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This article appeared on Tuesday, November 1st in the Deseret News.

In February of 2009 congress passed and President Obama signed the American Recovery and Reinvestment Act.  At the time it carried an estimated price tag of $787 billion.  Commonly referred to as "the stimulus bill," it was intended to reinvigorate an economy battered by the subprime mortgage financial crisis.  In September of this year, President proposed the American Jobs Act, which is also intended to invigorate the economy and spur jobs creation.  Under this act an additional $447 billion will be spent, leading some people to refer to it as "Stimulus Jr."

How exactly is increased government spending supposed to stimulate the economy.  The basis for this prescription lies in a particular school of macroeconomic thought known as Keynesianism.  The name comes from the famous British economist, John Maynard Keynes.  When he came up with his theories Keynes had in mind an economy mired in recession or depression, as was the case around the world during the 1930s.  In this environment Keynes claimed that workers and firms stood ready and willing to produce goods at the prevailing prices, if only someone would buy them.  This is the description of a market surplus, which occurs in individual markets occasionally for a variety of reasons.  Keynes argued there was an economy-wide surplus of goods, not just a surplus in a few scattered markets.

Normally with surpluses markets respond by lowering prices to clear the market, so that all goods offered for sale are purchased.  Think of sales on day-old bread or DVDs in the discount rack and you get the right idea.  However, Keynesian theory postulates that prices are slow to adjust, particularly downward.  This is referred to as price "stickiness" and it implies that markets will remain in surplus for long periods of time.  In the long run prices will eventually fall and markets will clear, but as Keynes famously quipped once, "In the long run we are all dead."  Hence, we may be quite concerned about what happens in the short run while prices are not adjusting.

In this scenario the problem with the economy is coming from consumers on the demand side.  They are not spending enough to purchase all the goods offered for sale.  A Keynesian prescription is to let the government purchase goods and services instead.  In theory this increases the demand for goods.  Firms sell goods that would otherwise remain unsold or not even produced in the first place.  And workers go back to work producing those goods.

There are complications, however.  The government needs to get the money to pay for these purchases somehow.  If it raises taxes, and uses the increased revenue to buy goods, it is also lowering the income of the households and businesses it taxes.  As a result, they spend less even as the government spends more.  Whether this leads to a net increase in the demand for goods depends on whether those taxes reduce their consumption of goods by more or less than the government increases its consumption.  Economists call this the marginal propensity to consume or MPC and argue that the MPC of the government is close to 100% (at least for stimulus spending) while the MPC of consumers in less than that.   Hence, a stimulus increases government spending more than it depresses private spending and yields a net increase in demand.

If, however, the government pays for spending by running a deficit, private spending need not fall, because households are not taxed and need not reduce spending.  This reasoning is why the traditional Keynesian policy prescription is to stimulate via deficit spending in a recession.

Since Keynes, macroeconomic theorists have run across flaws in this reasoning, however.  For example, when the government runs a deficit, it borrows more money from the general public.  When domestic households lend to the government, they voluntarily reduce spending and buy government bonds instead.  Hence, deficit-financed stimulus looks very similar to tax-financed stimulus in its overall effects.

Another reason why stimulus spending may be less effective than Keynesian theory suggests is that the effects depend crucially on how the money is spent.  For example, older and younger people may have different MPCs.  The old have less of a savings motive than the young.  Indeed most retired workers are dissavers, withdrawing funds on net from savings accounts and pensions.  If a stimulus package reroutes money from the old to the young it can actually reduce demand.

Recent studies suggest that much of the money from the 2009 stimulus was transferred to state and local governments for local spending projects.  However, many of these governments had quite low MPCs and used these stimulus funds directly or indirectly to pay off or avoid debt.  In other words they saved the money rather than spent it.  This may be one reason the stimulus was so much less effective that its proponents believed it would be.

Additional problems with stimulus spending include the effect it has in the long-run on burdens of taxation and expectations of future taxes.  More on those issues will be forthcoming in a later column.

This article came out in the Deseret News on Tuesday, October 18th.

Last Monday the Nobel prize in economics was awarded to Tom Sargent and Chris Sims.  Both are well-known macroeconomists and both have worked on economic issues relevant to the 2008 recession and recovery.

Forecasting the future of the economy is tricky business.  For one thing it is very complicated, with millions of goods and services changing hands.  Another reason is that it is subject to changes in the economic environment that are not economic in nature; weather and politics being two good examples.  Forecasting how the economy will behave requires simplifying models that capture most of its features without adding too much complexity.  Over the years, economists have developed increasingly sophisticated ways of doing this.

By way of analogy consider the portion of U.S. Highway 6 that runs between Spanish Fork and Price.  I drive this stretch of road on occasion on my way to the San Rafael Swell.  The road goes up Spanish Fork Canyon, over Soldier Summit, and down Price Canyon.  It is necessarily winding and steep in many places.  Suppose you were tasked with forecasting the fate of a convoy of vehicles traveling over this road.

A simple first stab at the problem might involve using elementary physics.  The vehicles have given weights, they travel at certain speeds over different portions of the road, the road's gradient and curvature are known.  Based on this information you could, with some effort, derive a forecast for the progress of the convoy.

However, to improve your forecast, you might also consider the weather.  Unfortunately, the weather is changeable.  You have a general idea of conditions, but the specifics at each point on the road are not known.  Furthermore, these conditions can change unexpectedly.  You need to make a best guess and factor this into your forecast.  You will also need to update it as the convoy progresses and available information changes.  The same principle applies to other factors like the mechanical condition of the vehicles, and the mental condition of the drivers.

When you make your forecast you realize that it is only a best guess.  It is subject to change due to factors that are difficult to predict.

If you had some control over the highway or the vehicles you might be able to reduce the chances of a serious slowdown or pileup.  Suppose you had a radio controller that could uniformly boost or reduce the amount of fuel all the vehicles consume.  If conditions looked dangerous you could dial down consumption of gas, slow the convoy down, and reduce the chances of something bad happening. 

 

This type of forecasting and policy recommendation corresponds roughly to state-of-the-art economic forecasting prior to the introduction of Rational Expectations theory thirty to forty years ago.  Tom Sargent was an important contributor to that literature.  Chris Sims' contribution was to develop statistical techniques that identify how economic variables influence each other as time progresses.

When you cut back gas consumption you assumed this would make the cars go slower.  However, drivers are not automatons and they adjust their driving behavior based on the conditions they observe.  They do this by gathering all the relevant information they can: direct observation of the road through the windows, listening to the radio, talking with other drivers on cell phones, etc.  When things look dangerous, they slow down on their own.  If you dial down the gasoline flow, drivers will simply push harder on the accelerator to compensate and will maintain the speed they think is best.  .  Ignoring the responses of the drivers (decision makers) in the convoy (economy) to your manipulation of the gas flow (economic policy) gives bad forecasts.  Good forecasts will incorporate these rational responses.

The 2008 financial crisis and recession have been held up by some people as evidence that Rational Expectations is incorrect.  If decision makers are gathering information and processing it effectively, how could they have missed the subprime meltdown?  Why did they ignore the warnings of those who were warning against just such a meltdown at the time?

Go back to the convoy.  Suppose you have a fellow forecaster who believes the brakes on a large semi-truck are about to fail.  As the convoy makes each turn along the route he announces over the radio to all concerned that the semi is about to run out of control, tip over, and cause a massive pileup.  However, for the first several turns the brakes hold and the convoy continues on unharmed.  Eventually, everyone discounts his predictions of doom.  If the brakes finally do fail, it comes as big surprise to almost everyone.  Why did drivers not foresee the crash?  Why did they ignore the voice on the radio?  Because the problem was small, subtle, not readily apparent to anyone but an expert, and the exact moment of failure was largely random.

The problem is not that the forecasting methodology is wrong.  Rather, it is that unexpected or difficult to predict events can in some circumstances have huge consequences.  They are easy to see in hindsight, but not so easy to see before they happen.  One message the Nobel committee sent was that rational expectations is still an important piece of economic theory.

This article appeared in the Deseret News on Tuesday, October 4th.

According to the National Bureau of Economic Research (NBER) our most recent U.S. recession began in December 2007 and ended 18 months later in June 2009.  There are no precise criteria for deciding when recessions begin and end.  Instead, the NBER uses a variety of economic data to reach a consensus on the dates.  The general idea is to look for turning points in economic activity.  A peak, when economic activity begins a sustained fall is the beginning of a recession.  A trough, when the economy stops shrinking and begins to expand again is the end.  One commonly used rule of thumb is that a recession is at least two quarters of falling inflation-adjusted gross domestic product (GDP), while a recovery is two quarters of rising GDP.

Not all recessions and recoveries are equal, however.  A downturn can be mild as the one from July 1990 to March 1991 was, when GDP fell by 1.3%.  Or it can be severe like the most recent one where GDP fell by 5.1% from peak to trough.  In addition, recoveries can be anemic or robust.  For example GDP grew almost 14% in the two years following the 1981-82 recession, while it has only grown 5% in the two years since the end of the last recession.

What exactly causes a recession is a matter of intense debate amongst macroeconomists.  It is likely that there are many causes.

Keynesian theories focus on the role that consumer confidence plays in recessions.  When consumers begin to feel pessimistic about the future, they will save more and spend less.  This leads to a decrease in demand for goods and services.  If the prices of goods are slow to adjust, this will, in turn, lead to a surplus of production and firms will begin to lay off workers.

New classical economic theories point to the role of technology.  When there is a drop in productivity, firms will be unable to produce as many goods as they could previously.  The drop in worker productivity leads firms to lay off workers and leads to a recession.  It also causes capital to be less productive and this leads to large drops in purchases of investment goods.  New classical economists realize that technology rarely decreases, but they point out that energy price increases and increases in taxes are often identical in terms of their effects on firms.

Financial crises can also cause recession if they have a major impact on the banking sector.  When banks are in financial trouble they are reluctant to lend to businesses, and many sectors of the economy rely on bank lending to cover up front costs.  Residential construction and shipbuilding are two good examples.  A loss of lending forces these firms to lay off workers since they cannot borrow the money to pay their wages.

Our most recent recession was caused primarily by the subprime mortgage financial crisis.  The resulting drop in consumer confidence was likely an important contributing factor.  The anemic recovery, however, is likely due to other causes.  One facet of recent recoveries has been the slow rebound in employment.  This is especially true of the past two years.  A great deal of this is due to government policy.  Increases in personal and corporate income taxes are very similar to drops in technology from the point of view of firms hiring workers.  It makes no difference to the firm if revenue is lost because the firm is less efficient than before or because the government takes more in taxes.  Expectations of increased taxes act as a powerful disincentive to businesses.  Since most business operators dislike dealing with uncertainty concerning the future business environment, even uncertainty about whether taxes will go up or not, can act as a drag on the economy.  The expectation of increased government regulation can also mimic a productivity drop.  When particular methods of production are banned or made more costly, this forces firms to adopt different production techniques that are likely less efficient (else the firm would already be using them).

Are we headed toward another recession soon?  It is difficult or impossible to say for certain.  Unpredictable future events will have bigger effects than anything foreseeable right now.  The unfolding sovereign debt crisis in Europe has the potential to stress the banking sector.  But a banking meltdown is not a foregone conclusion.  Increased taxes are a possibility, particularly with the increased attention the public and policymakers are placing on reigning in government deficits.  However, budgets can be balanced by cutting spending rather as well, so it is entirely possible that tax rates will not be raised.  The implementation of Obamacare has the potential to impose costly regulation on firms that would lead to a drop in productivity.

One thing that is certain is that there will be another recession sometime.  It may begin this year or we may be lucky enough to go a decade or more without one.  When making financial plans for the future it is always a good idea to remember that recessions are a recurring feature of the economy.

This article was published in the Deseret News on Tuesday, September 20th.

The Greek financial system is in big trouble right now.  The fundamental problem is that the Greek government has been on a bit of spending bender over the past few years and has borrowed a lot of money to pay for this, all of it denominated in euros.  It has become frighteningly clear that this level of debt is unsustainable and the Greek government needs truly radical fiscal reform to avoid defaulting on its outstanding debt.  Much of that debt is held in the form of Greek government bonds by Greek banks, but a large amount is also held by various financial institutions outside of Greece.

By itself this is not really a very interesting or important situation.  There are a large number of countries in the world and inevitably, some of them get into fiscal trouble.  Some sort of financial crisis of this sort happens on a fairly regular basis.  Greece is, however, a member of a monetary union.  And its financial health could have an effect on the financial health of other members of that union.

The euro is a unique currency because it is issued by a collection of sovereign states, rather than by a single country as is usually the case.  The currency was formally introduced into circulation in 2002 and replaced the national currencies of the participating countries.  Control of the euro money was given to the European Central  Bank (ECB), which was created with the sole purpose of managing the euro.   When the euro was created it was very clear that all member countries would be using a single currency and would therefore be unified monetarily.  It was not clear, however, how unified these countries would be in fiscal terms, however.  There is no governmental equivalent to the ECB.  There is a European parliament, but there is no central government with authority to tax and spend for the European Union as a whole.  Fiscal matters are, in theory, left entirely to the individual member countries. This means there is no natural central source of funds to "bail out" the Greek government.  The two bailout packages worked out so far have been hammered out via complex negotiations between Greece, the ECB, and other European governments.

Suppose Greece decides it is going to default on its government bonds.  Does this necessarily mean that the euro as a currency is in trouble?  Not necessarily.  In fact, if there is no expectation that Europe is a fiscally united, then there should be no issue at all.  Greek bonds, though denominated in the same currency as German bond, already pay higher interest rates due to their higher probability of default.  If the Greek government decides to default, things could get really bad for Greece, but it need not affect other European countries.  The fact that German and other European banks hold Greek government bonds could lead to increased stress on the banking sectors in those countries, but it need not lead to dissolution of the euro as a currency.

However, a problem does arise with one the way that Greece might choose to default on its debt.  Rather than default outright, the Greek government could choose to drop out of the euro zone and reintroduce their previous national currency, the drachma.  They could do this by initially trading all euro amounts in Greece one-for-one with drachma, for example, and legally rewriting all contracts in euro to contracts in drachma.  Then the Greek central bank could drastically increase the number of drachma in circulation and repay its nominal debt with this new money.  The result would be a devaluation of the drachma.  Greek assets would be worth less on the world market, just like a default, but a formal default would be avoided.  In effect, Greece would be solving its fiscal problems by imposing an inflation tax and at least some of the burden of that tax would fall on non-Greek holders of Greek government bonds.

Now suppose you had a time machine and knew for certain that this was going to happen on Dec. 31^st 2011.  What should you do today?  You should sell any Greek assets you hold today to avoid the inevitable loss in their value when the drachma is devalued.  If you are a savvy investor you might take profits by short-selling Greek debt.  Even if you don't have the time machine and are uncertain what is going to happen, you might still find it prudent to sell.  When all or most investors do this, the result is a worsening of the financial crisis.

If investors feel that Greek devaluation is becoming more and more likely, it is only natural that they begin to look at other European countries with similar fiscal problems.  These countries include Ireland, Spain, Portugal, and perhaps even Italy & France.  If enough countries choose to withdraw and devalue their currencies - particularly if either of the latter two do - then the euro as a multinational currency will effectively be dead.

Greek fiscal problems don't automatically mean the euro is doomed, but it is very easy to see why policy makers in Europe and elsewhere are worried that events are moving in exactly that direction.

This article was published July 8th, 2011, at KSL.com and published in the Deseret News on July 12th.

Republicans in the House and Senate are preparing constitutional amendments that would require the government to run a balanced budget every year. Politically, the lines are already drawn, with Republicans generally in favor and Democrats generally opposed. But does balancing the federal budget each year make economic sense? Like many issues in economics, the answer is, "it depends." Specifically, it depends on the time horizon over which we balance.

One way to gain some insight into how the government should act is to imagine the parallel with your own household budget. The parallel is not perfect, because the government is big enough to affect the whole economy while your household (even if you are Bill Gates) is not. Nonetheless, the analogy is useful.

So, should you run a balanced budget as a household? The obvious answer is, of course you should. In fact, you really aren't given much of a choice in the matter, at least in the long run. If you spend more than you earn over a long period of time you will go into debt. And if you fail to pay that debt, your creditors will start seizing your assets. You might get out of paying back the full amount by declaring bankruptcy, but that's not a good choice when making a personal financial plan.

A more subtle question is, over what time horizon should you balance your budget? Should it be a year? Clearly you don't balance it over short periods of time, like a day. Most of us get paid relatively infrequently. If we adopted a strict balanced budget rule, we would spend our paycheck in full each payday. On days when we didn't get paid we would not be able to spend anything. Clearly a day-to-day balanced budget is silly for most of us. In practice, we set aside most of our paycheck on payday and gradually spend this balance down until the next one arrives.

Financial planners tell us to set some of our income aside each payday and save. One reason for saving is to be prepared for an unexpected expense. In many cases we can't really avoid running a household deficit. If the transmission goes out on the car, it is usually necessary to repair it or replace the car, even if this exceeds the planned budget for the month. We can dip into savings do to this or borrow money, but either way we are running a budget deficit.

Running this kind of deficit is not such a bad idea if we have the self-discipline to run surpluses later. That is, we either repay our loan or rebuild our savings account to its original level by spending less than our income.

When most of us manage our household expenses, we pay attention to the budget. We are aware of whether we have spent more or less than we intended and whether this is more or less than our income. However, we do not insist on a hard constraint that spending always be less than income. Instead, we keep an eye on our savings and borrowing. When savings falls or borrowing rises, we readjust our budget plans, realizing we need to spend less or do something to earn more.

Almost everyone in the U.S. realizes the government budget is seriously out of whack. We need major adjustments to spending if we are going to avoid bankruptcy. A balanced budget amendment is one way to force fiscal balance. Just as a financial planner might recommend a strict budget for a household that is heavily in debt, a balanced budget may be one part of a responsible plan to reform government spending and taxes. In this case, a strictly-enforced budget is a temporary tool that should be used to bring overall debt down. In fact, a good financial planner would recommend a budget surplus so that spending is significantly less than income and the large outstanding debt is reduced as quickly as is reasonably feasible. However, once the debt is reduced there is much to be gained from allowing borrowing in the face of unexpected events.

A balanced budget amendment is permanent and will bind all future congresses. Therefore, the short run gains in fiscal balance need to be weighed against the long-run losses in ability to respond to economic shocks. A better policy would be to impose spending restrictions until the level of debt reaches a much lower level. The best policy would be to elect a congress that is willing to spend within its means in the long run.

UPDATE July 25, 2011

Alex Tabarrok at Marginal Revolution has a proposal that brings together the good points of the balanced budget amendment, without the drawbacks I discuss above.  He calls it an "Unbalanced Budget Amendment," and it requires the government to run a surplus in good times, so that it has some savings to draw upon in bad times.

This article appeared in the Deseret News on June 28th, 2011.

In May, former Minnesota governor, Tim Pawlenty, declared his candidacy for the presidency of the United States. He also released a plan that is intended to lead to a revival of the US economy, which is in the middle of an anemic recovery. One of the key assumptions of this plan is that the economy can be coaxed and prodded into growing at an annual rate of five percent for a decade or more. As economist Donald Marron has pointed out, the US economy has grown at an average rate of 5% for ten years exactly once since the end of World War II. That was the period from mid-1958 to mid-1968. As he puts it, "Getting up to 5% over the next decade thus seems not merely ambitious, but almost unthinkable."

However, Stanford macroeconomist, John B. Taylor, argues that 5% is quite doable. One percent growth per year can come from growth of the population. Taylor argues another one percent can come from having a greater percentage of the population employed as workers. The remaining growth needs to come from increases in the productivity of capital and workers - what economists call total factor productivity or TFP for short. Since 1996 TFP has grown at an average rate of 2.7%, so the remaining three percent needed is not that hard to imagine.

When discussing growth it is important to distinguish between two different effects. The first is a levels effect. This occurs when something happens to permanently raise or lower the long-run productive capacity of the economy. For example, a one-time increase in the population due to a baby boom, or a relaxation of immigration constraints would give us a larger workforce and increase the amount of goods and services we could produce. Levels effects will cause the economy to grow in the short run as it adjusts slowly to incorporate these new resources. In the long run, however, the economy reaches a new higher level and then stays there without any further growth.

A second effect is a growth effect. This is a change that does not necessarily change the productive capacity of the economy immediately, but rather causes it to grow more rapidly over time. An increase in the rate at which new knowledge is discovered and turned into useful products would cause the economy to grow more rapidly over time, and these increases would continue for a long time without gradually petering out as level effects must necessarily do.

Pawlenty's plan calls for reductions in tax rates, balancing the federal budget, easing government regulation, and encouraging sound monetary policy. All of these are laudable goals, but they are also examples of levels effects. Eliminating burdensome regulation, for example, would allow firms to produce more efficiently and lead to increased production. It would also cause firms to hire more workers and invest in greater amounts of capital and machinery. However, once the firms have fully adjusted, there will be no additional economic growth.

If economic policies focus solely on these types of levels effects, then it might be possible to generate a decade's worth of growth in the neighborhood of five percent, but growth would not be sustainable at that level for much longer than that. To have long-lasting high growth rates, policy makers will need to focus on growth effects.

MIT economist Robert Solow won the Nobel Prize in 1987 for his pioneering work in economic growth. One his most important contributions was to show that much observable growth comes from increases in hard-to-measure intangibles that economists lump together and term "technology." Technological progress is now regarded as the primary engine of long-run, sustained growth. To raise the long-run growth of the economy, policy will need to focus on encouraging the expansion of technology.

Some countries, particularly developing ones, try to increase technology by government industrial policy. While this may be somewhat effective for economies that are catching up with the world technology leaders, it does not work well with economies that are already technologically advanced.

For countries like the US a much better approach is to put incentives into place that encourage the production of new ideas and technologies. Tax deductions or tax credits for research and development are one way to do this. Better enforcement of patents and other intellectual property would encourage firms and entrepreneurs to engage in more research and development as well.

Five percent growth for a decade is not an impossible goal for the US economy, but if it is to come about it will require careful consideration and implementation of policies that encourage investment in new ideas and technologies. A focus on policies like balancing the budget and reducing government inefficiency will make us better off, but by themselves are unlikely to yield the five percent growth that Mr. Pawlenty has in mind.

Dan Hamermesh is currently visiting BYU as an invited seminar speaker. I was showing him my picture of the normalized peak plot of employment in the last 14 recessions, and he told me about another labor fact from this recession that astounded me. Look at the picture below of average duration of unemployment in the U.S. since 1947. The average unemployment duration for everyone who said they were unemployed in August 2009 was 25 weeks (nearly 6 months). Compare that to the average of about 15 weeks between 1976 and 1992. This is the 60-year record in the U.S.

My 9-year-old son showed me this today, and we laughed our heads off together.

Score another one for the New York Times interactive graphics department. [Thanks to Jason for bringing this to my attention.] They wrote a cool little article highlighting the differences between how the unemployed and employed use their time in a given day using the American Time Use Survey (ATUS) for 2008, which includes data from our current recession. The best part is the interactive graphic (shown below) that allows you to see what percentage of people in the given classification are doing each different activity each minute of the average day.

Greg Mankiw posted this video sketch yesterday from The Daily Show on a major signal that the housing market has not yet stabilized. Hilarious! My favorite part is when Robert Shiller starts giving advice on how Geithner should redecorate his bathroom.

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Home Crisis Investigation
www.thedailyshow.com
Daily Show Full Episodes Political Humor Joke of the Day

My son found this for me in today's Sunday comics.

The employment numbers that came out today show that the economy is still in the process of gearing down. The normalized peak plot below shows U.S. employment levels as a percentage of their peak level in the last 14 recessions back to the Great Depression (dark black line). Employment in our current recession (the heavy lime green line) is 4.7% lower than its peak back in December 2007. The only recession that looks like this since the Great Depression is the post WWII reduction in spending in 1945. It looks like the recession still has some room to run. Similar comparisons of GDP and stock prices are in my post from a month ago.

Back in March, I wrote a piece entitled, "Overall economy not as bad... relatively" in which I graphically compared the current U.S. recession with the previous 13 recessions including the Great Depression. In that post, I concluded that the recession at that time was not the biggest since the Great Depression. This current post presents updated graphics and provides evidence that this is now the biggest U.S. recession since the big one at the beginning of the 1930s.

(Pardon the long post, but this is a topic that I love.) Adding another post to a topic that Jason and I have discussed often both on and off this blog (post 1, post 2), I wanted to post a link to a podcast interview with Ed Leamer on EconTalk. Leamer is a renowned economist in international trade and econometrics. Russ Roberts' interview with Leamer is interesting and insightful, and I recommend it as a good listen. But I finished the podcast feeling very confused. Leamer argues both that current macroeconomics does a terrible job at explaining the data and at having a story to explain the data. This is not an inditement, but rather a good indirect description of the two current ways of approaching macroeconomics.

The May edition of the International Economic Update from the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas was released on Monday. Two points stand out to me: (1) The global growth forecasts are less optimistic than most U.S. forecasters (e.g., Ben Bernanke), and (2) the ranking of countries by relative size of fiscal stimulus in 2009 puts the U.S. a little further from the top than I expected.

It's like Christmas eve... but not.  And "Santa" has been dropping some hints.  Here's a preview of what's coming tomorrow regarding the "Stress Tests".

Despite the leaks, I still expect some market reaction.  Why?  I don't know how to write down a rigorous model of it, but it seems like expectations are perceived differently from certainties, even if the expectations are correct.

A great animated map on the employment situation, from Slate.

Thanks to Bart-man for the link.

I've read a couple excellent articles in the last two days.  First, a piece by Nobel Laureate Vernon Smith and Steven Gjerstad in the Wall Street Journal.  And today, a fine work by Mario Rizzo of NYU. 

Gjerstad and Smith outline how the increase in consumer debt that results from a fall in home prices can lead to huge losses for the financial sector and severe recessions.  They point out how the losses from the stock market couldn't have caused the Great Depression (the timing wasn't right), but how the fall in home prices caused many banks to fail.  They also ask the great question- how did a $10 trillion fall in equity values from the Dot-com bubble not result in financial troubles even close to the levels we've seen after a $3 trillion dollar fail in home values?  Their conclusion is basically that homes are much more leveraged than stocks and thus the financial sector takes huge losses when home values fall.

More on the international bailout arms race.  I guess some people know when to hold 'em and when to fold 'em:

"First, in an interview for Monday's Wall Street Journal (no-subscription-required summary here), Jean-Claude Trichet, head of the European Central Bank, said that no new measures are needed to combat the global economic crisis. Then Mirek Topolanek, the prime minister of the Czech Republic and the president (in this rotation) of the European Union called the U.S. emphasis on fiscal stimulus "the way to hell.""

Greg Mankiw posted this link yesterday (3/17/09, St. Patrick's Day) to another funny Flash video from the folks at JibJab--Leprechaun Bailout.

I spoke two nights ago at a meeting of the Timp Valley (Utah County) chapter of the International Association of Administrative Professionals (IAAP). In preparing for the presentation, I gathered some information on the Utah economy. I was surprised to see how well Utah is doing relative to the rest of the country.

The following three graphs brought me to the conclusion that changed my perspective on the relative size of our current recession in the United States. You often hear that the current recession is the most severe since the Great Depression. However, when you actually go to the data, that is only the case if you look exclusively at the financial sector.

I couldn't resist posting and responding to this Glenn Beck video (1/29/09) because I know that he has been advised by multiple parties against the arguments that he is pushing. We all should have reason to be worried about the economy, but not for the reasons Beck is trumpeting.

Calculated Risk posted a series of very ominous graphs on Saturday showing just how bad things are in this recession. Almost as startling as the depth of our current troubles is how far above normal things were two years ago.

As I have argued before, the reason why this is a global recession--and not confined primarily to the U.S.--is the same reason that allowed the bubble to get so big. The financial instruments that were based on the U.S. real estate market got stamped AAA by S&P and Moody's and went around the world as low-risk, high-return investments. This further fueled the bubble while broadening the scope of what would turn out to be the biggest world economic downturn since the 1930s.

The New York Times ran an editorial today entitled, "When Will the Recession Be Over?" that surveyed 11 experts about their forecasts of when the recession would end. This is the first mainstream compilation of forecasts that I have felt was realistic.

I've read two good pieces on the subprime crisis this week:

1) Gary Gorton's "The Panic of 2007" provides detailed statistics on the mortgage market and a nice (albeit technical) description of how the mortgages were securitized.  He documents the incredible increase in subprime and Alt-A mortgages (going from 3% and 1% of the MBS in market in 2001 to 12% and 13% in 2006).  And the increasing securitization of mortgages (50% of subprime mortgages were securitized in 2001- this grew to 80% in 2006).  While Gorton certainly isn't making this point, you could see how that in real time, someone stuck in an office in New York or DC would be very excited about these new ways to package debt and the increasing ease with which people could buy a home.  Think of Greenspan's quote from 2005;

"Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants. Such developments are representative of the market responses that have driven the financial services industry throughout the history of our country ... With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers."

2) "The End", by Michael Lewis, is also about the mortgage market but is more a story of the characters behind it.  I particularly liked Lewis' description of the work Steve Eisman and his colleagues put in to see what was going wrong.  They saw the numbers that Gorton presents, and thought something must be out of whack, but at first they weren't exactly sure why these things were happening.  To reaffirm what they were seeking in the data, they made visits to South Florida (to see the housing bubble first hand) and talked with those who were securitizing mortgages.  Both highlighted the insufficient regard for the risks being taken.  Although Lewis doesn't explain exactly why things went so wrong, he'll make you wish you were in the trenches trying to figure it out back in 2005-2007. 

The only significant policy difference between the current period of global recession and the Great Depression is monetary policy and financial market intervention. The government spending part is looking like it will be the same. The annual deficit is projected to rise from its current 2008 level of just under 3% of GDP to potentially 10% of GDP in 2009. However, this rise in the deficit is also similar to the early 1980s and 2000. (The big blip is World War II.)

Back in October 2008, I was a member of a panel discussion hosted by the BYU Economics Department that was tasked with explaining different aspects of the financial crisis up to that point and answering questions from the audience. Each member of the panel, myself included, supported the government's role in bailing out U.S. banks and financial companies citing the systemic role they play in the world economy (see my post 1 and post 2). However, since the crisis began in October 2008, two of my colleagues have consistently made what I see as the only good argument against the TARP financial bailout program--the slippery slope costs will outweigh the systemic risk reduction benefits.

John Cochrane had the following great quote in his insightful article, "Fiscal Stimulus, Fiscal Inflation or Fiscal Fallacies?"

"Others say that we should have a fiscal stimulus to 'give people confidence,' even if we have neither theory nor evidence that it will work. This astonishingly paternalistic argument was tried once with the TARP. Nobody could say how it would work in any way that made sense, but it was supposed to be important do to something grand to give people 'confidence.' You see how that worked out. Public prayer would work better and cost a lot less."

We have commented before on John Cochrane's uncanny ability to deliver biting rebuttals when challenged.

(Thanks to Mark Showalter for sending me this.)

Greg Mankiw posted a link to The Bailout Game this morning, and I couldn't resist putting it up here and on our economic jokes page. Here are a couple of tips for the game. When you get to AIG, don't bail them out and watch what happens. Also, you might enjoy the comments on the little ticker at the bottom of the page.