AUGUST 6 2010

Martin Feldstein, Project Syndicate: The Hidden Future of the US Economy. Recent US data have clearly raised the probability that the economy will run out of steam and decline during the next 12 months. The key reason for increased pessimism is that the government stimulus programs that raised spending since the summer of 2009 are now coming to an end. As they have wound down, spending has declined. The government programs failed to provide the “pump-priming” role that was intended.

Alan S. Blinder, Mark Zandi: How the Great Recession Was Brought to an End. When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing—we estimate that the latter was substantially more powerful than the former. Nonetheless, the effects of the fiscal stimulus alone appear very substantial, raising 2010 real GDP by about 3.4%, holding the unemployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls. These estimates of the fiscal impact are broadly consistent with those made by the CBO and the Obama administration. To our knowledge, however, our comprehensive estimates of the effects of the financial-market policies are the first of their kind.

J. Bradford DeLong, Project Syndicate: John Stuart Mill vs. the European Central Bank. The ECB contends that the core economies of the global North – Germany, France, Britain, the United States, and Japan – are now at the point where they need rapid fiscal retrenchment and austerity, because financial markets’ confidence in the quality of their debt is shaken, and may collapse at any moment. I see a very different picture – one in which markets’ trust in the quality of government liabilities of the global North’s core economies most certainly is not on the brink of collapse. I see production 10% below capacity, and I see unemployment rates approaching 10%. More importantly for near-term economic policy, I see a world in which investors have enormous confidence in core economies’ government debt – for many, the only safe port in this storm. In these circumstances, we can be sure of what Mill would have recommended.

Andrew K. Rose, Mark M. Spiegel, VoxEU: What do we know about the causes of the crisis? Despite a broad search, we have been unable to find consistent strong linkages between pre-existing variables that are plausible causes of the Great Recession and the actual intensity of the recession. It is natural for economists to generalise from experiences of a few particularly salient countries to make generalisations, though it is often inappropriate. Our poor results are simply telling us that the pre-conditions for the crisis in the US (or Iceland, or Latvia …) often do not describe other countries particularly well. Credit growth was high before 2008 in Australia, Canada, and South Africa, yet these countries seemed to have weathered the crisis well. Real housing prices actually fell in Japan, Germany and Portugal, yet these countries were hard hit. Since it is difficult to understand the cross-country incidence of the great recession even in retrospect, we are dubious about the potential for a comparable early warning forecasting model going forward.

CBO: Federal Debt and the Risk of a Fiscal Crisis. A sudden increase in interest rates would reduce the market value of outstanding government bonds, inflicting losses on investors who hold them. That decline could precipitate a broader financial crisis by causing losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt—losses that might be large enough to cause some financial institutions to fail. Foreign investors, who owned nearly half of U.S. debt held by the public in May 2010 (or about $4.0 trillion, $1.7 trillion of which was held by Japan and China alone), would also face substantial losses. If a fiscal crisis occurred in the United States, policy options for responding to it would be limited and unattractive.

Manmohan S. Kumar, Jaejoon Woo, IMF: Public Debt and Growth. The empirical results suggest an inverse relationship between initial debt and subsequent growth, controlling for other determinants of growth: on average, a 10 percentage point increase in the initial debt-to-GDP ratio is associated with a slowdown in annual real per capita GDP growth of around 0.2 percentage points per year, with the impact being somewhat smaller in advanced economies. There is some evidence of nonlinearity with higher levels of initial debt having a proportionately larger negative effect on subsequent growth. Analysis of the components of growth suggests that the adverse effect largely reflects a slowdown in labor productivity growth mainly due to reduced investment and slower growth of capital stock.

William T. Dickens, Brookings: A New Approach to Estimating the Natural Rate of Unemployment. This paper has presented a new method for estimating time variation in the NAIRU using the vacancy-unemployment relationship. A simple theory of this relationship based on a matching model suggests equations that do an uncannily good job of fitting transformed vacancy and unemployment data. When the Beveridge curve model is estimated simultaneously with a Phillips curve, the parameter estimates for both equations are reasonable and the parameters of the Beveridge curve are estimated with particular accuracy. The estimates suggest that the NAIRU is nearly exactly proportional to the residual in the Beveridge curve. Olivier Blanchard: Dickens’s paper offers a promising strategy to identify shifts in the natural rate of unemployment by looking jointly at the Beveridge curve and the Phillips curve.

Bas van der Klaauw, Jan C. van Ours, IZA: Carrot and Stick: How Reemployment Bonuses and Benefit Sanctions Affect Job Finding Rates. To increase their transition from welfare to work, benefit recipients in the municipality of Rotterdam were exposed to various financial incentives, including both carrots to sticks. Once their benefit spell exceeded one year, welfare recipients were entitled to a reemployment bonus if they found a job that lasted at least six months. However, they could also be punished for noncompliance with eligibility requirements and face a sanction, i.e. a temporary reducing of their benefits. In this paper we investigate how benefit sanctions and reemployment bonuses affect job finding rates of welfare recipients. We find that benefit sanctions were effective in bringing unemployed from welfare to work more quickly while reemployment bonuses were not.

David Leonhardt, NYT: The Case for $320,000 Kindergarten Teachers. Great teachers and early childhood programs can have a big short-term effect. However, research on the fade-out effect was based mainly on test scores, not on a broader set of measures, like a child’s health or eventual earnings. Mr. Chetty and five other researchers examined the life paths of almost 12,000 children who had been part of a well-known education experiment in Tennessee in the 1980s. The children are now about 30, well started on their adult lives. Students who had learned much more in kindergarten were more likely to go to college than students with otherwise similar backgrounds. Students who learned more were also less likely to become single parents. As adults, they were more likely to be saving for retirement. Perhaps most striking, they were earning more.

Yi Wen, St Louise Fed: Why Aren’t the Chinese Buying More American Goods? The important point is that both the Chinese trade surplus with the United States and the amassed foreign reserves result from the savings decisions of Chinese consumers. If consumers want to spend more on American goods, they can sell their government bonds and thus siphon some U.S. dollars from the Chinese government’s foreign reserves. This analysis suggests that lack of financial development in China—not the fixed exchange rate—has created the huge trade imbalance between China and the rest of the world. Hence, only financial development within China will ultimately resolve it.

Daniele Checchi, Vitorocco Peragine, Laura Serlenga, IZA: Fair and Unfair Income Inequalities in Europe. This paper analyses the extent of income inequality and opportunity inequality in 25 European countries. The present work contributes to understanding the origin of standard income inequality, helping to identify potential institutional setups that are associated to opportunity inequality. We distinguish between ex ante and ex post opportunity inequality. We find that ex ante equality of opportunity exhibits positive correlation with public expenditure in education, whereas ex post equality of opportunity is also positively associated to union presence and to fiscal redistribution.

Stephen Machin, Olivier Marie, Sunčica Vujić, IZA: The Crime Reducing Effect of Education. In this paper, we present evidence on empirical connections between crime and education, using various data sources from Britain. A robust finding is that criminal activity is negatively associated with higher levels of education. However, it is essential to ensure that the direction of causation flows from education to crime. Therefore, we identify the effect of education on participation in criminal activity using changes in compulsory school leaving age laws over time to account for the endogeneity of education. In this causal approach, for property crimes, the negative crime-education relationship remains strong and significant. The implications of these findings are unambiguous and clear. They show that improving education can yield significant social benefits and can be a key policy tool in the drive to reduce crime.

Torben M. Andersen, Allan Sørensen, Aarhus University: Globalization, tax distortions and public sector retrenchment. It is widely perceived that globalization is a threat to tax financed public sector activities. The argument is that public activities (public consumption and transfers) financed by income taxes distort labour markets and cause higher wages and thus a loss of competitiveness. Since this link is strengthened by globalization, it is inferred that the marginal costs of public funds increase and a retrenchment of the public sector follows. We challenge whether these conclusions have support in a general equilibrium model featuring standard effects from open macroeconomics and trade theory. Even though income taxation unambiguously worsens wage competitiveness, it does not follow that marginal costs of public funds increase with product market integration due to gains from trade. Moreover, non-cooperative fiscal policies do not have a race-to-the-bottom bias despite that taxes harm competitiveness. In fact we identify an expansionary bias in fiscal policies that is likely to increase with globalization when taxes finance either public consumption or transfers