July 10, 2003

David Wessel Wonders When the Recovery Will Begin

David Wessel wonders when the real recovery will begin--when real GDP will begin to grow at the 3.5% per year pace that we think is needed to keep the unemployment rate from rising, or the 4.0% per year pace that we think is necessary if unemployment is to start to decline (and even then only slowly: by perhaps 0.2 percentage points per year). Forecasters tell him that the real recovery should begin very soon--but they said the same thing six months ago, and six months before that as well.

More disturbing is the fact that it is not at all clear where any extra boost to the economy could come, should one turn out to be needed. The Federal Reserve is out of gunpowder. More aggressive fiscal policy--bigger short-run deficits--would be possible, but neither the president nor the congressional majority has shown any inclination at all to think seriously about how to try to use spending and tax policy to boost employment and growth in the next year or so. If neither monetary nor fiscal policy can be of use, the only remaining policy lever is to try to boost exports by talking the dollar down--a very difficult, hazardous, and possibly counterproductive exercise.

WSJ.com - Capital: ...But business spending is showing only the slightest signs of an upturn, and employers still are cutting payrolls. "Businessmen are unwilling to get out in front," says Mr. Meyer, who works with Macroeconomic Advisers LLC of St. Louis, which sees 4.5% second-half growth. "There is this lingering doubt that they know something we don't know."

Economists argue business has run out of excuses. "We felt like we were in this situation a year ago, and then came the accounting scandals and the stock-market sell off. We felt like we were in this situation six months ago, and then came the war with Iraq," says Robert Melman of J.P. Morgan Chase & Co., which expects 3.75% growth in the second half.

But executives don't need to justify their caution to economists. Nothing about this business cycle has obeyed forecasters' computer models so far. If business decides not to come to the party, there won't be a party. "Businesses want to see stronger demand for their products, and they don't see it," says Bank of America's Mickey Levy, whose relatively pessimistic forecast is for 2.9% growth for the rest of the year. "What's going to lead businesses to want to build inventories in the current environment?"

Then there are American consumers, stalwarts of the global economy. The optimistic consensus expects consumer spending to grow a bit faster in the second half than in the first. But why is that likely? Auto makers find consumers less responsive to zero-rate loans. The cash-generating mortgage-refinancing boom may be ending. And employers aren't adding many new workers yet, and are squeezing health-care and pension benefits for existing workers.

"Any newfound optimism will quickly fade unless the job market soon rights itself," admits Mark Zandi of Economy.com, a West Chester, Pa., forecaster that sees 3.5% second-half growth. "It's unlikely that consumers will ... continue to shrug off the mounting job losses and rising unemployment for much longer." That concern is precisely what has many businesses holding back.

The federal government has done all it's going to do to help the economy, its efforts partly offset by tax increases and spending cuts by states and localities...

Note that Wessel is careful not to say that the federal government has done all that it could have done to assist the economy. It could have proposed and pushed for a real, substantial short-term stimulus package to boost economic growth in the short run (rather than claiming that long-run tax cuts with extraordinarily little short-run employment and demand boost bang for the buck were a "stimulus package"). They could have acted quickly to repair the damage done by corporate accounting scandals (rather than sitting on their hands, when they weren't wondering why investors were upset when companies like Halliburton secretly made material changes to their accounting practices). They could have forgone their adventure in Iraq (which, whatever the real reason for it was, was definitely not aimed at protecting Americans from Saddam's weapons of mass destruction--Saddam's weapons of mass destruction are now in the hands of people with no known address who are hard to deter). It could have taken steps to boost business confidence by demonstrating that the president cared about getting economic policy right (instead of making it very clear--through the steel tariff, the farm bill, and the extraordinary disconnect between administration claims and the actual effects of its policies--that it really did not care about getting economic policy right at all). The president doesn't control the economy. The president can, however, powerfully influence the economy. And this president hasn't--at least not in any positive direction.

Posted by DeLong at July 10, 2003 12:21 AM | TrackBack

Comments

Why is talking the dollar down difficult or hazardous?

The real question is surely whether it would be worth it over the timescales, given J-curve effects and as exports are a relatively small proportion of US output.

Posted by: PJ on July 10, 2003 12:15 AM

"The president doesn't control the economy. The president can, however, powerfully influence the economy. And this president hasn't--at least not in any positive direction."

He's put plenty of money into the hands of the rich. And they have rewarded him by donating in record amounts.

I bet he considers that positive economic influence.

Posted by: Ian Welsh on July 10, 2003 01:18 AM

I wonder how practical it is to start devaluing the dollar or talking it down. We have to import a lot of dollars to meet our trade and budget deficits. If we start talking down the dollar, or if investors even expect that the dollar is going to fall relative to other major currencies, that will make it much harder to sell dollar debts. We would then have to pay higher interest on government bonds, increasing the deficit without gaining any stimulus effects. That would probably force other interest rates hiogher, leaving a big mess - perhaps a return to the stagflation of the 70s in a worst-case scenario.

Posted by: Alex on July 10, 2003 01:36 AM

The recent recovery in the dollar vs the euro seems to stem largely from Japanese investors, who were big buyers of euro-denominated debt on the euro's way up, shedding that debt in favor of the Nikkie and US debt (corporate and agency, as well as Treasury debt). That sort of gets to the point Alex made. To the extent that governments actually have control over currencies separate from monetary policy (Bush says Greenspan determines the dollar's value), is it wise to drive down the currency of a nation that is a net borrower? Japan's efforts to drive down the yen are a horse of a different color, what with the big current account and savings surpluses Japan runs.

Posted by: K Harris on July 10, 2003 05:03 AM

When the economy is at a low point, next year will be either better or much better. Come next year to show an even worse economy, then next year will be either better or even much better.

Nothing new here, this blabber can be traced back in centuries or probably millenniums long gone.

And - lo and behold - when one day, perhaps after many years of decline, the economy starts growing again, you'll hear "what did I tell you!"s over and over again. This too, can be traced back in centuries past.

Posted by: John Ståhle on July 10, 2003 06:18 AM

When the economy is at a low point, next year will be either better or much better. Come next year to show an even worse economy, then next year will be either better or even much better.

Nothing new here, this blabber can be traced back in centuries or probably millenniums long gone.

And - lo and behold - when one day, perhaps after many years of decline, the economy starts growing again, you'll hear "what did I tell you!"s over and over again. This too, can be traced back in centuries past.

Posted by: John Ståhle on July 10, 2003 06:23 AM

When the economy is at a low point, next year will be either better or much better. Come next year to show an even worse economy, then next year will be either better or even much better.

Nothing new here, this blabber can be traced back in centuries or probably millenniums long gone.

And - lo and behold - when one day, perhaps after many years of decline, the economy starts growing again, you'll hear "what did I tell you!"s over and over again. This too, can be traced back in centuries past.

Posted by: John Ståhle on July 10, 2003 06:28 AM

Whatsa goin' on here?
Experience has taught me that posting at ofLongs board takes a long time - left to itself, this thingummijig keeps repeating itself!

Posted by: Me again on July 10, 2003 06:37 AM

"We would then have to pay higher interest on government bonds, increasing the deficit without gaining any stimulus effects. That would probably force other interest rates hiogher, leaving a big mess - perhaps a return to the stagflation of the 70s in a worst-case scenario."

I'm curious as to how you see this scenario leading to stagflation? Given the current context of persisting threats of *deflation* wouldn't a rise in interest rates drive inflation down even further?

Posted by: Lorenzo on July 10, 2003 06:49 AM

PJ, outside of the very negative monetary effects described above, the last thing the Germans, Japanese, French, etc. need is a large increase in U.S. exports displacing their own.

Posted by: Stan on July 10, 2003 07:24 AM

Remember China! The Chinese have a large payments surplus and a dollar peg which they were encouraged to set and are determined to keep. The Chinese and Japanese, perhaps all of Asia save Australia, buy however many dollars it takes to maintain dollar-Asian currency stability.

Posted by: anne on July 10, 2003 08:22 AM

Anne writes:
> Remember China! The Chinese have a large payments
> surplus and a dollar peg which they were encouraged to
> set and are determined to keep.

I have heard that, but I guess what I'm not sure about is how sustainable it is for China to defend the US dollar. Isn't the theory on this that nobody can prevent a run on a currency these days once investors have decided the effort will not succeed? (OK, so I could easily have this wrong.)

But this should be interesting if the story of the dollar remains important. I have heard tell that the NY Times has a columnist who is a bit shrill but who is also believed to be an expert on this kind of thing; any chance he'll actually do another column soon about economics? :-) By my account, 7.5 of the last 10 columns were about other stuff. Not unimportant stuff, but stuff where I'm not sure you could argue that Krugman has any special expertise.

Posted by: Jonathan King on July 10, 2003 09:04 AM

Concerted intervention by China, Japan, and several of the Asian "tigers" kept the currencies steady against the dollar. The dollar decline was against the Euro, Canadian and Australian dollars, and selected Latin American currencies.

Posted by: anne on July 10, 2003 09:10 AM

Anne writes:
> Concerted intervention by China, Japan, and several of the
> Asian "tigers" kept the currencies steady against the dollar.
> The dollar decline was against the Euro, Canadian and
> Australian dollars, and selected Latin American currencies.

I understand that, but my question is how long can they keep that intervention up? Surely the situation has placed some pressure on them as well, or does the dollar-yen peg (say) really have no influence on the yen-euro exchange rate? I think I should go back and look at some background again here...

Posted by: Jonathan King on July 10, 2003 09:27 AM

Fine question. If Stephen Roach is right we may be in for quite a currency shock. We are approaching a zero national saving rate and have a rapidly growing balances of payments deficit. Look out???

http://www.morganstanley.com/GEFdata/digests/20030707-mon.html

Anne

Posted by: anne on July 10, 2003 09:50 AM


Once again - will no administration-apologist stand up and explain how on earth these particular tax cuts will stimulate the economy? And don't give me platitudinal nonsense about putting money in consumer's hands. Because if that was the plan, a massive payroll cut would do that in spades and have immediate stimulative effect.

The macroeconomic outlook will not improve until something happens to increase aggregate demand. It could be some enormous technological innovation (possible, but hope is not a plan), or a fiscal policy designed to boost aggregate demand. This administration seems to have accomplished the incredible feat of giving us the downside of deficit spending (increased debt burden) with precious little upside (increased aggregate demand).

Argh!!! And why can't we have a media that understands econ 101!!!

Posted by: SZ on July 10, 2003 10:23 AM

>>He's put plenty of money into the hands of the rich. And they have rewarded him by donating in record amounts.>>

Many of the rich have large equity portfolios which have been devastated (compare stock market today and when Bush became president). What profiteth a man to gain a few percent annual of income but lose a large amount of wealth?

Posted by: richard on July 10, 2003 10:29 AM

"This administration seems to have accomplished the incredible feat of giving us the downside of deficit spending (increased debt burden) with precious little upside (increased aggregate demand)."

Wonderfully put.

Posted by: jd on July 10, 2003 10:31 AM

"They could have forgone their adventure in Iraq (which, whatever the real reason for it was, was definitely not aimed at protecting Americans from Saddam's weapons of mass destruction--Saddam's weapons of mass destruction are now in the hands of people with no known address who are hard to deter)."

A sad and chilling and important comment.

Posted by: ari on July 10, 2003 12:57 PM

Alex -

"I wonder how practical it is to start devaluing the dollar or talking it down. We have to import a lot of dollars to meet our trade and budget deficits. If we start talking down the dollar, or if investors even expect that the dollar is going to fall relative to other major currencies, that will make it much harder to sell dollar debts."

But if you talk it down sufficiently, providing the Marshall-Lerner condition applies, America will need to import less foreign capital. Exports will increase - that's the point of talking it down in the first place - and imports will decline. Mainstream economic theory says that a country can't run deficits forever, and that this must happen eventually. Of course, the best way in which it could happen would be for economic recovery in Europe and Japan to stimulate demand for US exports, but as this seems pretty unlikely, a dollar decline is, perhaps, just what is needed.

The Asians can of course buy dollars if their currency peg is under threat, but only at the cost of partially losing control of their own money supplies and interest rates. China is in a better position to avoid such side-effects than Japan, at least in the short term, because its financial system is much more state-controlled (in particular, its currency is not fully convertible). And the US can print and sell as many dollars as it likes to attain whatever exchange rate it wants. This will, of course, have the beneficial effect of reducing the probability of deflation in America.

Of course, it is arguable that printing a bunch of money, thereby increasing its money supply, is exactly what Japan needs to do to get its economy out of its decade-long slump. Hong Kong and China, too, are fairly close to deflation. So if America prints money, and that forces other countries to do the same to preserve their pegs, this sort of competitive devaluation will contribute to the easing of the monetary conditions in those countries. No doubt some countries with dollar pegs do not need monetary easing, but then the decision to peg to the dollar is theirs, and can be reversed if necessary.

So, where does this leave us? Contrary to what Brad says, it's NOT difficult to talk a currency down - if Greenspan and the Treasury Sec said one day, "the dollar is a piece of s*&t and is worth about 60 Euro cents", that would probably do the trick! What is difficult is to ensure that an orderly decline does not turn into a complete rout. But the current situation, of a gigantic balance of payments deficit, is dangerous too.

Posted by: PJ on July 10, 2003 02:54 PM

Would one of the Econ 101-literate folks here please tell me if there is a difference between "The Federal Reserve is out of gunpowder" and "We are in a #%@^! liquidity trap"? Thanks.

Posted by: Matt Weiner on July 10, 2003 06:15 PM

Jonathan King writes:
> I have heard that, but I guess what I'm not sure
> about is how sustainable it is for China to defend
> the US dollar. Isn't the theory on this that nobody
> can prevent a run on a currency these days once
> investors have decided the effort will not succeed?

What makes the RMB peg sustainable for China in this instance is that there is no "over the counter" convertability for the RMB. If you are a random entity with a pile of RMB you want to turn into dollars, you can't. There's no market for it.

If you are a foreign direct investor, you can convert RMB earnings in your capital accounts into dollars, but with a lot of paperwork under strict central bank currency controls.

Thus, the RMB is an unattractive currency to hold if you don't plan to spend it in China. This tends to make it easier for the People's Bank of China (China's central bank) to keep the currency down in the restricted market that does exist.

Posted by: Michael Robinson on July 10, 2003 07:37 PM

> Hong Kong and China, too, are fairly close to deflation.

In terms of CPI, China is in deflation, and has been for some time. Ironically, though, this actually stimulates economic growth, because such a large percentage of the population can't afford anything. Every time the price of anything drops, the potential market for it grows significantly.

The Chinese middle class is growing as much through deflation (increased affordability of consumer goods) as through wage growth.

Posted by: Michael Robinson on July 10, 2003 08:01 PM

You know, I had a thought on this subject inspired by a flip line at another blog about using helicopters to drop money on the thirld world.

Stop me if I'm way off, please, but in deflationary conditions there is no inflationary effect to printing more money, right? I.e. until deflation ceased you could print as much money as you like without that money becoming worthless, could you not? And if this is the case, then wouldn't giving money away to the thirld world so they could spend it to buy things (hence increasing demand and capacity utilization) be a good idea?

Posted by: Lorenzo on July 11, 2003 07:43 AM

PJ, I hope that you aren't missing the irony in your words here: "Contrary to what Brad says, it's NOT difficult to talk a currency down... What is difficult is to ensure that an orderly decline does not turn into a complete rout."

Posted by: Stan on July 11, 2003 10:24 AM

I really enjoy these David Wessell columns but I have a question. David Wessell is the name of the author who wrote a near Labor Economics piece that suggested wage floors in competitive markets would lead to market clearing reductions in fringe benefits. I once submitted a version of this model as applied to monopsony models to the Journal of Labor Research which ultimately got published after revisions suggested by the most professional referee report I have ever read. I also wondered if Dr. Wessell was this excellent referee. Is the WSJ columns written by a different David Wessell or am I talking about the same gentlemenly scholar? If so, I'm not surprised at the high quality of these WSJ articles.

Posted by: Hal McClure on July 11, 2003 01:24 PM

Lorenzo, I think you are brushing up against the position that many have taken about the misplacement of the Bush administration's production of deficits. Rather than running a deficit to fund the third world, it's been suggested many times that a general payroll tax cut (personally I'd go for the first $X,000 of income being free of Federal income tax across the board) or programs to spend money on producing jobs would be better ways to (effectively) print more money and give it away.

Actually funding HIV/AIDS amelioration programs would be pretty much along the lines of your proposal (with the things being bought largely comprising anitretroviral drugs and other medical supplies). But funding employment and welfare programs at home would probably be more politically advantageous for the administration than giving the money to non-citizens.

Posted by: Bob Webber on July 11, 2003 04:43 PM

Michael R:

"In terms of CPI, China is in deflation, and has been for some time. "

I picked up the Economist, and couldn't help notice that China's CPI is crawling up by 0.7% per annum. A tiny point, and I'm aware that the figures can overstate inflation. Is that what you're arguing?

Stan:

You'll have to explain that irony to me. I went to high school in Germany, and I think that was equivalent to having an irony-bypass operation. :)

Posted by: PJ on July 12, 2003 04:06 PM

PJ:

--------------------
China ended a 20-month long deflationary spiral in January, when the consumer price index (CPI) rose 0.4 percent.

The CPI has been positive since then and during the first five months of this year rose 0.6 percent.

The think-tank warned, however, that the PBOC has been misled by these gains and roaring M2 growth, and that China's inflationary picture is more fragile below the surface.

The report cited central government statistics showing that of a group of 600 commodities measured in the first half of the year, 523 were in oversupply, 87 were in balance - and none of them were in shortage.

"With the world in deflation, and China suffering an oversupply in commodities, it's only because M2 is constantly showing growth that they (the central bank) have concluded that China is in inflation," the information center said.
------------------
http://www.busrep.co.za/index.php?fSectionId=566&fArticleId=181861


As far as overstatement is concerned, that's doubly an issue in China, where published statistics have traditionally been determined by government policy more than actual fact, and the data collection infrastructure is notoriously unreliable.

Posted by: Michael Robinson on July 12, 2003 10:01 PM

Also, what little raise there has been in the CPI since January has been attributable entirely to Iraq-related increases in the price of petroleum imports.

China's consumer market is unlikely to truly escape deflation until the restructuring and rationalization of production capacity and labor allocation are mostly complete, and I wouldn't expect that to take less than 5-10 years.

Posted by: Michael Robinson on July 12, 2003 10:12 PM
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