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More on Units and the Economic Cost of Spending Cuts

There is a new estimate of the effect of $ 60 billion spending cut on GDP and employment. Since this estimate was made by brilliant economist* Ben Bernanke aided by the staff of the Federal Reserve Board, it will get a lot of attention.

Bernanke said that a $60 billion cut along the lines being pursued by Republicans in the House of Representatives would likely trim growth by around two-tenths of a percentage point in the first year and one-tenth in the next year.

“That would translate into a couple of hundred thousand jobs. So it’s not trivial,” he said in response to questions from members of the House Financial Services Committee.

This sure seems to be completely different from Mark Zandi’s estimate of 700,000 jobs. I think there is some confusion about units of measure and, in particular about the unit the “job.”

How can that be ? Well the effect of a policy shock changes over time and so one can discuss the effect on person-years of unemployment. One can also discuss the maximum effect on unemployment, which, in practice means the effect measured in the month with the largest effect.

Bernanke explained his calculation. He calculated the effect on yearly GDP in 2012 then applied Okun’s law. Thus he calculated the effect on average employment in 2012. His estimate of job-years lost is around 200,000 in 2012 after 133,000 in 2011 and presumably some in 2013. There is no way to calculate the largest monthly difference between employment given Obama’s budget proposal and employment given the House Republicans budget from yearly growth rates.

I’m sure Zandi is talking about the largest monthly difference which I would guess he forecasts for late 2011 or early 2012.

I can do an Okun’s law calculation for Phillips et al. (the Goldman Sachs team). They predict that the cuts will cause third quarter GDP to be 0.75% lower. By Okuns law, that corresponds to roughly 500,000 fewer jobs (three eighth’s of one percent of the labor force).

They forecast that second quarter GDP will be 0.375% lower. That means that they forecast that growth from fiscal year 2010 to fiscal year 2011 will be reduced by
9/32 percent, that is roughly 0.3%. This is a larger effect than the Fed’s estimated effect on growth (I can’t tell how much larger as Phillips et al didn’t report a forecast for the 4th quarter). But 0.3% is 0.3%. I describe Phillips et al’s estimate as implying the loss of 500,000 job-quarters in the quarter of maximum impact. Using the same Okun’s law and the same Phillips et al forecast, Bernanke would say 200,000 job-years in fiscal 2011. The 2.5 fold difference is a matter of units of measure.

* This is not at all ironic. I think he is brilliant. Also and much more important, he is reality based. There are smart mathematicians who present themselves as economists but really study formal systems. Bernanke has brilliant thoughts about what really happened in the real world *and* he confronts them with the data.

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MA Teacher Retirement System (and WI a bit)

H35 provides for these amendments to the MA teachers retirement system by Gov. Duval Patrick:

An Act Providing for Additional Pension Reform and Benefits Modernization
This legislation filed by Governor Patrick proposes further pension reforms to achieve the following objectives:

  • Update the system to reflect demographic changes, such as the fact that people are living and working longer;
  • Eliminate abuses, through anti-spiking measures, extending the number of years used to calculate pension benefits, and increasing scrutiny of legislation benefiting individual employees; and,
  • Address fairness issues, through updating purchase of creditable service and buyback provisions, eliminating early retirement incentives, pro-rating benefits based on employment history, eliminating the right to receive a pension while receiving compensation for service in an elected position, and allowing retirees who married a person of the same sex within the first year after it became legal to change their retirement option in order to provide a benefit to their spouse.

Most of the provisions in the bill would apply to new members of the retirement system.

H1 (section 37):Governor Patrick recommends a 3% cost of living adjustment (COLA) for retired members of the state and teachers’ retirement system as part of his FY2012 state budget. The COLA will be applied to the first $12,000 of the retirement benefit, for a maximum increase of $360 per year or $30 per month.

From the annual report of the Mass. Teachers Retirment System finacial report: MTRS statement demonstrates the heavy use of equity and other non-fixed income assets to generate returns, which make for volatility.


New teacher’s pay in approximately 10% of salary.

I believe in 2008 the MTRS reported a 29% drop in ‘value’ of its assets:
$ 25,318,713,892 2007

$ 17,177,957,406 2008

$ 19,311,587,953 2009

$21,262,462,000 2010

Via Andrew Leonard at Salon comes this quote from the CEPR and Dean Baker

On July 1, 2010, the S&P 500 was already more than 11 percent higher than its July 1, 2009 level (from 987 on July 1, 2009 to 1101 on July 1, 2010). Most funds use the stock market’s closing value at the end of the fiscal year as the basis for determining the valuation of their assets. Of course they also use an average, so the valuation would not simply reflect the market value at the end of the fiscal year. However, with the market having already risen substantially from its low (the S&P 500 had risen another 19 percent to 1293 by January 10, 2011), it is likely that pension valuations based on current and future market levels will show smaller shortfalls. In other words, a substantial portion of the shortfalls that were reported based on 2009 valuations have likely already been eliminated by the rise in the market.

MA Massachusetts Teachers 0.12% (unfunded liabilities as a per cent of expected revenues) 1/1/2010

WI Wisconsin Retirement 0.00% (unfunded liabilities as a percent of expected revenues) 12/31/2009

Of course projected revenues can be argued at another time.

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Too Big to Fail? Wall Street and Main Street: How Big Are They

Guest post by Steve Roth
crossposted at Asymptosis

Too Big to Fail? Wall Street and Main Street: How Big Are They

People are forever talking about banks that are too big to fail. But you rarely hear about the larger issue: The financial industry is too big to fail. Click for larger graphic.)

Note that “Main Street” here includes government expenditures — 20% of the total. Remove those, and Wall Street money flow is 58 times the size of Main Street.

I haven’t pulled these numbers for past years,* but it’s clear that this disparity has grown hugely since the 80s, driven by credit issued by the financial industry, to the financial industry, with the money circulating in the financial industry. From Dirk Bezemer:

(FIRE is finance, insurance, and real estate.) The financial industry has spent the last 30 years inflating its own bubble.

So much for the flows. What about the stocks? This is harder to compile, and it’s also difficult to compare Wall Street and Main Street. I’ll explore this in future posts. But here are two numbers worth pondering:

The red bar on the left is the one I’m concentrating on here. (It’s probably a big understatement, because it doesn’t include assets held by financial corporations; see “tally stick,” below.) Divvy these financial assets between every household in America, and each one gets half a million dollars. Yow.

Think of that pool of financial assets as stored money. While they couldn’t all be turned into actual “money” at one time, they constitute the pool of money held by people and businesses, which money flows into (from personal savings and undistributed profits) and out of (for consumption, fixed investment, and tax-paying). This pool is also expanded by new credit/money creation, and increases in asset values. It is shrunk by loan payoffs and declines in asset values.

Now here’s the key point to understand: everything of value to humans is created by the people and businesses on Main Street producing, buying, selling, and investing (in productive assets and housing). Yes, Wall Street produces and sells some of that value: vehicles for investing business and personal savings in a variety of real assets (“intermediation”), safe storage (compared to your mattress), convenience, bookkeeping, advice, etc. That’s all paid for via fees and commissions, and those Wall Street fees and commissions are counted as part of GDP (aka Main Street). As they should be.

But you have to ask: did Wall Street deliver 35% or 45% of the human value of all American businesses in the 2000s? That was the “financial services” share of business profits — the reward received for value created. (I’ve seen some variance in this number, but 34% is the lowest number I’ve seen.)

Whereas the financial sector claimed less than 15 percent of total U.S. corporate profits in the 1950s and 1960s, its share grew to 25 percent in the 1990s and 34 percent in the most recent decade through 2008. Testimony by Sheila Bair, January 14, 2010.

Here’s a picture:

You don’t have to imagine “evil actors” (though there is some proportion of those on Wall Street) to understand why a massive financial sector could be really, really bad for the real economy.

Imagine one of those super-hot racing sailboats that let you pump water from side to side as you switch tacks, to keep the boat upright, stiff, and stable. Now imagine all that water leaks out into the bottom of the boat, so it’s sloshing around with the wind and wave action. Every time you run into a big wave, all the water flows to the front of the boat. A big gust of wind heels you over, and all the water flows over in the same direction. It makes the boat really unstable.

That water is the money swirling and sloshing around in the financial economy. In the short term, those flows are are driven largely by people trying to predict what other people are going to do, so they can go in the same direction. Sound like our sailboat? With $55 trillion of financial assets in the U.S (4 x GDP), and those assets trading hands maybe twelve times a year, that’s a lot of sloshing.

It’s no wonder the sailboat gets knocked over periodically.

Now imagine that a whole bunch of your best and brightest crew members are spending their time with buckets pouring more water into the boat, and moving the water around from place to place (while furiously collecting as much as they can in little bottles in their pockets). Do you think you’re gonna win the race?

But here’s what’s weird: neoclassical economics basically ignores the motive effects of financial sector, treating it like a transparent, frictionless, and inert tally stick or bookkeeping system — like the bank in Monopoly. As Dirk Bezemer has pointed out, the model that the Fed uses to predict our economic future does not include the financial sector as an active entity.

The boxes indicate the variables included in the model. In the present context, the important observation is that all are real-sector variables except the money supply and interest rates, the values of which are in turn fully determined by real-sector variables. In contrast to accounting models, the financial sector is thus absent (not explicitly modelled) in the model.

Paper (pdf). A very nice summary here. You may take issue with Bezemer’s statements, but it’s certain that the Fed’s model does not consider the spectacularly large and highly variable flows within the financial economy, or model their effect on the real economy beyond the rather static notions of money supply and interest rates.

This is especially strange since the Fed is explicitly tasked with compensating for the business cycle. And the business cycle is largely driven by … the financial sector. (Main-street businesses’ cash flows, profits, and losses don’t display anything like the volatility of financial assets.)

Aside from those destabilizing money flows, which are pretty much inherent to financial economies (though their effects on the real economy depend crucially on plain old quantity), what other pernicious effects might we expect to see when a self-inflating financial sector does a very good job of inflating itself?

Moral Hazard. Because the financial economy is so massive, government has no choice but to bail it out if it gets in trouble. Financial-industry players know that, and they act accordingly.

Stagnant Growth in the Real Economy. As the pool of new financial assets (many of which are fabricated using finance-industry-issued credit) increases in value (in a boom or bubble), we see:

rising commitments for the real sector to finance asset transaction out of wages and profit, and rising actual debt levels. When the asset was sold at a profit, someone else bought the asset at the new, higher price. He or she financed this either by diverting liquidity away from real-sector transactions, or by borrowing – at higher levels than did the first buyer. Therefore asset price booms are accompanied by rising debt and by a slowdown in real-sector nominal growth.

Government Capture. Unlike welfare payments, for instance, which distribute money widely and hence are difficult to bring to bear on lobbying etc., the financial sector concentrates wealth, so it can be effectively used to capture government — which further benefits the financial sector, in a self-perpetuating cycle.

Misallocation of Resources. Since the financial industry provides rewards to employees and shareholders that are well in excess of the human value it produces (even considering its role as an intermediary delivering financial capital to the real economy, and its resulting second-hand contribution to delivering things that humans value), both financial and human capital are diverted away from the real economy that produces stuff we want.

I can think of several others (without even starting on things like fairness), but I’ll leave it to my gentle readers to fill out the whole set.

Supply siders, conservative politicians, and freshwater economists are fond of referring to financial capital as the “fuel” of the real economy. But if anything, labor, sales, innovation, or maybe natural resources constitute the real economy’s “fuel.”

Financial investments in business — whether in the form of equity or credit or some weird hybrid — are more like lubrication. A flow of financial capital is crucial to keep the machine running, but you don’t need all that much flow relative to output (43x? 58x??). (And Fama and French showed us long ago that it takes very few traders or trades to create an efficient market with reasonably accurate price signals.) This especially as business owners consistently tell us that investment is dead last on their list of business constraints.

Too much lubrication, in fact (I’m repeating my own line here), and the shop floor starts to get very, very slippery.

Truth told: we have truly oceanic quantities (both flows and stocks) of money, credit, liquidity — whatever you want to call it — far in excess of what’s necessary to lubricate the real economy. When somebody tells you that we need more savings to augment those quantities (and that we should, for instance, tax the rich less so they can provide those savings), I suggest that you go directly to Go, and look at the first three graphics in this post.

If I am correct, the financial sector is much larger than is necessary to lubricate the real economy, and as a result delivers far greater downsides than are necessary to fulfill its valuable purposes.

Is there anything we can do about that? Monsieur Pigou gave us the solution long ago: If you want less of something, tax it.

* It amazes me that these Wall Street figures are so hard to compile, and in fact are never compiled. (Google “financial industry profits” One useless hit.) The ratio between the financial economy and the real economy is not part of the everyday language of economic discourse. A kudos to Dean Baker and the folks at CEPR for putting these Wall Street numbers together.

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A Scalia Tea Leaf on the Healthcare Law?

by Beverly Mann
from The Annarborist

A Scalia Tea Leaf on the Healthcare Law?

Judicial decisions, like the Constitution itself, are nothing more than “parchment barriers,” 5 Writings of James Madison 269, 272 (G. Hunt ed. 1901). Both depend on a judicial culture that understands its constitutionally assigned role, has the courage to persist in that role when it means announcing unpopular decisions, and has the modesty to persist when it produces results that go against the judges’ policy preferences. Today’s opinion falls far short of living up to that obligation—short on the facts, and short on the law.

—Antonin Scalia, yesterday, dissenting in Michigan v. Bryant

The tea-leaf-reading on how two or three of the justices will vote on the constitutionality of the PPACA has become a bit tiresome, I think, but I’ll engage in it here anyway.

As most people who’ve followed the issue closely know, in 2005 the Supreme Court held (in a case called Gonzales v. Raich) that Congress had the authority under the Commerce Clause to criminalize the production and use of marijuana even when the marijuana is home-grown and used only by the grower, and therefore never enters interstate commerce, because marijuana grown for the personal use can have a substantial effect on the marijuana trade in interstate commerce.

Also as people who’ve followed the PPACA-constitutionality tea leaf-reading debate know, Scalia wrote a separate opinion in that case concurring in the majority’s result. The Commerce Clause alone, he said, does not give Congress that authority, but that Clause coupled with the Necessary and Proper Clause—the clause that gives Congress the power to “make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof,” including the power to regulate interstate commerce—do.

A fine distinction that only constitutional law nerds think about, but it is the distinction that is at the heart of the debate about the constitutionality of the PPACA.

Michigan v. Bryant is not a Commerce Clause case. It is a Sixth Amendment Confrontation Clause case. The Sixth Amendment gives criminal defendants certain specific rights, including the right to confront (i.e., cross-examine) the prosecution’s witnesses under oath at trial. And seven years ago, in a case called Crawford v. Washington, the Court reversed a 1980 opinion that had carved out a chasm of an exception to that right by allowing the admission of hearsay statements if the statement bears “adequate ‘indicia of reliability.’ ”

Scalia wrote the Crawford opinion. Since then Scalia has been at the forefront of the Court’s expansion of Crawford to kill prosecutors’ use at trial of various types of hearsay evidence, and apparently had been able to run interference internally within the Court to kill attempts by prosecutors to overturn Crawford at least in part. Until yesterday, when he lost that battle to, of all justices, Sonia Sotomayor.

Scalia, in a dissent eloquent both in its logic and its passion, masterfully deconstructs Sotomayor’s opinion. I recommend it to anyone who’s interested in issues of this sort or who wants to see Scalia in a context beyond the sort of public caricature he has, seemingly deliberately, become. That opinion is very understandable to non-lawyers, I think.

But its importance to the issue of the constitutionality of the PPACA is not just the paragraph I quoted from it but that he wrote it in defending a constitutional right dearer to the political left than to the political right. The paragraph is the second-last one. The very last one says:

For all I know, Bryant has received his just deserts. But he surely has not received them pursuant to the procedures that our Constitution requires. And what has been taken away from him has been taken away from us all.


Scalia’s dissent is here. Sotomayor’s opinion is at here.

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DoD Major Weapons Acquisition

guest post by Ilsm

According to GAO 11-394T 17 Feb 2011 , DoD Major Weapons Acquisition continues to be a high risk item watched by GAO. In the testimony the GAO is concerned about waste and mismanagement in the 102 largest DoD acquisition programs. The testimony states that in the five years starting in 2011 that $300B are spent by the programs GAO reviews annually, while the rest of the Trillion plus dollars in the budget for those years is to develop and acquire things in DoD and are smaller programs which are far less well managed, whose decisions are made less formally and whose engineering has much less experience and authority to do the job well.

From 2011 through 2015 the DoD will spend appropriations totaling $1.1 Trillion dollars for R&D and Buying new war making stuff. If recent reviews hold, none of it will be spent well.

I have followed the GAO annual reports over the past several years. Refer to GAO 10-388sp, 30 Mar 2010: Assessment of Selected Weapon System Programs.

Some of the findings: few of the 102 major programs, about $300B in funds the next 5 years, met statutory requirements to have their Selected Acquisition Reports (SAR) to Congress by May 2009, most had not delivered their SAR by Nov 2009 when GAO needed the data to do the report.

Specific observations: cost over growth is hard to measure this year as the management is too late with data, decisions on spending money for systems are consistently made without sufficient “product knowledge” or without managing the technical work using Congress’ required configuration steering boards (CSB), nor managing the programs’ system engineering and finally with too many requirements change (which ironically is not much of an issue since the programs were not managed by knowledge or understanding of the performance of the configurations).

Pretty revealing and no one makes any changes even though congress adds to its direction the programs are not managed.

No one will kill a bad program.

No wonder DoD cannot pass an audit.

I have a note on my calendar to look for the March 2011 release to see if anything is better

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Is the President Reading Angry Bear?

AB, late Thursday:

If you want to stop a dictator from killing his people, freeze any of his personal assets that are held out of the country.

In cases where the dictator is likely to fall, it sends a clear signal to other countries. (In cases where the dictator is likely to succeed, the worst case scenario is that banking relationships will be damaged, a consideration that the domestic government would have considered before making the decision to freeze the assets in the first place.)

The purpose of financial in lieu of military intervention is to balance the tradeoff. A dictator whose funds will remain unencumbered no matter how many of his people he kills will not change his behavior. A dictator who stands to lose a large (and increasing) portion of $70 billion faces a scenario where extending his time in office may well appear too costly.

Treasury, Friday night:

On Friday evening, President Obama took decisive steps to hold the Qadhafi regime accountable for its continued use of violence against unarmed civilians and its human rights abuses and to safeguard the assets of the people of Libya.

The President issued an Executive Order freezing the assets of Muammar Qadhafi and four of his children, as well as the Government of Libya and its agencies, including the Central Bank of Libya and the Libyan Investment Authority – the country’s sovereign wealth fund.

I report. You decide.

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Public sector collective bargaining and secrete corporate political campaign contributions

Jonathan Zasloff asks at The Reality-based Community blog New Directions in GOP Political Economy

Quite subtle, actually:

Public-sector collective bargaining is unhealthy and distorts democracy because it enables workers to influence the government which negotiates with them; but

Unlimited and secret corporate political campaign contributions are necessary to democracy because they enable corporations to influence the government which regulates them.


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Trichet and King: it’s energy, VAT, and food!

The global inflation picture is heating up. On Google, a search of ‘inflation’ spanning the month of February 2011 gets 311,000,000. For one year ago, the same search parameters yielded 1,850,000 hits. Inflation’s on the monetary policy makers’ minds. But why? In the developed world, it’s a food and energy story!

Seriously, look at German and US inflation since the 1960’s. Furthermore, check out core price pressures:

US 0.95% in January 2011…

…Germany 0.77% in January 2011

Dear Trichet, King, and part of the US FOMC: it’s energy and food….energy and food….energy and food…and VAT! David Beckworth writes a great piece about the merits of inflatin targeting.

Wheat, corn, soybean, and sugar prices have surged, whose price gains are now sitting very much on the back burner to oil prices. But look, wheat, soybean, and sugar price pressures are coming down. Therefore, food prices are showing signs of peaking. This should be taken into account when the ECB and BoE meet this week and next, especially if gas and fuel prices start to hinder economic growth prospects.

Some evidence:

* In the UK, price pressures are ever-present – the diffusion is much higher than in other European economies – but it’s very likely that prices peak. The economy’s been hit by a VAT hike twice in the last two years, and the depreciation of the nominal exchange rate continues to pass through to prices. Fiscal austerity will drag aggregate demand and prices – just hold on.
* In Germany, the domestic measure of consumer prices is expected to mark a 2.05% annual pace in February (1.96% in January), but the core level is growing a just a 0.77% annual rate (in January, which the latest available data point). For now, and probably throughout the rest of the year until union contracts reset on an aggregate level, it’s really all food and energy there.
* And in the US, core inflation is rising, but that’s primarily based on the re-emergence of the micro-pressures that are owner’s equivalent rent AND food and energy. Core inflation is now rising again (see recent Calculated Risk article), however, in my view, there’s not enough leading evidence to suggest that inflation expectations have in any way become unmoored. Unit labor costs, for example, remain submerged below a sea of economic profits (more on that tomorrow – but you can see a previous post on the subject here).

Watch monetary policy closely. The oil inflation may simply be the straw that breaks the camel’s back for some, since food prices have been headed north for some time. Key central banks shouldn’t hike – UK and ECB are notable examples – but they may.

I, consequently, still ‘hope’ that the recent hawkish rhetoric coming out of the ECB is simply a reflection of the hole that is the appointee to run the ECB after Trichet leaves in October. More bluntly put: they’ll say anything to get the job. (See Eurointelligence’s case for Mario Draghi.)

Rebecca Wilder

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Do Queues for Public Sector Jobs Tell Us Anything?

The question of whether public sector workers are overpaid or underpaid compared to what they would earn in the private sector is a hot topic these days. A fair bit of academic research shows that people generally earn less money in the public sector (particularly in state and local governments) than people with the same qualifications doing the same type of job in the private sector.

Some people who disbelieve this evidence are now suggesting a different approach to illustrate that workers in the public sector are overpaid: looking at queues for job openings. For example, Andrew Biggs (from the AEI) argues that “state and local government jobs offer workers higher total compensation than those individuals could get in the private sector. As a result, people are lining up to get them.”

But taking the existence of queues for public sector jobs as evidence that those jobs are overpaid is problematic, for a couple of reasons.

1. Nearly all jobs – public and private sectors – have “queues”, if you define that as a situation in which there are more applicants than open positions. What matters is whether the queues for public sector jobs are longer than the queues for private sector jobs for the same occupation and qualifications, and I have yet to see compelling evidence that that is the case. (I would welcome help in identifying some; the most commonly cited papers, e.g. Krueger (1988), do not seem to contain such direct evidence.)

2. If racial or sexual discrimination exists in the private sector but not in the public sector (and there’s evidence that this is the case), then women and racial minorities would tend to be underpaid for their labor in the private sector, giving them a strong incentive to try to switch into the public sector whenever possible. This would explain excess queuing for public sector jobs (if such excess queuing does indeed happen).

3. If, as the evidence suggests, public sector jobs tend to have compressed pay schedules, with relatively good compensation for entry-level jobs but only modest increases in compensation over an entire career (leaving overall lifetime compensation lower), then that means that individuals who can not afford to wait for the higher pay that they would eventually get in the private sector would tend to prefer public sector jobs. For those people, the requirement for a higher salary early in their career would make them willing to accept the lower lifetime earnings they’ll get in the public sector. This would also tend to cause excess queuing for public sector jobs, even though compensation is lower than private sector jobs. (Yes, this will only happen if there are incomplete credit markets such that those people can’t borrow sufficiently to make up the difference in the early part of their careers, but the fact that credit markets are indeed imperfect has been well-established, particularly for certain segments of society.)

So put me in the camp of those who are not persuaded by the “queuing” methodology of trying to determine if public sector jobs pay better or worse than their private sector counterparts.

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