Finding the Heavy Mortgages

USA today has a great map.

cnnmoney survey of small business

Sorry, it does not fit the credit crunch stereotype.

Washington Post misreports BEA release

The Washington Post reported today that "Investment in office buildings, shopping centers and other nonresidential structures sank 5.9 percent" .

That caught my attention because the Post's sentence contradicts my theory that the composition of building pre-2006 drives construction these days, not a credit crunch.

Upon further investigation, I learned that the Post's sentence not only contradicts my theory, but also the facts! The sentence is incorrect, and taken out of context.

The Post's is (attempting to) citing the BEA numbers for Q4 released today:

(a) Actually, the -5.9% refers to the combined category of non-residential stuctures and equipment. Any time you combine those two categories, the latter will dominate the flow and the former will dominate the stock (ie, structures have much slower depreciation). So all you learn from the -5.9% is that equipment investment is down.

(b) If you look at real investment in non-residential STRUCTURES, that fell 1.5%.

(c) The -1.5% hardly changed since the BEA's last estimate Jan 30. Thus, while I was surprised at many entries in the report, commericial construction was not one of them. (in general, the quarterly GDP figures on construction do not contain surprises, because we have timely monthly releases. Quarterly equipment investment is another story).

(d) The index for real investment in non-residential construction was 109.567. The prior quarter was 111.257. The same quarter one year ago (start of the recession) was 102.076.

(e) Thus, Q4 was a small pull back (-1.5%) in strong uptrend since 2006. In this regard, commercial construction is nothing like residential construction, or consumption.

(f) Even with the BEA's revisions, investment in general in this recession is typical of the previous 3 recessions. Non-residential building is much stronger than we have seen in previous recession (see the chart below).

[It is possible that the Washington Post meant that non-residential building would shrink -5.9% if the 4th quarter repeated itself three more times. By coincidence, -0.059 is both equal to (109.56/111.257)^4 - 1 and the quarterly reduction in nonresidential investment (equipment and structures combined). In any case, the Washington Post does not know how to read the BEA report. The only question is what theory properly describes their misreading.]

[added: you will not see the error any more because the Washington Post rewrote the article over night]

Real Personal Income GREW at 3.4 percent/year

The BEA's revision also says that real personal income GREW 3.4%/year 2008 Q3-Q4. Thus, so far the loss of real GDP has not stopped households from having more real income. It's "just" that the businesses they own have (a lot) less retained earnings.

Nominal GDP and the Deflators

The Table below shows my predictions (from early in the year) for 2008 Q4 nominal spending and its components. For comparison, the first two columns show the BEA's advanced estimate (released Jan 30) and its estimate release this morning.

I over predicted government purchases, and presume that BEA has that right.

The BEA has also revised its deflators (they convert nominal spending into real spending), so that they are now even further from mine. I see the rationale for some of their deflators, but am baffled that they have investment goods getting more expensive -- maybe it is something in the aggregation of various types of investment.

Productivity Revision

Previously the BEA had said that productivity had grown at more than 3%/yr (2008 Q3-Q4). Now its revisions imply that it grew 1.2% per year.

1.2%/yr is a bit less than one would expect based on the decline in labor input. That is, the productivity residual declined a bit (about 0.3 percent). Still, the productivity residual declined a LOT less than it has in previous recessions.

6.2 percent!

BEA now says that real GDP fell 1.6 percent in Q4 (if that were repeated 3 more quarters, that would be -6.2 percent 2008 Q3 to 2009 Q3)! The -1.6 is revised from -0.95 (3.8 percent/year).

One of the components significantly revised seems to be with real investment -- now they say it fell 5.8 percent for the quarter, rather than the 3.3 percent previously estimated. I don't think they really changed their estimate of investment expenditure, just that they now say that investment goods prices ROSE at a 3.6 percent annual rate. I don't see how that could be true.

Nevertheless, even with this revision my investment-by-recession figure below stilll shows that the recession is "run of the mill" when it comes to investment.






Another significant component of revision seems to be nominal government spending.

"It’s Obama spreading panic" says Dick Morris

Read his version here.

I complained about Obama's false alarms during the stimulus bill debate, and during the election, showing how the data clearly reject his claims of catastrophe.

Deflation – Let’s Not Try That Again!

Copyright, The New York Times Company

The Great Depression years 1929-33 featured a large and prolonged deflation. January 2009 reversed a deflation pattern for 2008 that was ominously similar to 1929’s.

During most of our lifetimes, the prices of things we buy have generally increased over time. We can name some exceptions, such as toys over the last decade and computer equipment over the last couple of decades, but otherwise most items (even houses) have prices that are higher now than they were ten, twenty, or thirty years ago.

This general increase in consumer prices – often called inflation – has become familiar. Employees expect regular pay raises, and employers can normally afford them because they are increasing the prices of the products they sell.

Just as important, familiarity with inflation comforts lenders who offer loans to consumers and businesses under assumption that those borrowers will tend have incomes that rise together with all other prices. That is, lenders typically arrange for repayment at regular intervals in specific dollar amounts – such as the regular monthly payment on a home mortgage – and inflation helps borrowers “grow into” their loan payments.

On rare occasions, consumer price trends suddenly change directions.

Nineteen twenty-nine was one of those occasions. Consumer prices were pretty constant during the 1920s. The chart below picks up the story in January 1929 with the red line. That line measures the (seasonally unadjusted) consumer price index in each month through July 1930, normalized so that October 1929 is 100 (for example, the value of 97.9 in April 1929 means that prices then were 2.1 percent lower than they would be in October).



Prices were heading up in the spring and summer of 1929, during which time lenders might have expected that the typical home owner would obtain a pay raise and the typical farmer would someday fetch more for his crops – in both cases making it easy to pay back their respective mortgages.

In the fall of 1929, the inflation stopped (incidentally, the stock market crashed in late October of that year) and prices headed down, falling almost every month for almost four years. By the spring of 1933, this deflation brought prices down almost 50 percent from their 1929 peak. It was difficult for homeowners and farmers to make their mortgage payments when their paychecks had been cut in half.

The blue series in the chart shows the consumer price index for 2008 and 2009. Like the 1929 series, the 2008 series is normalized so that October is 100.

The chart shows how consumer prices also rose in the spring and early summer of 2008. Inflation had stopped by the fall (there was a stock market crash in October 2008, too), and consumer prices headed down. In fact, the deflation at the end of 2008 brought prices down more than four percent in a couple of months, as compared to the one percent drop at the end of 1929.

Price reductions since the summer of 2008 have been credited to declines in prices of commodity– such as fuel and food. That’s not the whole story, because other prices (notably housing prices) were falling in 2008. Moreover, the role of commodity prices adds to the similarity between 1929 and 2008, because commodity prices were falling in 1929-33 too.

If the Great Depression consumer price parallel were to continue beyond 2008, we would be in for a sustained deflation until the year 2012. At that point, with most borrowers earning less than half of what they were when they applied for the loan, today’s mortgage problems would seem minor. Thus, January’s C.P.I. report released on Friday was a welcome return to something familiar: inflation.

Housing Prices in 2009

Today S&P and OFHEO release their housing price indices for December 2008. But one of the important determinants of those prices is construction cost. Last week the BLS released its JANUARY PPI for residential construction. It fell 0.4 percent, as compared to the declines in excess of 1 percent (that's a lot for just one month) for each of the previous three months.

Unless the January PPI is an aberration, it looks like housing prices and housing construction are about at the bottom. I am sticking by my earlier prediction that housing construction will resume in spring/early summer 2009.

Interestingly, the OFHEO said today that housing prices increased in December for the first time in 11 months and only the second time in almost two years. When measured relative to construction costs (which fell a lot in December), housing prices increased even more in December.

The Week's GDP Report

On January 30th, the BEA released its first estimate (known as the "advance" estimate) of 2008 Q4 GDP. The estimate said that, if Q4 repeated itself 3 more times, real GDP in 2009 Q3 would be 3.8 percent below what it was in 2008 Q3. (In other words, 2008 Q4 was 0.95 percent lower than 2008 Q3 GDP).

Throughout February, the BEA has obtained additional data to improve that estimate, and will release a revision (known as the "preliminary" estimate) this Friday. I think the revised estimate will be between -2.8 and -3.8 -- somewhat better than the advance.

The main area I see for revision is the investment deflator -- it seems to me that the advance estimate exaggerated the inflation rate for investment good prices and thereby overestimated the decline in real investment.

Improving the Allocation of Water

California often has water shortages. California also provides water to its farmers much more cheaply than it provides to households and non-farm businesses.

Basic supply and demand reasoning tells us that this form of farm subsidy makes California's water problems much worse than they need to be.

Today it was reported that (for a while at least) water in California would not longer be allocated so freely to farmers. That is great news for conservation, and efficiency!

Inflation Resumes

Inflation resumed in January -- good news if you do not want to follow the path of 1930.

The chart below shows the CPI in 1929-30 and 2008-9, normalizing Oct 1929 to be 100 (the stock market crashed at the end of that month) and Oct 2008 to be 100 (the stock market crashed at the beginning of that month).

Still More Evidence Against the Credit Crunch

On Wednesday, I showed investment activity in various recessions, and noted how investment during this recession -- despite its alleged origins in a credit crunch -- has been doing better than in previous recessions.

Today Professor Perry looked at consumer loans, and found them to be increasing during this recession, while they fell during previous recessions.

Can we end the credit crunch myth now?

[added: Karl cautions against interpreting those as aggregate consumer loans]

Yet More Evidence of the Treasury's Impotence

Yesterday a nytimes editorial complained that TARP money invested in bank holding companies did not go to banks, because the bank holding companies viewed giving money to banks as a bad investment.

Even before the first dollar of TARP money was paid, I explained how there are dozens of ways that the private sector can neutralize Treasury transactions. Because the market does not want to invest in bad banks, we will continue to discover the ways until the Treasury stops transacting.

Sadly, those who do not appreciate this very general principle of economics will continue to believe just a little more micro-management will render the Treasury potent. Professor Sharfstein himself wrote that dividends were one way the TARP would become impotent, but -- instead of seeing this as a general principle -- said that we needed only to prohibit bank dividends. It will be interesting to see what new loophole his discovers this summer, after yesterday claiming that all is needed is to plug an old one.

Obama and Bush Congratulate Each Other on Bad Policy

The Obama Administration explained today how they will reduce housing payments to 31 percent of income for as many as 5 million borrowers.

The Bush Administration had also taken a number of steps to make such mortgage modifications.

I have previously explained how these programs damage our labor market (see also here), despite the fact that the labor market is weak enough on its own.

Interestingly, the Obama Administration congratulates the Bush Administration for the steps already taken: "Treasury will develop uniform guidance for loan modifications ... building on the FDIC's pioneering work." [The "pioneering work" was done under the Bush administration]

So we cannot blame just one political party for this public policy damage.

Terms of Trade Improve Further in Jan

The BEA reports that U.S. Import prices fell 1.1 percent in January -- good for U.S. consumers. Export prices rose 0.5 percent -- good for U.S. producers.

Previously, both import and export prices had been falling, with import prices falling more.

Update: Industrial Production in 1929 and 2009

Here's an update through Jan 2009. Pessimistic interpretation: 2008 is 1/2 as bad as 1929. 1/2 of the Great Depression would not be good.

Real Investment in 2008: Just a Run-of-the-Mill Recession

Copyright, The New York Times Company

The amount of productive assets in place is one of the important legacies of any economic year. And 2008 finished with more productive assets than would be expected of a run-of-the-mill recession.

One reason that the United States economy produces more now than it did years ago, and more than most countries ever have, is the vast quantity of its productive physical assets: buildings, equipment, and software. Economists refer to the accumulation of these assets — new building, the manufacture of new equipment, and the release of new software — as “real investment.”

Economics’ “real investment” is distinct from the term investment in financial jargon, because the latter refers to an individual’s purchase of stocks, bonds, mutual funds, and other financial instruments that are often merely a transfer of ownership of a real productive asset from one person to another, rather than creating such assets anew.

The higher the rate of real investment, the more productive assets we’ll have in the future, and the more that we can produce in the future. Thus, one mechanism by which a recession might create a bad legacy for the future is by doing less to enhance the stock of productive assets.

The investment mechanism is of particular concern in this recession. We all saw the banking sector’s meltdown, which was the worst since the 1930s. For good reason, many have been concerned that real investment would suffer because of a “credit crunch”: distressed banks would no longer be willing or able to lend money to business with opportunities to build new things, put new equipment to work, or develop new software.

The chart below shows the quantity of real investment in four recessions (1981-82, 1990-91, 2001, and the current recession). The chart begins with the initial quarter of each recession (as determined by the National Bureau of Economic Research), and shows how much real investment changed from that quarter up to eight quarters later. Each recession is shown as a different color. For example, the fourth quarter of 2008 was the fourth full quarter of the current recession (indicated by a green line), by which time real investment was 7.7 percent lower than it was when the recession began (in the fourth quarter of 2007).

Normally, investment increases over time, so -7.7 percent is nothing to celebrate. But the chart shows that (so far) investment has fared better in this recession than in each of the previous four –- even though two of those (1990s and 2001) were considered “mild.” Investment was down 13.5 percent in the recession that began in 1990 — almost twice the decline experienced in 2008.

As House Speaker Nancy Pelosi and others have pointed out, the 2008 employment picture looks weak even by comparison to some of the previous recessions. However, the fact that real investment is not (yet) so weak suggests to me that a credit crunch is not a fundamental cause of this recession.

The False Alarm of 2008 Continues

Policy makers and political candidates told us at the end of September that the economy was in crisis and that we likely faced a second Great Depression. Yet the Bureau of Economic Analysis showed recently that so far this recession is mild by historical standards. Nevertheless, President Obama's fear-mongering continues.

The economic news headline on January 26, 2009 was that the annualized real G.D.P. growth rate was ‑3.8 percent in the fourth quarter. In plain English: adjusted for inflation, total spending in the United States economy was about one percent lower in October-December than it was July-September. (The fourth quarter performance would have to repeat itself three more times – for a full year – in order for real GDP to actually fall the 3.8 percent in the headline.)

None of us likes to see our purchasing power fall, but it helps to put the one percent drop in perspective. That drop was pretty similar to what happened during the 1990 recession. Real spending has so far done much better than the 1981-82 recession, when it fell three times as much. The Great Depression of the 1930s was far worse.

Another way to understand the headline: spending fell $120 per person.

Normally, a small G.D.P. change is not big news – but it is today, because political leaders of both parties have grossly exaggerated the economy’s problems. October 1 began the quarter, within just a few days of Bernanke’s and Paulson’s telling President Bush “if we don’t act boldly, Mr. President, we could be in a depression greater than the Great Depression.” Then presidential-candidate Barack Obama said that “the credit market is seized up and businesses, for instance, can’t get loans to meet payroll.”

These dire alarms were used to justify hastily giving Paulson the authority to spend $2300 per American to bail out banks. Yet they were speaking about an economy that so far has only dropped by $120 per person. Perhaps the economy has more to fall, but it doesn’t make sense to spend thousands of dollars in order to rescue a few hundred.

The economy is hard to predict, so the alarmists might be excused for thinking that this recession was much worse than previous ones. But the January 26th report finally showed us that so far this recession is a lot like 1990’s: not a happy time, but mild by the standards of previous recessions.

Nevertheless, Congressional Democrats and President Obama persist in sounding economic alarms to justify still more government spending. President Obama said Wednesday that the recession will become “a catastrophe” unless an economic stimulus bill soon becomes law. The proposal now is a stimulus plan costing almost $3000 per American.

Only a few people pointed out last year that chaos for the finance industry does not necessarily mean tragedy for the economy as a whole, so that bailouts and stimulus packages are worth far less than their price tag. Now we know: the economy as a whole continued to maintain high levels of production production and spending. Although the economy should be closely watched in 2009, taxpayers would be better served if their representatives would discern hype from real disaster, and thereby better protect taxpayer wallets from the alarmists.

What Caused the Recession of 2008? Hints from Labor Productivity

Just released at NBER, including data through the end of 2008.

Economists' Full Employment

The employment numbers are the big news in this recession. David Altig explains how they are a mess to interpret, which helps ensure that economists keep their jobs!

Professor Nunes compares consumer activity across recessions

Professor Nunes writes:

"I agree that the Investment data do not point to a "credit crunch". But then there is consumption (Durables and Non Durables and Services separately). The fall in Durables Consumption is poised to be the worse over the last 5 recessions. Non Dur & Services is also not doing well (comparatively). Some could point to the behavior of Durables and say Credit Crunch on the consumer. More relevant, I think, is the steep drop in Consumer Confidence (influenced strongly by the employment situation. The 1990-91 recession, although short, had a similar effect on Cons Conf and overall consumption flagged. This was not so evident in the other recessions."

I see three possible factors that would reduce consumption:

1. wealth effect of (technology components of) the housing crash (Luke Threinen and I estimate this to be about 3 percent)


2. substitution effect from labor market distortions (I have not quantified this yet -- but guess maybe 1 percent)


3. credit crunch

As long as (1) and (2) are real, evidence on low consumption does not convince me of the existence of a credit crunch. In fact, I were told that the credit crunch were affecting consumption, I'd be surprised that consumption hadn't fallen MORE. For credit crunch impacts, I look to the investment data because they are much less affected by (1) and (2).

My Economic Model -- Fall 2008 and Now

After four or five months, now is a good time to take stock of my economic model. I see four important areas to consider:

1. employment and labor usage
2. productivity, GDP, and spending
3. investment, and its decomposition between residential and non-residential
4. the impotence of public policy

I have significantly revised my thinking on employment, but in the other three areas it seems my model does quite well.

EMPLOYMENT. I initially thought that the adverse wealth effects experienced in 2007 and 2008 would soon induce people to work more. I still believe that will happen, but not in the next couple of months. I started to change my thinking a bit already in November when I realized that mortgage modification was in essence paying people lots of money not to work. Other bad incentives like this have come along. I have not yet done the hard work required to quantify the impact of these incentives, but at this point I don't see how that could reduce employment by 3 or 4 million. So I have more to do here if I am going to be able to accurately predict when the employment situation turns around. My only consolation is that most economists and commentators are still barking up the wrong tree -- that spending and a credit crunch are the root problems.

PRODUCTIVITY. Whatever is happening to employment, I continue to believe that productivity will advance. And it has. So, even if employment continues down, GDP and spending will not be dragged down that much. Thus, I am more confident than ever with my prediction that real GDP will stay above $11 trillion. There is still a good chance that, when this recession is over, it will be considered mild by GDP standards. It is impossible to have a second Great Depression with advancing productivity.

INVESTMENT. I predicted earlier that residential investment would continue to decline. It has. I am staying with that prediction through May or June. I predicted that nonresidential investment will increase. It has for most of this recession, but not for Q4. So maybe this category is more like other recessions than I thought. But still not bad, let alone disastrous. Going forward, I predict that non-residential investment will do fine, and will be one of the first activities to improve when we move out of this recession.

PUBLIC POLICY IMPOTENCE. I was right that the bank bailout would no nothing but disappoint and embarrass the Congressmen who voted for it. The "fiscal stimulus" will be more wasteful, although probably less embarrassing politically because it has so many disparate pieces. Most of the pieces will eventually be acknowledged as wastes. But by (blind squirrel) luck a couple of small pieces will look pretty good, and those will get the spotlight from our politicians.

In summary, I am thinking about the neoclassical growth model with a labor market distortion, but close to efficiency on all of the other margins. For the reasons cited above, I am now giving the labor market distortion piece more emphasis than I did last fall.

Low spending is a symptom in this recession, not a cause. The fundamental problem is somewhere in the labor market (I don't yet know exactly what, although mortgage modification is part of it). That is why total spending is doing much better than employment and hours.

[update: Donald P. Morgan left a comment with links to a lot of interesting results. I haven't digested them yet, but I highlight them so readers can take a look themselves.]

Retail Sales Rise in Jan

More evidence for my view that spending is not the fundamental problem.

Credit Crunch Hard to Find in the Investment Data

If the credit crunch were the big deal people say it is, then you would think it would be readily visible in the investment data.

It's impossible to see a credit crunch in the first two graphs -- investment looks like it does in a "run-of-the-mill" recession (recessions that needed no trillion-dollar-financial-sector bailout).

The last graph shows non-residential investment. As Luke Threinen and I have pointed out, non-residential investment has been unusually strong in this recession, at least through 2008 Q3. 2008 Q4 takes a dip down -- maybe that's an effect of a credit crunch -- but that dip has a number of precedents in previous recessions.

More Proof that Banks did not Need the Bailout

Bank of America received $45 billion bailout funds.

Bank of America spent $50 billion to acquire Merrill Lynch.

Bank of America CEO said told lawmakers this week that his company extended more than $115 billion in new credit to consumers and businesses during the fourth quarter.

Because 150 + 50 >> 45, it is clear that Bank of American could have survived AND loaned lots of money to customers without a bailout. Whether they would have bought Merrill is another story.

How Long Until the Stock Market Fully Rebounds?

Copyright, The New York Times Company

Even if the economy recovers quickly, I am skeptical that stock prices would soon return to what they were in 2007. During the housing boom, so many resources were devoted to housing that it was hard for new companies in other sectors to find the funding they needed to get off the ground or significantly expand their operations. This put incumbent companies at an advantage in the marketplace, and made them more valuable to stockowners. With the housing bubble now burst, a situation like this will not happen again soon.

Stock prices, such as those measured by the Dow Jones industrial average, represent the market’s valuation of ownership of established corporations. One factor contributing to the reduction in stock prices during 2008 was that markets became concerned that the earnings of those corporations were going to be reduced for a while as the economy endures a potentially severe recession. As fourth quarter earnings reports are released, those concerns now seem warranted.

Even if the economy had not been in a recession, or the recession proved to end quickly, the earnings of established corporations were going to suffer – thanks to the legacy of the housing boom and bust.

One stock market legacy of the housing boom and bust is that a number of established corporations – especially those in the banking industry – own mortgages, typically bundled up into securities. Now that it is apparent that the housing sector is overbuilt, the residential properties that back those mortgages are not worth much. With homeowners defaulting on their mortgages left and right, and their homes worth very little when they do default, the earnings banks had hoped to obtain through those mortgages will not materialize.

Even stock prices in the non-financial non-residential sectors (that is, the stock prices of businesses that do own few, if any, mortgages) were elevated by the housing boom because of all of the capital used by the housing sector. Last week I showed how the non-residential investment had suffered during the housing boom. The housing boom was a time when established non-residential businesses had a measure of protection against new entry into their industries and expansion by their competitors, because some of the resources needed for that expansion had been diverted to housing.

The housing boom is over, and it seems that the United States economy can go a long time without building houses at the rate it did in 2002-2006. This measure of protection for established businesses is now gone. When the economy recovers, investment in new and expanding companies will keep a lid on the earnings – and thereby stock prices – of established, incumbent corporations.

Crowding Out: Becker and Murphy Agree with Me

It's pretty obvious that the stimulus bills will reduce private spending. Becker and Murphy give their explanation today.

Here are some of mine.

Aggregate Hours Decline Less than They have in any Month Since September

Aggregate hours were lower in January than in December -- neither a surprise nor good news. However, aggregate hours declined less than they have recently. The table below shows the percentage change in aggregate hours (private industries) from the previous month, starting in Sept 2008.

-0.57% Sep
-0.76% Oct
-0.86% Nov
-0.77% Dec
-0.68% Jan

Note that aggregate hours are the product of employment and hours per employee. Interestingly, employment dropped a lot Dec-Jan, but hours per employee did not. In previous months, both employees and hours were making about equal contributions to the aggregate hours changes.

134 million floor

In October I predicted that employment would not drop below 134 million. It hasn't yet -- but it got close enough in January that I am skeptical that this prediction will turn out right.

On-Line Revenue Hype

There is some noise about the fact that Q4 on-line ad revenue exceeded Q3's. I like to ferret out good news, but I think this series needs seasonal adjustment, in which case Q4 is not extraordinary.

Productivity Marches Ahead

Today the BLS reported productivity -- that is, real output per hour worked -- for Q4.

It continues to grow, as shown in Figure 6 below (these are figures from my paper "What Caused the Recession of 2008? Hints from Labor Productivity"). Interestingly, the more severe recession of 1981-82 had productivity falling, as did the Great Depression (not shown).

The conventional wisdom ignores the comparison with previous recessions, and says that productivity falls merely because labor hours are falling. That is incorrect. I prove this by calculating a "productivity residual" -- the amount of the productivity growth that cannot be explained by the fact that labor fell. The productivity residual has been rising in this recession -- much like it does during non-recession times.

Productivity residuals are shown in Figures 5 and 7 (productivity residuals are measured in the quantity dimension so that they can be compared with changes in the amount of labor). The 1981-82 recession had the productivity residual falling (that is, given that jobs were lost in that recession, productivity should have risen but in fact it fell -- so the productivity residual must be falling). So did the Great Depression.

Crunch Breeds New Banks

Yesterday that was a Wall Street Journal headline (hat tip to Bryan Cross at UBS).

Four months ago, that was a headline on this blog.

Working with Prof Nunes on the Monthly Data

Professor Nunes gives more detail on consumption, and takes a look at real disposable income (I think aggregate, rather than per capita) subtracting out the rebate from earlier in the year.

I think the monthly data look pretty good. But President Obama says that a catastrophe is coming.

[I think the Lehman arrow needs to be moved one bar to the right.]

The Spending Myth

It is very often said that low spending is the fundamental problem in our economy. This is wrong.

Note that income and spending fell less then 1.0 percent from Q3 to Q4. Labor hours fell twice as much.

So why is spending said to be the cause, and labor hours the effect?!

This looks to me like a problem with the labor market, which spills over a bit on income and spending.

This means two things:

1. attempts to stimulate spending, even if they actually stimulate the spending, will have only an indirect effect on employment (given some of the bad incentives of the stimulus plans, the effect on employment may be in the wrong direction!).
2. income and spending will head up before employment does. Income and spending may already be headed up!

Working with the Monthly Data

Holbrook Working published a paper in 1960 that is now famous only in geek circles. The paper is called "Note on the Correlation of First Differences of Averages in a Random Chain."

WORKING EXAMPLE. Despite its user unfriendliness, the paper has a basic idea that is quite helpful for anyone interested in where our economy is headed for the next quarter or two.

To appreciate the idea, consider a series that is continuously updated and hard to predict, such as the S&P 500 index. This series is updated every second or so (at least during trading hours). It is hard to use changes in the S&P index to predict changes going forward. For example, the fact that the index fell in the morning (that is, was lower at noon than it was at 9:30am) does not suggest that it will also fall in the afternoon (that is, would be lower at 4p than it was at noon). Nevertheless, the fact that the morning's AVERAGE index was lower than the index was, say, when the market opened in the morning tells us that this afternoon's average will be somewhat lower than the morning's average!

The reason is that, given that the morning average was lower that the morning's open, it must be that the index was relatively high soon after the open, and fell sometime thereafter. The morning average includes those early morning highs, but the afternoon average will not.

LESSON FOR MACRO FORECASTING. The lesson applies to GDP just as well as to the S&P index. People produce and spend every day, but the BEA reports to us the AVERAGE spending for all the days of the quarter. The fact that 2008 Q3 GDP was lower than 2008 Q2 by itself suggests that, other things the same, 2008 Q4 may be lower than 2008 Q3. The reason has nothing to do with the possibility that negative growth begets more negative growth. Rather, the fact that 2008 Q3 GDP was down means that spending fell sometime between July 1 and September 30. As long as the fall did not all occur on July 1, then the 2008 Q3 average has the benefit of some high spending days early in July that Q4 does not, even if every single day in Q4 were at least as good as September 30.

This is why I pay attention to the monthly data when trying to make forecasts for quarterly averages.

So what's going to happen in 2009 Q1? A good forecast, IMO, depends very much on when economic activity dropped in such a way to make the Q4 average worse than Q3's. If it dropped in, say, August, then I more optimistic than if it dropped in November. A (hypothetical) November drop means that the 2008 Q4 average we were given last Friday from BEA includes some high spending in October that I don't expect to carry over to January, given that it did not even carry over to December.

Below I show a couple of pretty important income and spending indicators that the BEA measures monthly and released on Monday. One of them is real disposable personal income per person -- the average amount of income, adjusted for inflation, that people have after paying taxes and receiving transfers. The other is an index of the volume of consumer spending (the number and quality of items they buy, not the amount spent on those items).

Real disposable personal incomes reached their low in September and have increased every month since. If you just compared the quarterly averages, Q4 might look close enough to Q3 to suggest that 2009 Q1 can't be good. But the underlying monthly income pattern is pretty promising.



The real consumption data are less amazing, but still suggest that 2009 Q1 begins in about the same spot that 2008 Q4 did. Moreover, given the movement of spending away from brick and mortar and toward on-line, it is possible that the BEA's seasonal adjustments allocate too much consumption to November and too little to December.

A Commercial Real Estate Crisis? Probably Not

Copyright, The New York Times Company

For months now experts have been predicting that commercial real estate will be “the other shoe to drop.” But in fact, non-residential building fell far behind housing construction during the housing boom. This shortage of commercial buildings relative to housing suggests that a commercial real estate crisis will not occur, or at worst it will occur with much less severity than did the housing crash.

While there is much disagreement as to the proper remedies for the current economic situation, there is wide agreement that the housing boom and crash that followed were the major factor in putting us where we are today. These days, “real estate” is a term that provokes fear, not optimism. Nevertheless, it is a mistake to assume that commercial real estate shares the housing sector’s ailments.

The chart below shows the amount of housing and non-residential structures in place in America. The amounts are measured at the beginning of each year, relative to the 1990-2000 trend. By the beginning of 2007, the amount of housing – that is, square footage adjusted for quality – was 3.5 percent above that previous trend. The amount of non-residential structures was 2.0 percent below trend.

We all know that there is a nationwide surplus of housing. But there is little if any nationwide surplus of non-residential buildings.

Business conditions have deteriorated recently, so it might seem that even a normal amount of commercial real estate would be too much these days. However, we probably ended the housing boom with enough of a commercial real estate shortage that economic activity could “back up” a bit toward the amount of commercial real estate.

For example, the chart suggests that non-residential building is now about 2 percent below trend. Employment has fallen about 2 percent so far during this recession. Inflation-adjusted gross domestic product is down one percent in the last six months, and down about 0.2 percent for the recession as a whole. Thus the real G.D.P. and employment shortfalls so far are in line with the relatively small amounts of non-residential building.

I continue to watch the economy in 2009 but, barring a significant further decline in business activity, I do not expect to see a nationwide surplus of commercial real estate and therefore do not expect to see commercial real estate suffer the kind of crisis that followed from the housing surplus.

A Robust Fiscal Policy Proposal

I am toying with this idea:

1. eliminate the employer portion of the Medicare tax, which is currently 1.45% of payroll.
2. increase the employee portion of the Medicare tax, which is currently 1.45% of wages, to 2.694% of payroll of wages.

If you believe that wages fully adjust in response to taxes, then this change would have no effect on a worker's take home pay, employer costs, or government revenue because wages would just adjust up in response to the changing incidence of the payroll tax. So you would have no problem with my proposal. There is the added bonus that this policy would make people feel like government is "doing something" when in fact it isn't.

If you think that wages are currently too high (a traditional Keynesian view), then my proposal ought to: lower employer costs, and thereby raise employment and government revenue. The only question is whether the amounts above are enough to bring employment back -- but at least it would be a move in the right direction (or no change at all).

To Watch in February

"as lawmakers and the public learn in real time that the classic points of Robert Barro and of Merton Miller and Franco Modigliani apply well in the present situation, their frustration will lead to demands to regulate more closely the operations of banks receiving Treasury funds."

I published this in November 2008. February 2009 will be the month when you see significant new regulation of banks receiving Treasury funds.

Media Trims GDP stats

According the BEA's advance estimate, the fourth quarter GDP growth rate of -3.8% was better than the -5.4% pundits expected (although worse than I expected).

Many of the media responded by finding a spending segment that grew and declaring that it should not be counted. They choose inventory accumulation, saying that "fixing" that makes it -5.1%.

Their GDP trimming is incorrect, both as statistical and economic practice. Even if it were correct to trim, they have highly exaggerated the results.

A. If you want to eliminate inventory accumulation from GDP growth, then you should eliminate it from the pundits' forecast too. After all, the pundits were trying to predict all of GDP, not just the parts of it that the media would find relevant ex poste.

B. As a matter of economic theory, there is not a "problem" that inventories accumulated:

1. Carrying an inventory takes some financing. The fact that businesses are doing so tells me that they have financing -- yet more evidence against the common wisdom that we are experiencing a terrible credit crunch.


2. Nobody is forcing business to accumulate inventory: businesses CHOSE to do it. Maybe it's their judgment that they will make more money selling the items later rather than dropping price now.


3. I am not aware of statistical evidence that high inventory accumulation forebodes low GDP growth in the future. Professor Nunes kindly send a scatter plot of historical measures of inventory accumulation and subsequent GDP growth:

[source: Professor Marcus Nunes]

The horizontal axis measures inventory accumulation as a percentage of GDP. The vertical axis measures real GDP growth in the next quarter. I don't see any obvious negative relationship.

C. Even if there were on obvious negative relationship, it would not tell us much about 2009 Q1 because 2008 Q4 inventory accumulation was not particularly unusual. Inventories were de-accumulated in an amount of .3% of GDP in Q3. That changed to accumulation of 0.1% of GDP in Q4 -- neither of these are notable deviations from the center of Professor Nunes' data.

That this trivial line in the GDP statistics makes headlines proves the media's (and by deduction, their readers') desperation for bad news.