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Category: macroeconomics

Published on Leave a comment on Significant but not Overwhelming, Take 2

Back in September, the CBO made a forecast of the likely effect of Hurricanes Katrina and Rita on economic growth for the remainder of 2005. In my post on the subject, I noted that the bottom line prediction was about a percentage point off annualized growth in the third and fourth quarters. It didn't seem like we saw too much of that in the third quarter, and that wasn't surprising, given how late in the quarter the hurricanes hit.

Today, the BEA released its advance estimate of GDP growth in the fourth quarter. It comes in at a lackluster 1.1 percent, well below the forecasts of about 3-3.5 percent. I wonder--and at this point, it is only wonder--if the CBO got its forecast about right and we now see most of the impact in this fourth quarter number. That provides no explanation of why the forecasters were off, but it does suggest that we should have been expecting slow growth. The composition of the decline--a big slowdown in personal consumption expenditures--fits with this story.

If it was the hurricanes, we expect a rebound. If it was not the hurricanes, we don't. Read more on the latter over at Angry Bear.

Published on Leave a comment on A Forecast and a Budget

Last Thursday, the Administration released its economic forecast that will be used as the basis for its FY 2007 Budget, to be released early in 2006. See the actual forecast summary here, and a transcript of a conference call with CEA Member Matt Slaughter here. It is in general little changed from the mid-session review forecast released 6 months ago.

Even with the hurricanes, the real GDP forecast is up a tenth of a percentage point over the 4 quarters of 2005. That will allow for more revenues relative to expenditures. The "wedge" between inflation in the GDP price deflator (which corresponds most closely to the tax base) and the CPI price deflator (which corresponds to the way government expenditures, like Social Security benefits, are indexed) widened for 2005, with some narrowing forecast for 2006 and 2007. I suspect that energy prices are the culprit--given how much we consume rather than produce (i.e., import). When the wedge gets wider, that suggests faster growth in expenditures than tax revenues, and this will offset to some degree the impact of a higher GDP growth assumption. If the deficit is to come down in the FY 2007 budget relative to past forecasts, most of the work will have to be done by changing taxes and expenditures, not by relying on a more favorable economic picture.

Yesterday, the President was on the road to promote continued extension of some of the soon-to-sunset tax cuts. The ones in question pertain to the tax rates on dividends and capital gains. I find this whole discussion to be disheartening. The first order issue with tax policy is that we are not raising enough revenue to match our expenditures. Making the lower tax rates permanent just makes sure that we will permanently not have enough revenue to match our expenditures, unless we decide to lower expenditures by even more.

That brings us back to the FY 2007 budget. I would be much happier if the President spoke about which expenditures he will cut in that budget with the same specificity that he talks about which tax cuts he'd like to make permanent. Yesterday's road show was not a high point. Consider this:

Bush fell back on campaign-style rhetoric yesterday: "When you hear people say that we don't need to make the tax relief permanent, what they're really saying is, they're going to raise your taxes."

I'm prepared to be very unhappy come budget time.

UPDATE: This post was picked up by a Post with a much larger circulation.

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Published on Leave a comment on Significant but not Overwhelming

So says the Congressional Budget Office in its preliminary report on the likely economic impact of Hurricane Katrina on economic growth. Quoting from the opening paragraph of the report:

Katrina could dampen real gross domestic product (GDP) growth in the second half of the year by ½ to 1 percentage point and reduce employment through the end of this year by about 400,000. Most economic forecasters had expected 3 percent to 4 percent growth during the second half, and employment growth of 150,000 to 200,000 per month. Economic growth and employment are likely to rebound during the first half of 2006 as rebuilding accelerates.

How do they get these numbers? Start with an overestimate of the affected areas:

The gross state product of Louisiana is about 1.2 percent of U.S. GDP, and that for Mississippi is about 0.7 percent. If half of that product were lost for three months (September to November), the level of real GDP would be lowered by about 1 percent from what it otherwise would be, cutting about 1.3 percentage points from the annualized growth rate for the third quarter and about 2.7 percentage points from the fourth quarter.

They then argue that production of the key industries in those areas will be unlikely to be affected for that long, putting the impact at about 1 percentage point (off an annualized growth rate) in each quarter. They then conduct an analogous exercise to estimate the loss in jobs:

Employment for September will decline significantly—estimates of the impact range from 150,000 to half a million—as a direct consequence of the hurricane. The Bureau of Labor Statistics (BLS) may or may not be able to estimate the size of this effect when it releases the September data on October 7. Employment will increase in subsequent months, as workers return home and businesses reopen and as reconstruction activity gathers steam. The large-scale relocation will generate additional demand for workers in receiving communities; some of those jobs will be filled by the evacuees themselves. Once New Orleans residents are able to return home, the net effect on the level of employment will be positive, as reconstruction activity continues.

A reasonable first pass at the questions they were asked. It is not CBO's fault that rebuilding after a natural disaster is one of the more obvious times when GDP--as a measure of economic well-being--comes up short.

Published on Leave a comment on August Employment Report

First Friday of the month, so the employment report is out for last month. Despite all of the news about Katrina, there is no impact yet, as the hurricane hit Florida and the Gulf after the survey reference week (the one including the 12th of the month). Following an earlier example, let's break it down, starting with Table A:

1) Top line number: Change in nonfarm employment measured from the establishment (or payroll) survey came in at +169,000.

2) Revisions to the top line number from previous months: Each month, the establishment survey revises its prior two months of data, as more establishments report in. So the last number not revised is for May (reported in last month's release), when payrolls were 133.413 million. Payroll job growth for June and July were revised up, by 9,000 and 44,000, respectively. So the last three monthly numbers (with the last two subject to further revision in the coming months) are 175k, 242k, and 169k, for a total of 133.999 million employed in the establishment survey. A three-month average of 195k per month looks pretty solid.

3) Don't forget the workweek: The employment report also reports the length of the workweek for private production or nonsupervisory workers. This month, it held steady at 33.7 hours. Updating some calculations in my earlier post, a change of one tenth of an hour in the average workweek would be the equivalent of a change in the labor input of about 318,000 workers. That's larger than the typical change in the number of bodies, so always watch the workweek (and it's revisions, which had no effect this month).

4) Earnings growth: The survey also reports the average hourly wages and average weekly earnings for private production or nonsupervisory workers. Since these numbers are revised over the subsequent two months as well, go back to May (in last month's report) to find values of $16.03 and $540.21, respectively. The August figures of $16.16 and $544.59 reflect growth at an annual rate of 3.3% (they are the same because hours haven't changed). That may be a little bit better than inflation--inflation ran at a 3.5% annual rate from January to July but only a 1.9% annual rate from April to July. We won't know for sure until the August CPI estimate comes out.

5) Unemployment Rate: The top line number in the household survey is the unemployment rate, which is reported to have fallen by 0.1 percentage point, down to 4.9 percent of the labor force. (The actual change is 0.08 percentage point, rounded up to 0.1.)

6) Other Ratios from the Household Suvey: The decline in the unemployment rate is due to an increase in household employment of 373k, a decline of 106k in unemployment, and an increase of 1k in those not in the labor force. So this is going to mean good things for the labor force participation rate and employment-to-population rate. Both are up by 0.1 percentage point, to 66.2 and 62.9, respectively.

7) Caveats to the Household Employment measure: Once again, we get a pretty large disparity between the household and payroll measures of employment growth (373k versus 169k). Part of this is due to different samples (e.g., household survey includes the self-employed, establishment survey counts multiple job holders). The rest is that they are both estimates of an underlying population number. In general, the establishment survey is to be preferred for the purpose of counting the change in the number of jobs, because that number is estimated more precisely in the establishment survey (it's a bigger survey and it uses administrative data).

8) Alternative Measures of Unemployment: The full list is given in Table A-12. All but one shared the decline of 0.1 percentage point that the main number showed. We can also construct another one based on reclassifying all of those who are not in the labor force (i.e., not actively looking for work) but who do "want a job." This group fell from 5015k to 4823k between July and August. If we reclassified them as unemployed (and thus in the labor force), this augmented unemployment rate would have fallen by about 0.2 percentage point, from 8.1 to 7.9 percent.

9) Duration of Unemployment: Some commentators also look at the duration of unemployment, reported here. It lengthened over the month, from 17.6 to 18.9 weeks on average and 9.0 to 9.4 weeks at the median. The fraction of the unemployed who have been unemployed for 15 weeks or longer rose from 32.8 to 35.8 percent, and the share unemployed for 27 weeks or longer rose from 18.7 to 19.2 percent. These numbers are all down slightly relative to August 2004. The recent changes reflect a greater share of the short-term unemployed either finding jobs or leaving the labor force than the long-term unemployed.

Plenty of other stuff to look at, but these are the highlights. For Fed watchers, it will be interesting to see whether the anticipated economic weakness due to Hurricane Katrina or these retrospective data on a fairly strong labor market will prevail in the decisions to keep raising short-term interest rates.

Linked at Outside the Beltway Traffic Jam.

Published on Leave a comment on Inflation and Social Security Finances

A comment on the previous post asks:

What is the source of the (small) beneficial effect that higher inflation has on the SS balance? Why does higher inflation help the SS balance?

Good question. There are actually two inflation series that are relevant, the CPI and the GDP price deflator. Quoting from Section V.B of the Trustees Report:

Future changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (hereafter denoted as CPI) will directly affect the OASDI program through the automatic cost-of-living benefit increases. Future changes in the GDP chain-type price index (hereafter, the GDP deflator) affect the nominal levels of the GDP, wages, self-employment income, average earnings, and the taxable payroll.

As to why there is a slight positive effect of inflation on the program's finances, Section VI.D5 of the Trustees Report later states:

The patterns described above result primarily from the time lag between the effects of the CPI changes on taxable payroll and on benefit payments. When assuming a greater rate of increase in the CPI (in combination with a constant real-wage differential), the effect on taxable payroll due to a greater rate of increase in average wages is experienced immediately, while the effect on benefits due to a larger COLA is experienced with a lag of about 1 year. Thus, the higher taxable payrolls have a stronger effect than the higher benefits, thereby resulting in lower cost rates. The effect of each 1.0-percentage-point increase in the rate of change assumed for the CPI is an increase in the long-range actuarial balance of about 0.21 percent of taxable payroll.

That seems like a pretty tenuous justification, and, not surprisingly, the effect is not large. More importantly, there is typically a "wedge" between the inflation in the CPI and the GDP price deflator (assumed to be 0.3 percentage point per year, see Table V.B1). Very roughly, the CPI is what we consume, and the GDP deflator is what we produce. The most important item that is weighted more in the former than the latter is oil, since we import so much of it. If we get unexpectedly higher inflation due to oil prices, that will likely worsen, not improve, Social Security's finances.

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Published on Leave a comment on Previews of a Mid-Session Review

There were two significant pieces of information this week regarding the likely Mid-Session Review of the Budget, to be formally released this summer.

First, as is now the custom, the Administration released an overview of its economic forecast as soon as it was finished. (The next step is for that forecast to be used by OMB and Treasury as they estimate expenditures and revenues.) This is a good move, because the Administration might otherwise be in the position of presenting this information six weeks or more from now as if it were current. The key changes since the last economic forecast six months ago are a reduction of the real GDP growth rate from 3.5 to 3.4 percent in the four quarters of 2005 and an increase in the CPI inflation rate from 2 to 2.9 percent over the same time period.

Both of these changes suggest a slight worsening of the future budget outlook for economic reasons. Lower real GDP growth suggests a lower future level of the tax base. Higher CPI inflation--when it is due to increases in the prices of energy, which is largely imported--raises the amount of government expenditures on things like Social Security benefits without an offsetting increase in revenues from the tax base, which is tied to the GDP price deflator. For 2005, the "wedge" between CPI and GDP inflation has opened up from a 0.1 percentage point forecast last December to a 0.6 percentage point forecast this week. I don't have a good feel for how large the impact of these two changes will be, and a lower interest rate forecast may offset some of the impact. We'll find that out when the MSR is released this summer.

Second, and much more importantly for the daily headlines and the near-term budget outlook, the Congressional Budget Office released its Monthly Budget Review for May. The deficit through the first eight months of fiscal year 2005 was $73 billion less than the comparable period of fiscal year 2004. This is attributed to revenues that are 15 percent higher than the same period last year and outlays that are 7 percent higher. As reported in the Wall Street Journal, forecasts of the deficit by CBO and others are now running about $350 billion, which is less than last year's $412 billion and earlier forecasts of this year's deficit.

So I'll take the good news, but I remain very concerned about the budget outlook, for three reasons:

1) We are in the fat part of the business cycle. A sensible fiscal policy is to run a balanced budget over the business cycle and to save Social Security surpluses for future Social Security benefits. So we should be running surpluses, not deficits, and that should be excluding the Social Security surplus.

2) The 7 percent increase in outlays compared to last year looks to be no smaller than the difference in nominal GDP across the two periods, so I guess I disagree with OMB Director Joshua Bolten's characterization (in the WSJ) of this as "spending discipline."

3) Baby boomers, lots of them, start retiring and collecting their entitlements soon. Full Social Security and Medicare starting in 2011. Early Social Security benefits starting in 2008. No preparations being made to lessen that financial burden on future taxpayers. Douglas Holtz-Eakin, Director of the CBO, summarized this well in the WSJ:

These are the good ol' days. These are the best of times. After this, it gets worse.

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Published on Leave a comment on Maybe the Best Econoblog Yet

Nouriel Roubini and David Altig spar today in what I think is the best WSJ Econoblog yet. The topic: Does Overseas Appetite for Bonds Put the U.S. Economy at Risk?

It's a funny question as a lead-in. Generally, when some other country has an "appetite" for something (like U.S. government bonds) that we make, we are not at risk but richer for it. There are some relative price shifts that have distributional consequences (like making U.S. exports relatively more expensive compared to foreign imports), but on the whole, the country is richer. For a variety of reasons, Asian central banks have been willing to not only hold U.S. debt but (via undervalued exchange rates) pay too much for it. At least initially, it's their problem, not ours.

So the real question, and the one that Nouriel and David seek to answer, is whether a potential loss in overseas appetites for U.S. government bonds will put the U.S. economy at risk. I think they both agree that the answer is affirmative, but they disagree on the magnitude and timing of the adjustments. Nouriel is arguing for big adjustments on a possibly sudden time scale (the hard landing), and David is arguing for more gradual adjustments (the soft landing). They come at the issue from every conceivable angle, and so I recommend it (as well as both of their blogs, linked at the right). The discussion is extensively documented.

Where am I on the issue? I've been a fan of Nouriel's for (ahem) 17 years, since he was a TA at Harvard in an undergraduate international macro class that I took, but I tend to agree with David that it is difficult to see the U.S. in a hard landing scenario. We're too big an economy, and our creditors' portfolio holdings are simply too large for them to behave rashly. Unfortunately, that perception that we may be immune from a hard landing has encouraged behavior--over a period of decades, in both the private and public sectors--that makes us a high-borrowing, high-consuming economy. In my view, it is our low national savings rate that puts us at risk, not the propensities of our creditors per se.

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Published on Leave a comment on The Chapter that Wasn’t

Via Brad DeLong, we find Jonathan Weisman's article in the Washington Post about a chapter that wasn't:

At the National Security Council's request, the White House excised a full chapter on Iraq's economy from last week's Economic Report of the President, reasoning in part that the "feel good" tone of the writing would ring hollow against the backdrop of continuing violence, according to White House officials.

The decision to delete an entire chapter from the Council of Economic Advisers' annual report was highly unusual. Council members -- recruited from the top ranks of economic academia -- have long prided themselves on independence and intellectual integrity, and the Economic Report of the President is the council's primary showcase.

The withholding of a completed chapter struck some economists from both political parties as evidence of the council's waning influence.

I only worked one year at CEA, and so I don't know how things used to be. The relevant comparison on "waning influence" would be just the 10 years since the National Economic Council was instituted. One would also want to make some allowance for the impact that 9/11 had on the relative importance of different groups within the Executive Office of the President--some reduction in prominence should be expected. Someone from the Clinton CEA years would have to tell me how influential they were in things like NAFTA, welfare reform, and the failed healthcare overhaul for me to get a better understanding of trends over time.

The CEA appears to have been very influential during the first two years of the Administration. That seems to be due to the combination of Glenn Hubbard serving as Chairman and the Administration being focused on tax cuts. Glenn was involved with the 2000 campaign and has been focused on tax reform for his entire career in government. I could be persuaded that the CEA was less influential after Glenn left. Greg Mankiw was a newcomer to the senior staff and he arrived just as the 2003 tax law was enacted. Even the Medicare bill was in conference by the end of June 2003. Changes in the leadership at the NEC (Steve Friedman replacing Larry Lindsey) and Treasury (John Snow replacing Paul O'Neill) also led to a more unified and collegial working relationship among 3 of the key economic entities. "Influence" would be harder to measure in that environment. Renovations at the EEOB also got CEA staff moved out of the White House complex in the spring of 2003, and that probably reduced the informal interactions between CEA staff and other policy staffs in the EOP.

This isn't a complaint or criticism about anyone at CEA or in the rest of the EOP--it's just an assessment of how things might be different now. I learned a lot from Greg Mankiw and others at CEA and consider my time there to be one of the highlights of my professional career. But even if the CEA's influence has receded a bit over the past couple of years, it doesn't strike me as some insidious development, nor is it necessarily a trend. This episode regarding the chapter on Iraq doesn't really change my view all that much. As we learned last year (if we didn't know it before), the ERP can get quite a bit of media attention, because it is perceived as reflecting the President's policies. In 2004, we got hit with negative press over the economic forecast, outsourcing, the Social Security chapter, and some other issues. Much (though not all) of this negative press was overblown. A chapter on Iraq might have been the chapter to get all of that attention this year. It's not surprising that NSC would look to head that off.

The ERP goes through the White House staffing process. This means that all Executive Branch offices, departments, and agencies have the opportunity to request changes, and the CEA must respond to each request or explain why the request is not being accommodated. The ERP is one of a very few documents that CEA puts through the staffing process. In most cases, it is CEA insisting on major changes to materials submitted by other offices. Briefing materials for the President, comments on legislation moving through Congress, speeches made by the President, and Congressional testimony by senior officials are the most important such documents. Over a chapter on the Iraqi banking system and reconstruction, I'm not sure that I would compromise CEA's authority to insist on changes to all of those other documents over the course of a year. Sometimes, you have to pick your battles, and I don't think this is a new development.

One of the biggest surprises I found in working at CEA was just how involved NSC is in international economic policy within the Executive Office of the President. I would have thought this to be more the province of CEA, Treasury, and the US Trade Representative. That said, I have very positive things to say about the economic analysts working at NSC while I was at CEA--they were extremely knowledgeable about a lot of topics and generally on the right side of issues at meetings that I also attended. (I wasn't around when the steel tariffs were put in place, and I don't know the details of which agencies lined up on which side.)

Would I be happier if the Iraq chapter were in the 2005 ERP? Sure. Do I believe the following quote in Weisman's article?

White House spokeswoman Dana Perino dismissed the excision as insignificant, saying the chapter may still be published in some form in the future. The piece dealt with the development of the Iraqi banking system, financial markets and other economic institutions after the end of Saddam Hussein's rule. It painted a positive portrait of Iraq's emergence as a potential free-market bulwark in the Arab world.

Perino said the chapter did not belong in the Economic Report of the President. "A decision was made not to include a chapter on Iraq's economy in the report, as the Economic Report of the President is an analysis of the American economy," she said.

No, it's obviously not accurate, as the article goes on to demonstrate. But is the loss of the chapter a big event in the history of CEA? No, I don't think so.

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