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Sunday, January 27, 2013

Break the Silence on the Unemployment Problem

In his inaugural address, President Obama said that “An economic recovery has begun.” It was an applause line. The line is correct of course, but it is really nothing to applaud.  As economists define it, the recovery began nearly four years ago when the 2007-2009 recession ended in June 2009.  So we have had a recovery for most of the Obama Administration.  The problem is that it is a recovery in name only, one of the weakest recoveries in American history.  Growth has been about 2 percent since the recovery began and median household income has declined. That is far less economic growth than recoveries following deep recessions with financial crises in American history.

This slow recovery has left unemployment tragically high in most parts of the country. In the San Francisco Bay Area where I live we are relatively lucky. In San Francisco the unemployment rate is 6.7%. The rate is 7.8 % in the country as a whole, and 9.8 % in the state as a whole. In the nearby central valley—cities like Yuba City, Modesto, Merced, Fresno—it’s about 15%, and down south in El Centro California it’s 27%.    

The numbers would all be worse if they included the unusually large number of people who have dropped out of the labor force and are no longer counted as unemployed.  If they counted, the national unemployment rate would be 9.1 percent. Another way to think about this is to look at the fraction of working age adults who are employed. Though this number usually rises during recoveries, it is actually smaller now than when the recovery began.

But you know even that relatively low 6.7% in San Francisco is pretty terrible.  I like to tell the story about what Senator Hubert Humphrey said when President Ford’s Council of Economic Advisers, where I worked with Alan Greenspan, reported to the Joint Economic Committee (JEC) that it was raising the definition of the normal unemployment rate from 4.0% to 4.9%.  Humphrey, who chaired the JEC, was outraged and told us in the JEC hearing that “if the country was suffering a plague and you economists were doctors your solution would be to raise the definition of normal body temperature above 98.6 degrees”   

So I am worried when people stop talking about today’s very high unemployment rates as if they were normal.  It is not a good sign that the inaugural address was silent on the subject, not even including the word unemployment. 

Thursday, January 17, 2013

A Debt Limit Strategy Rather Than Tactics

The recent debate about the debt limit focuses on the negative economic impact of a decision by the government not to increase the debt limit. That’s why President Obama says he is asking for clean debt limit increase—one not linked to spending reductions, saying that a default would cause economic harm, and that we should not play chicken with the American economy.

But with current high and growing debt levels a clean debt limit increase would also hurt the economy. If politicians just increase the debt limit now without reducing the rapid growth of spending, then they will be expected to do so in the future and the debt explosion will continue to create a drag on the economy with a likely future crisis. The time pattern may be different with a clean debt limit increase--if kicking the can down the road postpones the harm, but the overall impact is negative, and it could be worse if there is a debt crisis.

There is an obvious way to prevent both evils: follow a policy strategy which links debt limit increases to reductions in the growth of spending. By focusing on tactics--games of chicken, leverage and threats—Washington is ignoring this sensible policy strategy.

In a recent technical paper my colleague Bob Hall, rigorously works out the effects of severing the link between debt increases and deficit spending. He defines a parameter which he calls “alpha.” It’s simply the amount by which politicians reduce the deficit when they increase the debt, measured as a fraction of the debt to GDP ratio. In other words, alpha is an indicator of how much the government “leans against” the debt. As Bob puts it: “Alpha is all-important in the analysis….Governments with no tendency to lean against debt, with alpha = 0, face a likelihood but not a certainty of debt crisis.” The problem with a clean debt limit increase is that it effectively sets alpha to 0.

A much better value of alpha, as Bob shows, is around .1, which, if you measure spending reductions on a ten year basis, translates to .1X10 or 1, or, in other words, a strategy like the one-to-one link sometimes called the Boehner rule. So while some may think of such a rule a threat, it is really a strategy, and a sensible strategy in my view.

Thursday, January 3, 2013

No Debt Fix In Sight

The election is over, the fiscal cliff is over, and the problems remain.

For the past several years on this blog I have been showing simple charts to monitor progress—or lack of progress—on the persistent deficit and the growing debt, which in my view are impediments to returning to strong economic growth. Unfortunately neither the election nor the fiscal cliff deal has resulted in any meaningful change in these budget charts.

Here is the latest spending chart. It shows the Administration’s spending proposal prior to the debt deal of 2011, a CBO forecast with the fiscal cliff deal, and my pro-growth alternative which would balance the budget.

Clearly we still have a long way to go to bring spending growth down and thereby reduce spending as a share of GDP. The battle in Washington in the next few years will be where between the black and the green line we go.

Note that the CBO forecast is based on its alternative fiscal scenario, which is very close to what actually happened in the so-called fiscal cliff deal. As the CBO stated in their August 2012 report “That scenario incorporates the assumptions that all expiring tax provisions (other than the payroll tax reduction in effect in calendar years 2011 and 2012) are extended; the alternative minimum tax (AMT) is indexed for inflation after 2011; Medicare’s payment rates for physicians’ services are held constant at their current level; and the automatic spending reductions required by the Budget Control Act of 2011 (Public Law 112-25), which are set to take effect in January 2013, do not occur."

Moreover, the tax increase in the fiscal cliff deal has not affected the budget deficit in any substantial way. The assumption is that this tax increase will raise revenues by about $600 billion over ten years—probably an over statement as people adjust to the higher rates. But even that $600 billion is only .3 percent of GDP which is expected to be about $201,000 billion over that ten year period. This would hardly be noticeable in the spending chart.  So the scary the 2012 fix the debt chart and 2009 fix the debt video still apply in 2013.