Oil Demand Elasticity

In the light of the story in column 5 of today’s Wall Street Journal, I’d like to amend my application for membership in Greg Mankiw’s Pigou Club. To quote my earlier position,

I have to confess that my rationale is not 100% Pigovian. It seems clear to me that, even if Al Gore is only a little bit right about the causes and consequences of global warming, the optimal Pigovian tax is extremely high – much higher than what would be politically feasible (in the US) even in my wildest dreams. Energy demand is just not elastic enough, even in the long run, and the social costs of global warming are too high. So, for practical purposes, I see any increase in energy taxes more as a nondistortionary tax than as a Pigovian tax. There is a standard argument that taxes don’t do any harm if they don’t change behavior; in this case, changing behavior is gravy. (As for global warming, well, I’m just glad I’m going to die in another 40 years or so.)

“Energy demand is just not elastic enough, even in the long run…” After today’s news, I’m not so sure:

Oil consumption fell in the developed world last year for the first time in more than 20 years…

Never mind the rest of the article; the first half of the headline is enough. I thought oil consumption might fall eventually, but I was sure it would take a big recession to accomplish that. But instead here it is: good, old-fashioned demand elasticity. Make energy more expensive, and people just buy less of it. I feel like a kid who is old enough not to believe in Santa Claus but then sees a man in a red suit climb out of the fireplace.

I still think the optimal Pigovian tax is considerably higher than anything that might conceivably be politically feasible in the US. But I’m willing to say now that this is more a problem with the US political climate than with the enormity of the economic problem surrounding climate change. The economic problem is still a big one, but perhaps not so gargantuan as to be unsolvable. And I guess I can be a true Pigovian now, rather than a Ricardian masquerading as a Pigovian.

I temper my newfound optimism, however, in a couple of ways. First, as implied above, given political reality, I do not think a Pigovian tax would be sufficient to solve the problem (especially when you recognize that the US – indeed the whole developed world – is only part of it). Second, I’m not quite sure this guy in the red suit is really Santa Claus: a lot of what has happened recently is a shift of energy-intensive production from the developed world to the developing world, and most of the products are still consumed in the developed world, so it’s not clear how much of this ostensible reduced demand is really just a geographic shift in where the energy is used to satisfy existing final demand. Still, I didn’t expect to see anyone in a red suit coming out of the fireplace, so I’m pretty impressed, even it’s just Uncle Joe who decided to do something crazy after the 20th eggnog.

Housing Price Wealth Effect?

This topic is rather stale, but it’s on my mind again, and it appears I never made this point before in this blog.

I have no doubt that home prices have a positive (as opposed to inverse) effect on consumer spending. But I quibble strongly (and who can quibble more strongly than I?) with the semantics when people refer to this effect as a wealth effect. Rising home prices do not, in general, increase aggregate wealth (or, as may be more relevant in the immediate future, falling home prices do not reduce aggregate wealth). For the relevant range of values, over the relevant time frame, in aggregate, households are short the housing market, not long the housing market.

If you own a house and plan to keep living in it, you gain no direct advantage when the market price rises. If you don’t own a house but hope to own one in the future, you do suffer a direct disadvantage when housing prices rise. Aside from builders and speculators, the only people who benefit directly from rising home prices are those who contemplate selling their homes either for the purpose of moving into a rental property or for the purpose of buying a less expensive home. Do you know a lot of people who fit into that category?

Granted, homeowners do gain an indirect advantage when home prices rise: the value of their collateral goes up, and they can borrow at a lower interest rate. (My former unsecured creditors and I are well aware of this effect.) This is partly a wealth effect, because it means that the present value of homeowners’ liabilities is reduced, thus increasing their net wealth. (With a little fancy economic theory, I could show that this is also a wealth effect for new borrowers, assuming they are behaving rationally.) But weigh this indirect benefit to current homeowners against the direct cost to future homeowners, and it would seem rather tough to come up with a positive net wealth effect. (I’m also ignoring the loss to creditors, who must accept lower interest rates, because I’m not prepared to deal with the thorny theoretical issue of risk adjustment.)

The positive effect of home prices on personal consumption has to do not with wealth but with liquidity constraints. Rising home prices increase consumption for the same reason that temporary tax cuts increase consumption: they put more money in people’s pockets (though mortgage equity withdrawal). Money, not wealth.

Idea for Blogger

For an ordinary blogger like me, the spam comments seems to come mostly with a delay of at least a few weeks (presumably after the spambots have decided which posts to spam), whereas most of the legitimate comments come within a few days. I’d rather not subject legitimate commenters to those annoying human-readable text tests if I don’t have to. Here’s my suggestion: Blogger should have a time delay (chosen by the blogger) before applying the test. So if you comment within, say, the first 3 days, your comment will go straight through, whereas if you comment a month later, you’ll be subject to a security check. (Or do they already have this feature, and I don’t know about it?)

Help Wanted Advertising Stabilizes

US help wanted advertising, which dropped precipitously during the spring and summer of 2006, appears to have stabilized during the fall. The Conference Board Help Wanted Index was essentially flat from August through November (the latest report), at a level about 20% lower than where it was a year earlier. (Taking online advertising into account would mitigate the decline, but given the normal growth in help wanted advertising over time due to a growing economy, the 20% figure gives a pretty good indication of the amount of deterioration.)

What this means exactly I’m not sure, but in my mind it tends to reduce the chance of a recession. On the other hand, it also tends to confirm the expectation of an economy too weak to please Main Street, and perhaps a little weaker than Wall Street would prefer.