Relevant and even prescient commentary on news, politics and the economy.

Simple Answers to Simple Questions, CRA edition

Dear Barry:

The need for posts such as this one recurs because the large majority of economists are idiots. (Multiple exceptions noted—but not enough to change the truth of the initial statement.)

As the regulatory reform report notes (quoted by PK at the last link above):

In fact, enforcement of CRA was weakened during the boom and the worst abuses were made by firms not covered by CRA.

But the truth should never be allowed to get in the way of Economic Theory.

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CBO: Long Term Budget Outlook

by Bruce Webb

Congressional Budget Office Long Term Budget Outlook

(Social Security is chapter 3)

(Update) Not a lot of meat here. CBO offers two outlooks for Social Security, one which projects a payroll gap of 1.33% (extended baseline) and another 1.54%. (alternative fiscal scenario). The former assumes that the 2001 and 2003 tax cuts sunset on schedule and the AMT is not indexed for inflation, the latter assumes the opposite. In any event either is below the Trustees’ current law projection of 2.00%. Meaning the cost of the Northwest Plan would be adjusted down by a third or a quarter respectively.

Oh my gosh! As the percentage of people of retirement age doubles so does the amount of GDP needed to house and feed them! Hmm, what the hell is wrong with that? Retirees not having to shuffle up to the table to beg for scraps? Getting their proportionate share of GDP? The horrors!

And for the privatizers out there, be sure to compensate for the fact that 36% of benefits goes to survivors and disabled workers when calculating your ROI.

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V-22 Osprey

by reader ilsm

GAO Testimony 09-969T, On Cost and Performance of the V-22 Osprey.

“Availability challenges also impacted the MV-22. In Iraq, the V-22’s mission capability (MC) and full-mission capability (FMC) rates fell significantly below required levels as well as rates achieved by legacy helicopters.6 The V-22 MC minimum requirement is 82 percent, with an objective of 87 percent, compared with actual MC rates for the three squadrons of 68, 57 and 61 percent.” Pg 7.

Availability is the percent of a fleet of systems which are serviceable to be committed to military missions. The only valid way to measure availability is across fleets. Here GAO errs slightly and uses mission capability in the same paragraph; possibly because it is the metric the Navy wants to use to save face. GAO goes on to state that the required mission capability is not achieved. Mission capability is important to the individual squadron which has to perform instant operations with its assigned aircraft, which are all serviceable going into the operation. This does not account for systems in long term unserviceable condition, which are counted in availability figures.
Generally, mission capability runs 20% higher than availability, but availability is hidden on new stuff, while shouted about on older stuff, because there would be severe embarrassment if you considered that 40% of the brand new V-22 were not available (okay 60% available sounds much better, buy a car which is broke 40% of the time, how good does the warranty service need to be?).
The Navy and GAO are not sure which metrics to use. One of the reasons that US quality fell in the 70’s was avoiding measuring the hard things gets you in trouble; a weakness of the DoD acquisition process. But the spending is more important than meaningful results.
Missing mission capable suggests that basic reliability and maintenance performance are not part of V-22 repertoire. Quality may not have been affordable during the long development cycle, and the savings are now costing in added support and lost use of the V-22
Not surprising the MV-22 was deemed unsuitable in 2000. Nothing seems to have improved in the past 9 years.
A lot of reliable beaks could have been whittled and as useful as the unavailable, not mission capable V-22 taking up maintenance space.
by reader ilsm

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A Short Note on Optimality

Via Eszter, there is one thing that is very clear from this graphic (duplicated below because I can’t figure out how to embed it):

There is an excess of home-based internet capacity in the United States, for which people are definitionally paying too much.

The question is whether this is a problem. If you argue it is not—that the excess spending gets reinvested and used to develop new products and services that, on balance, benefit the economy—then please explain this in the context of any contemporary economic model.

Discuss in comments.

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Vertical specialialization in world trade


The Economist reminds us of a common notion, but not explored a lot in the news. Decline in demand overall, and finance, is a major concern for trade partners, but is complicated because products often travel from country to country in stages of completion to finished product.

Economists believe that an additional reason for these sharp and co-ordinated drops lies in a fundamental change in the nature of global trade over the past three decades, as a result of the rise of global supply chains. When David Ricardo posited that comparative advantage was the basis of trade, he conceived of countries specialising in products, such as wine or cloth. Now, they specialise not so much in final products as in a step, or steps, in the production process, what economists call “vertical specialisation”. Vertical specialisation has grown by about 30% and accounts for a third of the growth in trade over the past 20 to 30 years.

Vertical specialisation led trade to grow much faster than it would have otherwise. Earlier, a tractor made in America would use American steel and parts: its only contribution to trade would come if the finished item were exported. Now, that tractor may use steel from India that is stamped and pressed in Mexico, before being exported to Tanzania. Global supply chains have increased the amount of international trade involved in getting a product made and delivered to its final user.

On the flip side, declines in demand that would once have resulted primarily in a fall in domestic output, and would only have had a second-order effect on other countries’ exports because of the decline in domestic incomes, now immediately affect trade flows in several countries. The same mechanism that was responsible for the remarkably rapid growth in trade since the early 1980s is now amplifying the extent to which trade responds to a decline in demand, which explains the remarkable synchronisation with which trade is declining everywhere.

Kiplinger offers an example of such a process, the manufacture of plastic pipe. Product crosses the border multiple times as it is completed.

Update: Voxeu covers the issue, of course, very thoroughly.

Much of U.S.-Canadian trade involves goods crossing the border multiple times before the products in which they’re used are finally completed. Indeed, supply chain integration has long been one of the main benefits of NAFTA, given its role in increasing trade and lowering production costs. Makers of water and wastewater equipment, the manufacturers hit hardest by the stimulus bill’s Buy American rules, accounted for $10 billion in cross-border trade last year. Other industries with North American supply chains will get dragged down, too, if they’re unable to buy from Canada and Mexico.

Consider the case of IPEX, a Canadian-based manufacturer of thermoplastic pipe systems for the construction sector, to see how the problem is playing out on both sides of the U.S.-Canadian border. Before it can participate in a U.S. construction project, IPEX is now asked to sign a certificate affirming that all its products are made in the U.S. Since IPEX’s supply chain is integrated across the border, its product load is invariably a mix of Canadian and U.S. parts. The result is that it is either unable to bid on the project or the parts are turned away if they have already been shipped to a construction site.

“Before Feb. 17, we had access to the U.S. market,” says Veso Sobot, an IPEX engineer, referring to the date the stimulus bill became law. “Since Feb. 17, we have not.” That’s bad news for companies such as Westlake Chemicals. Westlake, based in Houston, manufactures the raw materials IPEX uses to make its pipes. IPEX’s troubles in the U.S. market will force it to cut back production.

“America ships way more product into Canada than Canada ships into America,” says Sobot. “If we injure either one of us, we’re injuring ourselves collectively, and we won’t be able to compete effectively on the world stage.”

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Who represents domestic manufacturers?


American Economic Alert points us to a lack in who has a voice in manufacturing. The Economic Recovery Advisory Board was set up in 2008:

ERAB’s makeup is a case in point. Headed by former Federal Reserve Chairman Paul Volcker, the panel contains members from many perspectives beyond what Mr. Obama calls the Washington “echo chamber.” But ERAB needs more than the academics, labor leaders, financiers, chief executive officers and former officials whom the president has appointed (along with a media representative and a major Realtor).
Like the rest of Mr. Obama’s advisory team, the board also needs adequate business representation from the economy’s real wealth-creating sector – the goods-producing industries that Washington has too long neglected and whose revival is essential to overcome a crisis born of overconsuming, overborrowing and excessive debt.
ERAB does contain two representatives from manufacturing – which dominates the goods-producing sectors. But the picks – Jeffrey Immelt of General Electric (GE) and Jim Owens of Caterpillar – head multinational companies whose top declared priorities do not include expanding output in the United States.
Two years ago, for example, senior GE executive Lloyd Trotter told an investor conference that by 2010, more than 50 percent of the company’s worldwide manufacturing would be performed outside the United States. As recently as 2002, that figure was only 28 percent. At the end of 2006, Mr. Immelt said that in five years, GE would likely at least double the share of its global purchases from low-income countries, like China and India, from the then-current level of 19 percent.
As Mr. Trotter explained: “Low-cost country savings are generally 20 [percent] every time we do it.”
As Mr. Immelt made clear, except for goods restricted by export controls, there are many other products “that we can move substantially outside the United States.” Mr. Immelt did specify that these offshored goods wouldn’t be sold only locally, but worldwide, including of course to U.S. customers.
Because the United States still represents nearly a third of the world economy and an outsize share of its consumption, it’s easy to see how Americans fit into this business model as customers. It’s much harder to see how they fit in as producers to any comparable extent. With America’s chances for recovery depending ultimately boosting production relative to consumption, Mr. Obama clearly needs to hear a fundamentally different manufacturing perspective.
Caterpillar doesn’t fit the bill, either – even though the president keeps touting its achievements (during a visit to its Peoria, Ill., headquarters) and its challenges (at the Group of 20 summit). For many years, the company has indeed kept a much higher share of its worldwide employees in the United States than most other U.S. multinational manufacturers. But it preserved U.S. jobs mainly by crushing its unions and slashing wages, down to near Wal-Mart levels for new hires. That’s a recipe for fixing Americans’ broken finances only if living standards fall even more dramatically.
Moreover, Mr. Owens lately has been moving many more Caterpillar jobs and production offshore despite these employee sacrifices. From 2006 to 2008 alone, according to the company’s latest figures, its U.S. work force rose by nearly 10 percent, but its foreign work force increased by more than 29 percent. As a result, the U.S. share of its global work force has slipped during this period from 51.5 percent to 47.4 percent. And during this period, Caterpillar’s foreign work force grew fastest by far – more than doubling – in predominantly low-wage Asia.

More important, the economy remains so weak that Mr. Obama can’t afford to wait for new priorities from Mr. Immelt or any of his peers. The administration urgently needs to start hearing consistently from executives fiercely devoted to producing, innovating, and creating good jobs in the United States, and boasting decades of experience in succeeding. The U.S. Business and Industry Council knows nearly 1,900 of them. It owns our member companies. We would be honored to recommend any of them to help the president put the economy back on track.

Caterpillar is scheduled to replace older factories in the US with new facilities in China…three new facilities I believe, to manufacture and sell for Chinese consumption as well as ours. However, I have not found announcements of plant closings at this time.

It is not the fact of new plants in China that is a problem. Chinese government stimulus spending emphasizes infrastructure spending as well. What is a global economy going to look like, and what response needs doing other than simple slogans like “Buy American”.

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Are We in a Liquidity Trap ?

In which Robert Waldmann finds economic theory useful.

A question: when does deficit financed public spending cause higher interest rates which cause private investment to be lower than it would be other things (including the spending) equal.

Proposed answer, not when we are in a liquidity trap.

Depending on the definition of liquidity trap this answer is wrong or not relevant to the current situation.

Now I confess that some economists (including me) sometimes rely on an equivocation to argue that we are in a liquidity trap and therefore there will be no crowding out via interest rates. The evidence that we are in a liquidity trap is that safe short term interest rates are very low. However, for there to be no crowding out via interest rates it is necessary either that deficit financed public spending doesn’t affect long term interest rates, or that long term interest rates don’t affect investment.

Also note that investment depends on factors other than just interest rates. In the data, high investment is associated with high GNP growth as well as with low interest rates, so even if there is some crowding out via interest rates, the net effect of the spending on private investment can be positive.

One justification for looking only at safe short term interest rates and the whole yield curve is that, if safe short term interest rates are zero expansionary monetary policy is pushing on a rope (as is absolutely demonstrated by recent experience). This means fiscal policy is the only available demand policy so “is there any crowding out via interest rates” is not the key issue. So we should define a liquidity trap as a period with safe short term interest rates are zero and define a new term for the whole term structure is zero — say a super liquidity trap and get to a second proposed answer

Not when we are in a super liquidity trap. After the jump I criticize my second proposed answer.

It is clear from the data that increased deficits and expected future deficits cause higher long term nominal interest rates. Direct measurement of real interest rates via markets for TIPS (indexed to the CPI) is a recent phenomenon. The anticipated effect of Bush deficits on long term interest rates didn’t IIRC show up. The counter-argument basically is that the period whith both TIPS and insane US fiscal policy is identical to the period of insane People’s Bank of China policy.

However, it is also possible that deficits affect long term interest rates only via inflation. Economic theory suggests that investment should depend on real not nominal interest rates. So it is possible that there is no crowding out via interest rates due to deficit spending.

Oddly, there is a strange argument which is the same up to the last sentence and then draws the opposite conclusion. The argument is high deficits cause high expected inflation which causes high nominal long term interest rates which cause reduced investment. One often meets this argument in non-academic discussion of the economy. My reaction has always been “huh?!?” (also before I took my first economics course). I don’t think it is possible to write down an economic model in which people are rational and price indices are available and indexed contracts can be written, in which long term nominal interest rates matter.

I now discover that I find economic theory useful in my efforts to understand this argument. I don’t generally find economic theory useful. Certainly my opinions on the economy and economic policy haven’t been influenced at all by my own work in economic theory which is modest but not zero.

However, I didn’t find economic theory useful in a way which is flattering to economic theory. My reasoning is that an argument which is so theoretically unsound probably wouldn’t survive if it weren’t supported by actual experience. Now this argument might rely on an underestimate of human idiocy, but I find it convincing.

If all firms considered only their expected long term real interest rate when deciding on investment, then people would notice.

It is very possible that nominal interest rates matter because debt contracts aren’t indexed. For example take floating interest rate loans with fixed nominal repayment schedules. Higher inflation implies a more rapid rate of required real repayment. Ooops. There are many many such contracts. It is hard to reconcile the existence of such contracts with rationality but they exist. If people look at debt service ratios and count nominal not real interest as the cost of debt then they will be confused by inflation. And so forth and so on.

To me the fact that the argument makes no sense in theory leads me to suspect that it is important in practice.

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By Spencer

In today’s New York Times business section I read this headline:

Weak Dollar Helps Send Profit Down at Oracle

As I read the article I found this statement:

The company attributed the declines to the effects of a stronger dollar, which makes deals done in other currencies worth less.

I wonder which statement is correct.

In general, the best relationship between the dollar and earnings growth is a negative relationship between the change in the dollar lagged about one year.

P.S. Earlier chart updated to show last year. Thanks Greg.

Note, despite all the headlines about the weak dollar, in May the dollar was 15% above its year ago level. Like bonds, late last year when the markets feared a depression scenario the dollar rallied strongly, and the recent weakness looks more like a return to normal than anything else.

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United Nations conversation on the global economic crisis


UNU Conversation Series

As the think-tank for the United Nations and its member states, the United Nations University brings some of the most important intellectual and policy voices from around the globe, including Olivier Blanchard, Janos Bogardi, Francois Bourguignon, Noam Chomsky, Richard Cooper, Evsey Gurvich, Thomas Hoenig, Robert Johnson, Jomo Kwame Sundaram, Wim Naude, Léonce Ndikumana, Eisuke Sakakibara, Luc Soete, Joseph Stiglitz, Roberto Mangabeira Unger, Aude Zieseniss de Thuin, to name a few, to help bring clarity to some of the key issues at the center of the economic crisis.

The portal of the UNU Conversation Series will be launched on June 23 2009 and
available at As these conversations are meant to be a work in progress, your feedback, comments and suggestions on the conversations are welcome and can be addressed to

Update: Link fixed

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Inflation or Deflation, That is the Question

by cactus

Inflation or Deflation, That is the Question

These days some smart people are expecting inflation, other smart people are expecting deflation, and there’s another big batch of smart people who are either expecting both or don’t know. I figured – why should smart people have all the fun?

So I came up with a working hypothesis that the evaporation of wealth created a hole in the public’s collective balance sheet which the Fed is trying to fill with money. While the hole doesn’t have to be completely filled for there to be inflation, I suspect while the hole is mostly empty pumping money in won’t create inflation. After all, for years following the dot com bomb, the Fed kept the money supply nice and loose and there was no inflation. (And yes, I’m sidestepping what constitutes a mostly empty hole and at what point it becomes filled enough for inflation to be a worry.)

I got net worth for households and nonprofits (sorry, but the Fed groups nonprofits in there and I can’t find this series without nonprofits) and m2 from the fed, both quarterly. I annualized quarterly inflation, then adjusted both series (net worth and M2) and then divided by population. I then graphed ’em both. (Note – normally I would use M1 as opposed to M2 because the Fed has more control over M1. However, in this instance, it seems that some of the actions we’ve seen the Fed plus the gubmint take are intended to loosen up components of M2 that are not encompassed in M1, so I’m going with M2 here.)

The hole in the public’s collective balance sheet appears to be quite a bit bigger than the pile of money the Fed has shoveled into it, or rather, into the big players on Wall Street. (Note the big difference in the scale of the two axes!!) Thus, for the time being at least, I think we’re closer to deflation (in general) than inflation (in general).

I realize this isn’t the usual way to think about inflation, and I’m not sure its right. Any thoughts?

households and nonprofit organizations net worth (market value) asset
CPI, M1, M2 and Population
by cactus

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