It Was the Saving Glut?

An increasing number of observers are placing the origins of the current economic crisis with the saving glut explanation of global economic imbalances. This trend was noted (and more-or-less endorsed) by The Economist this week and mentioned by Menzie Chinn in this post. It is worth noting some prominent observers such as John Taylor and Stephen Roach dismiss the notion of a saving glut entirely and instead pin the blame on bad policies. My own view is that both bad policies--specifically loose monetary policy--and a saving glut played a part. Here is what I said over at Econbrowser on the role played by policy:

What the about Fed's low interest rates in early-to-mid 200s? Surely there was something exogenous here in that no one expected the interest rates to drop as low and long as they did during this time. Not only did the Fed's unexpected loose monetary policy affect domestic consumption/savings, but it got exported to the dollar block countries and to some extent to non-dollar block countries (e.g. ECB had to keep watchful eye on dollar lest the Euro got too expensive). I am not saying it was the only enabler, but it certainly seems important...

I further develop this point--and provide some evidence--in this article (see page 374). However, as noted by Brad Sester, the expansionary policy story for the rising current account deficit best fits the data for the period 2002-2004 while the traditional saving glut story does a better job thereafter. Of course there were other factors at work during this time--the securitization of finance, underestimating aggregate risk, the lowering of lending standards--but the low interest rate environment generated by these two forces was a key contributor to the current economic crisis.

The Future of the Euro (Part V)

Here is another article--this one from the New York Times-- suggesting the current economic crisis may ultimately force some countries off the Euro. Some observers like Willem Buiter and Barry Eichengreen dismiss such claims. Here is some of what Eichengreen has to say:

There is an alternative [to abandoning the Euro], namely fiscal retrenchment, wage reductions, and assistance from the EU and the IMF for the cash-strapped government.

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

But, ultimately, everyone will swallow hard and proceed... [E]ven the most blinkered politicians will see what is at stake here. Investors would flee en masse from the banks and markets of a country that contemplated abandoning the euro. No matter how serious the crisis, politicians will realise that attempting to jettison the euro will only make it worse.

Dr. Eichengreen, one word: Argentina. This country tried fiscal retrenchment, wage reductions, and help from the IMF leading up to the 2001-2002 crisis. And yes, the leaders of Argentina realized that if they abandoned their dollar peg this action would likely lead to default and investors fleeing en masse from Argentina. But they still broke the peg. Commentator Brian over Willem Buiter's blog sums up this comparison best:

[I]f Argentina decided to leave the dollar, because it couldn’t take the pain of real depreciation without nominal depreciation, should we be that surprised if Greece (or more likely Ireland) shares a similar fate? The scale of the real depreciation required by Ireland, which has been amplified by sterling’s depreciation, looks particularly daunting.

See also Paul Krugman who makes a similar point here. History shows us that anything could happen, even a country leaving the Euro.

Where Are the "Safe" Jobs?

The New York Times had an article today titled "Bad Times Spur a Flight to Jobs Viewed as Safe." Here is an excerpt:

Fearing layoffs, investment bankers at a Merrill Lynch or a Morgan Stanley are joining small Wall Street firms for less pay but with signed employment guarantees. Academics are migrating to community colleges, which are adding teachers as enrollment rises. And in Eastern Wisconsin, workers furloughed from a paper mill they fear will not reopen are training as truck drivers and welders.

It was interesting to read how individuals displaced by the recession or fearful they would be displaced by the recession are taking steps to secure what they perceived to be safe jobs. This got me wondering how one would know what is a safe job at this time. I looked to the Nonfarm Payroll employment data broken into sectors for some insight. Below is what I found for the period covering the recession (click on figure to enlarge):


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

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

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

The Battle of the Spreads

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

As you can see from the figure, the spread is currently relatively large and positive, usually a sign of economic growth ahead. This fact was noted by the Cleveland Fed recently as indicating the recession may soon be over. However, Paul Krugman took issue with this interpretation:

The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

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

[...]

So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.

So Krguman does not take solace in the current yield curve spread. Does his interpretation find support in corporate bond yield spread? Or does it provide some sign of hope? The figure below provides an answer. It plots the corporate BAA yield minus the corporate AAA yield spread. (Click on figure to enlarge.)

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

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

The Failure of Deflation Orthodoxy

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

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

The Great Depression Debate in One Picture (Part II)

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

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

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

The Employment Numbers in Perspective

Friday we learned the employment conditions continue to deteriorate:

The nation lost 524,000 jobs in December, bringing the total drop for last year to 2.589 million, just shy of the 2.75 million decline at the end of World War II, the Labor Department reported yesterday in Washington. The unemployment rate climbed to 7.2 percent, the highest level in almost 16 years.

Although these numbers are bad, the widely-reported comparison to WWII is misleading. It fails to account for the fact that the U.S. labor force is now about 2.5 times larger than at the end of WWII. Consequently, a more appropriate comparison would look at the number of lost jobs relative to the labor force for these two periods, not the absolute number. Alternatively, one could simply look at the percent change in employment. As noted by The Economist magazine, this approach shows a 1.9% employment loss in 2008 versus a 2.7% 12-month loss at the dept of the 1974-75 and 1981-82 recessions. This fact is highlighted below in the figure of the year-on-year percent change in NFP employment since the late 1940s. Recessions are highlighted by the gray columns. (Click on figure to enlarge.)

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

Update: ECB once again provides a good response in the comments section:

[I]f we look at the fall-off in the employment/pop ratio since 2000, that is dramatic is it not? And one measure of hardship that mainstream economists ignore, is the number of people suffering from what USDA calls food insecurity. This number now stands at 12 million. That is a 40% increase from 2000. I think you may be a little blase in downplaying the recent employment fall.

See also Barry Ritholtz's post here for more sobering news coming from the labor force participation rate.