The US has lost more than 7 million private-sector jobs since the recession started. To make up for the job losses during this period and get the labor market back to the pre-recession level, it will take more than seven years, assuming each year the economy will be adding 2 million jobs.

If you sum up the job creation in the recent decade from 2000 to 2009, it’s estimated that we will end up with 1.7 million fewer jobs –call it “the lost decade of employment“.

Interview of Dr. Doom on the shape of recovery.

China’s current account surplus is dramatically shrinking.

Robert Barro, economist at Harvard, deciphers the history and answers the question whether government stimulus spending really work as claimed.

However, Barro did not mention the potential benefits of using government stimulas spening to reverse the “vicious cycle” during the time of panic.

(source: WSJ)

The global recession and financial crisis have refocused attention on government stimulus packages. These packages typically emphasize spending, predicated on the view that the expenditure “multipliers” are greater than one—so that gross domestic product expands by more than government spending itself. Stimulus packages typically also feature tax reductions, designed partly to boost consumer demand (by raising disposable income) and partly to stimulate work effort, production and investment (by lowering rates).

The existing empirical evidence on the response of real gross domestic product to added government spending and tax changes is thin. In ongoing research, we use long-term U.S. macroeconomic data to contribute to the evidence. The results mostly favor tax rate reductions over increases in government spending as a means to increase GDP.

For defense spending, the principal long-run variations reflect the buildups and aftermaths of major wars—World War I, World War II, the Korean War and, to a much lesser extent, the Vietnam War. World War II tends to dominate, with the ratio of added defense spending to GDP reaching 26% in 1942 and 17% in 1943, and then falling to -26% in 1946.

Wartime spending is helpful for estimating spending multipliers for three key reasons. First, the variations in spending are large and include positive and negative values. Second, since the main changes in military spending are independent of economic developments, it is straightforward to isolate the direction of causation between government spending and GDP. Third, unlike many other countries during the world wars, the U.S. suffered only moderate loss of life and did not experience massive destruction of physical capital. In addition, because the unemployment rate in 1940 exceeded 9% but then fell to 1% in 1944, there is some information on how the multiplier depends on the strength of the economy.

For annual data that start in 1939 or earlier (and, thereby, include World War II), the defense-spending multiplier that applies at the average unemployment rate of 5.6% is in a range of 0.6-0.7. A multiplier less than one means that, overall, other components of GDP fell when defense spending rose. Empirically, our research shows that most of the fall was in private investment, with personal consumer expenditure changing little.

Our research also shows that greater weakness in the economy raises the estimated multiplier: It increases by around 0.1 for each two percentage points by which the unemployment rate exceeds its long-run median of 5.6%. Thus the estimated multiplier reaches 1.0 when the unemployment rate gets to about 12%.

To evaluate typical fiscal-stimulus packages, however, nondefense government spending multipliers are more important. Estimating these multipliers convincingly from U.S. time series is problematical, however, because the movements in nondefense government purchases (dominated since the 1960s by state and local outlays) are closely intertwined with the business cycle. Thus the explanation for much of the positive association between nondefense spending and GDP is that government spending increased in response to growing GDP, rather than the reverse.

The effects of tax rates on GDP growth can be analyzed from a time series we’ve constructed on average marginal income-tax rates from federal and state income taxes and the Social Security payroll tax. Since 1950, the largest declines in the average marginal rate from the federal individual income tax occurred under Ronald Reagan (to 21.8% in 1988 from 25.9% in 1986 and to 25.6% in 1983 from 29.4% in 1981), George W. Bush (to 21.1% in 2003 from 24.7% in 2000), and Kennedy-Johnson (to 21.2% in 1965 from 24.7% in 1963). Tax rates rose particularly during the Korean War, the 1970s and the 1990s. The average marginal tax rate from Social Security (including payments from employees, employers and the self-employed) expanded to 10.8% in 1991 from 2.2% in 1971 and then remained reasonably stable.

For data that start in 1950, we estimate that a one-percentage-point cut in the average marginal tax rate raises the following year’s GDP growth rate by around 0.6% per year. However, this effect is harder to pin down over longer periods that include the world wars and the Great Depression.

It would be useful to apply our U.S. analysis to long-term macroeconomic time series for other countries, but many of them experienced massive contractions of real GDP during the world wars, driven by the destruction of capital stocks and institutions and large losses of life. It is also unclear whether other countries have the necessary underlying information to construct measures of average marginal income-tax rates—the key variable for our analysis of tax effects in the U.S. data.

The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP.

Every month when we have a uptick on housing price index, there will be a discussion on whether housing price will recover soon.

Following my last update in August, here is another update from two housing experts on recent housing trends.

First, David Levy on housing:

Then, the interview of Robert Shiller on longer-term housing trends.

Q&A: Shiller Sees 5 Years of Stagnant Home Prices

Robert Shiller, the Yale University economist who famously predicted the housing bust, was awarded the Deutsche Bank Prize in Financial Economics today. In this interview, he talks about the state of the housing market and the implications of low interest rates.
Robert Shiller is awarded Deutsche Bank Prize in Financial Economics 2009. (Center for Financial Studies)

Is the slump in U.S. home prices bottoming out?

Shiller: The situation has definitely changed. With our numbers — the S&P/Case Shiller home price index — going up sharply. It looks like a major turnaround. We’ve been watching that for three months now, and we have some concern that it could be an aberration and temporary. But, at this point, it seems to be evident in just about every city in the U.S. That suggests it’s real. But it probably isn’t the beginning of a major boom, just because the economy is in such bad shape. There’s also a chance that it will reverse. It’s still only three months old, so it’s very hard to be sure at this point. The most likely scenario is that it won’t continue at this high rate of increase, but that it will neither go down a lot, nor up a lot.

So the index will move sideways for a while?

Shiller: Yes, for a while, meaning five years.

What are the main factors driving U.S. house prices? What could push them up, or cause another slump?

Shiller: The main factor is the world economic crisis and the efforts of governments around the world to stimulate the economy. Parts of those efforts have been directed at the housing market. In the U.S., there is an 8,000 dollar first-time home buyer’s tax credit which expires at the end of November. That’s a reason for concern, as it comes to an end. Also, the Federal Reserve has a plan to buy $1.25 trillion worth of mortgage-backed securities to support the housing market. They are most of the way through the program and anticipate phasing it out at some time in 2010 – that’s another thing that will go away. We’ve yet to see how the housing market will continue. Part of the problem is that people are buying now rather than later. When later comes, there could be a downturn in the market.

Is there an oversupply of houses in the U.S.?

Shiller: That’s been a problem. The inventory of unsold houses has been high, but has come down a bit. On top of that, there will be more foreclosures, more homes are going to be dumped on the market as people default. Now, that may show down as home prices will start going up again. But I suspect that this isn’t going to happen. Also, banks have more REO, or real estate owned, that they’re holding on to for the time being. But eventually those REOs are going to be dumped on the market. So that’s why it doesn’t look particularly encouraging from a supply consideration.

Turning to interest rates, which are at exceptionally low levels: Is there a risk that this eventually will cause irrational exuberance?

Shiller: There is always a risk of that. Those things are hard to predict. However it seems like the present time is least conducive to bubbles of any time. We’re in what some people call “pretend-and-extend” economy, which means that banks that have commercial loans are often extending those loans and pretending that the property is worth something. That’s because they don’t face reality. This kind of economy isn’t really suited to a beginning of a real bubble. Now, everything could change… It’s surprising how strong the residential, single-family home market looks right now. It makes me think that it’s hard to predict animal spirits.

How long can central banks afford to keep expansive policies in place?

Shiller: In principle we can keep this in place for a long time. That’s what Japan did… But confidence is definitely coming back. The depression scare is over at the moment. So it would be plausible that central banks could be raising interest rates — both in the U.S. and Europe — [as early as next year]. But I just have a worry that this isn’t going to happen and that it’s not going to be so easy to extricate [themselves from the low-rate environment].

Will the sharp increase in global debt levels drive up inflation over the medium to long-term?

Shiller: My best guess is that we won’t have inflation, that central banks will pull it back as inflation starts to begin. But I think that there’s a chance of it; people have to be defensive in their investments. It always amazes me that people are so trusting and that they want nominal debt as much as they do… So a good long-term strategy is to invest a good part of one’s portfolio in inflation-indexed bonds, even though it doesn’t particularly look like the time to worry about inflation right now.

FT’s short view explains why Yen is so strong at the moment and whether an intervention is looming.

What to take away is Dollar’s interest rate is so low right now that it is being used as a funding currency for carry trade.

(click to play video; Source: FT)