Defense Spending?!

As in prior quarters, net exports have been helping hold up GDP (it is the expenditure category that increased the most in real terms 2009 Q1-Q2). More surprising to me is that defense spending is the second largest increase ... my spending-based forecasting method would not have picked that up.

NOTE: Nondefense spending was hardly changed Q1-Q2. I assume that the "stimulus package" did not have a big dose of defense spending, but rather was essentially all nondefense spending.

Not as Bad as 1982

This revises the graph I had in the New York Times Blog section.



During the three years prior to the end of this recession, three year GDP growth was essentially the same as in 1980-82, but we got there with less depth (ie, more GDP DURING those three years), because the famous early 1980's recession was actually two recessions.

Of course, we have to wait to see whether this recession will be followed by a second.

Better Than I Thought

My vacation schedule did not permit me to attempt a spending-based real GDP forecast for 2009 Q2, but I did offer one based on productivity: 1.0 percent less than 2009 Q1.

I had read that others were more optimistic with spending-based forecasts -- I might have been too I had attempted one.

Anyway, the BEA's advance estimate this morning was 0.3 percent lower than Q1.

What's important about this is that productivity rose a lot Q1 to Q2 (that's why my productivity approach -- which assumed that productivity would rise, but not so much -- delivered an underestimate). I have sounded this theme for a while now: employment is going down yet productivity is going up. Other's say "Okun's Law is broken." However you label this fact, it is telling us a lot about why we have this recession.

Corporate Tax Incidence

Two supersmart profs emailed me this question:

"[x] and I have a disagreement that you should be able to settle. I claim that the corporate income tax (a tax on profits) does not result in higher prices since a proportional tax on profits doesn't change the firm's profit maximizing output and hence price.

[x] believes that the tax literature indicates that some of the tax is passed on to consumers in terms of higher prices. Who is right?"

Tax incidence is a fascinating subject, but (at least the version of it that actually uses economics) is terribly out of fashion, so I cannot cite a credible empirical study that looks for, and finds an effect on prices.

In theory, if the corporate tax were really a tax on economic profits, then [y] would be right. But, if the corporate tax were really a tax on economic profits, it would get no revenue!

In reality, corporate profits are part of the return on a particular type of capital is not productively organized in some noncorporate way (small business, or nonprofit), or outside of the tax jurisdiction, and cannot be entirely used to collateralize debt. Although I confess that that "particular type" is a bit vague, it's easy to see that some industries ultimately rely on it more than others. This is the mechanism by which the corporate income tax would likely change relative output prices (raising some, and lowering others).

For example, the housing and health service industries are organized with little corporate capital. Manufacturing is pretty corporate intensive. So a corporate income tax would raise the price of manufacturing goods relative to housing and health services. The famous Harberger model had this effect.

I have written some empirical papers about the effect of corporate income taxes on the after-tax return to capital (not the type of price you were asking about), and believe that the return to capital is essentially unaffected in the medium and long run. The corporate tax does reduce the total amount of capital (that's why its after-tax return is ultimately unaffected), and by this mechanism would reduce wages (and push employment outside of the tax jurisdiction) -- probably the most important price effect of all.

Commenters: what do you think? Are there empirical studies of effects on the prices corporations charge to their consumers?

Treasury Still Working Hard to Destroy Incentives

Treasury has been working hard this week to expand the number of households that would have no incentive to earn income, urging lenders to modify 500,000 mortgages according to its HASP plan.

HASP is the Obama Administrations plan to reduce mortgage payments for people earning less money, and insisting that people making enough to pay their mortgage keep paying in full.

Looking for a Housing Recovery

Copyright, The New York Times Company

Recent reports have shown that housing starts, new home sales and some measures of housing prices have not only stopped their decline, but have improved. Does that mean that the housing recovery has begun? Yesterday's release of the Case-Shiller housing price index may confirm that it has.

The housing crash is the single most important factor that started this recession, so it would be nice to know when it will end.

We have known for a while that the basic supply and demand ingredients would permit a genuine housing recovery this summer. Population has continued to grow more and larger families tend to create more housing demand =97 and housing construction has been practically nothing for the past nine months. Thus, while the housing inventory exceeded the demand in 2007 and 2008, it looked like demand would catch up by this summer.

As demand catches up, housing prices should stop falling and stabilize at more normal levels (sorry, we cannot expect to see 2005 housing prices any time soon). Housing construction would proceed at a normal pace, which in 2010 and beyond would keep the supply of housing together with the demands created by population and income growth.

Of course, we are in a recession now, and most of us feel that we have less income than we once did. In an earlier post, I showed how this could hold back demand despite the continued population growth, at least if people did not expect their incomes to recover soon.

Moreover, some think that banks want to avoid granting mortgages, because those loans caused them so many problems in 2007 and 2008. Without bank lending, housing demand could also be depressed despite continued population growth.

Because income and lending factors could offset population growth, it will be comforting to see actual housing data that characterize a recovery: stabilized housing prices, more home sales and a healthy amount of new construction.

Housing construction continued to fall this spring far short of what anyone would consider =93normal.=94 But recently we learned that housing starts the beginnings of new home building projects were quite high in June 2009. If those starts are eventually finished, that probably means a more normal pace of construction activity this summer.

For several months now, there have been conflicting reports as to housing prices. An often-followed housing price index (calculated by the Federal Housing Finance Agency, or F.H.F.A.) showed prices stabilizing early this spring. In contrast, the Case-Shiller index had suggested that housing prices had been falling as fast as ever.

Some have argued that the Case-Shiller index over-weights regions like California, where the housing market has been much worse than typical in most of America, and that the F.H.F.A. index is enough to tell us that housing prices have stabilized in much of America.

Nevertheless, it was big news yesterday to learn that the Case-Shiller index showed its first increase since June 2006.

Case-Shiller Index Late to the Party?

Finally the May entry of the Case-Shiller housing price index shows an increase. Other indices have shown that for a while.

Interestly, Professor Shiller himself (with the ideas of supply and demand conspicuously absent from his analysis) said last month that housing price declines "may well continue for some time."

Big Housing News Rolling in this Summer

December 2008 was a long time ago in the time frame of economic events, but that was when I first said that I "expect to see housing construction resume next summer". I reiterated that prediction at nytimes.com in April.

Almost nine months after my prediction, the headlilne today is "New Home Sales Soar in June". "The last time sales rose so dramatically was in December 2000. Sales have risen for three straight months."

Supposedly supply and demand are not applicable any more, but I am not aware of any other framework that generated this prediction so far in advance!

Okun's Law Failure is not a Mystery

Recently more economists are noticing that the labor market is getting a disproportionate share of the bad news in this recession. Unemployment is much worse then you'd expect from the GDP growth we've had; GDP growth is much better (less bad) than you'd expect from the unemployment we've had.

This is no surprise to readers of this blog. In February 2009 I released a working paper documenting the divergence between GDP and employment, although using real business cycle methodology as opposed to "Okun's law". Since November 2008, I have been saying employment should be especially bad because this recession has especially many government policies that discourage work.

Debate on Second Stimulus

Commenters: I would like your input. Would a second stimulus be in the public interest? Why? or Why not?