links for 2010-03-07
Covering the Effects of the ARRA: Self-Denying Columnist Department

Ten Pieces Worth Reading, Mostly Economics: March 7, 2010

1) Robin Wigglesworth: Moody’s downgrades Abu Dhabi companies:

Moody’s downgraded government groups in oil-rich Abu Dhabi on Thursday, after reviewing state-linked entities following neighbouring Dubai’s $22bn debt restructuring. The troubles at Dubai World, the debt-laden conglomerate owned by Abu Dhabi’s northern neighbour, has rattled financial markets and led many people to question the level of government support that state-linked conglomerates in the United Arab Emirates can command. “Dubai has changed the dynamic of how investors look at government-related entities,” said Nish Popat, head of fixed income at ING Investment Management in Dubai. “People will now look at each entity on a case by case basis.” The downgrades included leading companies involved in Abu Dhabi’s ambitious development plans such as Mubadala, the sovereign investment fund with stakes in the Carlyle Group and General Electric, Tourist Development & Investment Company, which is developing the $27bn Saadiyat Island project, and International Petroleum Investment Company...

2) David Leonhardt: Weak Economic Reports Raise Specter of Double Dip Recession:

[T]he stimulus program and the Fed’s emergency programs are in the early stages of slowing down. These programs have done tremendous good, as I’ve written before. The bubbles in housing and stocks over the last decade were far larger than an average bubble, and yet the resulting bust is on pace to be shorter and less severe than the typical one in the wake of a financial crisis. That’s not an accident. It’s a result of an incredibly aggressive response by the Fed, Congress, the Bush administration and the Obama administration.... The stimulus bill last year included a tax credit for first-time home buyers that originally expired on Dec. 1. Like clockwork, home sales fell 16 percent in December. From March to November, sales rose 36 percent. The credit has since been extended, but if you combine the other fading parts of the stimulus with household debt burdens, you can see why some economists are concerned. Mr. Shapiro predicts monthly job growth will be only 50,000 to 75,000 by the end of this year. To keep up with population growth — to keep unemployment from rising — the economy needs to add more than 100,000 jobs a month.

Recent events in Congress, however, have offered some cause for optimism. Last week, the Senate passed a small-bore $15 billion jobs bill, focused on road building and employer tax credits. But on Monday, Democratic leaders announced a proposal that would do more: a $150 billion bill to extend jobless benefits, Medicaid payments to states and some tax cuts. Some of the extensions last through the end of the year, rather than for just a few months, as is typical. Senator Jack Reed, Democrat of Rhode Island, told me the bill was meant to prevent what he called the “Perils of Pauline” problem — referring to the silent movie serial that placed its heroine in repeated danger. The most recent extension of jobless benefits expired on Sunday. The Senate voted Tuesday night to extend the benefits for 30 more days after Senator Jim Bunning, Republican of Kentucky, dropped his opposition to the measure.

If Congress passes a longer-term extension and adds some measures — like more aid to struggling states, maybe the single most effective form of stimulus — it can offset the winding down of other government programs...

3) Paul Krugman: Economics and Politics:

To stabilize the real value of debt, all the government has to do is pay the real interest on it. So suppose that we add debt equal to 100 percent of GDP, which is much more than currently projected; servicing that debt should cost only 1.4 percent of GDP, or 7 percent of federal spending. Why should that be intolerable? And even that, you could argue, is too pessimistic. To stabilize the debt/GDP ratio, all you need is to pay r-g, where r is the real interest rate and g the economy’s real growth rate; and right now r-g looks, ahem, negative. And this benign view of debt isn’t just hypothetical: countries have, in reality, run up immense debt/GDP ratios without going insolvent: see the history of Britain....

So what’s the problem? Confidence. If bond investors start to lose confidence in a country’s eventual willingness to run even the small primary surpluses needed to service a large debt, they’ll demand higher rates, which requires much larger primary surpluses, and you can go into a death spiral. So what determines confidence? The actual level of debt has some influence — but it’s not as if there’s a red line, where you cross 90 or 100 percent of GDP and kablooie; see the chart above. Instead, it has a lot to do with the perceived responsibility of the political elite. What this means is that if you’re worried about the US fiscal position, you should not be focused on this year’s deficit, let alone the 0.07% of GDP in unemployment benefits Bunning tried to stop. You should, instead, worry about when investors will lose confidence in a country where one party insists both that raising taxes is anathema and that trying to rein in Medicare spending means creating death panels.

4) Alwyn Young: The African Growth Miracle:

The principal result of this paper is that real household consumption in sub-Saharan Africa is growing around 3.3 percent per annum, i.e. more than three times the 0.9 to 1.0 percent reported in international data sources and on par with the growth experienced in other developing countries. This growth is not due to the influence of any particular product group, as durables, housing, health, and family economics all show growth which is at least double that reported in international sources. The growth of non-African economies3 is also higher than reported in international sources, but most of this discrepancy stems from units of measure. My estimate of the growth of living standards is the mean of ln consumption, while conventional data sets report the ln of mean consumption, which depends upon average living standards and the degree of within country inequality. I find that inequality is declining in the poorer countries of the world, particularly outside of sub-Saharan Africa. My methodology allows me to construct ln of the mean equivalent estimates of living standards and these show non-African growth (at 3.0 per- cent) to be closer to and not significantly different from the growth rates reported in international sources (1.7 to 2.2 percent). I find the overall dispersion of levels of incomes in my base year (2000) to be consistent with and highly correlated with those indicated by Penn World Tables, although there are large and significant differences for individual countries.

5) GRAPH OF THE DAY: [Larry Mishel[(http://www.epi.org/economic_snapshots/entry/where_has_all_the_income_gone_look_up/):

Where has all the income gone? Look up.

6) DELONG SMACKDOWN OF THE DAY: Robert Waldmann: Things Now Getting Worse Much More Slowly:

Odd, when Bush was President, DeLong reserved "getting better" for increases in the ratio of employment to the working age population. That requires employment growth of about 150,000 per month, so there are only two possibilities. 1) a whole lot of people would have been hired if not for the snowstorms or 2) the definition of a simple phrase depends on whether or not you share a principle economic advisor with Brad DeLong (and me). DeLong Smackdown duty calls. A friend in need is a friend indeed and a friend has asked us to smack him down.

7) SECOND BEST NON-ECONOMICS THING I HAVE READ TODAY: Sen. Michael Bennet: 'Nothing in the rest of the world operates like the U.S. Senate. Nothing.':

I'm sure as long as the Senate has been around, you’ve heard people complain about things. But nothing in the rest of the world operates like the U.S. Senate. Nothing. What became apparent to me pretty quickly was that one of the consequences of the way it operates is that we move in an enormously slow pace on the one hand, but in a way that terribly compromises outcomes on the other.... The polarization that exists on the floor of the Senate does not reflect the American people. Let's look at the recovery package. This was a package where almost 40 percent was tax cuts for middle-class families. But not one Republican vote in the House for it. If you look at the health-care package, with so much polarization, the amendments we worked on, often passed with bipartisan support. One of my amendments had 100 votes in the Senate.... [W]e are right now going through an enormously profound test of our democracy and our democratic institutions.... [P]eople don’t know what to do about it. They're so fearful of yielding political advantage to the other side. You said that’s people acting in their self interest. And that’s true if the incentives are that anything that politicians need to do to get elected, they're going to do. I thought the president put his finger on it at the State of the Union when he said our job is not to get elected. He’s right about that. But the pervasive view is that our job is to get elected. The question is whether you can construct a politics that rewards people for getting things done. And that’s not trivial in a 24-hour cable-news echo chamber that ignores substance and focuses on people saying idiotic things. I’m not complaining about that. It is what it is.... In Washington, the political game is as much about making the other person lose as about your winning. That’s not going to get us where we need to be. An attitude that says my political success is predicated on the other party’s failure is never going to drive the solutions we need.

8) BEST NON-ECONOMICS THING I HAVE READ TODAY: Heebie-Jeebie: In Defense of Obama:

Here are two things that I am not defending: his first year was poor, and he will always govern from the center. I'm not arguing those points. Here are two things that I will argue:

  1. He is a smart guy. I bet he navigates the presidency lightyears better than he did six months ago, and likewise six months before that. I bet he becomes an increasingly deft and agile leader. I think the health care summit was a pretty clever piece of theatre.

  2. He could profoundly change the rhetoric for the next thirty years, even if in practice he is frustrating centrist. If he says it enough, and the voters believe it, and the media then internalizes it, the following could become a truth: that government is capable of addressing inequality competently, and that everyone benefits when you shrink the gap between the haves and the have-nots. That would be a monumental achievement.

9) STUPIDEST THING I HAVE SEEN TODAY: David Brooks, January 31, 2009:

[Because of the ARRA, a] governor with a few-hundred-million-dollar shortfall will suddenly have to administer an additional $4 billion or $5 billion...

10) HOISTED FROM THE ARCHIVES: >DeLong (June 2005): Analyzing Marty Weitzman, "A Unified Bayesian Theory of Equity 'Puzzles'":

Over the past century in the United States, the equity premium has been on average 5% per year. Over the past century in the United States, the standard deviation of a diversified portfolio of equities has--accounting for apparent mean reversion--compounded at a rate corresponding to about a 10% standard deviation per year. This means that if you buy-and-hold stocks for... thirty-six years, you have a "t-statistic" of 3: 99.5% of the time your portfolio will outperform the risk-free portfolio. This is the asset market version of the equity-premium puzzle. Why don't agents--at least agents with secure other forms of wealth that they can pledge--borrow at nearly the risk-free rate and invest in stocks? Why don't they do this on a large enough scale to drive the risk-free rate up and the return on equities (and the equity premium) down, and so avoid the paradox of a market where it looks like there is a thirty-six-year portfolio strategy that earns you a sixfold profit on your original long position (and a sixty-fold profit if you were able to borrow 90% of your original investment)?

Now comes Marty Weitzman (2005) with a very impressive and well-worked out paper on the importance of taking into account our ignorance of the structure of the economy. His is the observation that investors do not know but have to estimate the parameters of the economy's structure, and that under Constant Relative Risk Aversion utility this structural uncertainty adds fat tails to the subjective return distribution and could easily account for the equity premium and for related puzzles. Is this a reformulation of Rietz (1988)--and thus subject to the same critiques? Is this a reformulation of Geweke (2001)--and thus primarily a statement about the limited usefulness of CRRA utility (with its asymptote at Wealth = 0) in addressing economic questions? Or is this a statement about the way the world works--a successful assertion that our ignorance about the true structure of the economy is such that rational investors with reasonable preferences are right to be at least somewhat shy of equities?

Rietz's (1988) answer to the equity premium puzzle was this: a long, fat lower tail to the return distribution. A small probability of very bad things happening to stock returns could support both (a) a relatively small sample variance of returns, and (b) rational aversion to large-scale stock ownership large enough to produce the observed equity premium. The question that Rietz was unable to answer was: "What exactly are these very bad things?" Remember that the equity premium is a premium relative to the return on relatively short-period U.S. Treasury securities. Any macroeconomic factor to drive the equity premium must therefore be a factor that leaves the real value and real return on short-period U.S. Treasury securities unaffected. But almost all true macroeconomic disasters that could halve or do worse to the real value of equities are likely to produce at the very least rapid and substantial inflation, if not confiscatory taxes on or outright repudiation of government bonds.

Geweke's (2001) observation was that the CRRA utility function is an extraordinarily fragile tool when confronted with alternative distributions than the Gaussian Normal. We use CRRA utility because it buys us extraordinary analytical simplicity.... but we are not thereby committed to riding the taxi of this vertical asymptote at Wealth=0 to its final destination. The CRRA implication that investors limit the size of their leveraged equity positions because bankruptcy is seen as infinitely painful does not appear to correspond with our world.

The third possibility is that Weitzman (2005) really is a profoundly powerful statement about the world: that structural uncertainty, even conditional on the requirement that whatever bad news comes does not materially affect the real rate of return on relatively short-term U.S. Treasury securities, combined with plausible preferences and risk aversion would lead us to expect a considerable equity premium. It is pretty clear to me that Weitzman (2005) is saying considerably more than Rietz (1988)--that it is either the second or the third. It's clear to me that it's both, but I'm not sure of the weights. I'm not at all sure whether it's primarily the second (in which it is a very useful illustration of the fragility of CRRA-based models, and thus in most part, as Daniel Davies puts it, "a fact about applied math"), or primarily the third (in which case it is the solution to a puzzle that has stood effectively unanswered for a generation).

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