Russ Roberts and Edward Leamer

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I love this video, but that is because I agree so much with Leamer.

One thing I would point out about his charts is that he uses trend lines and implies that mean reversion is the norm. That is, for most of the postwar period, if you had a recession that took GDP below trend, you would then have above-trend growth. An alternative hypothesis is that real GDP follows a random walk with drift. That would mean that it always tends to grow at 3 percent, regardless of its recent behavior. The last three recession seem to follow such a model.

In the late 1980s, some folks, notably Charles Nelson and Charles Plosser, argued strenuously against mean reversion and in favor of the random walk with drift. Note that this is back when Leamer describes output and employment as mean-reverting. I wonder if what happens as data get revised over long periods of time is that random walks get turned into mean-reverting trends.

Note Tyler Cowen’s comment on the latest employment report:

we are recovering OK from the AD crisis, but the structural problems in the labor market are getting worse. It’s becoming increasingly clear those structural problems were there all along and also that they are a big part of the real story. On the AD side, mean-reversion really is taking hold, as it should and as is predicted by most of the best neo-Keynesian models.

An Interesting Abstract

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The paper is by Ross Levine and Yana Rubinstein.

We use the classification of the self-employed into incorporated and unincorporated to separate between “entrepreneurs” and other business owners. Using data from the CPS and the NLSY79, we find, in contrast to a large body of research, that entrepreneurs earn much more per hour and work many more hours than their salaried and unincorporated counterparts. Moreover, the incorporated self-employed have distinct cognitive and noncognitive traits: they are more educated, and even as teenagers, they score higher on learning aptitude tests, exhibit greater self-esteem, and engage in more aggressive, illicit, risk-taking activities. And, these traits are much more important for entrepreneurial success than they are for success in other employment activities.

The press has picked up on the part about teenage propensity for illicit, risk-taking activities. Doesn’t describe me as a teenager.

Two Interesting Interviews

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1. Marlene Zuk.

My objection is to the assumption that what we did before — say, pre-agriculture — was healthier, or even ideal, and then, somehow, we got kicked out of the Garden of Eden, and it’s all been downhill. Diamond talks about the ways in which agriculture was bad, and he is right about those costs. Of course, walking upright is bad for us too, at least in some ways, but that ship has sailed. I think a deeper understanding of evolution helps you better understand the futility of pointing to a moment in time as being the perfect one.

2. Gary Becker.

In terms of understanding the crisis, I do not think that more realistic behavioral assumptions would solve the problem. It has always been difficult in rational choice models to adequately account for the coordination of people’s expectations. To some extent, the crisis involved the coordination of irrational expectations…the theory of rational expectations always said that people make a forecast and could coordinate on a bad forecast. That has always been part of the theory, however there is more attention being paid to that phenomenon now.

He takes some swipes at Austrian economics.

Pointers to both from Jason Collins.

Fiscal Crunch Time

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John Cochrane links to a WSJ editorial and a working paper by Greenlaw, Hamilton, Hooper, and Mishkin. The authors make the point that I have been making, which is that when government has accumulated a lot of debt, an increase in interest rates can be catastrophic. This almost forces the central bank to abandon its inflation-fighting goals when the crunch hits.

On the basis of intellectual history, there is another prominent economist who one might expect to endorse and amplify these concerns. He would dismiss the current low interest rates as Wile E. Coyote market behavior. He would trot out diagrams illustrating multiple equilibria. But that economist seems to have disappeared.

Kyle Bass thinks that this scenario will appear in Japan before it strikes Europe or the United States. If you are familiar with John Mauldin, then you know what Bass is going to say.

Most of the questions that Bass gets are “What should an ordinary investor buy?” Interestingly, I get that question a lot from friends on the left. I think that all of us happen to be at an age, close to 60, where the worst case scenario is that your savings take a big hit. If you were 40, you would figure that your human capital is still your most important asset. If you were 80, you would say that you don’t have to worry about how far your savings will go.

I would say that my worries would go away if the politics in this country shifted toward the right. Presumably, that is not where my friends on the left are coming from. My guess is that they connect their fears about preserving the value of their savings with doubts about the capitalist system in general.

Bass suggests oil wells, apartments, and firms with productive assets. I have shifted in that direction the past couple of years, so anyone who has been betting on the U.S. stock market as a whole has been doing better than I have lately. And I hope they continue to do so. Because there is no hedge against a breakdown of the social fabric, which is what Bass is predicting for Japan. There, if he is correct, the worst case scenario for a 60 year old is about to become reality.

Big Sugar’s Gall

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This is the first time I have ever written a blog post to comment on a newspaper advertisement, in this case in The Washington Post, on March 6th. I assume that there is no way to link to it. The ad says:

Big Candy’s Greed
[picture of a suit pocket stuffed with cash next to a picture of a farm with a foreclosure sign]
Jeopardizing 142,000 U.S. jobs and America’s food security isn’t a game. It’s a travesty.
So why are Big Candy executives lobbying Congress to outsource America’s sugar production?
To boost their already bloated profit margins at the expense of American farmers, workers and consumers.
Winners: A few corporate executives.
Losers: America
Support Current Sugar Policy–It Works for America
American Sugar Alliance
Backing America’s Beet and Cane Farmers

Why did the trade association executives choose to run this ad? Consider these possiblities:

1. They do not actually believe the oppressor-oppressed narrative they have concocted (to support sugar tariffs, of course), but they think that they can fool people with it and thereby influence policy.
2. They do not believe the narrative will influence policy, but they believe that they can fool the donors who sponsor their organization into thinking that they are getting something valuable for their contributions.
3. Actually, they are not trying to fool anyone with this narrative. In fact, they believe it themselves, even though to everyone else it is transparently ridiculous.

I lean toward (3). When you cash your paycheck from a pure rent-seeking organization, you want to convince yourself that you are actually a good guy, and in the process you make someone else the bad guy.

Tod Lindberg On the Left’s Success

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Read the whole essay. He views the Left as animated by egalitarianism. This is close to my thesis that progressives use the language of oppressor-oppressed. Some excerpts:

The Left shares the suspicion of government power at the heart of classical liberalism, but only up to a point. Individuals need rights to protect them from overweening government intrusion, true, but government power in the proper hands can do good, and indeed the proper hands must wield the power of government in order to do the good of pursuing equality.

I have written that progressives believe that what their goals require is sufficient moral authority. Getting government to do good things is just a matter of summoning enough moral authority.

Few on the Left are willing to grant that their critics are likewise reasonable — in other words, that the Left has anything to gain from taking its critics seriously. That leaves the Left in search of an explanation for why it hasn’t won over its critics. The Left has three main explanations. The first is ignorance, in the sense that its critics lack sufficient knowledge of how society could be improved and why what the Left seeks would constitute improvement. For this category, there may be hope in the form of remedial education. The second is stupidity; its critics are simply unable to understand superior wisdom when they face it. There is little hope for them, alas. The third is venality — that its critics know better but seek to defend their position of personal privilege anyway. The only way to deal with these critics is to defeat them politically.

Lindberg notices, as I do, that this is not the New Left of the 1970s, with its revolutionary rhetoric and anti-establishment ideology.

The Left’s ambition is to obtain majority political support — no more, no less. The Revolution has been canceled. “The system is the solution.” The Democratic Party is the sole legitimate representative of the aspirations of Left 3.0.

Lindberg also notices the hard-line stance of today’s left. This may be the key quote of the essay:

The notion of an invincibly center-right electorate was anathema to the emerging Left 3.0. A key moment in its reconciliation with the Democratic Party was the latter’s abandonment of policies designed with a center-right electorate in mind. For the foreseeable future, the party would lay claim to the center not on the basis of adopting positions to appease moderates and independents, but on the basis of winning more than 50 percent of the vote on election day for candidates congenial to Left 3.0 and garnering majority public support for positions congenial to Left 3.0.

I see this hard-line stance evident in the progressive’s resistance to any suggestion for reducing government spending. You cannot suggest cuts in the short run, because that would mean austerity. You cannot suggest trimming entitlement promises, because Social Security is sacred and control over health care spending is a job for technocrats.

As an aside, possibly related, I find Venezuelans’ grief at the passing of Hugo Chavez to be fascinating and frightening. If nothing else, it suggests that earning popular support does not vindicate a politician’s wisdom or benevolence.

Some Perspective on Budget Cuts and Austerity

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Employment, in thousands:

Category 2000 2006 2012
Private sector employment 111,101 114,155 111,820
Government employment 20,790 21,975 21,915

Source: FRED graph, establishment survey. Private sector employment increased less than 1 percent from 2000 to 2012, while government employment (Federal, state, and local) increased more than 5 percent.

Spending, millions of dollars:

Category 2006 Q4 2012 Q4
Total GDP 13584.2 15851.2
Government Expenditures 4325.9 5704.9

Source: FRED graph, national income accounts. Government spending (again, including state and local government) is up 32 percent since 2006.

In my view, these facts can provide some perspective on the issue of spending cuts and austerity. Draw your own conclusions.

As an aside, two documents that usually come out in February were not available when this was written (on March 6th, scheduled for posting March 8th). One is the President’s Budget. The other is the Economic Report of the President. I wonder if they are being planned for release at “news graveyard” time, which is late afternoon on a Friday.

Hall of Shame Forecasters

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I am pleased to see that Nouriel Roubini makes this list. He is famous for predicting the Great Recession. But if you always predict bad things, then you are certain to be correct when they happen–and equally certain to be incorrect the rest of the time.

Pointer from Scott Sumner.

For what it’s worth, I increased my exposure to the market late in 2008 and early 2009. But these days I am happy to have a very low-beta portfolio, in which my participation in the ups and downs of the market is small. For every 10 percentage points the stock market goes up, my portfolio gains about 2 percentage points. I am more weighted toward real estate and commodities (oil, not gold), as befits my fear that the next decade might unleash considerable inflation.

One phenomenon I am not bearish about is the sequester. My guess is that its adverse effects on the economy will not be visible to the naked eye, which will observe a rebounding economy. The sequester’s adverse effects can only be seen through the lens of a Keynesian macroeconomic model. Such models always include government spending multipliers of about 1.5 (or 1.57). However, a forecaster might have been better served by assuming a negative multiplier.

[UPDATE: The employment figures for February were relatively positive. Even if you take a conventionally Keynesian view of aggregate demand, you should be quite bullish. Whatever negative impacts of “austerity” have been more than offset by the positive surprises in the stock market and home prices.]

Can He Get Away with This?

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The Washington Post reports,

Fannie Mae and Freddie Mac will create a common platform for issuing mortgage-backed securities as they wind down operations and plan for a future in which the two companies no longer exist, their regulator said today.

I must have been absent the day they announced that Edward J. DeMarco was going to settle the fate of the housing finance system going forward. Not that I have a problem with it. I just thought that the Administration was more interested in kicking the can down the road.

By the way, my online course on the American housing finance system is proceeding. We will try a live video chat this Friday at 1 PM eastern time.

Meanwhile, Michael Barr reports on the recommendations of a group called The Bipartisan Policy Center’s Housing Commission. The recommendations include,

The 30-year fixed rate mortgage is an important option for American families. American homeowners are not the best bearers of interest-rate risk in our economy. To have a robust and liquid market for such mortgages for most households, there needs to be a government guarantee.

I disagree with this, and with nearly everything else in this group’s recommendations. So I Googled to see who they were. They represent all sides of the issue, if by all sides you mean left-wingers and housing industry lobbyists. My guess is that these folks representing all sides of the issue will not make life easy for Mr. DeMarco.

In other news, Peter J. Wallison and Edward J. Pinto write,

Despite the claim that it is “protecting consumers from irresponsible mortgage lenders,” the new Qualified Mortgage rule finalized in January by the Consumer Financial Protection Bureau turns out to be simply another and more direct way for the government to keep mortgage underwriting standards low.

Sounds like the Qualified Mortgage rule was shaped by the folks representing all sides of the issue.

The Controversy Over the 1920’s Housing Cycle

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Michael Brocker and Christopher Hanes write (NBER, $)

We find that cities which had experienced the biggest house construction booms in the mid-1920s, and the highest increases in house values and homeownership rates across the 1920s, saw the greatest declines in house values and homeownership rates after 1930. They also experienced the highest rates of mortgage foreclosure in the early 1930s. These patterns look very much like those around 2006, despite the gap between the house-market peak in 1925 and the businesscycle downturn in 1929. They are consistent with a bubble. They show that the effects of the mid-1920s boom on house markets were still present as of 1929. They suggest that in the downturn of the Great Depression house values fell further, and there were more foreclosures, because the 1920s boom had taken place.

This appears to be part of a conference volume. The introduction to the volume, ungated and recommended, is by Kenneth Snowden.

The conference volume also includes Gjerstad and Smith, who view the housing cycle as important in the Great Depression. But we saw that Alexander Field, another author in the conference volume, disputes the view that housing leverage was important in the 1920s and 1930s.

So confusing! I think that all of these economic historians agree that the 1920s boom peaked in 1925. All seem to agree that the economy survived the ending of the boom quite well until 1930. Apparently, the big decline in house prices took place in the 1930s, although the authors note that good data on house prices for this period is lacking. Note also that there was general deflation, so that the decline in real house prices was much less than in our recent financial crisis. Of course, that is of little comfort to someone who borrows at a positive nominal interest rate.

Based on this, I am reluctant to assign housing a major causal role in the Depression. If the big decline in house prices took place in the 1930s, then that could be an effect of, or a part of, the overall Depression. Note, however, that the authors write,

This [the cross-sectional correlation between severity of house price declines in the 1930s and the extent of the construction boom in the 1920s] remains true when we control for measures of the local severity of the depression – changes in family income, changes in retail sales – or for changes in average rents.

The Snowden piece is filled with interesting background information, such as

The home mortgage market of the 1920s grew even more rapidly than the nonfarm housing stock, with nonfarm residential debt tripling (from $9 to $30 billion) in less than a decade, while the ratio of debt to residential wealth doubled from 14 to nearly 30 percent

He summarizes other papers in the volume, including one by Eugene White.

He argues that the double liability rule faced by bank shareholders and the restrictions on mortgage lending meant that both national and state-chartered banks were well-capitalized relative to the modest risks that they carried on real estate loans.

White argues that although there were some common factors that affected the banks during the building booms of the 1920s and the 2000s…the important difference between the two episodes is that banks were induced in the modern period to participate in risky real estate finance by a set of policies that were missing in the 1920s—deposit insurance, the “Too Big to Fail” doctrine, and federal subsidization of risky mortgage lending and securitization.