The Roller Coaster of Economic Indicators

The economy has been on a roller coaster ride since the cyclical peak of December 2007. (See illustration.) The gradual slide of early 2008 turned into a terrifying freefall in the last quarter of 2008 (after the Lehman Brothers bankruptcy) and the first quarter of 2009. Now the train is probably at the bottom of the roller coaster valley.

The Index of Leading Economic Indicators, represented by the first car in the train, was this morning reported to have risen for the seventh consecutive month in October. Similarly, consumer confidence is substantially improved relative to February (though it, like all economic statistics, has experienced some bumps in the ride). The important middle cars, which represent measures of aggregate output, probably reached bottom in the early summer, and then started back up.  The BEA’s advanced estimate for GDP growth in the third quarter was 3 ½ % .

The jobs measures are lagging well behind the rest of the train, as usual.
Among three key labor market measures, the hours worked series has apparently reached the bottom. Employment is still falling, though thankfully not at the very rapid pace of a year ago. The unemployment rate brings up the rear; people in that car are understandably unhappy.

The Dodd Bill: CoCo’s? Fine; Hobble the Fed? Don’t Do It.

The National Journal asks views on a recent proposal for financial reform:

“The Dodd bill on financial regulatory reform embraces a supposed solution to the ‘Too Big To Fail’ conundrum: Contingent Convertible Bonds, or CoCos, which turn into equity once a bank’s capital falls below a certain level.”

My response:

I do think that measures such as the Contingent Convertible Bonds would be a useful step. Some argue that it would be hard to know when to invoke the contingency clause. It strikes me that this argument largely vanishes when one realizes that the clause would of necessity be invoked by the time we got to the stage of a Bear Stearns or Lehman Brothers bankruptcy.

CoCos would not go very far in themselves toward comprehensive reform of the financial system, if that is the goal. But then no single policy measure would do that. I agree with Gillian Tett: “In theory, I think that CoCos certainly could be a useful additional to banks’ tool kits. However, in practice, the contagion risk suggests it would be dangerous to rely too heavily on an exclusive diet of CoCos for any policy ‘fix’.” (in the Financial Times, Nov. 12).

Two related issues are of much bigger import. First, is it a feasible goal to eliminate, credibly, the problem “too big to fail” or “too interconnected to fail,” ,thereby eliminating the critical moral hazard problem? My suspicion is that this is not an achievable goal, when push comes to shove, ex post, in a crisis; and if I am right, then it is very important that we don’t return to the rhetoric of claiming “no bank is automatically too big to fail” and so fail to regulate and collect insurance from the banks ex ante. This would just exacerbate the moral hazard problem. Commercial banks are like river banks in this respect.

Second, would the legislation that is offered by Senator Chris Dodd be a better approach to financial reform than alternative proposals, or even than the status quo? While the 1,000+ page Dodd bill undoubtedly has some good things in it (the CoCos and the principle of a Consumer Protection Agency in lending are probably at the top of the list), I believe it would be very damaging overall. The major reason is that it would seriously undermine the power of the Fed to set fully-informed monetary policy in normal times and to respond effectively in times of crisis. It seems that Barney Frank understands these things much better.

Counting Jobs Saved by Obama’s Fiscal Stimulus

The National Journal asks: “Is the Obama administration’s stimulus plan helping to create or ‘save’ 650,000 jobs, as the president and his aides say? Is that an appropriate way to measure the stimulus’ impact?”

My response:

I am astounded by claims that fiscal stimulus under recession circumstances doesn’t create jobs. Or at least I am astounded when such claims come from reputable economists. Do they think that a construction job on a road-building project doesn’t count as a real job if the funding comes from the government? Or do they think that the increase in demand doesn’t raise output in the aggregate, because the federal debt crowds out private production and so someone else somewhere loses his or her job? That would be hard to believe, at a time when the Fed is keeping interest rates at zero, long-term interest rates are also quite low, and capacity is lying idle. Moreover, Republican lectures to Democrats about the evils of the national debt take real chutzpah, after Presidents Reagan, Bush I and Bush II increased the debt ten-fold during periods when no national emergency required it.

Yes, the effort to identify specific jobs saved is more a political exercise than an economic exercise; the true number of jobs saved, relative to what would otherwise have happened is greater than the 650,000 number. It is legitimate as a communications strategy for the White House to make the benefits concrete by pointing to the many teachers who would have been laid off by fiscally devastated state and local governments in the absence of federal government money. But one problem is that the exercise doesn’t count the indirect effects of most of the spending and tax cuts, where it is hopeless to try to pinpoint whose job was saved.

The biggest problem, of course, is that one cannot estimate accurately, let alone prove, what would have happened in the absence of the stimulus package. Claims by Republican congressmen that one should judge Obamanomics by looking at whether employment is greater now than before February are nonsense. If there hadn’t been a severe recession underway (starting on the predecessor’s watch, if you want to get political about it), there would have been no need for the stimulus. None of us claims that fiscal stimulus creates a lot of jobs on net when the economy is already expanding strongly. The increased government spending that occurred during the terms of Presidents Reagan and Bush after the recessions of their respective first terms had already ended, for example, did not create a lot of jobs. But without the recent stimulus, the recession would have been worse.

The appropriate way to estimate the stimulus impacts is by means of a standard macroeconomic model with fiscal multipliers in it. But if you believe philosophically that fiscal multipliers are zero, even in a severe recession, then neither a standard macroeconomic model nor anything else will convince you.