"As a young man, Ryan held numerous amusing summer jobs, including a stint as an Oscar Mayer salesman in which he drove a Wienermobile. He envisioned eventually going to the University of Chicago for an advanced degree in economics and becoming an economist/academic, but he says he 'kept getting lured into politics.'"
Source.
Thursday, October 11, 2012
Tuesday, October 9, 2012
Saturday, October 6, 2012
The Two Labor Market Surveys
If you go to the recent release from the BLS, you can find these two sentences a few paragraphs apart:
Total employment rose by 873,000 in September.
Total nonfarm payroll employment increased by 114,000 in September.
To a layman, this may seem confusing. The first statement suggests a robust labor market, the second a more lackluster one. What is going on?
The issue is that there are two surveys. The first estimate of employment comes from the survey of households; the second is from the survey of establishments. I thought readers might like to hear what my favorite intermediate macro textbook says about this issue. Here is an excerpt:
-----
More important than the specifics of these surveys or this particular episode when they diverged is the broader lesson: all economic statistics are imperfect. Although they contain valuable information about what is happening in the economy, each one should be interpreted with a healthy dose of caution and a bit of skepticism.
Total employment rose by 873,000 in September.
Total nonfarm payroll employment increased by 114,000 in September.
To a layman, this may seem confusing. The first statement suggests a robust labor market, the second a more lackluster one. What is going on?
The issue is that there are two surveys. The first estimate of employment comes from the survey of households; the second is from the survey of establishments. I thought readers might like to hear what my favorite intermediate macro textbook says about this issue. Here is an excerpt:
-----
Because the BLS conducts two surveys of labor-market conditions, it produces two measures of total employment. From the household survey, it obtains an estimate of the number of people who say they are working. From the establishment survey, it obtains an estimate of the number of workers firms have on their payrolls.
One might expect these two measures of employment to be identical, but that is not the case. Although they are positively correlated, the two measures can diverge, especially over short periods of time. A particularly large divergence occurred in the early 2000s, as the economy recovered from the recession of 2001. From November 2001 to August 2003, the establishment survey showed a decline in employment of 1.0 million, while the household survey showed an increase of 1.4 million. Some commentators said the economy was experiencing a “jobless recovery,” but this description applied only to the establishment data, not to the household data.
Why might these two measures of employment diverge? Part of the explanation is that the surveys measure different things. For example, a person who runs his or her own business is self-employed. The household survey counts that person as working, whereas the establishment survey does not because that person does not show up on any firm’s payroll. As another example, a person who holds two jobs is counted as one employed person in the household survey but is counted twice in the establishment survey because that person would show up on the payroll of two firms.
Another part of the explanation for the divergence is that surveys are imperfect. For example, when new firms start up, it may take some time before those firms are included in the establishment survey. The BLS tries to estimate employment at start-ups, but the model it uses to produce these estimates is one possible source of error. A different problem arises from how the household survey extrapolates employment among the surveyed households to the entire population. If the BLS uses incorrect estimates of the size of the population, these errors will be reflected in its estimates of household employment. One possible source of incorrect population estimates is changes in the rate of immigration, both legal and illegal.
In the end, the divergence between the household and establishment surveys from 2001 to 2003 remains a mystery. Some economists believe that the establishment survey is the more accurate one because it has a larger sample. Yet one recent study suggests that the best measure of employment is an average of the two surveys. [George Perry, “Gauging Employment: Is the Professional Wisdom Wrong?,” Brookings Papers on Economic Activity (2005): 2.]
More important than the specifics of these surveys or this particular episode when they diverged is the broader lesson: all economic statistics are imperfect. Although they contain valuable information about what is happening in the economy, each one should be interpreted with a healthy dose of caution and a bit of skepticism.
Friday, October 5, 2012
How Central Bankers Think
When I read Charles Evans's most recent speech, I was struck by these two sentences:
(1) r = R - i
(2) u = f(r-r*)
(3) I = i + g(r-r*)
In equations (1)-(3),
r = real interest rate
R = nominal interest rate
i = anticipated inflation rate
u = unemployment rate
r* = efficient real interest rate
I = actual inflation rate
f(.) is an increasing function
g(.) is a decreasing function
In this model, R is set by the Fed, i is exogenous, and r* is exogenous. Equation (1) is a Fisher relation. The real rate is the nominal rate minus the anticipated inflation rate. When the Fed says that "inflation expectations are well-anchored," what they mean is that i is independent of how the Fed sets R (as the Fed can always say reassuring things about how it is committed to price stability, apparently). Thus, when the Fed moves the nominal rate R, the Fed thinks it moves the real rate in lockstep.
The economically efficient real interest rate r* is what Woodford would call the "Wicksellian natural rate." In Woodford's world, this would be the equilibrium real interest rate if all wages and prices were flexible. This may or not be what Bernanke has in mind - he tends to leave unspecified the sources of the inefficiencies he is trying to correct. Equation (2) states that the unemployment rate rises if there is an increase in the difference between the actual real interest rate and the efficient real interest rate. But how do we know what r* is? From Charles Evans's point of view, that's easy. If Fed policy stayed unchanged (so that r is unchanged), and the unemployment rate went up, r* must have gone down.
Equation (3) states that the the current inflation rate is the anticipated rate of inflation, plus a term that depends negatively on the difference between the actual real rate and the efficient real rate. Therefore, if the real rate is above the efficient rate, the inflation rate will be low. Implicit in equations (2) and (3) is the Phillips curve - a central part of FOMC religion. FOMC statements and public discussion by Fed officials are replete with Phillips curve language. Note that changes in R which translate into changes in the same direction in r will move u and I in opposite directions - a movement along the Phillips curve.
Some readers will recognize the similarity between equations (1)-(3) and the three equations that some New Keynesian researchers work with. Typically the three New Keynesian equations are: (i) IS curve; (ii) Taylor rule; and (iii) Phillips curve. What I wrote down above is roughly the same idea, and that's no accident. What Woodford and his disciples did was to essentially reverse-engineer actual Fed policymaking. That's why central bankers are infatuated with New Keynesian economics - it rationalizes what they do.
Here is how the FOMC sees its current predicament. r* is really low, making u really high. The optimal thing to do would be to lower R to reduce r and reduce u. But R = 0 and can't go lower. Solution: There are long-term Rs that we can go after, which are currently above zero. Let's buy long-maturity assets and lower long-term Rs instead. You can read about that in Bernanke's speech.
But what's wrong with this approach? These ideas may be easy for Fed officials to explain to the Rotary club, but if you recite the ideas enough you start to believe them. How can anyone think that our current problem is that efficient real interest rates fall far below actual real interest rates? A short rate of -2% is too high? Why? TIPS yields of -1.65% (5 year) or 0.37% (30 year) are too high? Again, why? No one thinks that monetary policy has any long run consequences. Over what horizon do FOMC members think that they can essentially peg a real interest rate? Didn't exploitation of a perceived Phillips curve tradeoff get us in trouble in the past? Aren't we worried about that? Why did Phillips-curve "theory" become the dominant theory of inflation among policymakers? Why did monetary theory disappear? We know there are problems with the targeting of monetary aggregates, but surely most of us think that exchange in some class of assets is what drives long-run inflation. Where's the money?
Whenever the economy operates below its potential, the key mechanism that returns the economy back to potential is a fall in real interest rates. This decline reduces the supply of saving and boosts the demand for investment, resulting in increased spending.Ben Bernanke tells us about how the Fed can speed the adjustment to "potential:"
Generally, if economic weakness is the primary concern, the Fed acts to reduce interest rates, which supports the economy by inducing businesses to invest more in new capital goods and by leading households to spend more on houses, autos, and other goods and services. Likewise, if the economy is overheating, the Fed can raise interest rates to help cool total demand and constrain inflationary pressures.Those two quotes encapsulate the dominant school of central banking thought on the FOMC. We could even write this down formally - it's simple. Here are three equations that describe the economy and what monetary policy does, according to Evans, Bernanke, Kocherlakota, and I think Rosengren and Yellen, at least:
(1) r = R - i
(2) u = f(r-r*)
(3) I = i + g(r-r*)
In equations (1)-(3),
r = real interest rate
R = nominal interest rate
i = anticipated inflation rate
u = unemployment rate
r* = efficient real interest rate
I = actual inflation rate
f(.) is an increasing function
g(.) is a decreasing function
In this model, R is set by the Fed, i is exogenous, and r* is exogenous. Equation (1) is a Fisher relation. The real rate is the nominal rate minus the anticipated inflation rate. When the Fed says that "inflation expectations are well-anchored," what they mean is that i is independent of how the Fed sets R (as the Fed can always say reassuring things about how it is committed to price stability, apparently). Thus, when the Fed moves the nominal rate R, the Fed thinks it moves the real rate in lockstep.
The economically efficient real interest rate r* is what Woodford would call the "Wicksellian natural rate." In Woodford's world, this would be the equilibrium real interest rate if all wages and prices were flexible. This may or not be what Bernanke has in mind - he tends to leave unspecified the sources of the inefficiencies he is trying to correct. Equation (2) states that the unemployment rate rises if there is an increase in the difference between the actual real interest rate and the efficient real interest rate. But how do we know what r* is? From Charles Evans's point of view, that's easy. If Fed policy stayed unchanged (so that r is unchanged), and the unemployment rate went up, r* must have gone down.
Equation (3) states that the the current inflation rate is the anticipated rate of inflation, plus a term that depends negatively on the difference between the actual real rate and the efficient real rate. Therefore, if the real rate is above the efficient rate, the inflation rate will be low. Implicit in equations (2) and (3) is the Phillips curve - a central part of FOMC religion. FOMC statements and public discussion by Fed officials are replete with Phillips curve language. Note that changes in R which translate into changes in the same direction in r will move u and I in opposite directions - a movement along the Phillips curve.
Some readers will recognize the similarity between equations (1)-(3) and the three equations that some New Keynesian researchers work with. Typically the three New Keynesian equations are: (i) IS curve; (ii) Taylor rule; and (iii) Phillips curve. What I wrote down above is roughly the same idea, and that's no accident. What Woodford and his disciples did was to essentially reverse-engineer actual Fed policymaking. That's why central bankers are infatuated with New Keynesian economics - it rationalizes what they do.
Here is how the FOMC sees its current predicament. r* is really low, making u really high. The optimal thing to do would be to lower R to reduce r and reduce u. But R = 0 and can't go lower. Solution: There are long-term Rs that we can go after, which are currently above zero. Let's buy long-maturity assets and lower long-term Rs instead. You can read about that in Bernanke's speech.
But what's wrong with this approach? These ideas may be easy for Fed officials to explain to the Rotary club, but if you recite the ideas enough you start to believe them. How can anyone think that our current problem is that efficient real interest rates fall far below actual real interest rates? A short rate of -2% is too high? Why? TIPS yields of -1.65% (5 year) or 0.37% (30 year) are too high? Again, why? No one thinks that monetary policy has any long run consequences. Over what horizon do FOMC members think that they can essentially peg a real interest rate? Didn't exploitation of a perceived Phillips curve tradeoff get us in trouble in the past? Aren't we worried about that? Why did Phillips-curve "theory" become the dominant theory of inflation among policymakers? Why did monetary theory disappear? We know there are problems with the targeting of monetary aggregates, but surely most of us think that exchange in some class of assets is what drives long-run inflation. Where's the money?
Bullard and Price Level Targeting
Jim Bullard (St. Louis Fed President) gave a talk yesterday which has some interesting ideas in it. In the second chart in this post, you can see that the pce deflator, which is the Fed's favorite measure of the price level, is currently very close to a 2% growth path starting in 2007. Bullard's slides show that this is the case even if our base year is as far in the past as 1995. Thus, while the Fed speaks a language that might make you think it believes past inflation is irrelevant, in practice the Fed appears to be targeting a 2% price level path.
But why do that? Bullard makes the case that this is the prescription that comes out of a Woodford sticky-price model. While I think price and wage stickiness is at best of second-order importance, I think there are other good reasons to think that price level targeting is a good idea. For example, such a policy rule appears to have good properties in terms of minimizing the inflation uncertainty associated with long-term nominal debt contracts.
But there is more on Bullard's mind. He seems to want to make the case that, in spite of the weak recovery we have been experiencing in the U.S., monetary policy has been close to optimal. In support of that argument, he enlists Reinhart and Rogoff, who document a slow recovery as a regularity in the aftermath of previous financial crises. One could say that Reinhart and Rogoff don't have a theory to explain the regularity, or that there may be something policy could do in response to the slow recovery, in spite of the regularity. For example, some people think that high inflation, which would redistribute wealth from creditors to debtors, would be a good idea in current circumstances. In response to that, Bullard argues that inflation redistribution would do more harm to the Fed's credibility than it's worth. One could argue as well that, if redistribution is the answer to our problems, then fiscal policy is a more efficient vehicle for doing it than is monetary policy.
A point that Bullard emphasizes is that nominal GDP targeting in the current circumstances would be the wrong policy. Basically, there is nothing much that monetary policy can do about the slow recovery so, for example, targeting 5% nominal GDP growth would give us too much inflation. By implication, it seems Woodford is contradicting himself. Bullard argues that the policy we have (optimal, he says) is the one Woodford would recommend. But Woodford's Jackson Hole paper seems to view nominal GDP targeting favorably. Woodford-optimal policy and NGDP targeting appear to be two different things.
But why do that? Bullard makes the case that this is the prescription that comes out of a Woodford sticky-price model. While I think price and wage stickiness is at best of second-order importance, I think there are other good reasons to think that price level targeting is a good idea. For example, such a policy rule appears to have good properties in terms of minimizing the inflation uncertainty associated with long-term nominal debt contracts.
But there is more on Bullard's mind. He seems to want to make the case that, in spite of the weak recovery we have been experiencing in the U.S., monetary policy has been close to optimal. In support of that argument, he enlists Reinhart and Rogoff, who document a slow recovery as a regularity in the aftermath of previous financial crises. One could say that Reinhart and Rogoff don't have a theory to explain the regularity, or that there may be something policy could do in response to the slow recovery, in spite of the regularity. For example, some people think that high inflation, which would redistribute wealth from creditors to debtors, would be a good idea in current circumstances. In response to that, Bullard argues that inflation redistribution would do more harm to the Fed's credibility than it's worth. One could argue as well that, if redistribution is the answer to our problems, then fiscal policy is a more efficient vehicle for doing it than is monetary policy.
A point that Bullard emphasizes is that nominal GDP targeting in the current circumstances would be the wrong policy. Basically, there is nothing much that monetary policy can do about the slow recovery so, for example, targeting 5% nominal GDP growth would give us too much inflation. By implication, it seems Woodford is contradicting himself. Bullard argues that the policy we have (optimal, he says) is the one Woodford would recommend. But Woodford's Jackson Hole paper seems to view nominal GDP targeting favorably. Woodford-optimal policy and NGDP targeting appear to be two different things.
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