Sunday, January 25, 2009

It Was the Saving Glut?

An increasing number of observers are placing the origins of the current economic crisis with the saving glut explanation of global economic imbalances. This trend was noted (and more-or-less endorsed) by The Economist this week and mentioned by Menzie Chinn in this post. It is worth noting some prominent observers such as John Taylor and Stephen Roach dismiss the notion of a saving glut entirely and instead pin the blame on bad policies. My own view is that both bad policies--specifically loose monetary policy--and a saving glut played a part. Here is what I said over at Econbrowser on the role played by policy:
What the about Fed's low interest rates in early-to-mid 200s? Surely there was something exogenous here in that no one expected the interest rates to drop as low and long as they did during this time. Not only did the Fed's unexpected loose monetary policy affect domestic consumption/savings, but it got exported to the dollar block countries and to some extent to non-dollar block countries (e.g. ECB had to keep watchful eye on dollar lest the Euro got too expensive). I am not saying it was the only enabler, but it certainly seems important...
I further develop this point--and provide some evidence--in this article (see page 374). However, as noted by Brad Sester, the expansionary policy story for the rising current account deficit best fits the data for the period 2002-2004 while the traditional saving glut story does a better job thereafter. Of course there were other factors at work during this time--the securitization of finance, underestimating aggregate risk, the lowering of lending standards--but the low interest rate environment generated by these two forces was a key contributor to the current economic crisis.

Saturday, January 24, 2009

The Future of the Euro (Part V)

Here is another article--this one from the New York Times-- suggesting the current economic crisis may ultimately force some countries off the Euro. Some observers like Willem Buiter and Barry Eichengreen dismiss such claims. Here is some of what Eichengreen has to say:
There is an alternative [to abandoning the Euro], namely fiscal retrenchment, wage reductions, and assistance from the EU and the IMF for the cash-strapped government.

To be sure, this alternative will be excruciatingly painful. No one will like it except possibly the IMF, which will relish the opportunity of reasserting its role as lender to developed countries. There will be demonstrations against the fiscal cuts and wage reductions. Politicians will lose support and governments will fall. The EU will resist providing financial assistance for its more troublesome members.

But, ultimately, everyone will swallow hard and proceed... [E]ven the most blinkered politicians will see what is at stake here. Investors would flee en masse from the banks and markets of a country that contemplated abandoning the euro. No matter how serious the crisis, politicians will realise that attempting to jettison the euro will only make it worse.
Dr. Eichengreen, one word: Argentina. This country tried fiscal retrenchment, wage reductions, and help from the IMF leading up to the 2001-2002 crisis. And yes, the leaders of Argentina realized that if they abandoned their dollar peg this action would likely lead to default and investors fleeing en masse from Argentina. But they still broke the peg. Commentator Brian over Willem Buiter's blog sums up this comparison best:
[I]f Argentina decided to leave the dollar, because it couldn’t take the pain of real depreciation without nominal depreciation, should we be that surprised if Greece (or more likely Ireland) shares a similar fate? The scale of the real depreciation required by Ireland, which has been amplified by sterling’s depreciation, looks particularly daunting.
See also Paul Krugman who makes a similar point here. History shows us that anything could happen, even a country leaving the Euro.

Where Are the "Safe" Jobs?

The New York Times had an article today titled "Bad Times Spur a Flight to Jobs Viewed as Safe." Here is an excerpt:
Fearing layoffs, investment bankers at a Merrill Lynch or a Morgan Stanley are joining small Wall Street firms for less pay but with signed employment guarantees. Academics are migrating to community colleges, which are adding teachers as enrollment rises. And in Eastern Wisconsin, workers furloughed from a paper mill they fear will not reopen are training as truck drivers and welders.
It was interesting to read how individuals displaced by the recession or fearful they would be displaced by the recession are taking steps to secure what they perceived to be safe jobs. This got me wondering how one would know what is a safe job at this time. I looked to the Nonfarm Payroll employment data broken into sectors for some insight. Below is what I found for the period covering the recession (click on figure to enlarge):


So 3,369,000 net jobs were lost in the first 11 sectors in the table and 780,000 net jobs were added in the latter three sectors. I would not put too much hope in the first of these three--natural resource and mining--going forward.

Update: Further evidence that the safe jobs are in the government, education, and health care sectors can be seen below. The first figure shows employment in the professional & business services and retail trade sectors since 2000s. They are highly procyclical sectors. (Click on figures to enlarge.)

The next figure shows employment in the government and education & health services sectors. Notice any contrasts?


Monday, January 19, 2009

The Battle of the Spreads

The treasury yield curve spread--the interest rate on a long-term treasury minus the interest rate on a short term treasury--has been a good indicator of future economic activity. Typically, if the spread turned negative a recession was looming and vice versa. The corporate bond yield spread--the interest rate on a risky corporate bond minus the interest rate on a safer corporate bond--has also been a good indicator of future economic activity. Here, if the spread significantly increased in value then a recession was looming and vice versa. So what do these spreads now show? Are there any signs of hope? First take a look at the 10-year treasury yield minus the 3-month treasury yield spread in the figure below. (click on figure to enlarge.)

As you can see from the figure, the spread is currently relatively large and positive, usually a sign of economic growth ahead. This fact was noted by the Cleveland Fed recently as indicating the recession may soon be over. However, Paul Krugman took issue with this interpretation:
The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down.

[...]

So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.
So Krguman does not take solace in the current yield curve spread. Does his interpretation find support in corporate bond yield spread? Or does it provide some sign of hope? The figure below provides an answer. It plots the corporate BAA yield minus the corporate AAA yield spread. (Click on figure to enlarge.)

This figure suggests Krugman's view is correct: the corporate yield spread is the largest it has been since the Great Depression. No sign of soon recovery here.

Update: Paul Krugman replies to Dean Baker's assertion that corporate yields do not show a credit crunch.

Friday, January 16, 2009

The Failure of Deflation Orthodoxy

As readers of this blog know, I am someone who believes that the loose U.S. monetary policy of 2003-2005 was an important contributor--though not the only one--to the buildup of economic imbalances that are the source of the current economic crisis. I have also argued that a key a reason for the highly accommodative monetary policy was that the Fed, following the conventional wisdom on deflation, viewed the deflationary pressures at the time as a sign of weakened aggregate demand and acted to offset it. Though well intended, the Fed's response was highly distortionary since the deflationary pressures turned out to be driven by rapid productivity gains rather than weakened aggregate demand. The Fed, therefore, was adding significant stimulus to the economy at the same time it was being buffeted by rapid productivity gains, a surefire way to push the U.S. economy past its speed limit. What all this means is that had the Fed been better able to distinguish between malign and benign deflationary pressures some, maybe much, of the economic imbalance buildup could have been avoided. This is an important lesson from this economic crisis. It is also one that I more fully discuss in a recently published article that can be found here.

Update: In addition to my article cited above, other recent papers making a similar case include William White's article "Is Price Stability Enough?" and this interesting article by The Economist magazine.

Tuesday, January 13, 2009

The Great Depression Debate in One Picture (Part II)

Over at his blog, Eric Rauchway takes note of my attempt to summarize the Great Depression debate in one picture. He asked me what years I used to make the trend. The answer is I used the entire 20th century to estimate the fitted linear trend. The figure below shows log real GDP and trend log real GDP for this time. This figure also make clear why constructing the trend this way is a reasonable approach: it shows a persistent pattern of growth for the entire period, except for the 1930s. (Click on figure to enlarge.)


Eric also notes that my original graph only speaks to one of the three Rs--relief, recovery, and reform-- of of the the New Deal, the recovery. I am not sure there is a good way to summarize the other Rs, but the figure below which similarly graphs per capita log real GDP and its trend may provide some perspective on the relief front. (Click on figure to enlarge.)

All data comes from the historical GDP database at EH.Net

Saturday, January 10, 2009

The Employment Numbers in Perspective

Friday we learned the employment conditions continue to deteriorate:
The nation lost 524,000 jobs in December, bringing the total drop for last year to 2.589 million, just shy of the 2.75 million decline at the end of World War II, the Labor Department reported yesterday in Washington. The unemployment rate climbed to 7.2 percent, the highest level in almost 16 years.
Although these numbers are bad, the widely-reported comparison to WWII is misleading. It fails to account for the fact that the U.S. labor force is now about 2.5 times larger than at the end of WWII. Consequently, a more appropriate comparison would look at the number of lost jobs relative to the labor force for these two periods, not the absolute number. Alternatively, one could simply look at the percent change in employment. As noted by The Economist magazine, this approach shows a 1.9% employment loss in 2008 versus a 2.7% 12-month loss at the dept of the 1974-75 and 1981-82 recessions. This fact is highlighted below in the figure of the year-on-year percent change in NFP employment since the late 1940s. Recessions are highlighted by the gray columns. (Click on figure to enlarge.)

To be clear, I am not saying the almost 2.6 million lost jobs are inconsequential. What I am saying is that these numbers do not yet indicate that this recession in terms of employment is the worst since the end of WWII.

Update: ECB once again provides a good response in the comments section:
[I]f we look at the fall-off in the employment/pop ratio since 2000, that is dramatic is it not? And one measure of hardship that mainstream economists ignore, is the number of people suffering from what USDA calls food insecurity. This number now stands at 12 million. That is a 40% increase from 2000. I think you may be a little blase in downplaying the recent employment fall.
See also Barry Ritholtz's post here for more sobering news coming from the labor force participation rate.

Thursday, January 8, 2009

Monetary Policy and the Crime Rate

Mark Thoma directs us to an interesting article by James Q. Wilson on the link between the economy and crime rates. Wilson notes that while economic conditions can explain some of the variation in the crime rates, there are other important contributors:
Economists who have checked this view have discovered that it is often true, but not always. They have found, for example, that the burglary rate goes up by 2 percentage points for every 1-percentage-point increase in the unemployment rate. That sounds like a big change until you realize that if the unemployment rate rises from 6% to 8% (which is about what it is in California now), the burglary rate will increase by 4%. Because burglaries aren't measured all that accurately (some are never reported, and police vary in how they report the statistics), it's not certain that we would even notice so small an increase.

A lot of other factors affect the crime rate as well. It often goes up when the population gets younger, and when drug abuse becomes more common. Murder rates are profoundly influenced, at least in big cities, by gang activity. We don't have good ways of understanding why gang activity changes, though we suspect that changes in behavior are influenced by what the police do, whether gang truces have worked and whether gangs are fighting over drug and other illegal transactions.

All these imponderables make it difficult to fully understand why crime rates rise and fall...[So] [w]hy do crime rates change? If you have any good ideas, let me know.
Professor Wilson, how about monetary policy? That is what Garett Jones and Ali M. Kutan find in their study Volatile Interest Rates, Volatile Crime Rates: A New Argument for Interest Rate Smoothing:
Good monetary policy requires estimates of all of its effects: monetary policy impacts traditional economic variables such as output, unemployment rates, and inflation. But does monetary policy influence crime rates? By extending the vector autoregression literature, we derive estimates of the dynamic effect of higher interest rates on crime rates. Higher interest rates have socially and statistically significant positive effects on rates of theft and knife robberies, while effects on rates of burglary and assault are smaller and statistically insignificant. Higher interest rates have no effect on homicide rates. We conclude that monetary policy influences the rate of economically-motivated crimes.
These findings suggest that Greenspan's low interest rate policies that fueled the housing bubble also lowered the crime rate.

Wednesday, January 7, 2009

Any Hope for the Global Economy?

Foreign Policy asked five observers who saw this economic crisis coming to assess what will happen to the global economy in 2009 (hat tip Mark Thoma). Here are two excerpts:

Nouriel Roubini:
Last year’s worst-case scenarios came true. The global financial pandemic that I and others had warned about is now upon us. But we are still only in the early stages of this crisis. My predictions for the coming year, unfortunately, are even more dire: The bubbles, and there were many, have only begun to burst.

Stephen Roach:
Before the year is over, no major region of the world will remain unscathed by recession. Indeed, I suspect that 2009 will go down in history as the first truly global recession of the modern economy.
The other contributors--Robert Shiller, David Smick, and Dean Baker--offer similarly discouraging assessments for 2009. Ken Rogoff, however, tells us not to lose faith:
But, just as optimists were too sanguine in the boom, ultra-pessimists probably go too far in forecasting a depression around the corner. 2009 will be a tough year. Yet, absent a large-scale conflagration, there is a fair chance that 2010 will see a restoration of weak growth in the U.S., Europe, and Japan, and probably robust growth in most emerging markets. The U.S. economy may have lost a fair chunk of its mojo, but it will require a lot more bad luck and policy blunders to get to a second worldwide Great Depression.
Thanks Ken for those encouraging words.

The Great Depression Debate in One Picture

The debate on whether the New Deal ended or prolonged the Great Depression of the 1930s continues with the latest installments coming from David Sirota of Slate and Jason Bean of The Beacon (hat tip Alex Tabarrok). This debate has been an ongoing one in the blogosphere with notable discussions in the past coming from Brad DeLong, James Hamilton, and Arnold Kling. Lately, though, this debate has taken on an increased intensity as many observers have been using the Great Depression experience to make sense of the current economic downturn. Among others, recent contributors to this debate include Paul Krugman, Alex Tabarrok, Eric Rauchway, Robert Higgs, and Amity Shlaes. With apologies to the contributors for oversimplifying, here is my attempt to summarize and capture the essence of this debate in one picture (click on figure to enlarge):

Sunday, January 4, 2009

The Future of the Euro (Part IV)

Sorry Barry Eichengreen, but Martin Feldstein tells me I should worry about the Euro.

Is the Recession Really Better for Evangelicals?

Paul Vitello's New York Times article that cited my research has started something of debate as to whether Evangelical Protestant churches truly are benefiting from the current recession. The debate began when Frank Newport of Gallup replied that polling numbers do not show any overall increase in weekly church attendance, a fact gleefully promoted by Jack Shafer of Slate and later challenged by Mark Silk. More recently, Tobin Grant of Christianity Today weighed in on the matter and concluded that there is no "evidence that evangelical churches would benefit more than other religious groups." His piece was of particular interest to me because he references my work and along the way makes this claim:
[Paul] Vitello should have interviewed a few more sociologists or economists, who would have told him that the link between recessions and revivals is just myth. This may have helped avoid the back-and-forth that has resulted in confusion over a topic where we need much more clarity.
Unfortunately, Grant himself adds to the confusion by making this brazen claim. Had he read my paper fully or knew the literature better on this issue he would have been more cautious in his conclusions. There is both evidence and theory that suggest a link between the business cycle and religiosity. Moreover, this evidence and theory also points to evangelical Protestants benefiting more from recessions than their mainline counterparts. Here is a quick overview.


Stephen Sales in a 1972 study titled "Economic Threat and the Determinant of Conversion Rates in Authoritarian and Nonauthoritarian Churches" found that the conversion rates for more conservative denominations to be countercyclical while for more liberal denominations they are procyclical. J.H. McCann did a study in 1999 titled "Threatening Times and Flucutations in Church Membership" that similarly used the authoritarian-nonauthoritarian classification scheme. His conclusions mirrored Sales. Although their studies were not limited to Protestant denominations, there is a close mapping in them between the authoritarian and Evangelical denominations. My own study also looked at membership patterns for a sample of 25 Protestant denominations over the years 1968-2004. I found a systematic countercyclical component to the membership of the evangelical Protestant denominations during this time. Specifically, evangelicals grew significantly faster in recession years, when unemployment picked up, and when the stock market tanked. This was not the case for the mainline Protestants. Grant, however, tries to dismiss these findings:
Beckworth's findings were limited to changes in total annual membership of 24 Protestant denominations. Beckworth acknowledges that this is merely a proxy for other types of religious activities such as attending worship. But as CT readers well know, church membership means different things in different denominations. Some have been members since infancy. Others attend the same church for decades and never become members. Membership also changes for reasons other than changes in religiosity. When a diocese, synod, or other group of churches leaves in protest, the membership numbers decline dramatically... At other times, church membership numbers may be inflated and need to be corrected.
The problem with Grant's critique is that while everything he said may be true, it cannot explain why for 30+ years the above mentioned economic measures were systematically associated in a countercyclical fashion with evangelical Protestant membership and not with mainline Protestant membership. The easy answer is that while all these other idiosyncratic factors may have been influencing membership, so was the economy. In fact, this understanding is consistent with my findings: about 1/3 of the variation in evangelical Protestant membership growth is explained by the economy. That leaves the rest to the Grant's other factors.


To be clear, a key assumption in these findings is that increased religious participation by U.S. Protestants will be manifested in increased attendance at churches and, in turn, in increased church membership. While increased religious participation could also be manifested in other ways, it should been seen at a minimum in increased church attendance and eventually in increased membership if some of the new attendees formally join the church. Yes, ther factors will also be influencing membership numbers, but given what the data shows this assumption is reasonable.

Now even if you accept Grant's critique of the membership findings, you then have to wrestle with the other findings in my paper. Primarily, the finding that during the last recession in 2001 employment status was a significant determinant of weekly attendance at church. This data was based on a pew survey and controlled for a number of confounding factors, including the 911 effect on attendance. What I found is that if one were unemployed there was a greater probability that he/she attended church weekly. Moreover, being unemployed only had an effect on evangelical Protestants.

This part of the paper also helps shed light on Newport's finding that overall attendance has not gone up. My findings for this period showed about 42% of population attended church weekly, almost identical to Newport's finding for this year. But this number by itself it does not necessarily shed light on the effect of the recession. What is needed to see what part of the population that is adversely affected by the recession is attending church on a weekly basis. That is how I found a higher rate of attendance in the 2001 recession. I suspect Gallup would too if they sliced up their data this way.

Finally, There are compelling a priori reasons why why evangelical Protestants should benefit more from recessions than mainlines Protestants. First, evangelicals sell a different product than mainlines. Of interest here, is that they sell more certainty. Mainline churches are more likely to have fewer absolute beliefs, question the Bible more, and raise more questions about God's role in human affairs. Evangelical Protestants, on the other hand, are more likely to sell a powerful God that can get you a job and bring you financial peace. For someone who is unemployed and trying to feed a family, the evangelical message is far more compelling. Second, evangelicals on average come from a lower socioeconomic background than mainlines. This means they are more likely to have a higher opportunity cost for religion. As a consequence, during economic booms religious participation becomes too costly while during recession it becomes cheap for them. The opposite holds true for mainline Protestants. (See here for more on these channels. There is also a social capital formation channel I discuss in the paper.) These stories imply that evangelical Protestants have more to gain during an economic downturn.

Let me close by noting that while I believe there is evidence and theory to support a link between the business cycle and Protestant religiosity, only time will tell is it will be borne out in this recession. I am, however, certain that calls to dismiss this link at any level are not well founded.

Update: The recession is the not the same everywhere in the United States. As I noted here, some states like Texas and Oklahoma are still adding jobs while states like California and Florida are a workers nightmare. Consequently, the benefit to evangelical churches should be occurring more in these states.