“The White House’s Deal With Big Pharma Undermines Democracy”

Robert Reich says the administration's promise not to use the government's purchasing power to lower the price of drugs in return for a large, pharmaceutical industry sponsored ad campaign in support of health care reform undercuts and threatens the democratic process:

How the White House's Deal With Big Pharma Undermines Democracy, by Robert Reich: I'm a strong supporter of universal health insurance, and a fan of the Obama administration. But I'm appalled by the deal the White House has made with the pharmaceutical industry's lobbying arm to buy their support.

Last week,... the White House confirmed it has promised Big Pharma that any healthcare legislation will bar the government from using its huge purchasing power to negotiate lower drug prices. That's basically the same deal George W. Bush struck in getting the Medicare drug benefit, and it's proven a bonanza for the drug industry. ... Let me remind you: Any bonanza for the drug industry means higher health-care costs for the rest of us...

In return, Big Pharma isn't just supporting universal health care. It's also spending a lots of money on TV and radio advertising... Big Pharma has budgeted $150 million for TV ads promoting universal health insurance, starting this August (that's more money than John McCain spent on TV advertising in last year's presidential campaign), after having already spent a bundle through advocacy groups like Healthy Economies Now and Families USA.

I want universal health insurance. And having had a front-row seat in 1994 when Big Pharma and the rest of the health-industry complex went to battle against it, I can tell you first hand how big and effective the onslaught can be. So I appreciate Big Pharma's support this time around...

But I also care about democracy, and the deal between Big Pharma and the White House frankly worries me. It's bad enough when industry lobbyists extract concessions from members of Congress, which happens all the time. But... [a]n industry is using its capacity to threaten or prevent legislation as a means of altering that legislation for its own benefit ... at the highest reaches of our government, in the office of the President.

When the industry support comes with an industry-sponsored ad campaign in favor of that legislation, the threat to democracy is even greater. Citizens end up paying for advertisements designed to persuade them that the legislation is in their interest. In this case, those payments come in the form of drug prices that will be higher than otherwise...

I don't want to be puritanical about all this. Politics is a rough game... Perhaps the White House deal with Big Pharma is a necessary step to get anything resembling universal health insurance. But if that's the case, our democracy is in terrible shape. How soon until big industries ... have become so politically powerful that secret White House-industry deals ... are prerequisites to any important legislation? When will it become standard practice that such deals come with hundreds of millions of dollars of industry-sponsored TV advertising designed to persuade the public...? (Any Democrats and progressives ... should ask themselves how they'll feel when a Republican White House cuts such deals to advance its own legislative priorities.)

We're on a precarious road -- and wherever it leads, it's not toward democracy.

“A Missed Opportunity on Climate Change”

In discussing proposed climate change legislation below, Greg Mankiw says:

To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

He then goes on to say "As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances..., sometimes good is not good enough" which, given his categorization of those supporting and opposing the bill, I interpret to mean that he is more worried about distortions from taxes than he is about global warming:

A Missed Opportunity on Climate Change, by N. Gregory Mankiw, Commentary, NY Times: During the presidential campaign of 2008, Barack Obama distinguished himself on the economics of climate change, speaking far more sensibly about the issue than most of his rivals. Unfortunately, now that he is president, Mr. Obama may sign a climate bill that falls far short of his aspirations. Indeed, the legislation making its way to his desk could well be worse than nothing at all. ...

The textbook solution for dealing with negative externalities is to use the tax system to align private incentives with social costs and benefits. ... A carbon tax is the remedy for climate change that wins overwhelming support among economists and policy wonks.

When he was still a candidate, Mr. Obama did not exactly endorse a carbon tax. He wanted to be elected... What Mr. Obama proposed was a cap-and-trade system for carbon, with all the allowances sold at auction. ... Such a system is tantamount to a carbon tax. The auction price of an emission right is effectively a tax on carbon. ...

So far, so good. The problem occurred as this sensible idea made the trip from the campaign trail through the legislative process. Rather than auctioning the carbon allowances, the bill that recently passed the House would give most of them away to powerful special interests.

The numbers involved are not trivial. From Congressional Budget Office estimates, one can calculate that if all the allowances were auctioned, the government could raise $989 billion in proceeds over 10 years. But in the bill as written, the auction proceeds are only $276 billion. ...

How much does it matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. ...

The problem arises in how the climate policy interacts with the overall tax system. ... The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans...

The hard question is whether, on net, such a policy is good or bad. Here you can find policy wonks on both sides. To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

What everyone should agree on is that the legislation making its way through Congress is a missed opportunity. President Obama knows what a good climate bill would look like. But despite his immense popularity and personal charisma, he appears unable to persuade Congress to go along.

As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances. Some might say a veto would make the best the enemy of the good. But sometimes good is not good enough.

What he doesn't mention, and I'm not sure why, is that the permit giveaways are scheduled to end after after 10-15 years. That's not as good as auctioning the permits from day one, but it does put a plan for auctions in place. So in the long-run, the intent is to auction 100% of the permits just as Greg desires, the giveaways at the beginning are an attempt to get the bill passed. There are lots of problems with the bill as currently formulated, and a key consideration is how credible you view the promise to auction permits in the future. Going on a diet tomorrow is easy to plan, but when tomorrow comes will the plan be executed? I hope so, but have my doubts.

Solow: Dumb and Dumber in Macroeconomics

<p><p>HTML clipboard</p></p>

Continuing with the discussion on the state of macroeconomics, this is Robert Solow from an October 25, 2003 address at Joe Stiglitz' 60th birthday conference. Solow gets extra credit for saying these things before the crisis hit, e.g. " I start from the presumption that we want macroeconomics to account for the occasional aggregative pathologies that beset modern capitalist economies, like recessions, intervals of stagnation, inflation, "stagflation," not to mention negative pathologies like unusually good times. A model that rules out pathologies by definition is unlikely to help." (Let me also point to a comment by Ping Chen at Free Exchange in response to the Lucas essay which I may highlight more explicitly later. Update: See also Jamie Galbraith's remarks at the Stiglitz conference):

Dumb and Dumber in Macroeconomics, by Robert M. Solow: So how did macroeconomics arrive at its current state? The answer might provide a lead as to where it ought to go.

The original impulse to look for better or more explicit micro foundations was probably reasonable. It overlooked the fact that macroeconomics as practiced by Keynes and Pigou was full of informal microfoundations. (I mention Pigou to disabuse everyone of the notion that this is some specifically Keynesian thing.) Generalizations about aggregative consumption-saving patterns, investment patterns, money-holding patterns were always rationalized by plausible statements about individual--and, to some extent, market--behavior. But some formalization of the connection was a good idea. What emerged was not a good idea. The preferred model has a single representative consumer optimizing over infinite time with perfect foresight or rational expectations, in an environment that realizes the resulting plans more or less flawlessly through perfectly competitive forward-looking markets for goods and labor, and perfectly flexible prices and wages.

How could anyone expect a sensible short-to-medium-run macroeconomics to come out of that set-up? My impression is that this approach (which seems now to be the mainstream, and certainly dominates the journals, if not the workaday world of macroeconomics) has had no empirical success; but that is not the point here. I start from the presumption that we want macroeconomics to account for the occasional aggregative pathologies that beset modern capitalist economies, like recessions, intervals of stagnation, inflation, "stagflation," not to mention negative pathologies like unusually good times. A model that rules out pathologies by definition is unlikely to help. It is always possible to claim that those "pathologies" are delusions, and the economy is merely adjusting optimally to some exogenous shock. But why should reasonable people accept this? During the past three years, unemployment has increased by three million with real wages stagnant and productivity growing, possibly abnormally fast. Capacity utilization has fallen by 10 percent, with trivial inflation and some prices falling. Real business investment in equipment peaked in the third quarter of 2000, fell by 20 percent to the first quarter of 2002, and has risen by a scant five percent since then. Is this a stagnation pattern? Does it reflect large-scale, perhaps irrational, overinvestment in the 1990s? Should it not be studied as such? Why should anyone take it as the solution of an Euler equation? It would not be hard to imagine a better path for the economy. Why should the burden of proof fall on those who see an ordinary standard pathology here? The odd thing is to regard this history as the working out of an other-worldly model.

What is needed for a better macroeconomics? My crude caricature of the Ramsey-based model suggests some of the gross implausibilities that need to be eliminated. The clearest candidate is the representative agent. Heterogeneity is the essence of a modern economy. In real life we worry about the relations between managers and shareowners, between banks and their borrowers, between workers and employers, between venture capitalists and entrepreneurs, you name it. We worry about those interfaces because they can and do go wrong, with likely macroeconomic consequences. We know for a fact that heterogeneous agents have different and sometimes conflicting goals, different information, different capacities to process it, different expectations, different beliefs about how the economy works. Representative-agent models exclude all this landscape, though it needs to be abstracted and included in macro-models.

I also doubt that universal rational expectations provide a useful framework for macroeconomics. One understands the appeal. Think of it this way: Herb Simon was surely right about bounded rationality; no one would deny that most economic agents are actually like that, and natural selection does not work fast enough to eliminate them. Why did the notion of "satisficing" never catch on? I think it is because the assumption of complete rationality tells the modeller what to do, whereas bounded rationality only tells the modeller what not to do. That is not helpful. Something similar is true about rational expectations. If there were a nice parametric family of alternative ways to model expectations, it might catch on. Most of us would happily go along with the notion of expectational equilibrium: if specific underlying expectations generate an outcome in which those expectations are systematically and non-trivially violated, that situation can not be an equilibrium. It is what happens then that needs thought. The situations that agents need to anticipate need not even be probabilistic, surely not stationary. The popular device used to be adaptive expectations; that may have been inadequate. Maybe this is a case for the application of psychological research (and sociological research as well, because the formation of expectations is a social process). Maybe experiments can be designed. Heterogeneity across agents and classes of agents is certainly important precisely here. One would like a simple, definite way to proceed, if that is possible. A good example of the sort of thing I mean is the way the Dixit-Stiglitz model made monopolistic competition easy. (The trouble is that we are dealing with an unobservable.)

Although I am going to take this back in a moment, it is certainly worthwhile mentioning the problems connected with real and/or nominal wage and price inflexibility and its sources in market structure, limitations of information, human nature, the specialness of zero, etc. This is an old issue in economics, macro and micro, and a lot of progress has been made in measuring and understanding it. Mere sluggishness is part of the picture, and that is easily modelled, but there is surely more that is less easily modelled. The devil finds work for idle hands to do, as you may have noticed.

Now here is a peculiar thing. When I was in advanced middle age, I suddenly woke up to the fact that my colleagues in macroeconomics, the ones I most admired, thought that the fundamental problem of macro theory was to understand how nominal events could have real consequences. This is just a way of stating some puzzle or puzzles about the sources for sticky wages and prices. This struck me as peculiar in two ways.

First of all, when I was even younger, nobody thought this was a puzzle. You only had to look around you to stumble on a hundred different reasons why various prices and factor prices should be much less than perfectly flexible. I once wrote, archly I admit, that the world has its reasons for not being Walrasian. Of course I soon realized that what macroeconomists wanted was a formal account of price stickiness that would fit comfortably into rational, optimizing models. OK, that is a harmless enough activity, especially if it is not taken too seriously. But price and wage stickiness themselves are not a major intellectual puzzle unless you insist on making them one.

The second peculiarity was that the path from nominal events to real consequences was not my idea of the fundamental problem of macro theory anyway. All along, I had been thinking--and this may be a Keynesian inheritance, though I doubt it because I may have picked it up from Gottfried Haberler's Prosperity and Depression, where my generation learned about business-cycle theory before "macroeconomics" had been invented--that the main problem was to understand why real shocks that took the economy out of some satisfactory equilibrium led to such a prolonged and sometimes unsatisfactory adjustment. These are medium-run problems--the capital stock moves--and there clearly are medium-run fluctuations in modern industrial economies. (This is documented for the U.S. in a recent paper by Comin and Gertler.)

Keynes claimed to have found the way to account for this: he thought he had a theory of unemployment equilibrium. The reason adjustment took so long, or never really happened, is that the depressed state was actually an equilibrium. Most of us today think that Keynes failed in that effort; he lacked the tools. The exception was the case of wage rigidity, but we knew that all along. In my youth, we thought that macro-pathologies were disequilibrium phenomena, and then the puzzle was: why is the process so slow?

This choice between equilibrium and disequilibrium thinking may be a false choice. If I drop a ripe watermelon from this 15th-floor window, I suppose the whole process from t0 to the mess on the sidewalk could be described as some sort of dynamic equilibrium. But that may not be the most fruitful--sorry--way to describe the falling-watermelon phenomenon.

So I would hope that macro theory could get back to focusing on the adaptation-to-real-disturbance problem, without falling into the implausibilities of real-business-cycle theory. (Even RBC theorists may fight their way out of that paper bag.) The Ur-Problem may be: start in a situation of growth equilibrium (not necessarily a steady state, but don't get me started on that one), and imagine a real shock, perhaps a failure of real effective demand (!). What happens next? That may be the story of the period from 2000 to now, the real shock having been massive overinvestment in response to unrealistic profit expectations (accompanied by accounting swindles, just to make Joe happy).

links for 2009-08-09


Gregory Clark sees a bleak future for the unskilled:

Tax and Spend, or Face The Consequences, by Gregory Clark, Commentary, Washington Post: At some point, the Great Recession will end. ... Whenever it happens, we will see that the downturn was but a minor blip in the long story of the economy. In the next chapter, abundance beckons -- for some. Advances in technology drive economic growth, and there is no sign that they are slackening. The American economy is likely to continue unabated on the upward path that began with the Industrial Revolution.

No, the economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

The battle will be over how to get the economy's winners to pay for an increasingly costly poor. ... In a future with higher taxes, the divide between rich and poor would be the central economic challenge.

For much of the past 200 years, unskilled workers benefited greatly from capitalism. Before the Industrial Revolution, for example, skilled construction workers earned 50 to 100 percent more than unskilled laborers; today, that premium has fallen to 33 percent in the United States. ...

Why have the unskilled fared so well? ...[M]achines ... even today ... cannot replace many of people's manipulative abilities, language skills and social awareness. The hamburger you eat at McDonald's is still put together and delivered to you by human hands; even a fast-food "associate" deploys an astonishing repertoire of spatial and language skills.

But in more recent decades, when average U.S. incomes roughly doubled, there has been little gain in the real earnings of the unskilled. And, more darkly, computer advances suggest these redoubts of human skill will sooner or later fall to machines. We may have already reached the historical peak in the earning power of low-skilled workers, and may look back on the mid-20th century as the great era of the common man.

I recently carried out a complicated phone transaction with United Airlines but never once spoke to a human; my mechanical interlocutor seemed no less capable than the Indian call-center operatives it replaced. Outsourcing to India and China may be only a brief historical interlude before the great outsourcing yet to come -- to machines. And as machines expand their domain, basic wages could easily fall so low that families cannot support themselves without public assistance. ...

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners ... to provide for the losers. ...

The United States was founded, essentially, on resistance to taxes, and to this day, an aversion to the grasping hand of the state seems fundamental to the American psyche. ... The conflicts to come are foreshadowed in California, where popular anti-tax sentiment has forced substantial reductions in medical care for the state's poorest children.

How can we avoid or minimize such conflicts? The Obama administration seeks to do so in part through a more cost-effective health-care system. ... But ... this will at best buy time before an inevitable crunch.

Others see education as a way out of this dystopia. The root problem is, after all, the widening of the income gap between the skilled and the unskilled. Can expanded education give the poorest the tools to resist the march of the machines? I'm skeptical. Already, much of the supposed improvement in high school and college graduation rates has come by asking less of graduates. ...

 In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

As the world develops in the long, long run, and as countries move from "developing" to "developed," I still see a chance that the growth in the demand for the services that the unskilled provide will outstrip the growth in the supply. That doesn't mean that the wealth gap won't continue to increase, and that there won't be any problems associated with the growing gap between those at the top and those at the bottom, but I'm not so sure that wages will fall such that absolute living standards will decline as predicted above. But nobody knows for sure what will happen, so what do you foresee?

“School for Scoundrels”

Paul Krugman reviews Justin Fox’s “Myth of the Rational Market”:

School for Scoundrels, Book Review by Paul Krugman: Last October, Alan Greenspan — who had spent years assuring investors that all was well with the American financial system — declared himself to be in a state of “shocked disbelief.” After all, the best and brightest had assured him our financial system was sound: “In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. . . . The whole intellectual edifice, however, collapsed in the summer of last year.”

Justin Fox’s “Myth of the Rational Market” brilliantly tells the story of how that edifice was built — and why so few were willing to acknowledge that it was a house built on sand. ...

Instead of focusing on the errors and abuses of the bankers, Fox ... tells the story of the professors who enabled those abuses under the banner of the financial theory known as the efficient-market hypothesis. ... Wall Street bought the ideas of the efficient-market theorists, in many cases literally: professors were lavishly paid to design complex financial strategies. And these strategies played a crucial role in the catastrophe that has now overtaken the world economy. ...

One of the great things about Fox’s writing is that he brings to it a real understanding of the sociology of the academic world. Above all, he gets the way in which one’s career, reputation, even sense of self-worth can end up being defined by a particular intellectual approach, so that supporters of the approach start to resemble fervent political activists — or members of a cult. In the case of finance theory, it happened especially fast...

In this sense, efficient-market acolytes were like any other academic movement. But unlike, say, deconstructionist literary theorists, finance professors had an enormous impact on the business world — and, not incidentally, some of them made a lot of money in the process. ...

I came away ... wondering if [the] underlying premise — that the current crisis will put an end to Panglossian views of financial markets — is right. Fox points out that academic belief in the perfection of financial markets survived the 1987 stock market crash and the bursting of the Internet bubble. Why should the reaction to the latest catastrophe be any different? In fact, what I hear from my finance professor friends is that there’s a lot less soul-searching under way than you might expect. And Wall Street’s appetite for complex strategies that sound clever — and can be sold to credulous investors — survived L.T.C.M.’s debacle; why can’t it survive this crisis, too?

My guess is that the myth of the rational market — a myth that is beautiful, comforting and, above all, lucrative — isn’t going away anytime soon.

Jobs Report Sparks More Sparring Over Stimulus Impact

The White House and its critics on Capitol Hill drew different conclusions from the same set of numbers Friday, as new data on the U.S. job market fired up another round in the debate over the economic-stimulus package.

President Obama sees hopeful signs in the jobs report. (Getty Images)

A smaller-than-expected job-loss last month triggered cautious optimism from the Obama administration, which said the Labor Department’s July employment report is a fresh sign the U.S. economy, bolstered by stimulus funds, is on the mend. But it balanced that view with a warning that the recovery hasn’t arrived and joblessness is still likely to reach 10%.

Republicans, buoyed by polls pointing to public unease over President Barack Obama’s economic agenda, accused the White House of breaking promises.

Nonfarm payrolls declined by 247,000 last month. The drop was the best performance since last August, offering hope that the U.S. recession may be nearing an end. The unemployment rate, calculated using a survey of households as opposed to companies, slid unexpectedly from 9.5% to 9.4%.

Obama called the figures “additional signs that the worst may be behind us.”

“Today, we’re pointed in the right direction,” he said in brief remarks from the Rose Garden. “We’re losing jobs at less than half the rate we were when I took office. We’ve pulled the financial system back from the brink and the rising market is restoring value to 401(k)s that are the foundation of a secure retirement.”

White House spokesman Robert Gibbs said there’s “no doubt” the $787 billion recovery package is making a difference, but cautioned that sustained job growth, which will lag the broader recovery, won’t arrive soon.

“The patient has stabilized. Will the patient see good days and bad days? Will the fever come back and maybe spike again? Absolutely. We’re assuming that that’s going to happen,” Gibbs said.

White House economists say employment in the second quarter was around 485,000 jobs above where it would have been without the stimulus spending. The economy has lost 6.7 million jobs since the recession started in December 2007.

Republicans ridiculed the notion that the stimulus is working. House GOP Leader John Boehner (R., Ohio) said it has fallen “woefully short.” His deputy, Rep. Eric Cantor (R., Va.) said it hasn’t provided the promised “jolt” to the economy.

“For Americans, the test for stimulus success is whether or not they have a job,” Cantor said in a statement. “Today, for another 247,000 Americans and their families, the stimulus failed that test.”

Amid a swath of recent positive indicators, the White House has been pushing back against Republican claims that the stimulus is a costly failure. Officials have sought to ease concerns about the economy without creating unjustified optimism that the recession is over. It’s a message Obama has conveyed frequently, including in speeches this week in Indiana and Virginia.

Council of Economic Advisers Chair Christina Romer said she believes the U.S. remains in a recession. “If you look at the [gross domestic product] numbers, what we know is the GDP fell in the second quarter. In my mind that means we’re still in a recession,” she told CNBC.

Should the Fed Be Buying Fannie Debt?

Federal Reserve officials will be consumed next week in discussions of their far-reaching asset purchase program when they gather for their next policy meeting. Two parts of this program get most of the attention — $300 of purchases of U.S. Treasury securities and $1.25 trillion of purchases of mortgage backed securities. But the third prong of the plan — purchases of $200 billion worth of debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks — merits more attention.

This is not a small change program, but it is difficult to see the benefits of the purchases. By purchasing debt issued by Fannie and Freddie, the Fed helps to reduce the cost of funding of the two mortgage giants. That provides much needed financial support to two cash-strapped firms critical to the financial system. But the firms have already been bailed out and are already controlled by the U.S. government, which has an 80% stake.

It isn’t obvious how the $200 billion in Fed purchases feed through to consumers. Fannie and Freddie aren’t growing their mortgage holdings much right now. Fannie’s mortgage holdings in June were $793 billion, up just 0.7% from the end of 2008. Fannie has been paring back its own borrowing, with total debt down to $846 billion in June from $883 billion at the end of 2008. Fed purchases of Fannie’s debt, in other words, aren’t leading the firm to go out and buy more mortgages to the benefit of households. It’s only cushioning the finances of a firm that’s the responsibility of the Treasury anyway.

Moreover, it’s not clear that the Fed will be able to hit its target of $200 billion in purchases this year. It is now just a little over $100 billion. One option for the Fed – buy fewer of Fannie and Freddie’s debt and more directly from the Treasury. Fed officials haven’t been enthralled with the Treasury purchase program. But it is a more direct way of benefiting the broader financial system than purchases of Fannie and Freddie debt. Or, given that the economy shows signs of healing, the Fed could also let the program quietly run its course short of its target amount.

Jobless Rate Challenges Fed Outlook

The unexpectedly favorable turn in the July jobs report Friday is making some wonder if the Federal Reserve overestimated how bad unemployment will get in the U.S., which could have implications for its policy outlook.

The Fed’s rate decision is a done deal, but it must decide what to do about asset purchases. (Associated Press)

In the report, the government said July’s unemployment rate slipped to 9.4%, an improvement over June’s 9.5%, and perhaps more importantly, far better than the 9.7% unemployment rate economists had forecast.

The data cap the first month in some time where the pace of job losses seriously moderated, to a degree where economists could say the labor market’s fixed to join the rest of the economy’s slow emergence from recession.

What complicates things is that the Fed was counting on things getting worse, at least on the jobs front. A number of central bank officials have warned that the unemployment rate could go over 10%. San Francisco Fed president Janet Yellen has said she expected a further worsening in unemployment before that key barometer began to edge back down.

According to the Fed’s most recent official forecasts, its so-called central tendency forecast for the unemployment rate for this year ranged between 9.8% and 10.1%. In effect, central bankers were entirely prepared to see a lot more pain on the jobs front, especially since their long term trend unemployment rate ranges between 4.8% to 5.0%.

If Friday’s data signal a decline, it could challenge some of the prevailing orthodoxy surrounding the outlook for policy. Fed officials have for some time been under the belief that the recession would end this year, but they’ve signaled they expect no change in their zero-percent interest rate policy, in part because of excess slack in the job market. But if that slack starts to ebb sooner than expected, it’s possible the pressure to make the Fed tighten could also arrive sooner than expected.

For now, economists are viewing the situation cautiously. While most agree labor market trends are improving, the coming months could easily turn out choppy and not always deliver favorable numbers.

July’s report is “a significant dose of good news” but when it comes to unemployment, “we wouldn’t be surprised to see it trend higher over the rest of the year,” said Carl Riccadonna, economist with Deutsche Bank.

Economist Alan Levenson at T. Rowe Price predicted the unemployment rate will still crack 10%.

The unemployment rate remains vulnerable to further setbacks, even as job losses moderate, because of what could happen with those who’d given up on getting a job.

The July data give a sense that those who have been most hard hit by the recession will find hiring conditions more amenable.

The so-called U-6 measure of unemployment, which counts the jobless along with marginally attached workers and those who are doing part time work involuntarily, ebbed down to 16.3% last month from 16.5% in June.

Meanwhile, July’s labor participation rate edged down 0.2%. That move down comes in an economy where there were 2.3 million marginally attached workers and 796,000 discouraged workers, up by 335,000 from a year ago.

Economists warn that if people start reentering the labor forces looking for work, the unemployment rate could actually rise. In a sense, bad news would be a signal of improving sentiment about the economy’s outlook.

If events play out along those lines, and economists seem to think they will, the Fed’s forecasts will likely hold, and help policy makers put off the day before they need to raise short term interest rates.

Jobs Report Roundup

Most everything that can be said about the jobs report has already been said, so here's a roundup of various reactions. The point I want to emphasize is that it's far too soon for policymakers to begin easing up, they need to plan as though this is just a temporary aberration in the numbers. If that turns out to be wrong, then the plans do not need to be executed, but it's essential that we are ready to react if needed (e.g., though I think the political climate makes any action highly unlikely, policymakers could enact expenditures that kick in if the numbers in future reports fail to meet predetermined thresholds so that if there is sufficient improvement in the economy, the money won't be spent):

A remarkable jobs report, by Free Exchange: ...[T]he new nonfarm payroll employment data released by the Labor department this morning ...[shows] July job losses of just ... just 247,000... Just as remarkable, the unemployment rate actually declined, from 9.5% to 9.4%. This may end up being a short-term aberration, but it is a very unexpected and positive one.

Manufacturing employment fell by 52,000 for the month, the first time in ages that the number has been below 100,000. Health industry and government employment moved upward. Meanwhile, hours and earnings both rose, in a very good sign for the job market.

The news isn't all good. Since the recession began a total of 6.7 million jobs have been shed, and nearly 15 million people are currently out of work. And the number of long-term unemployed (those out of work for 27 weeks ore more) has reached 5 million—a third of those currently out of work. It is those workers that will have the most difficulty finding new employment, which is what must happen for the unemployment rate to decline to "normal" levels.

But this is one of the best economic reports America has seen to date...

Does this mean our problems are over?:

Has Unemployment Peaked?, by Brad DeLong: Almost surely not, alas. But a mere -247K on payroll employment is a good number--or, rather, a less-bad number than we all were expecting.

Economic glimmers of light, by Felix Salmon: What does it mean when employment and unemployment both move in the same direction? It might be an error in one of the two pretty fuzzy datasets, or it could be, as Agnes says this morning, a real turning point. That’s certainly what the bond market seems to think.

My feeling is that it’s far too early to say that unemployment has stopped rising, and that clearly nobody believes employment has stopped falling. ...

All the same, on such a happy day it would be churlish not to take some joy from today’s figures. The most vertiginous part of the economic plunge is clearly over, and there’s some real hope for (modest and painful) economic recovery going forwards...

The Least-Bad Jobs Report in a Long Time, by David Leonhardt: The story of today’s jobs report is pretty simple: given what was expected, it’s very good news. ... The one thing that doesn’t deserve much excitement is what will probably garner many of the headlines: the drop in the unemployment rate. It happened only because more people stopped looking for work and were thus ineligible to be counted as officially unemployed. The share of adults with jobs actually fell: to 59.4 percent, from 59.5 percent.

So the job market and the economy are still in bad shape. But, all in all, this was a very good report.

Anyone have any graphs?:

Employment Report: 247K Jobs Lost, 9.4% Unemployment Rate, by Calculated Risk: From the BLS:

Nonfarm payroll employment continued to decline in July (-247,000), and the unemployment rate was little changed at 9.4 percent, the U.S. Bureau of Labor Statistics reported today. The average monthly job loss for May through July (-331,000) was about half the average decline for November through April (-645,000). In July, job losses continued in many of the major industry sectors.

Employment Measures and Recessions Click on graph for larger image.

This graph shows the unemployment rate and the year over year change in employment vs. recessions.

Nonfarm payrolls decreased by 247,000 in July. The economy has lost almost 5.7 million jobs over the last year, and 6.66 million jobs during the 19 consecutive months of job losses.

The unemployment rate declined slightly to 9.4 percent.

Year over year employment is strongly negative.

Percent Job Losses During Recessions The second graph shows the job losses from the start of the employment recession, in percentage terms (as opposed to the number of jobs lost).

For the current recession, employment peaked in December 2007, and this recession was a slow starter (in terms of job losses and declines in GDP).

However job losses have really picked up over the last year, and the current recession is now the 2nd worst recession since WWII in percentage terms (and the 1948 recession recovered very quickly) - and also in terms of the unemployment rate (only early '80s recession was worse).

With fewer job losses ("only" a rate of 3 million job losses per year), and the dip in unemployment rate, this will be consider an improvement. It is still a weak employment report. Much more to come ...

[See also Employment-Population Ratio, Part Time Workers, Average Workweek, Unemployment: Stress Tests, Unemployed over 26 Weeks, Diffusion Index]

Employment Report, by spencer: The employment report was very encouraging.

Most importantly, aggregate hours worked were unchanged at 91.1 as compared to 104.1, 101.7 and 99.7 over the last three quarters. An unchanged reading is a massive improvement from the 8% to 9% rate of decline over the past three quarters. With positive productivity this impies that thrird quarter real GDP growth could easily be positive..

Moreover, the manufacturing work week rose from 39.5 to 39.8 hours and overtime hours were 2.9 hours versus 2.8 in the second quarter. Much of this was auto and confirms the other reports that at least auto output is rebounding. The hours worked together with productivity strongly impies that manufacturing output rose in July -- to be reported about mid-month. Moreover, the average workweek and overtime hours are traditional leading indicators.Wage growth improved, but not enough to reverse the sharp slowing in average hourly earnings growth.

With hours worked stable and hourly earnings rising average private weekly earnings rose from $611.49 to 614.34.
The improvement in weekly earnings is a welcome sign... Tax cuts are offsetting some of this weakness but a sustained recovery requires growth in real income.

The consensus forecast is for a very weak recovery. But the consensus forecast is always for a weak recovery. The actual historic record is for recoveries to be proportional to the recession. That is, severe recessions have strong recoveries and mild recessions have weak recoveries.
I'm not making a forecast or taking a position that the consensus is wrong, or that those who expect no recovery are wrong either. But at every bottom economists always have a long list of reasons why this recovery will be weak. And they are usually wrong. In 1981, I won the National Association of Business Economists annual forecasting contest by forecasting an average or normal recovery from the 1980 recession. It was the strongest forecast in the competition.Footnote. Despite the increase in the minimum wage the teenage unemployment rate actually fell.

What's going on with broader measures of unemployment?:

Jobs paradox?, by Paul Krugman: ...[H]ow do we measure unemployment? ... It comes, instead, from a survey in which people are asked whether they’re working and, if not, whether they’re looking for work. And what this month’s data show is a relatively large rise in the number of people “not in labor force” — neither working nor looking for work. That’s how the unemployment rate can fall even with fewer people working.

Isn’t U6, the broadest measure of unemployment, supposed to include people who are discouraged and stop looking? Yes — but at least according to the survey, that’s not the reason more people have dropped out of the work force.

Basically, though, what you need to bear in mind is that these are imperfect measures, subject to a fair bit of noise. When the trend in the labor market is very strong in either direction, the measures move together. But when you have the kind of scene we have now — the employment situation is drifting down, but not plunging — occasional mixed signals are likely. No big deal.

The basic story is that things are sort of stabilizing — but they’re definitely not improving yet.

Robert Reich is far from claiming victory:

The New Employment Numbers: Things are Worsening More Slowly, by Robert Reich: The economy is getting worse more slowly. That's just about the only clear reading that's coming from the economic reports, including this morning's important one on employment. ...

So let's be grateful that the economy is getting worse more slowly than it was. But don't be lured into thinking we're ever going back to where we were. Most of the jobs that have been lost are never coming back. New ones will replace some of them, eventually, but hardly all of them. The structure of the American economy is changing. We will emerge from all this with an economy that looks strikingly different from the one we had in 2007. More on this to come.

Justin Fox also notes "bad news" in the report:

Jobs! Jobs! Jobs!, by Justin Fox: ...The bad news is that there are no real signs of economic life in the details of the employment report, just a slowdown in the pace of losses in most of the big categories. The most significant job creation was in health care, which added 19,600 jobs. But that's nothing new, and it's not unmitigated good news—we want to cut health care spending, don't we? The federal government added 12,000 jobs, "arts, entertainment, and recreation" added 10,000 (who knew?). Oh, and the auto industry supposedly added 28,000 jobs, but I'll let the BLS explain that away:

In motor vehicles and parts, fewer workers than usual were laid off in July for seasonal retooling. ... In large part, July's seasonally-adjusted increase reflects the fact that previous job cuts had been so extensive that there were fewer workers to lay off during the seasonal shutdown.

The above numbers are seasonally adjusted—which is necessary to do, but adds lots of potential for weird statistical quirks like the auto employment increase. Without the seasonal adjustments, employment fell a whopping 1.3 million in the month. And there were 5.9 million fewer jobs in July 2009 than in July 2008. ...

The CBPP takes a look at long-term unemployment, and the news isn't good:

CBPP Statement, by Chad Stone: Today’s employment report shows that labor market conditions remain extremely harsh for job-seekers, generating a record level of long-term unemployment. One third of the unemployed (33.8 percent) have been looking for work for 27 weeks or more — the highest percentage ever recorded in data going back to 1948 and well above the peak reached in the severe 1981-82 recession (see Figure 1).

The report also shows that the deterioration in labor market conditions has slowed considerably from earlier this year, suggesting an economic recovery may be in sight. But that news must be tempered by the ongoing plight of the long-term unemployed....

Why did the unemployment rate fall?:

Why exactly did the unemployment rate fall?, by Rebeccas Wilder: Please correct me if I'm wrong. But the labor force is really big, 154,503,000 (see Table A on the BLS news release). Compared to that, the number of unemployed is really small, 14,462 (see the same table).

If the decline in number of unemployed, -267,000 was 63% the size of the decline in the labor force, -422, which shift is the dominant factor in the falling unemployment rate?

Unemployment rate = unemployed/labor force

I'd say the sizable shift in the really small numerator. Apparently, the AP does not think so:

One of the reasons the rate went down, however, was because hundreds of thousands of people left the labor force. Fewer people, though, did report being unemployed.

I'm pretty sure that this should read: The main reason that the unemployment rate went down was due to the number of unemployed falling significantly as workers left the labor force.

Unemployment Rate Falls as Employment-Population Ratio Declines, by pgl: BLS reports even more job losses in July:

Nonfarm payroll employment continued to decline in July (-247,000), and the unemployment rate was little changed at 9.4 percent

But the unemployment rate was 9.5 percent in June. Had the Administration been Republican, Lawrence Kudlow would be hailing this report as good news. Paul Krugman offers a different tone:

Some readers have asked how it’s possible for unemployment to fall when the economy is still losing jobs, albeit at a slower rate. The answer is a bit annoying. First, the jobs number and the unemployment number are based on different surveys — a survey of establishments in the first case, a survey of households in the second. Sometimes employment rises by one measure while falling by the other, although it happens that this month there isn’t much difference in the jobs number.

The household survey also showed job losses – with its figure being 155,000, which drove the employment-population ratio down from 59.5% to 59.4%. The labor force participation rate, however, also fell from 65.7% to 65.5%. The employment picture got a little worse last month or as Paul concludes:

the employment situation is drifting down, but not plunging — occasional mixed signals are likely. No big deal. The basic story is that things are sort of stabilizing — but they’re definitely not improving yet.

Finally, policymakers should look at the numbers the way Michael Mandel does and plan accordingly. It's far to soon for policymakers to ease up, and in fact, they ought to planning for more stimulus in case this is correct:

The Calm before the Storm?, by Michael Mandel: This morning’s jobs report seemed to show a firming-up of the labor market, with the unemployment rate dropping a tad, from 9.5% to 9.4%. Job losses have slowed too, down only 247,000 in July.

But one month’s numbers do not make a recovery. I’m betting that this may be just a temporary pause before the labor market worsens again towards the end of 2009. What happened is that the government has poured an incredible amount of money into the economy, through both monetary and fiscal stimulus. Policymakers have managed to blunt the downward spiral, which is a tremendous achievement. No depression on Bernanke’s watch.

But consumers are still cutting back, and the personal savings rate still has more to rise. I would treat this as the eye of the hurricane, with more yet to come.

David Wessel Answers Your Questions

Journal economics editor David Wessel will be answering questions from readers next week on the Fed, the financial crisis and his latest book “In Fed We Trust.”

Submit questions in the comment section or send an email to realtimeeconomics@wsj.com.

Readers can learn more about the book, which is a play-by-play account of the government’s response of the financial crisis, here and read the opening. An excerpt:

At the beginning of October 2008, after some of the toughest weeks of the Great Panic, the lines in Ben Bernanke’s face and the circles under his eyes offered evidence of more than a year of seven-day weeks and conference calls that stretched past midnight. Sometimes all that seemed to keep Bernanke going was the constantly restocked bowl of trail mix that sat on his secretary’s desk and the cans of diet Dr Pepper from the refrigerator in his office. But the balding, bearded chairman of the Federal Reserve managed a smile as he confided that he had a title for the book he would write someday about his watch as helmsman of the world economy: Before Asia Opens…

The phrase was a reference to the series of precedent- shattering decisions that Bernanke and others at the Fed and Treasury had been forced to make with insufficient sleep and inadequate preparation on Sundays so they could be announced before financial markets opened Monday morning in Asia, half a day ahead of Washington and New York.

Before Asia Opens . . . was not a laugh line. The subprime mortgage mess was made in America, and that meant the U.S. government was forced to lead the cleanup. Ben Bernanke had more immediate power to do that than any other individual. The president of the United States can respond instantly to a missile attack with real bullets; he cannot respond instantly to financial panic with real money without the prior approval of Congress. But Bernanke could and did.

Read an adaptation of the book from the Journal, and read an excerpt about Treasury Secretary Timothy Geithner.

Economists React: ‘Gift That Keeps on Giving’

Economists and others weigh in on the smaller-than-expected decline in nonfarm payrolls and the drop in the unemployment rate.

  • July’s Employment Report is the gift that keeps on giving. Nearly every element of it is positive. Most notably, non-farm payrolls fell by a more modest 247,000 last month, the smallest decline since August 2008. Admittedly, a decline in employment of that magnitude still seems hard to square with the growing speculation that the recession ended around mid-year. Looking back, however, the economy lost 265,000 jobs in the first month of the recovery in 2001 and 226,000 jobs in the first month of the recovery in 1991. –Paul Ashworth, Capital Economics
  • There is one disturbing trend evident from the household survey… Long-term unemployment is becoming an increasingly pressing issue. The number of those unemployed for 27 weeks or more rose to 4.965 million in July, up from 4.381 million in June. This is easily the highest number on record and, for those who would insist this is meaningless given growth in the labor force over time, it represents 3.21% of the civilian labor force, which is the highest share on record. As of July, 53.5% of the unemployed are so because they have lost their jobs permanently, the highest figure in the life of the data, while 11.4% are on temporary layoff. This is one sign that the current recession has generated a considerable degree of structural, as opposed to cyclical, unemployment, reflecting the amount of excess capacity that had developed in the economy over recent years in areas such as construction, financial services, retail trade, and auto production/sales. Even as the economy recovers, these displaced workers will likely be unemployed for a prolonged period. –Richard F. Moody, Forward Capital
  • Today’s news on employment was far better than expected with a mix of data that portrays near-term optimism that the economy is turning the corner but some indications that the loss in earnings power will be weighing on growth for some time to come. The better numbers reflect hiring by the auto industry and Federal government and a sharp slowdown in the reduction of jobs by temporary employment services. But people aren’t spending and the retail industry continues to lose jobs at an accelerating pace, in particular general merchandise stores. –Steven Blitz, Pangea Market Advisory
  • This was unambiguously a good report, considering the circumstances, and it was far better than what the market was expecting. More importantly, with the fall-off in the pace of job losses appearing to be gaining some traction and the improved tone of other economic reports, it appears that the U.S recession may well be in its last throes.r –Millan L. B. Mulraine, TD Securities
  • While on the face of it this report was “good” news, we are more than a bit suspicious of the result given the preponderance of evidence that points to worse conditions. However, whether or not today’s report overstated the case, the improving trend of the labor market after the autumn/winter carnage cannot be denied. What is still very much open to question is how fast the move will be to stabilization of payrolls and eventually to job growth. We continue to believe that the process will be a slow one, and that households will be contending with weak income growth and balance sheet issues for some time. –Joshua Shapiro, MFR Inc.
  • Estimates of employment for the two previous months were revised up by a net 43,000. The direction of revisions has proven in the past to be a reinforcing indicator of changing job market conditions. Consequently., the revisions reinforce hopes that the smaller July job loss is signaling a genuine improvement in labor market conditions. The jobs data augment a growing collection of data suggesting that the US economy is emerging from recession. –Nomura Global Economics
  • The case that the recession ended in June continues to grow with this report. The rate of job loss has downshifted and the lengthening of the workweek in July resulted in flat hours worked in the private sector and an increase in manufacturing hours worked, which in turn points to a gain in industrial production in July. However, the decline in the unemployment rate was not a product of job creation, but a result of falling labor force participation. The labor force is unchanged over the last year and, as the economy improves, people are likely to seek jobs, resulting in an increase in the unemployment rate. We do not think that the unemployment rate has peaked — although the case that it can peak at around 10% (rather than 11% or higher) is now much stronger. –RDQ Economics
  • Key question now is whether this can last; answer is yes if jobless claims can remain close to the 550,000 reported yesterday; indeed payroll losses could slow to only 150,000 in the next couple of months. What likely can’t last, though, is the unexpected drop in the unemployment rate, which was due entirely to a 422,000 drop in the labor force… Assuming more normal trends over the next few months, the unemployment rate has further to rise. That will intensify the squeeze on earnings… In short, then, we think only the payroll element of this report is sustainable, and it is very welcome. But the final peak in unemployment is not here yet, and wages are still under pressure. –Ian Shepherdson, High Frequency Economics
  • The dawn of an economic recovery is here. The sharp contraction in employment has moderated pointing to the end of the recession. The better average workweek and hourly earnings point to the same conclusion. The employment picture improved in almost every major sector of the economy. The economy is in the process of bottoming, but the job market will lag behind. Businesses, which engaged in preemptive layoffs earlier, are not about to start hiring people. Expecting sluggish recovery in demand in the foreseeable future, employers want to make sure that a sustained economic recovery is here before hiring. –Sung Won Sohn, Smith School of Business and Economics
  • There’s somewhat less improvement beneath the headline. Employment in motor vehicle and parts manufacturing rose by 28,000, as seasonal adjustment factors looked for layoffs that took place earlier in the year –Alan Levenson, T. Rowe Price
  • The lagging employment indicatorsare showing a more pronounced turn, reducing chances of a “W” recovery or deflation. –Stephen Gallagher, Societe Generale
  • It’s worth noting that the slippage in the overall unemployment rate was NOT attributable to a gyration in the teenage unemployment rate — which can often be quite volatile during the summer months. The unemployment rate for teenagers slipped 0.2 percentage points which more or less matched the move in the unemployment rate for adults. –David Greenlaw, Morgan Stanley

Compiled by Phil Izzo

Offer your reactions in the comments section.

Dig into an interactive summary of economists’ forecasts for the coming year from the latest WSJ.com survey.

Lucas Roundtable: Ask the Right Questions

In The Economist, Robert Lucas responds to recent criticism of macroeconomics ("In Defense of the Dismal Science"). Here's my entry at Free Exchange's Robert Lucas Roundtable in response to his essay:

Lucas roundtable: Ask the right questions, by Mark Thoma: In his essay, Robert Lucas defends macroeconomics against the charge that it is "valueless, even harmful", and that the tools economists use are "spectacularly useless".

I agree that the analytical tools economists use are not the problem. We cannot fully understand how the economy works without employing models of some sort, and we cannot build coherent models without using analytic tools such as mathematics. Some of these tools are very complex, but there is nothing wrong with sophistication so long as sophistication itself does not become the main goal, and sophistication is not used as a barrier to entry into the theorist's club rather than an analytical device to understand the world.

But all the tools in the world are useless if we lack the imagination needed to build the right models. Models are built to answer specific questions. When a theorist builds a model, it is an attempt to highlight the features of the world the theorist believes are the most important for the question at hand. For example, a map is a model of the real world, and sometimes I want a road map to help me find my way to my destination, but other times I might need a map showing crop production, or a map showing underground pipes and electrical lines. It all depends on the question I want to answer. If we try to make one map that answers every possible question we could ever ask of maps, it would be so cluttered with detail it would be useless, so we necessarily abstract from real world detail in order to highlight the essential elements needed to answer the question we have posed. The same is true for macroeconomic models.

But we have to ask the right questions before we can build the right models.

The problem wasn't the tools that macroeconomists use, it was the questions that we asked. The major debates in macroeconomics had nothing to do with the possibility of bubbles causing a financial system meltdown. That's not to say that there weren't models here and there that touched upon these questions, but the main focus of macroeconomic research was elsewhere.

One major debate, for example, was the rate at which the macroeconomy returns to its long run equilibrium after a shock. Both New Keynesians and Chicago type equilibrium theorists believed the economy was always moving in the right direction—toward long-run equilibrium—the question was simply how fast that movement occurred and whether there was any role for policy to help the process along. Neither side of the debate seriously considered the possibility that the economy would continue to move away from its long-run equilibrium outcome for a substantial period of time—for years—as a housing price bubble developed, and that once the bubble popped the interconnectedness of financial markets would cause the problem to spread in a falling domino fashion that would throw the entire economy into a deep recession.

The interesting question to me, then, is why we failed to ask the right questions. For example, notice Mr Lucas' defence of the simulations that failed to predict the crisis:

[T]he simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring. Until the Lehman failure the recession was pretty typical of the modest downturns of the post-war period... Mr Mishkin’s forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. After the Lehman bankruptcy, too, models very like the one Mr Mishkin had used, combined with new information, gave what turned out to be very accurate estimates of the private-spending reductions that ensued over the next two quarters.

I don't think we should be very impressed with the argument that once policymakers knew the economy was headed downward, the models were able to predict that the economy was headed downward. Further, even after it was known where the economy was headed, the models seriously underestimated the magnitude of the decline, and that led to an inadequate policy response.

But the important question is why policymakers didn't take the possibility of a major meltdown seriously. Why didn't they deliver forecasts conditional on a crisis occurring? Why didn't they ask this question of the model? Why did we only get forecasts conditional on no crisis? And also, why was the main factor that allowed the crisis to spread, the interconnectedness of financial markets, missed?

It was because policymakers couldn't and didn't take seriously the possibility that a crisis and meltdown could occur. And even if they had seriously considered the possibility of a meltdown, the models most people were using were not built to be informative on this question. It simply wasn't a question that was taken seriously by the mainstream.

Why did we, for the most part, fail to ask the right questions? Was it lack of imagination, was it the sociology within the profession, the concentration of power over what research gets highlighted, the inadequacy of the tools we brought to the problem, the fact that nobody will ever be able to predict these types of events, or something else?

It wasn't the tools, and it wasn't lack of imagination. As Brad DeLong points out, the voices were there—he points to Michael Mussa for one—but those voices were not heard. Nobody listened even though some people did see it coming. So I am more inclined to cite the sociology within the profession or the concentration of power as the main factors that caused us to dismiss these voices.

And here I think that thought leaders such as Robert Lucas and others who openly ridiculed models they disagreed with have questions they should ask themselves (e.g. Mr Lucas saying"At research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another", or more recently "These are kind of schlock economics"). When someone as notable and respected as Robert Lucas makes fun of an entire line of inquiry, it influences whole generations of economists away from asking certain types of questions, some of which turned out to be important. Why was it necessary for the major leaders in macroeconomics to shut down alternative lines of inquiry through ridicule and other means rather than simply citing evidence in support of their positions? What were they afraid of? The goal is to find the truth, not win fame and fortune by dominating the debate.

We need to take a close look at how the sociology of our profession led to an outcome where people were made to feel embarrassed for even asking certain types of questions. People will always be passionate in defense of their life's work, so it's not the rhetoric itself that is of concern, the problem comes when factors such as ideology or control of journals and other outlets for the dissemination of research stand in the way of promising alternative lines of inquiry.

I don't know for sure the extent to which the ability of a small number of people in the field to control the academic discourse led to a concentration of power that stood in the way of alternative lines of investigation, or the extent to which the ideology that markets prices always tend to move toward their long-run equilibrium values caused us to ignore voices that foresaw the developing bubble and coming crisis. But something caused most of us to ask the wrong questions, and to dismiss the people who got it right, and I think one of our first orders of business is to understand how and why that happened.

There are other entries from (I'll update the list as more are added):

Some successes, some failures by Tyler Cowen
Mind the frictions
by Markus Brunnermeier
A change in tune
by Brad DeLong

Rate Crimes: Impeding the Solar Tipping Point

The following guest essay was written by Paul Symanski. Paul is an electrical engineer with expertise in solar energy, and shares his views on why solar power often faces unnecessary headwinds.


To anyone who has ever spent a day in Arizona’s Valley of the Sun, it is obvious. The sunniest state in the nation is blessed, cursed, with a fierce sun. Yet, as one explores the landscape, artifacts of the capture of solar energy are conspicuously absent. This dearth is true for solar electric, domestic hot water, passive solar design, and even for urban design. It is as if the metropolis stands in obstinate defiance against the surrounding desert and its greatest gift.

Yet, the incessant sun is a constant agitator. Even visitors happily distracted by the Valley’s many amenities will remark while lounging by the pool, drinking in the clubhouse, or enjoying a repast on a misted patio, “Why doesn’t Arizona use more solar energy?”

Solar Tipping Point

One answer to this persistent question can be found once one comprehends that Arizona is where it first occurred: where solar energy first became economical.

Around the turn of the millennium, four decades after its destiny was foretold, an investment in electricity generated by an on-site photovoltaic system became a better investment than traditional investment vehicles. Finally, solar energy had become economically transcendent. Because of its abundant solar resource, solar energy’s transcendence occurred in the center of the desert Southwest, in sunny Arizona. It may not be mere chance that this tipping point coincided with the world’s peak production of petroleum.

The concept of “grid parity” has been promulgated by an energy regime that sees the world through grid-centric eyes. A more accurate and revealing comparison is investment parity. This approach more completely – and perhaps more directly – accounts for the myriad hidden costs embedded in the economics of the world’s energy system. Both the recent economic troubles and the fact that the solar tipping point occurred during an historical low for electricity prices in Arizona reinforce the validity of economic ascendancy of solar energy.

Implicit in the concept of grid parity is an ultimate arrival where both sides rest in balance upon the fulcrum. This subtle point of terminology further invalidates the utility of the concept of “grid parity”. The balance will likely be a brief moment of hushed breath . . . before the tipping continues in favor of solar energy.

The concept of grid parity also establishes a false dichotomy that reveals the term to be an indirection. Solar energy should be one of a multitude of energy sources to be impartially and intelligently incorporated into a flexible network of energy sharing. The concept of grid parity is a creation of a hierarchical system of centralized generation and distribution. Like the system that created it, the term ‘grid parity’ should be recognized for what it is.

The concept of a tipping point is a more appropriate metaphor. It is this tipping point that those favored by the status quo vigorously resist.

Delay Tactics

It is crucial that energy costs be accurately accounted in order to establish valid policies. Yet, in any forum where energy is discussed (present company excepted), retail energy costs are typically presented as an average, or as a range of values. Even in conversations amongst economists, engineers, scientists, business leaders, policy makers, and others who help guide our energy future, superficial valuations proliferate. Blunt statements of cost nearly always exclude associated economic, competing, and externalized costs. More dangerously, such simplification disguises a complex and telling reality.

The key observation – and the linchpin of the Rate Crimes exposé – is that the avoided cost value of solar electricity and other energy management strategies has long been dramatically lower than the retail cost of electricity under particular rate plans.

The graph below plots the avoided cost value of on-site solar electricity against retail energy costs under the Arizona Public Service E-32 commercial rate schedule for the summer season. The ranges of kilowatt demand and kilowatt-hour consumption reflect those of small businesses.

The avoided cost value of solar electricity is half that of the retail cost of electricity for a great portion primarily because of the uncontrollable billing demand, and a precipitous declining block rate structure compounded by the uncontrollable billing demand being used as a multiplier for the extents of the expensive initial block.

Of the hundred largest electric utilities (by customers served), fourteen are located in the sunny Southwest (excluding the unregulated utilities in Texas).

Of these fourteen, three have commercial rate plans with structures that most defeat the value of solar energy and energy conservation measures. These utilities are: Arizona Public Service, Salt River Project, and Tucson Electric Power. All are Arizona utilities.


The Arizona rate schedules provide an enormous subsidy and encourage prodigal consumption by discounting energy to the largest energy consumers. This was historically a common situation in other places as well. However, Arizona is special due to its extraordinary solar resources.

The pricing system redirects costs from any apparent savings in the residential and industrial sectors into the small commercial sector. Small commercial ratepayers have less capital, have fewer person-hours to commit to unusual projects, have less-diverse expertise, and are often constrained from making modifications to their premises. The redirection of costs into this captive market creates a hidden tax through the higher costs of goods and services, and through the subsequently higher sales tax charges.

Furthermore, while more fortunate homeowners can avoid energy costs by investing in subsidized solar energy, renters remain a captive market.

As you may surmise, nearly the entire Arizona economic and political system is complicit. Beyond Arizona’s borders, the state’s electricity generation from coal and nuclear sources remains the West’s dirty little secret. Environmentally conscientious Californians can nod appreciatively at their Tehachapi and San Gorgonio Pass wind farms; while behind the turbines, on the eastern horizon, the cooling towers and smokestacks of Arizona keep bright their nights.

All Arizonans need to be able to gain full value for investments in energy conservation and in solar energy. Until Arizona’s repressive rate schedules are reformed, energy efficiency measures and solar energy in the nation’s sunniest state will have diminished value. This diminishment of the value of solar energy affects all of us by delaying a cleaner energy future.


Paul Symanski is an electrical engineer, designer, human factors specialist, marketer, machinist, graphic artist, musician, LEED AP, and economist born of necessity. He is experienced with renewable energy, including expertise in solar energy both in practical application and in the laboratory. He is also a competitive masters-level bicyclist. ratecrimes [at] gmail [dot] com


Why Did the Unemployment Rate Drop?

The unemployment rate actually fell in July, hitting 9.4% from 9.5%, even as the economy lost a quarter of a million jobs. Does this signal the peak for the jobless rate? Will the talk of 10% unemployment end? Not necessarily.

The payroll figures — jobs lost — comes from a Labor Department survey of employers. The unemployment rate is measured through a separate survey of households — asking people whether they have a job, whether they want a job and whether they searched for a job (among other things). If people drop out of the labor force, the unemployment rate can decline because fewer people would be considered jobless.

The July household survey showed the civilian labor force shrinking by 422,000 and employment falling 155,000. That translated into 267,000 fewer people listed as unemployed. The labor-force participation rate fell 0.2 percentage point in July to 65.5%

The unemployment rate improving while payrolls continue declining is hardly unusual. It happened several times during and after the 2001 recession, most recently in August 2003 when joblessness declined to 6.1% from 6.2% while the employer survey showed a decline of 42,000 jobs.

When the economy recovers, more people are likely to reenter the labor force looking for jobs. People who decided to return to school during the downturn, for instance, would eventually return to the job search and help push the unemployment rate higher. (The government’s broader jobless rate declined a fifth of a percentage point to 16.3%. But its still-elevated level signals how many people want full-time jobs but stopped looking because they can’t get one.)

The payroll measurement is a coincident indicator, tracking current conditions in the economy. But the jobless rate, as a lagging indicator, is likely to resume rising even as the economy recovers and employers start adding jobs. So 10% unemployment isn’t out of the question.

Secondary Sources: Stimulus, Fed Funds, Japan

A roundup of economic news from around the Web.

  • More Stimulus: Writing for Project Syndicate, Joseph Stiglitz calls for more stimulus. “People are asking: Has Keynesian economics been proven wrong, now that it has been put to the test? The question, however, only makes sense if Keynesian economics had really been tried. Indeed, what is needed now is another dose of fiscal stimulus. If that doesn’t happen, we can look forward to an even longer period in which the economy operates below capacity, with high unemployment.”
  • Fed Funds Odds: On the Econbrowser, James Hamilton presents information from a new paper he co-authored that looks what fed funds futures say about the market’s perception of what the Fed will do. “The conclusion we draw from this exercise is that the modest upward slope of the futures curve in the summer of 2009 could easily be accounted for by risk premia in these contracts, and need not be interpreted as a belief by market participants that an increase in the target fed funds rate before the end of 2009 is particularly likely.”
  • Japan and Exports: Writing for the New York Times, Akio Mikuni points out Japan’s difficulty of being an export-led economy. “So what’s the problem with relying on exports? Let me give a simple example. We manufacture automobiles. When we sell them domestically, this is a boon to Japanese car dealers, insurance salesmen and repairmen. But when we ship them abroad, they are not making a meaningful contribution to the domestic economy. Income earned by the export sector is offset by the amount of capital that we invest in the United States to encourage a dollar strong enough to allow American consumers to buy our products. Sure, we get foreign reserves — like United States government bonds — in return for that capital. But as our 17th-century scholar would remind us, we cannot eat or wear American dollars. We need to replace external demands with domestic ones. We could do this by exchanging our dollar investments for yen. This would cause the yen to appreciate, reducing the costs of imports and enhancing real purchasing power. Already, some Japanese retailers are slashing prices because the strengthening yen is lowering the cost of their imports. They could do it again if the yen appreciated further.”

Compiled by Phil Izzo

Trichet’s Post-ECB Comments: ‘Vigilence’ Needed

Here are highlights from ECB President Jean-Claude Trichet’s comments to the media following the ECB’s decision to keep rates steady Thursday.

‘Vigilance’ Needed

Trichet Friday said the world economy is no longer in free-fall but called for vigilance. “We’re leaving this period of free-fall, we’re still falling,” Trichet said in an interview on RTL radio. “We’re in a period which still requires a great deal of vigilance,” Trichet added.

Banks Shouldn’t Retreat From International Markets
Banks mustn’t lose their international angle and return to financial protectionism, Trichet told Dow Jones Thursday, saying such a move would pose serious risks to global finance and prosperity.

“It is a danger, and the ECB will do all it can to avoid precisely such a move,” Trichet said.

The warnings come as global banks, burdened by heavy writedowns and toxic assets, have been quick to plan international disposals to cut risks. The remarks echo warnings from the Bank for International Settlements. BIS Chief Economist Stephen Cecchetti told Dow Jones Newswires in an interview
last month that “large-scale reversals of exposure have…been pretty serious for six months now.”

A return to financial protectionism would be “a blow for international finance” and prosperity, Trichet said. “It is a concern for the international community and certainly for the ECB.”

Latest BIS data show that external claims of banks in developed countries fell by 2.3%, or a total of $720 billion, in the three months to March, after dropping $1.9 trillion in the last quarter of 2008. That happened after cross-border financial stocks and flows had grown on a quarterly basis for roughly 30 years, or since the BIS started compiling the Trichet said the ECB is content with the way the European Union’s new financial regulator, the European Systemic Risk Council, is being set up.

“I don’t call for the Risk Council to have more [powers] than envisaged, namely the capacity to deliver warnings, risk assessments, early warnings and recommendations,” Trichet said.

Defending Policy

In an interview with the BBC, Trichet denied that the ECB was providing too little support for growth and said the actions taken by the major central banks are appropriate to the situations they face, reflecting in particular the different structures of their financial systems.

“We have all had to cope with exceptional situations,” he said. “We all took decisions that were commensurate with the problems we faced. We did not do the same because the situation was not the same.” He said he didn’t see a “major difference” between the approaches of the ECB and the BOE.

Trichet said despite the severity of the recession, for policy makers “caution and prudence are of the
essence.” Indeed, he said, without those qualities, confidence would be damaged.

Paul Krugman: The Town Hall Mob

Lack of passion is hazardous to health care reform:

The Town Hall Mob, by Paul Krugman, Commentary, NY Times: There’s a famous Norman Rockwell painting titled “Freedom of Speech,” depicting an idealized American town meeting. The painting, part of a series illustrating F.D.R.’s “Four Freedoms,” shows an ordinary citizen expressing an unpopular opinion. His neighbors obviously don’t like what he’s saying, but they’re letting him speak his mind.

That’s a far cry from what has been happening at recent town halls, where angry protesters — some of them, with no apparent sense of irony, shouting “This is America!” — have been drowning out, and in some cases threatening, members of Congress trying to talk about health reform. ...

[W]ell-heeled interest groups are helping to organize the town hall mobs. Key organizers include two Astroturf (fake grass-roots) organizations: FreedomWorks, run by the former House majority leader Dick Armey, and a new organization called Conservatives for Patients’ Rights.

The latter group, by the way, is run by Rick Scott, the former head of Columbia/HCA, a for-profit hospital chain. Mr. Scott was forced out of that job amid a fraud investigation; the company eventually pleaded guilty to charges of overbilling state and federal health plans, paying $1.7 billion — yes, that’s “billion” — in fines. You can’t make this stuff up.

But while the organizers are as crass as they come, I haven’t seen any evidence that the people disrupting those town halls are Florida-style rent-a-mobs. For the most part, the protesters appear to be genuinely angry. The question is, what are they angry about?

There was a telling incident at a town hall held by Representative Gene Green, D-Tex. An activist turned to his fellow attendees and asked if they “oppose any form of socialized or government-run health care.” Nearly all did. Then Representative Green asked how many of those present were on Medicare. Almost half raised their hands.

Now, people who don’t know that Medicare is a government program probably aren’t reacting to what President Obama is actually proposing. They may believe some of the disinformation opponents of health care reform are spreading, like the claim that the Obama plan will lead to euthanasia for the elderly ... coming straight from House Republican leaders... But they’re probably reacting less to what Mr. Obama is doing ... than to who he is.

That is, the driving force behind the town hall mobs is probably the same cultural and racial anxiety that’s behind the “birther” movement, which denies Mr. Obama’s citizenship. Senator Dick Durbin has suggested that the birthers and the health care protesters are one and the same; we don’t know how many of the protesters are birthers, but it wouldn’t be surprising if it’s a substantial fraction.

And cynical political operators are exploiting that anxiety to further the economic interests of their backers.

Does this sound familiar? It should: it’s a strategy that has played a central role in American politics ever since Richard Nixon realized that he could advance Republican fortunes by appealing to the racial fears of working-class whites.

Many people hoped that last year’s election would mark the end of the “angry white voter” era in America. Indeed, voters who can be swayed by appeals to cultural and racial fear are a declining share of the electorate.

But right now Mr. Obama’s backers seem to lack all conviction, perhaps because the prosaic reality of his administration isn’t living up to their dreams of transformation. Meanwhile, the angry right is filled with a passionate intensity.

And if Mr. Obama can’t recapture some of the passion of 2008, can’t inspire his supporters to stand up and be heard, health care reform may well fail.

“Keep Shoveling that Stimulus”

Joseph Stiglitz says we need "another big round of real stimulus spending":

Keep shoveling that stimulus, by Joseph Stiglitz , Commentary, Project Syndicate: The green shoots of economic recovery that many people spied this spring have turned brown, prompting concerns about whether the ... fiscal stimulus has failed.

People are asking: Has Keynesian economics been proven wrong, now that it has been put to the test? The question, however, only makes sense if Keynesian economics had really been tried.

Indeed, what is needed now is another dose of fiscal stimulus. If that doesn't happen, we can look forward to an even longer period in which the economy operates below capacity, with high unemployment. ... The problem is that the shock to the economy from the financial crisis was so bad, even Barack Obama's seemingly huge fiscal stimulus has not been enough. ...

The Obama administration erred in asking for too small a stimulus, especially after making political compromises that caused the stimulus to be less effective than it could have been. It made another mistake in designing a bank bailout that gave too much money, with too few restrictions, on too favorable terms to those who caused the economic mess in the first place – a policy that has dampened taxpayers' appetite for more spending.

But that is politics. The economics is clear: The world needs all the advanced industrial countries to commit to another big round of real stimulus spending. ...

I agree that this is needed, and that time is of the essence, but I can't imagine the political climate allowing it to happen unless there is even worse economic news than we've already had, and even then it wouldn't be certain.