Why did the stock market go up yesterday?

Barry Ritholtz, at The Big Picture, notes:

First, the bad news: The U.S. economy stunk the joint up in Q2, slowing sharply as inflation continued to climb.

The good news? You'll have to ask equity traders…

From the point of view of Mr. Market, the good news seems to be that the Fed is no longer likely to raise interest rates in August. I have a couple of problems with this good news. First, it may not even be true. Second, even if it is true, I don’t think it outweighs the bad news.

The inflation news was not good, by anyone’s estimation. One recognizes, of course, that the Fed is forward looking, and that the Fed would prefer, all other things being equal, to avoid a recession. The weak real GDP number might indicate a disinflationary slowdown, which might have a strong enough disinflationary impact to more than undo the observed increase in the inflation rate, which might lead the Fed to avoid tightening. But from the point of view of the Fed, might doesn’t necessarily make right. Right now the possibility of inflation getting out of control frightens the Fed more than does a recession. If recession is the cost of preventing an inflationary spiral, the Fed is willing to pay that cost.

Which brings me to the second point. If the Fed doesn’t tighten, it’s because the Fed thinks there is a serious risk of a recession. That can’t possibly be good news, can it?

Central Bank Bond Purchases and US Interest Rates

Do bond purchases by the People’s Bank of China (or the Bank of Japan or SAMA or [fill in the blank]) lower US interest rates? Clearly “no” is not quite an acceptable answer, but the answer is not quite as much of a “yes” as many people think.

In the short run the Fed has a target for the short-term interest rate. If the PBoC buys Treasury bills, the Fed will sell enough Treasury bills to keep the interest rate essentially unchanged.

What about the long-term interest rate? Certainly it’s true that, if the PBoC makes, out of the blue, a decision to buy long-term bonds instead of bills, those purchases will tend to push down the long-term interest rate. But why would the PBoC make such a decision? Presumably for the same reason that a domestic bondholder might typically make such a decision: the difference between the long-term rate and expected short-term rates over the life of the long-term bond is big enough (and in the right direction) to compensate for the risk of holding a longer maturity asset. Is there any reason to think that the PBoC has different maturity preferences than a typical domestic US investor? If anything, the PBoC takes more risk than a domestic investor by extending maturities. If long-term rates are high enough to be attractive to the PBoC, they should be, if anything, even more attractive to a domestic investor, which means, if the PBoC weren’t there to buy, domestic investors would have provided the same demand, and the interest rate would be the same.

Of course, Chinese demand will affect the long-term interest rate if it affects the expected path of short-term interest rates. And it probably does, but the influence is not entirely straightforward. China’s bond purchases are a side effect of China’s dollar purchases, and the dollar purchases have the intended effect of strengthening the dollar. The strong dollar makes US exports less attractive and imports more attractive, which reduces the level of aggregate demand in the US economy, and, as a result, the Fed is ultimately likely to follow a looser monetary policy, so interest rates do go down.

So intervention by China (or Japan or Saudi Arabia or wherever) does have the net effect of reducing US interest rates. At any particular time, though, the effect of such intervention is likely to be swamped by the effects of other business cycle phenomena. For example, dollar purchases (and the attendant bond purchases) by foreign central banks increased dramatically between 2002 and 2005, but so did US interest rates. In 2002, the US was experiencing the effects of the tech bust; in 2005 the US was experiencing the effects of the housing boom. Intervention was a factor – probably pushing interest rates farther down in 2002 and keeping them from rising quite as high in 2005 (and 2006) – but it wasn’t the main part of the story. In general, if you want to find out what’s going to happen to US interest rates, foreign central bank intervention is not the thing to look at.

Who cares about wages?

David Altig of Macroblog argues (continued here) that we should just ignore wages and look at total compensation. Greg Mankiw agrees. Brad DeLong disagrees, but only because we don’t have good enough data on total compensation. I would suggest, however, that there are a couple of reasons we should care about wages for their own sake.

First, even though compensation is the theoretically correct variable that rational firms and workers should care about, their behavior in the real world may reflect rules of thumb that give precedence to wages over benefits. As a result, the behavior of the Phillips curve – the short-run tradeoff between inflation and output – may depend on the exogenous behavior of benefit costs. Recent increases in the real cost of health insurance have, in my opinion, had an inflationary impact. In principle, they shouldn’t: firms facing rising benefit costs should just keep wages down. In practice, I suspect this is often not what they do. I can’t prove it, but I believe that the weak wage growth in recent years has been the result of weak labor market conditions – conditions that would normally have been disinflationary – and not the result of increasing benefit costs.

At the place I used to work, I was there for 6 years, and every year, they would announce a 5% wage increase. I found it kind of amusing because the memo always said what the inflation rate was, but it never seemed to make any difference: we automatically got a bigger real wage increase in years when the inflation rate was low. Since our benefits included health insurance, we also got a bigger increase in total compensation in years when the cost of health insurance rose more rapidly. (That part wasn’t even in the memo.). Firms have to take benefit costs into account in making employment and pricing decisions, but when it comes to wage-setting decisions, I would guess that a lot of firms behave like my old employer.

The second reason has more troubling implications. Wages, I think, have a lot to do with the subjective sense of prosperity. “Honey, I got a raise!” sounds a lot better than, “Honey, they expanded our health insurance to cover several newly developed procedures!” Even though rising benefit costs largely reflect real improvements in the quality of health care, these improvements don’t make us feel richer. Unfortunately (this is the troubling part) they really represent an acknowledgement that we weren’t doing so well to begin with. There are all kinds of health problems we could get, and it’s a good thing when new solutions are developed, but for those who are currently healthy, it is much easier to ignore the potential problem when we don’t have to pay for a potential solution.

More about Compensation and Productivity

In my previous post I discussed the empirical relationship between compensation growth and productivity growth in the US. One way of looking at the relationship is to look at the changes in labor’s share of total product – that is, gross compensation divided by gross output. This chart shows the evolution of labor’s share, measured 3 different ways (all computed for the business sector and expressed relative to their 1948 levels). The purple line (continued with estimates in yellow) uses NIPA data and divides “compensation of employees” by “gross value added.” The dark blue line (corresponding roughly to Lazear’s results) uses BLS data and divides “compensation” by “current dollar output.” The light blue line (corresponding roughly to Calculated Risk’s results) uses BLS data and divides “real hourly compensation” by “output per hour.”



The NIPA (purple) results are probably misleading because they ignore the decreasing role of proprietors’ income in the national accounts: labor’s share increased during the 50s and 60s because more production was shifted to the corporate sector in which labor gets separate compensation.

The BLS “product wage” (dark blue) results show a relatively steady share, although one might argue that there is a slight downward trend over time. In terms of dollars, workers are getting an output share only slightly smaller than what they got in 1948.

The BLS “consumption wage” (light blue) results show a dramatically declining share for labor. In terms of what they can buy with the money (compared to what firms can buy with their share), workers are getting a much smaller share (down by a factor of .73) than they were in 1948.

This discrepancy points to a basic flaw in the broadly phrased argument that “if productivity is rising rapidly, then standards of living for workers will also rise rapidly.” For the kind of time horizons that we’re dealing with here, the premise has to be about productivity of consumer goods, not productivity in general. Since productivity of consumer goods has in fact risen (though not as rapidly as overall productivity) and is expected to continue rising, Lazear still has a case to make, but he hasn’t quite made the case yet.

Compensation and Productivity

Does compensation always catch up with productivity? CEA Chairman Edward Lazear thinks so. Blogger Calculated Risk doesn’t. Which one is right? Turns out it depends on how you measure compensation.

Lazear presents a chart showing real compensation apparently following productivity closely. Compensation gets just slightly ahead in the 70s and falls just slightly behind in the 90s, but the two series always seem to catch up with each other (except at the very end, but that’s another story). Calculated Risk presents a couple of other charts which show more divergence. In particular, when he uses 1947 as the base year, compensation appears to follow productivity until the early 1970s and then falls farther and farther behind.

Why are their results so different? It turns out they are using different deflators for compensation. Lazear apparently uses the product deflator for the nonfarm business sector to produce his real compensation series. Calculated Risk uses the “real hourly compensation” series from the Bureau of Labor Statistics, which is produced using a consumption deflator. (I can’t figure out exactly what series the BLS uses to deflate compensation. It may be some version of the CPI or a consumption deflator from the national accounts. In any case, it appears to follow consumer prices.) In other words, Lazear measures compensation in terms of what people are producing (the “product wage”), whereas Calculated Risk measures compensation in terms of what people can buy with their compensation (the “consumption wage”).

Why do these two deflators produce such different results? They actually produce similar results until about 1970, and then they diverge. Something new has been happening in the last 35 years. To put it in general terms, many of the things Americans produce (computers, for example) have been getting cheaper, but most of the things Americans buy (health care, for example) have been getting more expensive. Much of the productivity growth we have experienced has been in the production of investment goods. That kind of productivity growth benefits the people who (indirectly) buy those investment goods, but it doesn’t help today’s workers very much (unless they’re also investors).

Inconvenient Weather

Now do you believe in global warming?

Yet Another Unconvincing Argument

The deficit redistributes wealth from relatively poor workers to relatively rich asset holders. The rich make a lot of money financing the deficit, while the poor get bad jobs because the deficit crowds out private investment, making workers less productive than they would otherwise be. This is a nice, elegant, classical argument, and I used to like it a lot back in the 1980s.

Today I’m not so sure. Is anyone making a lot of money financing today’s deficit? US investors are making a little bit: about 2.5% after inflation (but before taxes), judging by TIPS yields. Fully hedged Japanese investors are making exactly nothing. (The cost of hedging US Treasury securities into yen just offsets the interest on those securities.) Unhedged foreign investors (mostly central banks) will probably end up losing money.

Is the deficit crowding out private investment? Probably not in the US, because Asian central banks are willing to finance whatever deficit we throw at them. Moreover, the elastic part of investment in the US today seems to be in housing rather than productive assets. Is the deficit crowding out private investment in the Asian countries that finance it? By most accounts, China has too much investment already. Japan has near-zero interest rates, so there’s apparently not much of a crowd at the investment market. Generally, in Asia, the product demand coming from the US seems to be doing more to encourage investment than to discourage it. The crowding out argument applies when the world economy is running at or above potential. Today, it’s not.

Come back in a few years. If Japan has been running a convincingly positive inflation rate, maybe I’ll try to revive this argument.

Another Unconvincing Argument for Fiscal Responsibility

In an earlier post, I pointed out that, with the government’s interest rate below the expected US growth rate, running a deficit is cheaper than not running a deficit. The usual counterargument is that interest rates are going to rise soon, and then running a deficit will no longer be cheap.

If this is really true, it’s mostly an argument for the Treasury to finance at longer maturities. If interest rates are going to rise, the Treasury has the opportunity to lock in today’s low interest rates, and then running a deficit would once again be cheaper than not running a deficit. (It’s possible that a shift to long-term financing would push up long-term rates to the point where running a deficit becomes expensive, but we’ll never know until we try.)

But I have a couple of reasons for questioning the premise. First of all, if interest rates are going to rise, then what kind of idiots are out there holding the long-term bonds? You might say they are being held by central banks that don’t care about profits and losses. I’ll certainly acknowledge that central banks care a lot more about macroeconomic conditions than they do about profits and losses, but I won’t concede that they ignore profits and losses completely even when macroeconomic conditions are not an issue. If anything, investing short-term would give them more flexibility to deal with future changes in the macroeconomic environment. Why would they take the risk of investing long-term when they are getting no reward (indeed, being punished) for taking that risk? I expect that the People’s Bank of China has a pretty smart research staff, and if the PBoC is choosing to invest long-term, it is because they have good reason to expect interest rates to stay low.

When I look at macroeconomic conditions in the world, I’m inclined to agree with whoever is telling the PBoC not to worry so much about rising interest rates. With so much new labor being integrated rapidly into the world economy, potential output is rising quickly, but businesses are still cautious about investing (or, as in China, they are not so cautious, but they are facing adjustment costs), so central banks have to keep interest rates low to help actual output catch up with potential. Some (e.g. Japan and Europe) may be entering a tightening cycle, but others (e.g. the US) are nearing the end of their tightening cycle. In general in the world today, the risk that overheating will require interest rates to rise seems less than the risk that fragile sources of demand (e.g. overextended US consumers, emerging market investors) will collapse and require interest rates to fall.

Actually, I have come up with some reasons for me to oppose deficit spending, but rising interest rates isn’t one of them. (And, I’m afraid, neither are the reasons I will discuss in the next two posts on this subject.)

The Deficit and Future Generations, part two

As I asked in the previous post, if our descendants are going to be richer than we are, then why should we leave more for them than we’re already leaving? Here’s one possible answer.

In economic terms, even if consumption is increasing, the marginal utility of consumption may be increasing too, because innovation may produce new types of goods that are expensive to produce and severely nonsatiating (or it may produce many, many nonsubstitutable new types of goods that are expensive and only moderately satiating, which I think would be equivalent). To put it another way, except for the necessities that we obviously won’t give up, the goods we have available today are all basically a bunch of crap compared to what our grandchildren will have available. Wouldn’t it make sense for us to give up some of our crap so that they can have more of the really good stuff once it gets invented?

That’s the kind of argument that seems interesting at first but starts to seem silly once you put numbers or pictures to it. Would it have been reasonable for our grandparents – who mostly had to make do with bulky AM radios – to make additional sacrifices so that we could have more iPods? I don’t think so.

But there is one area where the argument might make some sense: medical technology. You might think of “lifespan” as an expensive (on the margin) and severely nonsatiating good. Another month of life is considered very valuable even if you’ve already had hundreds and hundreds of them. The technology to prolong life can get quite expensive, and new types of expensive lifesaving technology are constantly being invented. Moreover, “health,” though in one sense highly satiating (once you’re cured of a specific disease, you don’t need any more of the cure), is in another sense quite nonsatiating: even if a health plan already covers hundreds of diseases and procedures, you’ll be willing to pay more for it if it covers one more disease that you might get (even if it’s not life-threatening) or one more procedure that you might need (even if it’s not life-saving). It was reasonable for our grandparents to make sacrifices so that we could have laser surgery and MRI scanners.

Of course, in addition to laser surgery and MRI scanners, we do also have iPods. So apparently our grandparents made more sacrifices than they really had to. But if you look at what’s happening today, the idea of sacrificing for the sake of future medical technology may not seem so unreasonable. For several years now, people in some income ranges have typically experienced declining real wages but rising real compensation. The major difference is health insurance. In other words, they’re getting richer, but they’re spending all of the new income – and then some – on health care. To the extent that these people consume a constant fraction of their income, their overall consumption is going up, but their consumption of most goods is going down, even though the new goods they consume (more health care) are not substitutes for the old ones (iPods? restaurant meals? gasoline?). If this trend continues, then we have a clear example of growth that raises the marginal utility of consumption.

The Deficit and Future Generations, part one

In an earlier post, I discussed the argument that the budget deficit is economically efficient because it allows people to “borrow” at a low interest rate by paying lower taxes today and higher taxes in the future. The obvious counterargument is that the people doing the borrowing are not the same people who are going to be repaying. Is it fair to expect our grandchildren to pay for today’s government services?

Philosophically, the question of what we owe future generations is a difficult and controversial one, but with or without the national debt, we are leaving them a lot: the houses and offices we’ve built, the books and software we’ve written, the music and movies we’ve recorded, the businesses we’ve created, the machines we’ve constructed, the skills we’ve taught them, the technologies we’ve developed. It’s not obviously wrong for the bequest to come with a mortgage. The real question is, once you count the value of the assets and subtract the liabilities, are we leaving them too little, too much, or just the right amount?

Being an economist and not a philosopher, the only approach I’m prepared to take to this question is the utilitarian approach. If we leave more to future generations, will the additional amount be worth more to them than it is to us? Will it be more useful for them than it is for us? Will it give them more happiness, or relieve more of their suffering, than it does for us?

Once we’ve asked these questions, most economists will have to admit that the most obvious answer is “no.” Because productivity is growing and will in all likelihood continue to grow, our grandchildren will almost certainly be richer than we are. Why should we give up the things we want and need so that our grandchildren can have even more than the more that they will almost certainly have anyhow? In economic terms, the marginal utility of consumption falls as consumption rises, and consumption rises over time, so the marginal utility of consumption falls over time; therefore present consumption (by us) is more valuable than future consumption (by our descendants).

One obvious counterargument is that, properly measured, our grandchildren’s wealth won’t really be greater than ours. For example, if we allow global warming to become an ecological disaster, they’ll need all the resources they can get just to deal with all the extra hurricanes, tsunamis, and such. But if that’s true, wouldn’t it be better to run larger (or at least equally large) deficits and spend the money on finding solutions to global warming? It may be stupid to ignore global warming, but it is still almost certainly the case that, if we do things in the smartest way possible, our grandchildren will be richer than we are. As it is, they can blame us for being stupid about how we spend the money, but not for borrowing it in the first place.

There’s another counterargument that I find quite intriguing, but I’m afraid it will take a whole post to discuss. Until tomorrow, the anti-deficit case is still looking pretty weak.

Is the budget deficit destabilizing?

Hoping to avoid a descent into fiscal silliness, I am looking for reasons to be against the budget deficit. One possible reason is that the deficit has destabilizing effects on the international economy. It is surely true, to the extent that the deficit props up the dollar against floating currencies like the euro, that it sets up the dollar for a more precipitous fall – with more troublesome and unpredictable consequences – in the future.

On the other hand, the deficit may have a stabilizing effect on countries that (like China) effectively peg to the dollar or (like Japan) often intervene to keep their currencies weak. By pushing up US interest rates and thus making dollars more attractive to private investors, the budget deficit reduces the number of excess dollars that countries like China and Japan need to absorb. This presumably decreases the risk that such countries will eventually provoke instability by changing their minds about their massive dollar holdings.

So the answer to the question in the title of this post is only “maybe.” While it seems unlikely that the deficit has a net stabilizing effect (at least in today’s rapidly growing world economy), it is not clear that it has a net destabilizing effect.

US Job Market Jumps Off a Cliff

I wouldn’t read too much into any one indicator, but this one does have me a bit worried. Between February and May, help wanted advertising followed a steady downward trend, declining by over 12% in all, according to the Conference Board. (I have combined the Conference Board’s index with the Monster Employment Index to account for online job advertising. The raw Conference Board index actually declined by more than 15%.) Historically, declines of this magnitude have always been indicative of recessions (for example, March 2001 and November 1990).




There are reasons to think it might be different this time. For one thing, the data could be revised. And measuring the 3-month rate of change is only one of many ways to cut the data. The Monster Index did improve in June. (The Conference Board has not yet reported for June.) Hiring activity may be less important than in the past, as layoff rates are down, and the working-age population is growing more slowly. And employment as reported by households still seems to be rising rapidly. Nonetheless, after the third month of inadequate job growth as reported by firms (in today’s employment release), the decline in help wanted advertising does seem to be part of an unpleasant pattern.

How the Budget Deficit Props Up the Dollar

In an earlier post about the deficit and the dollar, I admitted to “glossing over a lot of details.” I’ll never get all the details into one post, but here are a few more.

What would happen if Congress were to reduce the deficit, let’s say by canceling a bunch of bridges to nowhere? If I were in a hurry, I would say, “The government will borrow less, easing demand on credit markets and causing interest rates to fall.” But that statement is misleading. Short-term interest rates are determined by Fed policy, and long-term interest rates are determined largely by anticipation of future Fed policy. The deficit affects interest rates because it affects Fed policy. So what would really happen? First, many of the people who were supposed to build those bridges to nowhere would lose their jobs, or would not be hired in the first place. The Fed, being a forward-looking institution, would attempt offset the decline in employment by stimulating new employment, which it would do by cutting interest rates.

What happens when US interest rates go down? Among other things, the dollar becomes a less attractive currency, because it offers less interest. Consequently, investors try to exchange their dollars for other currencies. These attempts to exchange dollars present different problems for different countries, depending on whether their currencies are pegged to the dollar.

Consider first a pegged country, China. China will have three options, none of which it will be very happy with. First, it can cut its own interest rates so as to reduce the incentive to hold yuan and stem the tide of dollar exchanges. The problem with this option is that it would further encourage Chinese investment, which by most accounts is already too high, and it would run the risk of causing the Chinese economy to overheat and generate inflation. Second, it can simply accommodate the demand for yuan by increasing its own holding of dollars. The problem with this option is that the People’s Bank of China already has more dollars than it could possibly want. At some point it’s going to start worrying about the risk it takes by holding ever increasing numbers of dollars. The final option is to revalue the yuan. It’s probably not as likely as the other options, but if we want to put pressure on China to revalue, cutting the budget deficit is a good way to do it.

Now consider an unpegged country – well, not a country but a union – the EU. Since the EU doesn’t normally intervene in the foreign exchange market, it will initially allow the market to handle the dollar exodus by letting the value of the dollar drop against the euro. The drop in the dollar will decrease demand for European products relative to US products, and the ECB will attempt to offset this decrease in demand by cutting interest rates. But how far will it go? Will it go all the way and cut interest rates to the point where the dollar rises back to its initial level? Consider what would happen if it did. Europe’s trade balance would be the same as before, but its interest rate would be lower. Since the lower interest rate stimulates demand domestically, the overall level of demand would be higher, and the ECB would worry about inflation. Consequently, it will not allow this situation to occur. It will cut interest rates somewhat, but not enough to fully offset the effect of the US deficit cut on the exchange rate. Thus, in the end, because the budget deficit declined, the dollar falls against the euro.

Notice that any US “weak dollar policy” or “strong dollar policy” has no effect on these outcomes (unless such a policy means that the Fed is willing to override its employment and inflation objectives). In principle, it can’t. If the US as a nation is going to borrow less, then it must run a smaller trade deficit, and the only way to do so (aside from having a recession) is to drop the value of the dollar to make US goods and services more attractive. If the government reduces its borrowing, unless this decline is offset by an increase in private borrowing (or unless the Fed allows a recession to happen), the dollar must fall, regardless of whether the US has a “strong dollar policy.”

TIPS

Boy, I miss some good stuff when I forget to check Brad DeLong’s blog for a day or two.

In the Red, White, and Blue

My economic intuition tells me that the budget deficit is bad and that we should make every effort to reduce it as much as possible, as soon as possible. That’s what all sensible economists think, isn’t it? The only economists who disagree are silly economists. (Politically, they are found on the right, the left, and the center, but they have silliness in common.) Yet when I think about this topic logically, I’m in serious danger of turning into a silly economist.

The US deficit clearly helped the world economy during the first half of this decade. What would have happened if the US hadn’t run a fiscal deficit from 2001 to 2005? The Asian countries, presumably, would still have bid the dollar up aggressively in order to ensure adequate demand; indeed, they would have had to do so even more aggressively to offset the weaker demand at any given exchange rate. Or possibly they would have given up, the Japanese economy would still be stagnating, and it would be joined in deflation by China. With the meager US demand going to keep the Asian countries out of severe deflation, there would be little left over for Europe and the rest of the world. The ECB would have brought rates down to zero, and Europe would be in a serious depression. Without a fiscal stimulus, a greater monetary stimulus would have been required to keep the US economy afloat: rates here would have gone to zero, and log cabins without indoor plumbing would be selling for seven digits. Ben Bernanke might well even have occasion to fuel up his helicopter.

The US deficit may still be helping the world economy. What will happen, then, if the US deficit disappears in the immediate future? If we’re lucky, the self-sustaining upward trends in private sector demand in the US, Europe, China, Japan, and elsewhere will continue. But there’s good reason to think we may not be so lucky. In the US, the end of the housing boom – if accompanied by a fiscal contraction – could send the economy back into recession, and we could end up in a position similar to where we were a few years ago. Hopefully, the Fed could succeed in replacing the stimulus, but the result would be a weaker dollar, wreaking havoc with the economies of those nations – such as our major trading partner, the UK – whose currencies trade freely against the dollar. Without the US eager to absorb it, Asia’s surplus of savings would be forced down the world’s throat, possibly inducing a worldwide recession and an international liquidity trap.

Running a (larger) deficit now is cheaper in the long run than not running one. It is often objected that our children will have to pay for today’s deficit. But in fact, it will be easier for them to pay than for us to pay now. The reason is that the US economy is growing at a rate greater than the interest rate the government pays on its debt. Therefore, for any marginal increase in the deficit from (or up to) today’s level, the tax rate increase necessary to pay it off in the future will be less than the tax rate increase necessary to eliminate it today.

Even if it weren’t cheaper, running a deficit would be economically efficient. Even if the government’s interest rate were higher than the growth rate, it would still almost certainly be lower than the marginal subjective discount rate for the average American. Given that many Americans are willing to borrow money at credit card interest rates, it seems likely that most would be willing to borrow even more if they could pay what the government pays. In fact, this behavior would seem to be a rational response to the income growth profiles expected by younger people. Aren’t they better off if the government borrows on their behalf at a very low interest rate, cuts their taxes today, and promises to raise their taxes, if necessary, later, when they can afford to repay?

This isn’t exactly “opposite day,” because I’m not quite ready to declare that my alter ego (author of the last 4 paragraphs) is definitely wrong. I still think he’s probably wrong, but there’s a real challenge here for sensible economists. Anybody want to take up the challenge?

Don’t Blame Rubin

Things are back to normal: I disagree with Dean Baker. But there is still something not quite right. Usually he is the one more critical of the Bush administration. This time he seems to be the one defending Bush.

Baker argues that the New York Times is wrong to blame Bush’s budget deficits for the high level of US foreign indebtedness and its potentially destabilizing effects. The problem, he argues, is the strong dollar, and this, he contends, is not the result of the budget deficit. If any American is to blame, he suggests that (former Treasury Secretary) Robert Rubin is the man.

He’s wrong. (Ah, yes, that feels natural.) First of all, he’s wrong because Treasury policy has little to do with the value of the dollar anyhow. Granted, there are occasions when a strategically placed gust of hot air from the mouth of the Treasury Secretary can shift the winds of a volatile foreign exchange market, particularly if the gust is supported by well-timed intervention and cooperation from foreign authorities. And granted, the Treasury can exert a slight modicum of influence over monetary policy, at least in the short run, when it comes to the value of the dollar. All these mechanisms might have been operative in 1985, when the dollar made a dramatic shift in direction after the Plaza Accord. But ultimately, the subsequent weakness of the dollar depended on a loose monetary policy occasioned by the sudden drop in oil prices in early 1986, which reduced the inflation rate while causing a regional recession in the Southwest. (Interestingly, the rest of us seemed not to notice that recession. Here in the Northeast, I only became aware of it several years later when I was studying regional data for my thesis.) In any case, the Plaza Accord seems to be a unique event. There is no analogous reverse event in the 1990s that caused the dollar to strengthen. It was strong not because of US Treasury policy but because the US was perceived as a good place to invest.

Second, he’s wrong because a strong dollar in the 1990s was a good idea, whereas a strong dollar (or even a not-weak-enough dollar) today is a bad idea. In the 1990s, the capital inflows supporting the strong dollar were largely going to private investment (directly or indirectly). A weak dollar in those days would have either dried up that foreign investment or caused our economy to overheat. Today, the capital inflows are largely going to consumption. A weak dollar today, properly engineered, could be associated with a higher savings rate rather than less investment.

Finally, he’s wrong because the budget deficit is the reason for the strong dollar. If the US were not trying to borrow so much, dollar interest rates would be lower (relative to other currencies), there would be less incentive to hold dollars, and the value of the dollar would be lower against those currencies that don’t peg to it (including that of our largest historical trading partner, the UK). (I’m glossing over a lot of details here, but that’s the gist of it.)

When I think about what might happen (or what might have happened) to the world economy without the US deficit (and the strong dollar), though, I wonder if it’s really such a bad thing. But that’s a big topic, and this post is already too long.

The Economics of Journalism of Economics

In a post that uncharacteristically portrays a (former) member of the Bush administration in a positive light, Brad DeLong continues his criticism of the mainstream media:

The world is a complex and intricate place. How is anyone to understand it--even a particular piece of it, for example the United States government in Washington DC and its economic policies? It is a big problem, for the standard sources that I was taught (perhaps wrongly) as a child to rely on--the Washington Post, the New York Times, Walter Cronkhite on the evening news--are breaking down.

I will suggest that he was in fact taught wrongly. But first I note that he later makes some important exceptions:

If you want to understand Washington DC, the American government, and American economic policy, then: trust the news pages of the Wall Street Journal, trust the Financial Times, trust the political and lobbying coverage of the National Journal. Trust Bloomberg and Knight-Ridder to try as best they can to get the story straight under immense time pressure.

I know very little about the National Journal, so I won’t comment on that, but the other four media outlets mentioned here have something obvious in common: they are all business and financial media. That orientation stands in contrast to those mentioned disparagingly in the earlier citation.

I am regular reader of the Wall Street Journal myself. (To be honest, I usually only make it through column 2 of the front page, and perhaps column 3, depending on how much fiber I ate the previous day.) The Journal’s coverage is far from perfect, but since it is the only paper that I read (even one column of) regularly, revealed preference would suggest that I tend to agree with Brad.

But even if I had never read the New York Times, it wouldn’t surprise me that the Journal has more reliable coverage. Business media are designed to provide news as useful information; general media are designed to provide news as a form of entertainment. Times readers want to find out what’s happening in the world because they enjoy finding out what’s happening in the world. In principle it doesn’t make much difference whether what they find out is what’s actually happening or some contrived alternate reality. In practice the distinction matters only to the extent that readers are likely to check the information against other sources.

Journal readers want to find out what’s happening in the world because they are going to make practical decisions based on that information – not just ineffectual decisions (from the individual perspective) like who to vote for, but decisions – like what investments to choose, how many widgets to produce, or whether to accept a merger offer – that will have noticeable effects on their lives. If the Journal gets a story wrong, it makes a practical difference to readers. Unlike the case of the Times, whether a story is substantively accurate makes more difference than whether the story is enjoyable to read. Naturally it is in the Journal’s interest to allocate more of its resources toward getting the stories right.