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

Japanese Q3 2010 GDP growth hit it out of the ballpark but set to fall flat next quarter

The Japanese economy grew 3.9% at a seasonally-adjusted annualized rate in Q3 2010 and over 2X the pace in Q2 2010 (data here). According to Bloomberg, the headwinds to Q4 growth are household consumption and the yen:

Consumption, accounting for about 60 percent of GDP, led the gain as households stepped up purchases of fuel-efficient cars ahead of the expiration of a subsidy program and as smokers stocked up before an Oct. 1 tobacco-tax rise. The yen’s climb to a 15-year high will probably damp growth this quarter as companies from Sharp Corp. to Nikon Corp. cut profit forecasts.

To be sure, the surge in real GDP growth is unlikely sustainable; but it’s not because of the yen’s strength, per se. True, consumption growth is more likely to print on the lefthand, rather than the righthand, side of the 0-Axis. However, the yen on a trade-weighted basis and in real terms hovers at its historical average; hence, the currency poses less of a risk to growth.

The chart illustrates the contributions to non-annualized quarterly growth (not annualized, GDP grew near 1% in Q3) from each of the GDP components: private consumption (C), investment (I), inventory build (Inv), government consumption (G), and net exports (NX).

The Q3 pace of growth is almost certainly not sustainable and has a decent chance of turning negative in Q4 2010 for the following reasons. (See charts below text for illustration)

* The biggest contribution to Q3 growth came from consumer spending, +0.66%. Investment contributed positively, 0.11%, but has been trending downward. Key data points are inauspicious for consumer spending: the unemployment rate hovers stickily around 5% and October auto sales saw a 27% annual decline, as green auto subsidies expired.

* Although the JPY/USD has appreciated 14% since the middle of 2010, the real effective exchange rate, the economic driver of a country’s trade balance, has been stable over the same period (see final chart below) and in line with its longer-term average. So while I don’t expect net exports to turn negative, per se, any additional impetus to growth is unlikely to come from trade.

* Therefore, the key to growth is final domestic demand, and more specifically consumer spending. That’s a stretch.

Rebecca Wilder

Ending Stimulus and the Shape of the Recovery

by Tom Bozzo

Brad DeLong observes that the FY2011 budget features “big, very big” tightening on the revenue and spending sides (2.5% of GDP “from 2010 to 2011”) for the prevailing labor market conditions. DeLong wants his “morning in America” (don’t we all?), and is understandably alarmed at the pessimistic forecast of the rate of labor market improvement. Paul Krugman echoes the sentiment on “near-term” fiscal tightening.

As is always the case, the tightening question has to be “relative to what?” [1] Receipts as a fraction of GDP are expected to increase fairly substantially, for example, but that’s largely a consequence of expected economic growth.

Compared to the current-policy baseline, the FY 2011 (10/2010-9/2011) budget increases the FY 2011 deficit by around 0.8 percent of GDP. In FY 2012, the budget would subtract around 0.7 percent of GDP from the current-policy deficit. Krugman is correct to attribute this to the winding-down of ARRA stimulus and of our “overseas contingency operations” better known as the wars in Iraq and Afghanistan. Go see Table S-2 here [PDF]. Additionally, current policy has some stimulus on top of current law. Allowing most of the Bush tax cuts to become permanent reduces FY 2011 receipts by around 0.9 percent of GDP. (See Table 14-2, here.)

As for the timing, the budget assumes (see Table 2-1) that real GDP in quarter 4 of calendar year 2010 will be 3 percent higher year-over-year; in Q4 of 2011 (a/k/a Q1 of FY 2012), real GDP is expected to increase another 4.3 percent. Even with the tightening, Q4 2012 real GDP would increase another 4.3 percent y/y. So the FY 2012 tightening only arrives after two years of modest growth.

If measures labeled as such are actually to be temporary economic stimulus measures, they obviously must end sometime. Ending them after the expansion ends is stupid — the tightening would reinforce the subsequent downturn — so it’s going to take some steam out of the expansion one way or another. The most pressing timing concern would be not to take away the stimulus before it’s clear that the recent GDP growth is sustainable; I’d argue that after two years of growth, should we get there, the case that measured GDP growth is a matter of one-time shots and/or statistical glitches will be fairly weak.

The slow assumed labor market recovery Brad DeLong notes might be seen as a mirror-image of the GDP recovery assumed in the budget baseline:

The budget’s baseline economy (with the triangle marks) isn’t as pessimistic as OMB is willing to imagine in public (and if you’re Ken Houghton, you might see all of these as irrationally exuberant), but the ‘output gap’ opened by the recession is assumed to close very slowly. While higher-frequency data are not equally optimistic, there’s building evidence (so far, outside of employment) for a reasonably strong recovery. And as Maynard explains at Creative Destruction, it’s arguably in the administration’s interest to err on the pessimistic side since people (again, even including some economists) don’t understand counterfactuals and thus tend to inappropriately place blame (or credit) for surprises.

[1] Every economics professor who disparages the “jobs created or saved” concept should be immediately stripped of tenure and exposed to the current labor market for forgetting that all economic analysis is counterfactual.

Government Site to Check

Mish sends us to “Track the Money,”’s breakdown of where funds have been sent and spent.

He’s not happy, but I suspect he’s suffering the Jared Bernstein Problem: only looking at one side of the equation.

But—and this is the key “but”—the reason it is right to do that is that ARRA money has two-way flow. It supports jobs and production, both priming the pump and moving production forward. This works if (1) the cost is minimal and (2) the production will be saleable (avoid the “double-dip”). Which implies (1) domestic interest rates must remain near zero and either (2a) U.S. consumer demand for domestic goods must increase or (2b) the U.S. dollar must depreciate, making our goods more desired abroad.

All of the above is reasonable and conceivable, even if it does imply the stock market may be overvalued.

And if the recent reports are true, the biggest effect of the stimulus has been in stabilizing education, which reaps long-term benefits, as conservative economist Ed Glaeser noted last month.

But that’s the stimulus. The bailout money, well, that’s another question. And another post.

More on Dubner and Levitt II

It has long been a standard claim of economics—iirc, Robert Lucas was the first to say it aloud, though it may have been Gary Becker*—that a man who marries his housekeeper lowers GDP.

Apparently, Dubner and Levitt have taken this claim—along with their Rick James title**—to heart. Echidne has the details. A short sample:

There is one labour market women have always dominated: prostitution. Its business model is built upon a simple premise. Since time immemorial and all over the world, men have wanted more sex than they could get for free. So what inevitably emerges is a supply of women who, for the right price, are willing to satisfy this demand. But what is the right price?…

It turns out that the typical street prostitute in Chicago works 13 hours a week, performing 10 sex acts during that period, and earns an hourly wage of approximately $27. So her weekly take-home pay is roughly $350. This includes an average of $20 that a prostitute steals from her customers and drugs accepted in lieu of cash.

If I didn’t know that Levitt has done some research on prostitution, I would think he left this section solely to Dubner. As it is, the skewed perspective (supply-side only) wouldn’t even pass muster in a basic neoclassical labor market model, and that the authors are trying to sell this as “economics” is, to extend a recent note from Brad DeLong that “Levitt and Dubner today appear to no longer be thinking like economists”, going to do Levitt much more harm than good.

Perhaps the difference between prostitutes and economists is that only the former have to worry about their reputation.

*Google indicates that the source is Pigou (1932). Does this explain the popularity of the Pigou Club?

**At this point, I’m betting they chose the title because of Abigail Breslin.

Debt fueled consumption


Rebecca Wilder will begin writing as a Bear soon. Meanwhile, she maintains her own blog NEWSNECONOMICS. Here is an example of an Aug. 19,2009 post, which I am cross posting today, and a follow up post here. There were several questions raised, but I think it an interesting notion. I own an old Malibu and not a Porsche, and have watched my premiums and out of pocket health expenses skyrocket this decade. I knew the money went somewhere! Here is the cross post:

Today I plan to rant just a bit about consumption because I was reading Yves Smith’s article today, and she referred to “debt-fueled consumption” – the now pejorative phrase that just rolls off the tongue. She says:

“no where does the article [referenced WSJ article in her post on the consumption share] acknowledge that the consumption level was unsustainable and debt fueled.”
And this is where I get just slightly irked, because it seems to me that the phrase “debt-fueled consumption” strikes the following chord: every American household was loading up on home equity debt just to buy big ticket items like Hummers and large sofa sets with cup-holders galore from Jordan’s Furniture (a discount furniture shop in the Boston area – generically, every city has one).”

I am sure that Yves Smith knows this, but the debt-fueled consumption was more likely paying surging health care bills than buying cute kitchenettes.
(charts are fixed…update rdan)

Myth 1: The years of debt-fueled consumption went into goods spending, jumping the consumption share of GDP to an excess of 70%.

Update: large edition of graph here.
Reality: The goods share of total consumption has been falling quite dramatically, while the service component surged. Therefore, it is more likely that the debt fueled consumption was going predominantly into the service component (paying service bills).

In Q2 2009, 25% of service spending went to health care – outpatient services (physician, drugs, dentist) or hospital and nursing home services – and 29% of service spending went to housing and utilities – rent, water, electricity, and trash. As such, over 50% of service consumption is more likely to remain stable, even rise faster, with the Boomers out there.

And as for the speculation that workers are postponing retirement due the drop-off in wealth, and consumption will be meager into the medium term, I simply don’t buy it. If anything, the aging population is going to fuel recovery – no matter when they choose to retire. Service sector consumption growth – much of it based on health care consumption – will simply become a larger share of GDP growth (cutting out autos, perhaps), and pick up some of the slack.

And here’s another thing. Myth 2: durables consumption – i.e., autos and furniture – are important contributors to the initial stages of the recovery. It helps, but service consumption is the biggie.

Update: enlarged chart is here

The chart lists the average contribution each GDP component during the initial year of recovery spanning the 1950-2007 (nine recoveries in total).

Reality: The average growth accumulated during the initial stages of recovery (1-yr following the recession’s end) following the last nine recessions is a remarkable 6.43% (consensus forecast for growth in 2010 is currently 2.3%). Only 0.47% of that came from durable goods. A huge 1.67% of that stemmed from the service component of consumption (again, health care and housing).

And as long as service spending rebounds, so too will the economy – even without a big pickup in autos. Inventories are almost a foregone conclusion, the residential construction sector is bound to pick up – 500-600k units is simply unsustainable for a US population that is growing at roughly 1% a year, and growth rates on such a small base can be large.

And here’s another link to jobs that has not been incorporated to many forecasts – growth in jobs means new health care insurance, means added spending on health care.

I could go on, but I won’t.

Rebecca Wilder

Chart from follow up here.

Another Reason to Avoid Handwringing Over the Stimulus Spending

Tom Bozzo

was just looking at this picture and thought it was worth sharing, a propos of recent postings on the prospective pace of stimulus expenditures:

(click to embiggen)

This shows subsequent revisions to the CBO’s real GDP forecasts. Barring an exceptionally rapid recovery, GDP looks to be materially below potential output in 2011 (i.e. 3 quarters of FY 2011 and 1 of FY 2012) and 2012. Not-so-near-term stimulus is thus defensible; the real question is whether the near-term package is enough.

The Alpha and the Omega of mid-2007

Sometimes, Blog Posts Write Themselves: Cleaning up a hard drive of old files, I ran across these two articles from the middle of last year.

First, the WSJ, arbiter of business sanity and purveyor of a positive meme whenever one is to be found, on 28 July 2007—nine months after the general supply of securitizable mortgage loans went away, at least six months after even those with their own origination capacity realised the game was over, and about two weeks before Bear Stearns would issue bonds at the then-junk-bond-area yield of 245 over:

The economy grew at an annual rate of 3.4% in the quarter, reversing the anemic 0.6% growth in the first quarter, the Commerce Department said. Increases in exports and government spending drove much of the improvement. A rise in commercial construction spending and building of inventories offset a drag from housing and sluggish consumer spending.

But the positive drivers aren’t expected to persist, and recent indicators cast a darkening shadow over the rest of the year. The latest readings for spending on plant and equipment, which grew at a tepid 2.3% pace in the quarter, are disappointing. Rising inventories of unsold homes, falling prices and tighter lending terms on subprime loans for marginal borrowers offer little hope that housing is stabilizing. The downturn in stocks crimps Americans’ wealth, and turbulence in credit markets is sparking fears that loans will be costlier or harder to get….

Some business executives expect things to get worse. “This idea that there’s been no spillover from housing into other segments is just faulty,” Mike Jackson, chief executive of auto dealer AutoNation Inc., said in a conference call. “I think it’s extreme economic distress out there right now. It’s one of the toughest environments I’ve ever seen since I’ve been in the business.”…

Some forecasters say the gloom is overdone. As long as businesses continue to hire, the jobless rate remains near its current low 4.5% and energy prices don’t go higher, they say overall consumer incomes should be strong enough to support a healthy level of consumer spending. In a favorable sign, the University of Michigan said Friday its consumer confidence index rose to 90.4 in July from 85.3 in June.

Corporate earnings outside of financial services remain robust, although companies have been worrying for months about higher input costs crimping profit margins. “The real risk for consumer spending is if for some reason companies slam on the brakes and stop hiring,” said Brian Bethune, an economist at Global Insight. “The employment market is still reasonably solid.”…

“The big picture is that you’ve got an inventory problem in both markets — you’ve got too many homes for sale and too many bonds for sale,” says Mr. Kiesel. “So prices need to adjust: You need lower house prices and much bigger credit spreads. It means the economy is going to slow.”

Downward revisions to growth from the first quarter of 2004 through the first quarter of 2007 added to concerns because they offer more evidence that the pace of productivity growth has slowed, and with it estimates of the speed at which the economy can grow without higher inflation. Economists at Bear Stearns, for instance, said that estimates of the economy’s potential growth rate are likely to fall below 2.5% a year.

Let’s ignore for the moment the delusion that it was All About Subprime—even though some idiot on CBC was making exactly that claim Friday, trying to explain Why Canada is Different. (I’ll take Stephen Gordon’s analysis, instead.) This is an attempt at being positive: in the wake of an annualized 3.4% growth rate, that should have been much easier. But the harbingers had landed by then.

Next, the guy who keeps getting slammed in comments here and elsewhere, often for no good reason (or, in the case of Stanley Fish, in the throes of full hypocrisy). Larry Summers about a month later, 27 August 2007, in the LA Times. First, he gives the lie to the “once a century” meme:

Over the last two decades, major financial disruptions have taken place roughly every three years — the 1987 stock market crash, the savings and loan collapse and credit crunch of the early 1990s, the 1994 Mexican peso devaluation, the Asian financial crises of 1997, the Russian default and Long Term Capital Management implosion of 1998, the bursting of the technology bubble in 2000, the disruptions of 9/11 and the 2002 post-Enron deflationary scare in the credit markets.

This record suggests that, by the beginning of 2007, the world was long overdue for a major financial disruption. And sure enough, the difficulties around sub-prime mortgages “went systemic” in the last month as the market seemed to doubt the creditworthiness of even the strongest institutions and rushed to buy Treasury debt.

Soon, he gets to the heart of the matter:

[A]s investors rush for the exits, the focus of risk analysis shifts from fundamentals to investor behavior. As some liquidate, prices fall, then others are forced to liquidate, driving prices down further. The anticipation of cascading liquidation leads to still more liquidation, creating price movements that seemed inconceivable only a few weeks before. Reduced credit feeds back negatively on the real economy.

Eventually — sometimes in a few months, as in the U.S. in 1987 and 1998; sometimes in a decade, as in Japan during the 1990s — there is enough liquidation and price adjustment to make extraordinary fear give way to ordinary greed, and the process of repair begins.

It is too soon to draw policy lessons from the current crisis or to determine exactly where in the cycle we are now. But it is not too soon to highlight the questions it points up. Three stand out.

From that point on, the article goes downhill:

First, the current crisis has been propelled by a loss of confidence in rating agencies, as large amounts of debt that had been very highly rated has instead headed toward default….But there is no doubt that, as in previous financial crises, the rating agencies have dropped the ball.

In light of this, should bank capital standards, Federal Reserve discounting policy and countless investment guidelines still be based on credit ratings? What is the alternative? What if any legislative response is appropriate?

It seems more likely to assume that rating agencies are lagging, not leading, indicators of credit crises, as investment products develop based on iterative variations of current products, whose risk profile is therefore (definitionally) somewhat less well defined, and (again definitionally) are likely to have thicker tails that will not be captured by standard modeling. (See Robert’s discussion here.)

Summers continues:

Second, how should policy respond to financial crises centered on nonfinancial institutions? A premise of our system is that banks accept much closer supervision from public authorities in return for privileged access to the Federal Reserve payments system and its “discount window,” which allows banks to borrow directly from the Federal Reserve. The problem this time is not that banks lack capital. It’s that the solvency of a range of non-banks is in question because of cascading liquidations and doubts about their fundamentals. In an old-fashioned phrase, central banks that seek to instill financial confidence by lending to banks or even by reducing their cost of borrowing may well be pushing on a string.

With the admission of insolvency of the financial institutions still at least six months away, Summers was already discussing the limits of liquidity provision.

His third point is only slightly less prescient:

Third, what is the right public role in supporting credit to the housing sector? The lesson learned from the S&L debacle was that it is catastrophic to finance home ownership through insured institutions that borrow short term and then offer long-term fixed-rate mortgages. Now a system reliant on adjustable-rate mortgages and non-insured institutions has broken down.

I might argue Summers took the wrong lesson from the S&L crisis, which grew in large part from primarily Texas-based S&Ls that loaned large amounts of money based on the idea that some barren desert land was valuable because it had oil under it. It does not seem coincident that the first wave of housing market collapses (ca. mid-to-late 2006) were all in similarly-desert areas—Phoenix, Lost Wages, the tracts of land near I-5 between LA and SF. But at least he knew what not to do:

[I]f there is ever a moment when [Fannie and Freddie] should expand their activities, it is now, when mortgage liquidity is drying up. No doubt, credit standards in the sub-prime market were way too low for way too long. But now, as borrowers face the reset of adjustable mortgages, it is not the time for authorities to get religion and encourage the denial of credit.

The next time someone tells you that “no one predicted” this phase of the current crisis, point them to Larry Summers fifteen months ago. Or even, in broad outline, the WSJ.

What do we want our economy to do? Misuse of GDP

by Divorced one like Bush
(successfully I might add)

I had the following quotes sitting around for awhile. Like May of 07. Being that we have a “crisis” with our economy (I have a hard time with the word crisis being used, it implies suddenness, unseen), a new governing philosophy in place and we really, really, really have to broaden our discussion, I feel this is the time to post some thoughts on GDP. It goes along with asking what I think is the most important, “In the beginning”, big bang question to ask now that we have been a “great social experiment” for TWO HUNDRED and THIRTY TWO years: What do we want our economy to do for us?

I think it’s about time we ask this question, No? The “for us” is the important subject of the question.

But even if we act to erase material poverty, there is another greater task, it is to confront the poverty of satisfaction – purpose and dignity – that afflicts us all. Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife. And the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.
Robert Kennedy, University of Kansas. 3/18/68

Unfortunately GDP figures are generally used without the caveat that they represent an income that cannot be sustained. Current calculations ignore the degradation of the natural resource base and view the sale of non-renewable resources entirely as income. A better way must be found to measure the prosperity and progress of mankind”
Barber Conable,
former President of the World Bank, 1989

Simon Kuznets – GDP’s creator – in his very first report to the US Congress in 1934 said[2]:
…the welfare of a nation can scarcely be inferred from a measure of national income. If the GDP is up, why is America down? Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.