Inside FOMC
Rick Mishkin talks about the decisions made during the Fed’s recent meeting.
A Cheer for Obama’s Corporate Tax Break
Reports WSJ:
President Barack Obama, in one of his most dramatic gestures to business, will propose that companies be allowed to more quickly write off 100% of their new investment in plants and equipment through 2011.
The proposal, to be laid out Wednesday in a speech in Cleveland, tops a raft of announcements, from a proposed expansion of the research and experimentation tax credit to $50 billion in additional spending on roads, railways and runways.
Companies can now deduct new investment expenses, but over a longer period of time—three to 20 years. The proposed change, which would let companies keep more cash now, is meant to give companies who may be hesitant to invest an incentive to expand, acting as a spur to the overall economy.
Although the timing of the announcement looks suspicious (see the video interview below), let’s genuinely hope this will increase business confidence and hiring.
What history tells us about the aftermath of a financial crisis
The Reinhart couple sounds the alarming bell (article from FT):
The landscape of Jackson Hole, Wyoming, where central bankers gathered at their annual conference last week, is spectacular and forbidding. Jagged peaks and vast empty spaces stretch across the horizon. For the attendees, however, it was both a vista and a metaphor. Having lived through a precipitous global economic drop, they now must forecast how steep or flat will be the incline of recovery.
Ben Bernanke, chairman of the Federal Reserve, painted a sober but reassuring picture of US prospects. The basis for sustained recovery is in place, and canny Fed officials are now alive to the dangers of both deflation and inflation. Similarly Jean Claude Trichet, head of the European Central Bank, spoke about how the dust had begun to settle on the crisis. Policymakers and financial markets seem to be looking at what comes next.
We have analysed data on numerous severe economic dislocations over the past three-quarters of a century; a record of misfortune including 15 severe post-second world war crises, the Great Depression and the 1973-74 oil shock. The result is a bracing warning that the future is likely to bring only hard choices.
Our research found real per capita gross domestic product growth tends to be much lower during the decade following crises. Unemployment rates are higher, with the most extreme increases in the most advanced economies that experienced a crisis. In 10 of the 15 episodes we studied, unemployment never fell back to its pre-crisis level, not in the following decade nor right up to the end of 2009.
It gets worse. Where house price data are available, 90 per cent of the observations over the decade after a crisis are below their level the year before the crisis. Median prices are 15 to 20 per cent lower too, with cumulative declines as large as 55 per cent. Credit is also a problem. It expands rapidly before crises, but post-crash the ratio of credit to GDP declines by an amount comparable to the pre-crisis surge. However, this deleveraging is often delayed and protracted.
Our review of the historical record, therefore, strongly supports the view that large destabilising economic events produce big changes in long-term indicators, well after the upheaval of the crisis. Up to now we have been traversing the tracks of prior crises. But if we continue as others have before, the need to deleverage will dampen employment and growth for some time to come.
Is unemployment insurance to blame?
Robert Barro thinks the expanded unemployment insurance (to 99 weeks) is the culprit for nation's high unemployment rate.
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I want to focus here on another dimension of the Obama administration's policies: the expansion of unemployment-insurance eligibility to as much as 99 weeks from the standard 26 weeks.
The unemployment-insurance program involves a balance between compassion—providing for persons temporarily without work—and efficiency. The loss in efficiency results partly because the program subsidizes unemployment, causing insufficient job-search, job-acceptance and levels of employment. A further inefficiency concerns the distortions from the increases in taxes required to pay for the program.
In a recession, it is more likely that individual unemployment reflects weak economic conditions, rather than individual decisions to choose leisure over work. Therefore, it is reasonable during a recession to adopt a more generous unemployment-insurance program. In the past, this change entailed extensions to perhaps 39 weeks of eligibility from 26 weeks, though sometimes a bit more and typically conditioned on the employment situation in a person's state of residence. However, we have never experienced anything close to the blanket extension of eligibility to nearly two years. We have shifted toward a welfare program that resembles those in many Western European countries.
The administration has argued that the more generous unemployment-insurance program could not have had much impact on the unemployment rate because the recession is so severe that jobs are unavailable for many people. This perspective is odd on its face because, even at the worst of the downturn, the U.S. labor market featured a tremendous amount of turnover in the form of large numbers of persons hired and separated every month.
For example, the Bureau of Labor Statistics reports that, near the worst of the recession in March 2009, 3.9 million people were hired and 4.7 million were separated from jobs. This net loss of 800,000 jobs in one month indicates a very weak economy—but nevertheless one in which 3.9 million people were hired. A program that reduced incentives for people to search for and accept jobs could surely matter a lot here.
Moreover, although the peak unemployment rate (thus far) of 10.1% in October 2009 is very disturbing, the rate was even higher in the 1982 recession (10.8% in November-December 1982). Thus, there is no reason to think that the United States is in a new world in which incentives provided by more generous unemployment-insurance programs do not matter much for unemployment.
Another reason to be skeptical about the administration's stance is that generous unemployment-insurance programs have been found to raise unemployment in many Western European countries in which unemployment rates have been far higher than the current U.S. rate. In Europe, the influence has worked particularly through increases in long-term unemployment. So the key question is what happened to long-term unemployment in the United States during the current recession?
To begin with a historical perspective, in the 1982 recession the peak unemployment rate of 10.8% in November-December 1982 corresponded to a mean duration of unemployment of 17.6 weeks and a share of long-term unemployment (those unemployed more than 26 weeks) of 20.4%. Long-term unemployment peaked later, in July 1983, when the unemployment rate had fallen to 9.4%. At that point, the mean duration of unemployment reached 21.2 weeks and the share of long-term unemployment was 24.5%. These numbers are the highest observed in the post-World War II period until recently. Thus, we can think of previous recessions (including those in 2001, 1990-91 and before 1982) as featuring a mean duration of unemployment of less than 21 weeks and a share of long-term unemployment of less than 25%.
These numbers provide a stark contrast with joblessness today. The peak unemployment rate of 10.1% in October 2009 corresponded to a mean duration of unemployment of 27.2 weeks and a share of long-term unemployment of 36%. The duration of unemployment peaked (thus far) at 35.2 weeks in June 2010, when the share of long-term unemployment in the total reached a remarkable 46.2%. These numbers are way above the ceilings of 21 weeks and 25% share applicable to previous post-World War II recessions. The dramatic expansion of unemployment-insurance eligibility to 99 weeks is almost surely the culprit.
To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%.
Consider how the prospects for Democrats in the November elections would look if the unemployment rate were now only 6.8%. Obviously, this change would make all the difference, and President Obama can reasonably blame his economic advisers. They should have protected their boss by standing firm and arguing that a reckless expansion of unemployment-insurance coverage to 99 weeks was unwise economically and politically. Congressman Boehner's advice to Mr. Obama seems correct, though possibly too late to matter.
No more prop-trading at Goldman
Goldman Sachs decided to close down its prop-trading business, to conform to the new finance overhaul bill, reports WSJ.
Goldman Sachs Group Inc. has decided to close its principal-strategies unit, which does proprietary trading, in the wake of financial-overhaul regulation passed by Congress, according to a person familiar with the matter.
The widely expected decision follows J.P. Morgan Chase & Co.'s decision this week to close its proprietary-trading business. That bank started telling its proprietary traders earlier this week that it would exit that part of the business.
Proprietary trading, which involves putting a company's own capital at risk in trades, is now a relatively small part of the two companies' operations. An analyst at Citigroup has estimated that Goldman Sachs Principal Strategies has shrunk in the past three years and generates less than 1% of the company's overall trading revenue, or about $100 million to $200 million a quarter. Virtually all of Goldman Sachs' proprietary trading is done in the principal-strategies unit.
Bob Shiller on confidence and the economy
Bob Shiller, economics professor at Yale University and a pioneer in behavior finance talks about the importance of confidence in economic recovery. He thinks with lingering high unemployment, the national morale is sinking.
And we have to admit we simply do not know many things in the working of our economy.
Is US labor market no longer flexible?
One of the greatest strength of American economy is its very flexible labor market. Following my previous post on hiring mismatch in the US labor market, here is a nice piece from Economist Magazine on whether the high unemployment rate, currently at 9.5%, is more due to structural change, rather than weak demand, in American economy.
There are a few things that might have contributed to such structural rigidities in the labor market. First is the skill mismatch. Imagine how many people went into housing and construction business in this great housing bubble, how many of them can retrain themselves and find jobs in new sectors. Also imagine how many people went into financial industry. If you agree that American financial industry is also in a secular decline, this just adds more into the structural skill mismatch.
Another factor is also related to housing. Buying at peak price and with more than 35% price decline at nationwide, a lot of home owners have their home equity now under the water. The heavy mortgage debt limits people's mobility, and prevents them from taking jobs in new places.
AMERICANS are used to thinking of their job market as lithe and supple. Employment snaps back quickly after recessions. Workers routinely shuttle between industries and cities to wherever jobs are abundant. But in the past decade, the labour market has resembled an ageing athlete. Each new injury is more painful and takes longer to heal. More than a year into the current economic recovery the unemployment rate remains stuck close to 10%, raising concerns about the kind of sclerosis that continental Europe suffered in the 1980s.
The slow rehabilitation is in part because the economy suffered a trauma, not a scrape. The fall in GDP during the last recession was easily the largest of the post-war period, and output remains well below its potential. Few had expected a rapid return to full employment, but even modest expectations for jobs growth have not been met. Employment has actually fallen since the end of the recession; and unemployment would be even higher than it is were it not for discouraged would-be jobseekers quitting the workforce. Some economists now fret that other barriers besides weak demand stand between workers and jobs, and that high unemployment is partly “structural” in nature.
The case begins with some kinks in recent data. Rising GDP has not led to the fall in unemployment predicted by Okun’s Law, established in the 1960s by Arthur Okun, an economist. The figures have also departed from the Beveridge curve (named for a British economist, William Beveridge) which relates job vacancies and the jobless rate. Unemployment has failed to fall in a way consistent with the increase in job openings.
Such deviations are perhaps too short-lived to be conclusive. But they jar because there are other reasons to believe that structural obstacles to jobs growth have risen. For instance, jobless benefits have been extended to 99 weeks in some states with high unemployment, compared with the usual limit of 26 weeks. Such payments provide crucial support to the long-term jobless and help to prop up aggregate demand. But they also push up the unemployment rate by discouraging workers from looking for jobs as assiduously as they might otherwise do.
A bigger worry is that jobseekers no longer have the skills demanded by employers. Half of the 8m jobs lost went in construction and manufacturing, and those departing these industries may struggle to adapt to jobs in more vibrant areas such as education and health services. The cost of this skills mismatch is compounded by America’s housing bust. Many owe more on mortgages than their homes are worth. Households often opt to stay put rather than default, leaving them trapped in places with high unemployment and unable to move to where jobs are plentiful. The rise of the two-income household has also made workers less mobile than they were: it is harder to move in search of jobs if there are two careers to consider.
How important are these factors? Very, says Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. He recently caused a stir by arguing that “most” of America’s unemployment is thanks to such mismatches, and hence not easily alleviated with looser monetary policy. Most American policymakers believe that structural joblessness has risen little, if at all.
One of the few concrete estimates comes from the IMF. A recent report compared the skill levels of the unemployed with indicators of the skills required by employers, to create state-level indices of mismatches. It used local mortgage-default and foreclosure figures to estimate geographical immobility. The results suggest that each of these factors acts to magnify the impact of the other. The authors conclude that, because of these rigidities, the unemployment rate consistent with stable inflation—roughly speaking, the structural rate—rose from around 5% in 2007 to between 6% and 6.75% by 2009.