Archive for January 2009
GDP: Even worse than it looks
Jan 30th 2009
From Economist.com
America’s economy shrank sharply in the fourth quarter. There are few reasons for optimism
The original article appears here.
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IT IS a measure of the prevailing gloom that the worst economic performance in 26 years could still be described as better than expected. Real gross domestic product fell at an annual rate of 3.8% in the fourth quarter, below the decline of 5% or more that many economists had anticipated.
However, there is precious little reason for optimism. Read the rest of this entry »
Blanchard roundtable: Pursue contingent policies
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A response to Olivier Blanchard’s guest Economics Focus. The original article is here.
This discussion can be followed in its entirety here.
UNCERTAINTY is a constant in economic life, but Olivier Blanchard notes that at present it is sufficiently pervasive as to be a major exogenous source of restraint on demand. He recommends policies that reduce uncertainty, as distinct from policies that simply boost aggregate demand.
Many of his policies, however, would take effect regardless of the state of the economy. It seems to me, by contrast, that the way to deal with uncertainty is through contingent policies that are triggered when a predetermined bad state of the economy is reached. Read the rest of this entry »
Lessons from Sweden’s “Bad bank”
AMERICA may be moving closer to creating a “bad bank” to absorb its banking system’s impaired assets. Would it work? No one knows, but everyone is looking to Sweden—which used that model in the early 1990s after its banks crumpled under the weight of bad real estate loans—for guidance. 
I talked to Bo Lundgren, who was the minister in charge of taxation, financial markets, and sports (yes, sports) at the time of the bail-out, to learn more about which issues are likely to prove stickiest for America. What are the toughest challenges—the extent to which banks are nationalised, the relative importance of recapitalisation versus purchases of bad assets, or something else? What follows is based on our conversation. Read the rest of this entry »
The economics of “Good bank-bad bank”
Economics focus
The spectre of nationalisation
From The Economist print edition
There are ways for governments to revitalise banks without taking them over
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IT IS generally easier to remove a kidney from a dead donor than a live one. When regulators in Scandinavia and America in the early 1990s started extracting the bad assets from their crisis-hit banking systems, it helped that the banks they dealt with were bust or in the government’s hands. Today, policymakers are trying to excise toxic assets from banks that are still, at least officially, private and viable. That is a much trickier proposition. Read the rest of this entry »
George Bush’s legacy
This was cowritten with my colleague, Washington Bureau Chief Adrian Wooldridge
The frat boy ships out
From The Economist print edition
Few people will mourn the departure of the 43rd president
HE LEAVES the White House as one of the least popular and most divisive presidents in American history. At home, his approval rating has been stuck in the 20s for months; abroad, George Bush has presided over the most catastrophic collapse in America’s reputation since the second world war. The American economy is in deep recession, brought on by a crisis that forced Mr Bush to preside over huge and unpopular bail-outs. 
America is embroiled in two wars, one of which Mr Bush launched against the tide of world opinion. The Bush family name, once among the most illustrious in American political life, is now so tainted that Jeb, George’s younger brother, recently decided not to run for the Senate from Florida. A Bush relative describes family gatherings as “funeral wakes”.
Few people would have predicted this litany of disasters when Mr Bush ran for the presidency in 2000. Read the rest of this entry »
How to compute sovereign default probabilities
My article mentions invesetors’ estimates of the probability the U.S. will default based on spreads on credit default swaps. Some readers have asked how I computed the probabilities. What follows is a guide but should not be considered authoritative. Read the rest of this entry »
Awful jobs report but temper the pessimism
From Economist.com
Reasons to temper pessimism, but not to delay action in America
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IF BARACK OBAMA grows tired of being president, he might have a future trading bonds. On Thursday January 8th he predicted that data would show that America had lost more jobs in 2008 than at any time since the second world war. An official report published on Friday confirmed precisely that. Non-farm payrolls plunged by 524,000 in December from November, and the picture was made darker by downward revisions of 154,000 to the previous two months. That brought the loss of jobs since the recession officially began in December 2007 to 2.6m, the largest 12-month drop in absolute terms since the aftermath of the war.
The unemployment rate has jumped from 6.8% to 7.2%, a 16-year high, far above economists’ already dire predictions. It is up from a low of 4.4% in early 2007. Throw in discouraged workers who have given up looking for work and those working part time who would prefer full-time work, and the “under-utilised” employment rate is 13.5%, up from a little over 8% in early 2008.
It is easy to begin fearing that not only will this be the worst recession since the Great Depression, it may be another depression. Yet two reasons exist to temper the pessimism. First, while the magnitude of job loss represents a lot of misery, the American labour force is some two-and-a-half times larger than it was right after the war. The 1.9% drop in employment last year was smaller than the 2.7% 12-month declines recorded at the depths of the 1974-75 and 1981-82 recessions. As a new database from the Federal Reserve Bank of Minneapolis helpfully shows, (see Free Exchange), the percentage decline so far in this recession is exactly equal to the median decline at this stage of the ten post-war recessions.
Whether this remains a median-scale slump depends on what happens next, and the prognosis remains grim. David Greenlaw, an economist at Morgan Stanley, predicts that job losses will continue on the scale of the past few months until around April. “There was a very significant and unusual turn in the economy in September-October when…credit markets were most tight. The consumer stopped buying cars, planned for a weaker Christmas, companies stopped ordering and started looking where they wanted to cut employment…we are in for several more months of this kind of deterioration in overall economic activity.” He sees the unemployment rate reaching 9.5% by the end of the year.
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Another reason to temper pessimism is that the earliest leading indicators, which are in the financial markets, have turned up. Stockmarkets bottomed in November and have since trudged higher, although they fell after Friday’s employment report. Spreads on corporate debt have narrowed since then, and on interbank loans even more so. To be sure, that is in large part thanks to the extension of federal guarantees to much of the financial system, but that demonstrates how rescue measures are getting some traction. Mortgage rates have tumbled on the purchases by the Treasury and the Fed of mortgage-backed securities (MBS), so waves of refinancing, which boosts consumer cash flow, and a rise in home sales, are not far off. “On the margin I’m less bearish on the economic outlook,” says Nancy Lazar, an economist at ISI, an investment group. Her favourite indicator is the broad money supply, which has grown at around a 20% annual rate in the past three months.
Pessimists would note that the Federal Reserve, having cut its short-term interest rate to zero (in effect), is out of conventional ammunition. It is using tools such as open-market purchases of MBS whose stimulative effect is far less certain. But that uncertainty may be symmetric: the impact of these unconventional policy instruments may be larger or smaller than is commonly thought. There is no useful history by which to judge.
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All that said, being less bearish is not the same as bullish. Ms Lazar notes that employment fell for more than two years in the past two cycles, and there is no reason to expect differently this time, even if output stops contracting by the end of this year.
More important, the rally in the financial markets in great part reflects anticipation of aggressive action to be taken by Mr Obama, such as $775 billion in fiscal stimulus, and the Federal Reserve, such as Treasury bond purchases. If they do not deliver, those gains may easily be unwound. “The situation is dire, it is deteriorating, and it demands urgent and dramatic action,” Mr Obama said after the release of Friday’s data. That is not just a political talking point: a gimlet-eyed bond trader would say the same.
Obama must not repeat Bush’s fiscal mistakes
After the recession, the deluge
Barack Obama must couple short-term stimulus with long-term fiscal reform
From The Economist print edition
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FOR all his talk of change, Barack Obama will start his presidency much as George Bush did: with a huge fiscal stimulus aimed at boosting an ailing economy and promoting some pet objectives. The need for stimulus is far greater than in 2001. America is in what could be its deepest recession since the Depression. With interest rates close to zero, the Federal Reserve is out of conventional monetary ammunition, so fiscal policy must do the lion’s share.
The problem with this is that higher spending and tax cuts will only make a big budget deficit even bigger. This danger does not justify penny-pinching now: that could merely prompt a bigger collapse in economic activity and even larger deficits. But Mr Obama should do what Mr Bush never did—and link the upcoming splurge to long-term fiscal reform.
The hole in America’s balance sheet is clearly partly Mr Bush’s fault. Even if you strip out the cyclical economic effects, the 1% surplus he inherited had become a deficit of more than 2% of GDP last year. But other things are at work. The collapse of the credit bubble will reduce tax revenues. The government has taken on big liabilities in its efforts to prop up the banking system. Above all, the first baby-boomers retired last year: as their numbers grow, the cost of the two big retirement programmes, Social Security (pensions) and Medicare, will soar.
The Congressional Budget Office says that, even without Mr Obama’s stimulus plans, America’s publicly held debt could rise from a perfectly reasonable 41% of GDP in 2008 to 54% in 2010, a 55-year high (see article). Under current tax and spending policies it is headed towards 400% by mid-century. Investors, fearing America will have to inflate its way out of such debt, could push the dollar down and interest rates up.
Mr Bush and the Republicans in Congress repeatedly gave voters goodies without paying for them: tax cuts without tax reform, subsidised prescription drugs without Medicare reform, and so on. Mr Obama must not make the same mistake. His stimulus plans may include cherished giveaways such as tax credits for low-paid workers, expanded unemployment insurance benefits, and investments in alternative energy. All have their merits; all will also increase the hole in the books. Despite some earnest waffle about addressing the long-term fiscal challenge, Mr Obama has been short on specifics.
The expiration of Mr Bush’s tax cuts at the end of next year imposes a deadline for dealing with the tax code. There is a powerful case for a grand bargain that overhauls the tax system, Social Security and Medicare all at once. The three are interconnected. Subsidised health insurance for the working poor, for example, could be paid for by eliminating the tax deduction for employer-provided insurance. The tax code could be made more progressive by reducing the payroll tax for low-income workers, but that would make it essential to rein in benefits, starting with a higher retirement age. Almost everyone would feel some pain. But in return Americans would get a tax system and budget that would be good for future growth.
If the economics of such a grand bargain are compelling, the politics are daunting. Armies of entrenched interests ring the tax system, Social Security and Medicare. Yet there may be no time like the present. Mr Obama has political capital and his party comfortably controls both houses of Congress (see article). He would also find some allies. Kent Conrad and Judd Gregg, the leading Democrat and Republican respectively on the Senate budget panel, have helpfully proposed a bipartisan task-force of congressmen and administration officials. It would come up with a single proposal that Congress could accept or reject but not amend, sidestepping the objections that would surely derail piecemeal reform.
Mr Obama does not need to produce a detailed solution right now. But by committing himself to a process that leads to such a solution, he could reassure investors that the grisly fiscal scenarios painted by the CBO will not come to pass.
A fiscal nightmare and opportunity for Obama
Waiting for God-only-knows-what
From The Economist print edition
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America’s grim fiscal outlook could either be a nightmare or an opportunity for Barack Obama
DURING one of his debates with Barack Obama, John McCain, the Republican candidate, kept referring to the “fiscal crisis” when he meant “financial crisis”. Perhaps he was on to something.
On January 7th the Congressional Budget Office (CBO), a non-partisan outfit, released projections that show the financial crash and the resulting recession are already wreaking havoc with America’s finances. It reckons that the budget deficit will soar from $455 billion in fiscal 2008 (which ended last September 30th) to an astonishing $1.2 trillion in the current year. At 8.3% that would be the most as a share of gross domestic product since the second world war. (The CBO does, however, see it dropping to 1.1% of GDP by 2019.)
The reality is both better and worse than these numbers imply. Of this year’s total, $420 billion represents the one-off subsidy implicit in the Treasury’s planned $700 billion of injections of capital and loan guarantees into the financial system and its “effective” guarantees of the two big mortgage agencies, Fannie Mae and Freddie Mac. Neither is a cash outlay in the usual sense.
But the underlying picture is worse for several reasons. First, it does not include any estimate of the cost of Mr Obama’s planned fiscal stimulus, which he will seek from Congress soon after being inaugurated. Second, the CBO assumes all of George Bush’s tax cuts will expire as scheduled at the end of next year and that the Alternative Minimum Tax, a parallel levy aimed at the wealthy, is allowed to ensnare a growing share of the middle class each year. True, that is what current law, as opposed to current practice, lays down; but neither is at all likely to happen. (The AMT has repeatedly been “patched” to lessen its baleful effects, and surely will be again.)
But the real problem is that the first baby-boomers retired last year. In coming decades spending on entitlements—the three main ones being Social Security (pensions), Medicare (health care for the elderly) and Medicaid (health care for the poor)—will drive deficits and so debt up sharply. Publicly held debt will climb from 41% of GDP last year to 54% next year, the CBO predicts, then decline (on the assumption that the recession will start to come to an end). But the CBO has previously said that, as America ages and if current policies continue, it could theoretically hit an otherworldly 400% by mid-century.
The situation sounds like a nightmare for Barack Obama. The figures hang over his negotiations with Congress on a fiscal stimulus plan. As currently envisioned, it would include business and individual tax cuts and, for those who pay little or no tax, tax credits. That would include a $500 per worker or $1,000 per household credit that was a centrepiece of Mr Obama’s campaign. It would include substantial funds for public works spending, additional Medicaid funds and other aid for cash-strapped states, and money to broaden the availability of unemployment insurance and provide health benefits to the unemployed. On January 7th Mr Obama said the package would be at the high end of estimates—which his team had previously pegged at $675 billion to $775 billion over two years—but not as high as some economists have urged.
Mr Obama faces three sceptical constituencies: Republicans, fiscal conservatives in his own party, and the markets. The addition of so many tax breaks to the package appears to have won over the co-operation of Republican leaders, although lengthy negotiations remain.
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Fiscal conservatives are resigned to a big expansion of deficits in the short term but they want an early commitment to deal with entitlements as well. This is where the confluence of the economic and budgetary crises creates an opportunity. Since Mr Bush’s tax cuts expire at the end of next year, Mr Obama could try to reform the tax and entitlement systems simultaneously, which makes economic sense since so many aspects of health care and retirement impact the tax code.
Politically, a reform that antagonises so many constituencies is hardly appetising. “When you start making choices, you start losing friends,” says Kent Conrad, the Democratic Senate Budget Committee chairman and a leading fiscal hawk. He argues the job should be handed over to a bipartisan task force. But Thomas Kahn, the top staffer on the House Budget Committee, notes that some legislators worry that such mechanisms undermine the democratic process by limiting the opportunity for amendment and debate.
For his part, Mr Obama has acknowledged the urgency of addressing entitlements, but said more specifics would have to await his draft budget proposal, due for submission in mid-February. He has aimed his anti-deficit rhetoric, both before the election and since, principally at waste and earmarks, the pet projects legislators insert into spending bills. But as Maya MacGuineas of the Committee for a Responsible Federal Budget, a watchdog group, notes, such spending is at most $30 billion a year, or 1% of total expenditures. By contrast, entitlements amount to $1.2 trillion, or 41% of the whole; and, left unreformed, will grow to 60% by 2030.
Still, Ms MacGuineas thinks Mr Obama has to start with waste and earmarks to build the necessary credibility for bigger steps. “Before you say, ‘Ladies and gentlemen, your Social Security and Medicare benefits are going down and your taxes are going up,’ they want to know there are no more bridges to nowhere.”
Will the markets co-operate? Since November stock and credit markets have rallied partly as previous initiatives gain traction and partly in anticipation of more aggressive actions by the incoming administration. Record deficit projections have not spooked investors: the dollar has strengthened as the overseas outlook turns grimmer, and deflation worries have driven Treasury yields to their lowest in over half a century. But as financial panic subsides, the prospect of huge current deficits combined with the coming entitlements crunch could cause investors to worry America will one day inflate its way out of the debt or even, in the extreme, default. The resulting higher interest rates would elevate the cost of servicing the federal debt, further aggravating the deficit. The threat of such dangerous debt dynamics is ample incentive for Mr Obama to hurry up and explain how he will tame the deficit once the recession is over.
Greg Ip 