krugman’s current version of Keynesian economics (and even then only sometimes), not Keynesian economics more broadly construed.  There is nothing in the (very useful) data cited by Mulligan, in his posts on supply and employment, which runs against the Keynesian story.  Of course I am a fan of the blogosphere, but sometimes it frightens me when I see it having influence over research interpretations.  We’re just a small number of apes sitting at computers, relative to the overall literature.  When it comes to Keynesian economics, I don’t always see us apes as reflecting the broader literature very well, yet we are read by a relatively large number of apes.  We can expect this problem to get worse, as people learn the “blogosphere versions” of different points of view.  Karl Smith comments.  And, as you might expect, Scott Sumner makes perfect sense.

MR commentator Donald A. Coffin posts on the wage stickiness issue:

There is, as it turns out, some actual research on this issue in the job search literature. The bottom line is that reservation wages appear to fall relatively quickly with duration of unemployment. One common conclusion is that wage stickiness comes from the behavior of *employers.* Some citations:

“Reservation Wages, Offer Wages, and Unemployment Duration–Some New Empirical Evidence” http://ideas.repec.org/p/kie/kieliw/1095.html The authors conclude that offer wages fall faster than do reservation wages (not that reservations wages do not fall).

“The Relationship Between Unemployment Spells and Reservation Wages as a Test of Search Theory,” by Stephen R. G. Jones, QJE, V. 104, N. 4, 1988. “…the main finding is that reservation wages play a significant role in the determination of duration.”

“Short-Run Equilibrium Dynamics of Unemployment, Vacancies, and Real Wages,” by C. A. Pissarides, AER, V. 75, N. 4, 1985.

“Efficiency Wage Models and Unemployment,: by J. L. Yellen, AER, V. 72, N2., 1984. The stickiness of wages is attributed to the reluctance of *employers* to reduce wages.

“Unemployment, Wage-Setting, and Insider-Outsider Relationships,” by A. Lindbeck, AER V. 76, N. 2, 1986. The stickiness of wages is again attributed to the reluctance of *employers* to reduce wages.

“Wage Dynamics: Reconciling Theory and Evidence,” by O. Blanchard and L. Katz, http://www.nber.org/papers/w6924 1999. “In this paper, we ask whether one can reconcile the empirical evidence with theoretical wage relations. We reach three main conclusions. First, we derive the condition under which the two can indeed be reconciled. We show the constraints that such a condition imposes on the determinants of workers’ reservation wages as well as the relative importance of workers’ outside options as opposed to match specific productivity in wage determination. Second, in the light of this condition, we reinterpret the presence of an “error correction” term in macroeconomic wage relations for most European economies but not in the United States. Third, we show that whether this condition holds or not has important implications for the effects of a number of variables — from real interest rates to oil prices to payroll taxes — on the natural rate of unemployment.”

“An Empirical Test Job-Search Model, with a Test of the Constant Reservation-Wage Hypothesis,” N. Keifer and G. Neumann, JPE, V. 87, N. 1m 1979. “Reservation wages are found to decline significantly with duration.”

“An Econometric Analysis of Reservation Wages,” by T. Lancaster and A. Chesher, Econometrica, V. 51, N. 6, 1983. Their table A-IV clearly shows reservation wages falling with duration of unemployment, from 21.28 pounds per week for durations less than 13 weeks to 17,74 pounds per week for durations exceeding 52 weeks,

I could go on, but go to Google Scholar and search on “reservation wages and duration of unemployment” if you want more.

If the employers don’t want you at the high wage, and don’t want you at the low wage, what might your perceived MP be, temporarily or not?  Keep in mind, firms are flush with cash.