November 08, 2003
Is Debt a Problem?

The Economist flirts with Austrian theories of the business cycle as it fears that the U.S. economy will not boom. The key problem it sees is that "it is... odd... at the beginning of... recovery [for] many indicators—low saving, rampant household borrowing, record house-building and uncomfortably high stockmarket p/e ratios to name but a few—[to] have more the look of a cycle that is drawing to a close." I've never been able to convince myself that such "Austrian" views have significant traction in the real world. It's always seemed to me that what Hayek and von Mises call "overinvestment" can just as easily be called "too high an interest rate"--that modern central banks have enough control over the prices of financial assets to prevent a Hayekian cycle from taking hold. That said, it certainly seems true that it is hard to see how a sustained boom could be driven by a sustained increase in consumption as a share of national income, and hard to see how a sustain boom could be driven by rising business investment given that a large chunk of financing for such investment would have to come from an expansion of the U.S. trade deficit. All in...

Posted by DeLong at 06:32 PM

October 07, 2003
Compensating Executives

Add to the to-be-read pile: Brian Hall on how to compensate executives: Six Challenges in Designing Equity-Based Pay: This paper analyzes why the primary goal of the equity-pay explosion--creating long-run ownership incentives for top executives--has often been difficult to achieve in practice. More generally, I describe six challenges in the design of equity-based pay plans and discuss potential solutions. The six challenges involve: 1. mismatched time horizons; 2. gaming; 3. the value-cost wedge; 4. the leverage-fragility tradeoff; 5. aligning risk-taking incentives; and 6. avoiding excessive compensation. The paper also discussed the merits of stock versus options and concludes that restricted stock is often a superior form of compensation. The point that restricted stock is better than options is surely 100% correct....

Posted by DeLong at 05:35 AM

October 02, 2003
Thinking About Puzzling Anomalies in the Flow of Macroeconomic Data

A precis of a discussion at dinner last Friday night. Things that readers think are smart should be attributed to Paul Krugman or to Janet Yellen. Things that people think are dumb should be attributed to me. We currently have two large, puzzling anomalies in the macroeconomic dataflow. First, productivity growth is ludicrously, ridiculously, unbelievably rapid. Second, the high current level of the U.S. trade deficit fits very uneasily with the relatively high value of the dollar and the lack of large interest rate differentials in favor of the U.S. relative to other countries. Could one or both of these anomalies be the result of data errors? Could--as Morgan Stanley economist Stephen Roach has hinted--much of the recent data oddities be the result of our failure to adequately track the ongoing process of international trade and globalization? Suppose that our system of national accounts is missing a lot of service-sector outsourcing. Suppose that $100 billion a year of call-center and other service-sector services provided by foreign companies to American companies is simply missed. And suppose that this missing component has all grown up in the past two and a half years. Then our current real GDP is overstated by one...

Posted by DeLong at 01:47 PM

September 03, 2003
Econ 101b: Fall 2003: The Erosion of Okun's Law

We used to have considerable confidence in Okun's law: that an extra one percentage point rise (or fall) in the unemployment rate over a year would reduce (or boost) that real GDP growth by an extra 2.5 percent over that year because a rising (or falling) unemployment rate would also be accompanied by a falling (rising) share of the population in the labor force and by falling (rapidly rising) productivity. Productivity would fall when the unemployment rate rose for two reasons: first, even when factories are not running at full capacity they still incur substantial setup and maintenance costs; second, even when there isn't enough work for them to do firms would rather hold onto skilled workers than watch them drift away and have to pay to train their replacements the next time the wheel of the business cycle turns. Things have been different, however, in this recession (and to a lesser extent in the preceding early-1990s recession. The standard relationship between output growth and hours worked has gone substantially awry. See that branch poking out of the scatter diagram on the left side? That's the most recent data. (The smaller twig pointing out below and to the left...

Posted by DeLong at 04:22 PM

August 16, 2003
"Exorbitant Privilege," or, How Worrisome Is the U.S. Trade Deficit?

Back in the 1960s Charles de Gaulle would complain about the "exorbitant privilege" that accrued to the United States by virtue of its role as the key currency in the post-World War II Bretton Woods international monetary system. Other countries had to worry about their balances of payments: they had to constrain demand or go through the distress of a devaluation in order to balance their trade. But the United States did not: it could simply print extra dollars to cover whatever excess of desired imports over desired exports happened to exist.The Bretton Woods system is long gone. But the United States continues to reap "exorbitant privileges" from its role as key currency in the international monetary system. Today, however, they are different of exorbitant privileges.Look at the figure below, showing America's net exports: measured net exports have been negative--often substantially negative--for nearly three decades. Some of these large trade deficits are the result of domestic economic mismanagement (the very large trade deficits of the mid to late 1980s were, in large part, consequences of the disastrously-botched fiscal policy that was the Reagan deficit). Some of these large trade deficits are the result of foreign economic mismanagement (the very, very...

Posted by DeLong at 10:49 AM

July 07, 2003
A Platonic Dialogue on the Practice of Monetary Policy

Glaucon: How does it stay so cool down here? I thought this place wasn't air conditioned? Admetos: It's the big stairwell. All the hot air rises up to the top floor. Glaucon: Where the Real Estate Center is? Admetos: Exactly. Glaucon: So what's your view of the Federal Reserve? Admetos: The market was surprised, but I wasn't. I saw it as Old Quarter-Point Al being true to form. Glaucon: Quarter-Point Al? Admetos: What a number of bond traders call Federal Reserve Chair Alan Greenspan. And he does seem to like to move in quarter-point increments--to raise or cut interest rates by 0.25 percentage points, 25 basis points at a time. Glaucon: Why? Admetos: Ah. There is a puzzle. You tell me. Why do you think? Glaucon: Well, the purpose of monetary policy is to get the economy to the magical point of full employment and price stability... It does this by changing the interest rate and thus changing business and consumer incentives to borrow and spend... The Federal Reserve is thus in the business of trying to figure out what, in Knut Wicksell's terms, the "natural" rate of interest is... And then it tries to adjust by setting the interest...

Posted by DeLong at 06:06 PM

The Long Dark Night of the Soul of the Monetary Economist: A Platonic Dialogue

Glaucon: You want to get really disturbed? Admetos: No! Glaucon: Too bad! How large an intervention does the Federal Reserve typically have to make to change the Federal Funds rate by 0.25 percentage points? And to change other interest rates in proportion--the one-year note rate by 0.10 percentage points, the seven-year note rate by 0.05 percentage points, and so forth? Admetos: Sometimes nothing... sometimes its in the hundreds of millions... sometimes more... Glaucon: OK. Let's take the case of a $100 million open market operation. So to raise interest rates the Federal Reserve sells $100 million worth of three-month Treasury bills for cash. Afterwards the private sector has $100 million more less of reserve deposits in its collective accounts at the Federal Reserve on the asset side of its balance sheet. Afterwards the private sector has $100 million more of interest-earning government bonds on the asset side of its balance sheet. Admetos: Yes. And because of the government purchase, the supply of bonds has risen. So by supply and demand, the prices of bonds fall--and that means that interest rates rise. Glaucon: And what are the total financial assets of the U.S. economy? Admetos: back of the envelope? $11 trillion...

Posted by DeLong at 06:03 PM

June 30, 2003
International Capital Mobility

The Commerce Department reports on how foreigners have invested much more in the U.S. than U.S. citizens have invested abroad: US net debtor gap grew to record $2.387 trillion in '02: WASHINGTON, June 30 (Reuters) - The shortfall between U.S.-owned investments abroad and foreign investments here widened again in 2002, to a record $2.387 trillion, the government said in a report Monday. In its annual report on the nation's international investment position, the Commerce Department said the gap between U.S. and foreign investments had increased by $407.31 billion from a revised $1.980 trillion seen in 2001... In the series of linked short runs, we understand why the U.S. is now a debtor nation: the Reagan-Bush deficits, the difference between near-full employment in the U.S. and stagnation in Europe and Japan, the extraordinary attractiveness of investing in U.S. high-tech in the 1990s, fear by rich in other countries that in some future decade political instability will make them glad to have a big bank account in New York, plus a good old-fashioned bubble. All of these contributed to the large capital inflows that have made the U.S. a massive debtor nation. But we neoclassical economists believe that the short runs...

Posted by DeLong at 10:42 AM

June 05, 2003
Gains From International Trade and Investment

An Irish-Arizonian-Australian cross-disciplinary alliance of Kieran Healy and John Quiggin is thinking about Pierre-Olivier Gourinchas and Olivier Jeanne's brand-new "The Elusive Benefits of International Financial Integration"--the conclusion of which is that in standard neoclassical models freeing up capital flows across nations has the capability to boost economic welfare by an amount on the order of magnitude of one percent: John Quiggin: (Small) gains from trade: (Small) gains from trade: Kieran Healy links to a paper by Pierre-Olivier Gourinchas and the missing-from-the-web Olivier Jeanne in which a calibrated growth accounting model is used to show that the gains from unrestricted capital mobility are likely to be of the order of 1 per cent of GDP. Gains from risk sharing aren't mentioned but other papers are cited to say that these are of a similar magnitude. Those who listen to the general pronouncements of economists might be surprised by the modest size of the estimated gains. But for those who have looked at similar exercises in the past there is no surprise here. One of the better-kept secrets of economics is the fact that most studies suggest that the replacement of a typical high-tariff regime (say Australia's in the 1960s) will yield...

Posted by DeLong at 07:09 AM

June 04, 2003
Notes: Inequality by Race

*Sigh* In the Affluent Suburbs, an Invisible Race Gap: June 4, 2003 | In the Affluent Suburbs, an Invisible Race Gap By MICHAEL WINERIP APLEWOOD, N.J. ACROSS America, there may be two or three dozen suburban school districts similar to this one, towns like Evanston, Ill.; Shaker Heights, Ohio; Arlington, Va.; White Plains. They are heavily upper middle class, are racially mixed and feature high quality public schools. The high school here, Columbia High, is 51 percent black and sends 77 percent of its seniors to four-year colleges. Five percent are accepted to the Ivy League. A lot of black Columbia High graduates go on to big things. Rhena Jasey went to Harvard, Colin Brown to Princeton, Carla Peterman won a Rhodes, Lauryn Hill won five Grammys. From afar, these racially mixed suburbs appear to be the fulfillment of the Brown v. Board of Education desegregation ruling a half century ago. Green and tree-lined, they look like the quintessential level playing field. They seem to make the need for affirmative action passe. But they are not what they appear to be, as Ronald Ferguson, a Harvard professor, knows from surveying 34,000 seventh to eleventh graders in 15 of these racially...

Posted by DeLong at 04:09 PM

May 30, 2003
Stephen Roach on the Limits of Monetarism

Stephen Roach on the limits of monetarism: Morgan Stanley: ...The monetarist cure is a final comparison worth making -- especially in light of the debate now raging in the US over the efficacy of the Fed?s coming assault on deflation.  The monetarist diagnosis and prescription is straight-forward: Inasmuch as fluctuations in the price level are believed to be first and foremost a monetary phenomenon, an injection of massive liquidity should stop deflation dead in its tracks.  Yet if it was all that simple, it?s hard to believe that the Bank of Japan wouldn?t have tried this recipe some time ago.  In fact, that?s exactly what happened.  Since early 1997, Japan?s broad money has increased by about 20%, its monetary base has surged by 84%, and the BOJ?s balance sheet has expanded by 122%.  Yet over that same six-year period, Japanese nominal GDP has actually contracted by 6%.  In other words the monetarist prescription has failed miserably in Japan -- hardly a comforting result for other central banks as they now face the perils of deflation......

Posted by DeLong at 06:44 AM

May 10, 2003
The Causes of Slavery or Serfdom: A Hypothesis

Paul Krugman's post, Serfs Up!, reminds me of one of my major sins this spring (for which I must atone): my cutting Evsey Domar (1970), "The Causes of Slavery or Serfdom: A Hypothesis," Economic History Review 30:1 (March), pp. 18-32, from my spring 2003 Economics 210a reading list. As Krugman summarizes Domar's main point: Domar was motivated by his knowledge of Russian history. Serfdom in Russia, he knew, wasn't an institution that dated back to the Dark Ages. Instead, it was mainly a 16th-century creation, contemporaneous with the beginning of the great Russian expansion into the steppes. Why? He came up with a simple yet powerful insight: there's no point in enslaving or enserfing a man unless the wage you would have to pay him if he was free is substantially above the cost of feeding, housing, and clothing him. Imagine a pre-industrial society where population is pressing on limited land supplies, and the marginal product of labor - and hence the real wage rate under competitive conditions - is barely at subsistence. In that case, why bother establishing property rights in human beings? It costs no more to hire a free worker than to feed an indentured laborer. Indeed,...

Posted by DeLong at 10:08 PM

April 10, 2003
Notes: Risk Aversion

Teaching Notes for Econ 236: April 9: What do different risk aversion parameters imply about gambles? Kocherlakota (1995) [Narayana R Kocherlakota (1995), "The Equity Premium: It’s Still a Puzzle," Journal of Economic Literature, 1996-1, pp. 42-72.] reports that the raw "equity premium puzzle" implies a coefficient of relative risk aversion of 18... (and then there is the risk-free rate puzzle: at a crra of 18, you need a raw time preference factor of -8% per year to fit average per-capita consumption growth to the average real risk-free rate of interest. What does such a high risk aversion parameter mean? Well... ...At a coefficient of relative risk aversion of 1... you are indifferent between a this year's consumption level of $30,000 for certain and a 58% chance of $40,000 coupled with a 42% chance of $20,000. ...At a coefficient of relative risk aversion of 5... you are indifferent between a this year's consumption level of $30,000 for certain and a 86% chance of $40,000 coupled with a 14% chance of $20,000. ...At a coefficient of relative risk aversion of 10... you are indifferent between a this year's consumption level of $30,000 for certain and a 97.6% chance of $40,000 coupled with...

Posted by DeLong at 03:44 PM

April 05, 2003
Cognitive Economics

Robert Waldmann thinks about a seminar he saw: Alberto Bisin presenting joint work with Jess Benhabib on cognitive economics: robert's random thoughts: ...A pseudo explanation is that we fear regret -- to have had it and given it away. To me this is like saying morphine causes sleep because it has a dormative virtue. One of the great bits of evidence from the psych literature is that overweight people can resist nibbling if they are remembering a 3 digit number but not if they are remembering a 7 digit number (see the magic number 7). They had to remember for 5 minutes or so. They weren't warned that they would be tempted with food. The guess is that in the heads of the 3-digit non-nibblers is 6 4 7 don't eat 6 4 7 don't eat 6 4 7 don't eat 6 4 7 don't eat 6 4 7 don't eat ?", while in the heads of the the 7-digit nibblers is "6 4 7 3 5 2 4 ; 6 4 7 3 5 2 4, 6 4 7 3 5 2 4 , hey why is my stomach full ???". Maybe we make the Monty Hall blunder because...

Posted by DeLong at 09:17 AM

February 27, 2003
Excuse Me, What's Your Oxytocin Level Today?

I don't know about you, but in the future I'm only making contracts with people with elevated oxytocin levels... Virginia Postrel writes about those who are beginning to found the subdiscipline of Neuroeconomics: Looking Inside the Brains of the Stingy: ...Professor Zak and his colleagues study trust with a variation of the ultimatum game. Each player receives $10. Player 1 gets an additional $10. Players interact anonymously over computers. Player 1 can send any whole-dollar amount to Player 2. Whatever he sends is tripled, so a $5 gift turns into $15. Finally, Player 2 can return some of the money to Player 1. If Player 1 expects Player 2 not to send any money in return, Player 1 will keep the initial stake. That's the game's standard equilibrium. "In fact," Professor Zak said, "most people send about half of their stake to Player 2. They're signaling that they want to trust them." In response, about 75 percent of the Player 2's return some money, making both better off. "Even though we can't see each other and we don't know each other, we understand the other person as a human being," Professor Zak said. Extrapolating from animal results, he hypothesized that...

Posted by DeLong at 08:09 PM

September 12, 2002
More People Worry About Deflation

The Economist steps up to the "let's worry about deflation" plate. I agree with them. The Federal Reserve, however, does not seem to: the Federal Reserve appears to believe that the NAIRU--the unemployment rate at which inflation is constant--is somewhere near 5.5 percent (rather than the 4.5 to 5.5 percent I would estimate), and that the rate of growth of potential output--which is the rate at which real GDP has to grow to keep the unemployment rate constant--is only a shade above 2 percent per year (rather than the 3.5 percent per year that I would estimate). ...As a result, there is a risk that, before the end of 2003, the rich world's three biggest economies—America's, Japan's and Germany's—could all have negative inflation rates. A sharp jump in oil prices as a result of America invading Iraq could, of course, push up headline inflation. But the longer-term impact of higher oil prices would be deflationary, not inflationary. Higher oil prices operate like a tax that depresses growth, so their medium-term impact would be to heighten the deflation risk. DeAnne Julius, a former member of the Bank of England's monetary policy committee, argued in a recent speech that there is...

Posted by DeLong at 04:45 PM

Ken Rogoff on the IMF

Ken Rogoff on the claim that IMF bailouts take the money of rich-country taxpayers, give it to the unworthy, and so create "moral hazard". (He also covers a host of other issues.) ...It would be hard to overstate the influence of the popular perception that IMF crisis loans are thinly disguised bail-outs, with the tab paid mainly by ordinary taxpayers in the industrialised world. The presumed need to limit such bail-outs, and their adverse long-term incentive effects, is a central element of virtually every important plan out there to improve the way the IMF does business. The challenge posed by the bail-out view is not simply lack of transparency—that IMF loans are really outright transfers and should be called such. No, the deeper and more troubling implication is the “IMF moral hazard” theory. Simply put, if lenders are confident they will ultimately be bailed out by heavily subsidised IMF loans, they will extend too much credit to emerging-market debtors at rates that do not reflect the true underlying risk. The result? Bigger and more frequent crises than if the IMF did not exist. Giving the IMF more resources, it is argued, exacerbates the crises it was designed to alleviate....

Posted by DeLong at 02:21 PM

September 09, 2002
Alan Murray on IPO Underpricing

Alan Murray wrestles with the problem of IPO--Initial Public Offering--underpricing. On the one hand, why should the rest of us care if entrepreneurs wish to sell 10 percent of their companies at a half-off discount to the friends and clients of their investment bankers when their firms go public? Entrepreneurs are giving a rather large present to those on the IPO list, but if they did not wish to do so they could always use Hambrecht and Quist and run a true auction to sell off the initial tranche of shares. And they get benefits--a bunch of people who will have made money by investing in their stock, and who are likely to hold onto it and talk it up. Murray comes down on the side of the--highly plausible--theory that IPO underpricing is a way that investment banks get their going-public client corporations to bribe those from whom they want to be thrown other prices of investment banking business. - Article ...When the price of a stock jumps to $20 from $10 in the first day of trading, reaping instant profits for the lucky few who have been allocated shares, the investment bankers celebrate a "hot" offering. They ought...

Posted by DeLong at 09:18 PM

July 07, 2002
Why the Decline in Health Insurance Coverage?

The continued decline in the share of Americans with health insurance coverage places additional stress on our health care financing system. Sometimes those without health insurance get no or get substandard treatment. Sometimes those without health insurance get adequate or excellent-quality catastrophic treatment--but the treatment is paid for by somebody else. Such cost-shifting further increases the cost of insurance, and reduces coverage. The fear is that at some point large chunks of the financing system will enter an adverse-selection death-spiral as each wave of price increases generates a large reduction in the pool of those paying for insurance and a further wave of price increases. And the derangement of the health-care financing system leads to a significant deterioriation in the quality of care provided. But, fortunately, we aren't there yet. However, we are getting closer. Here David Cutler tracks the decline in health insurance coverage in the 1990s. Employee Costs and the Decline in Health Insurance Coverage David M. Cutler NBER Working Paper No.w9036 Issued in July 2002 ---- Abstract...

Posted by DeLong at 07:51 PM

July 03, 2002
The Two Decade-Long Fall in America's Private Savings Rate

Of all the remarkable things to happen in the U.S. economy over the past two decades, the fall in the private savings rate must rank among the top ten. Net private savings in the United States--the sum of household savings on the one hand and business retained earnings on the other--used to fluctuate between nine and twelve percent of gross domestic product [NDP]. Then in the mid-1980s, during the Reagan years, private savings began to fall. This was a mystery: after all, the government was running substantial deficits, and there were theoretical reasons to believe that individuals might save more to offset the risk--nay, the certainty--that higher levels of government debt would one way or another increase their taxes in the future. Some argued that the private savings rate was fallen because the 1980s stock market boom had made people wealthier, and they wanted to spend some of that wealth. But the crash in inflation-adjusted stock market values in the 1970s had not led people to save more to offset their reduced stock-market wealth. It remained a puzzle. And the puzzle gathered strength in the 1990s. By the peak of the late-1990s boom, the private savings rate was only three...

Posted by DeLong at 12:57 PM

July 01, 1986
J. Bradford DeLong and Lawrence H. Summers (1986), "The Changing Cyclical Variability of Economic Activity in the United States," in Robert J. Gordon, ed., The American Business Cycle: Continuity and Change (Chicago, IL: University of Chicago Press for the National Bureau of Economic Research), pp. 679-719.

J. Bradford DeLong and Lawrence H. Summers (1986), "The Changing Cyclical Variability of Economic Activity in the United States," in Robert J. Gordon, ed., The American Business Cycle: Continuity and Change (Chicago, IL: University of Chicago Press for the National Bureau of Economic Research), pp. 679-719....

Posted by DeLong at 08:11 AM