SEPTEMBER 3 2010

Carmen M. Reinhart, Vincent R. Reinhart, Jackson Hole: After the Fall. This paper examines the behavior of real GDP (levels and growth rates), unemployment, inflation, bank credit, and real estate prices in a twenty one-year window surrounding selected adverse global and country-specific shocks or events. The episodes include the 1929 stock market crash, the 1973 oil shock, the 2007 U.S. subprime collapse and fifteen severe post-World War II financial crises. The focus is not on the immediate antecedents and aftermath of these events but on longer horizons that compare decades rather than years. While evidence of lost decades, as in the depression of the 1930s, 1980s Latin America and 1990s Japan are not ubiquitous, GDP growth and housing prices are significantly lower and unemployment higher in the ten-year window following the crisis when compared to the decade that preceded it. Inflation is lower after 1929 and in the post-financial crisis decade episodes but notoriously higher after the oil shock. We present evidence that the decade of relative prosperity prior to the fall was importantly fueled by an expansion in credit and rising leverage that spans about 10 years; it is followed by a lengthy period of retrenchment that most often only begins after the crisis and lasts almost as long as the credit surge.

Ricardo Caballero, VoxEU: A helicopter drop for the Treasury. The US may be near a liquidity trap. This column argues that the ineffectiveness of monetary policy can be turned on its head by using money creation to finance fiscal policy stimulus – such as a large but temporary cut in sales taxes. To avoid future problems, the Treasury could commit to transfer resources back to the Fed when the economy is back to full employment. This would be a helicopter drop with a drainage contingency.

Arnaud Mares, Morgan Stanley: Ask Not Whether Governments Will Default, but How. It is not GDP but government revenues that matter: Whatever the size of a government's liabilities, what matters ultimately is how they compare to the resources available to service them. One benefit of sovereignty is that governments can unilaterally increase their income by raising taxes, but they will only ever be able to acquire in this way a fraction of GDP. Debt/GDP therefore provides a flattering image of government finances. A better approach is to scale debt against actual government revenues. An even better approach would be to scale debt against the maximum level of revenues that governments can realistically obtain from using their tax-raising power to the full. It is not whether to default, but how, and vis-à-vis whom. What this means is that - as indicated above - governments will impose a loss on some of their stakeholders and have in fact started to do so (across Europe at least). The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take. From the perspective of sovereign debt holders, this translates in two questions: Does their claim on governments rank senior enough relative to other claims to fully shelter them from losses? If it does not, what form will this loss take?

Lawrence J. Christiano, Martin Eichenbaum, Sergio Rebelo, Fed Atlanta: When Is the Government Spending Multiplier Large? We argue that the government spending multiplier can be very large when the nominal interest rate is constant. We focus on a natural case in which the interest rate is constant, which is when the zero lower bound on nominal interest rates binds. For the economies that we consider it is optimal to increase government spending in response to shocks that make the zero bound binding.

Christina D. Romer, Council of Economic Advisers: Not My Father’s Recession: The Extraordinary Challenges and Policy Responses of the First Twenty Months of the Obama Administration. In her farewell speech, Christina Romer notes that the current recession has been fundamentally different from other postwar recessions. This is not my father’s recession. Rather than being caused by deliberate monetary policy actions, it began with interest rates at low levels. It is a recession born of regulatory failures and unsound practices that contributed to a housing bubble and eventually a full-fledged financial crisis. Precisely what has made it so terrifying and so difficult to cure is that we have been in largely uncharted territory. An all-out financial meltdown in the world’s largest economy and the center of the world’s financial system is something the world has experienced only once in the past century — in the 1930s. Thus, the President took office in the midst of a recession of historic proportions, but for which history provided little guidance.

Jose M. Berrospide, Rochelle M. Edge, Fed: The Effects of Bank Capital on Lending: What Do We Know, and What Does it Mean? We use panel-regression techniques---following Bernanke and Lown (1991) and Hancock and Wilcox (1993, 1994)---to study the lending of large bank holding companies (BHCs) and find small effects of capital on lending. We then consider the effect of capital ratios on lending using a variant of Lown and Morgan's (2006) VAR model, and again find modest effects of bank capital ratio changes on lending. These results are in marked contrast to estimates obtained using simple empirical relations between aggregate commercial-bank assets and leverage growth, which have recently been very influential in shaping forecasters' and policymakers' views regarding the effects of bank capital on loan growth.

BIS: An assessment of the long-term economic impact of stronger capital and liquidity requirements. The main benefits of a stronger financial system reflect a lower probability of banking crises and their associated output losses. Another benefit reflects a reduction in the amplitude of fluctuations in output during non-crisis periods. In this analysis, the costs are mainly related to the possibility that higher lending rates lead to a downward adjustment in the level of output while leaving its trend rate of growth unaffected. While empirical estimates of the costs and benefits are subject to uncertainty, the analysis suggests that in terms of the impact on output there is considerable room to tighten capital and liquidity requirements while still yielding positive net benefits.

Robert Barro, WSJ: The Folly of Subsidizing Unemployment. To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%. My calculations suggest the jobless rate could be as low as 6.8%, instead of 9.5%, if jobless benefits hadn't been extended to 99 weeks.

Conor Dougherty, WSJ Blog: Cities Where Women Outearn Male Counterparts. In 2008, single, childless women between 22 and 30 were earning more than their male counterparts in most U.S. cities, with incomes that were 8% greater on average, according to an analysis of Census data by Reach Advisors, a consumer research firm in Slingerlands, N.Y. The trend was first identified several years ago in the country’s biggest cities, but has broadened out to smaller places and across more industries. Beyond major cities such as San Francisco and New York, the income imbalance is pronounced in blue collar hubs and the fast-growing metros that have large immigrant populations.

Dylan Matthews, Washington Post: Interview with James Heckman. 'It’s just a question of using the same dollars wisely'. President Eisenhower built the highway system. President Obama could build the child production system if he wanted to. It would have a much higher payoff than a lot of the programs that are currently there. If you do a cost/benefit analysis of the rate of return for job training, if you talk about early convict rehabilitation programs or literacy training for adults, the rates of return on those programs are generally quite low, very low. It’s just a question of using the same dollars wisely. We’re spending billions, $8.2 billion a year on Head Start, and Head Start is not a very effective program.

Marty Gaynor, Carol Propper, VoxEU: Healthcare competition saves lives. Governments faced with rising costs and growing demand are constantly searching for methods of delivering higher productivity in healthcare. This column suggests that the introduction of competition among UK hospitals – yet with a fixed price – has increased quality, as measured by lower death rates, and this without a commensurate increase in costs.

Efraim Benmelech, Claude Berrebi, Esteban F. Klor, NBER: Economic Conditions and the Quality of Suicide Terrorism. While the existing empirical literature shows that poverty and economic conditions are not correlated with the quantity of terror, theory predicts that poverty and poor economic conditions may affect the quality of terror. Poor economic conditions may lead more able, better-educated individuals to participate in terror attacks, allowing terror organizations to send better-qualified terrorists to more complex, higher-impact, terror missions. Using the universe of Palestinian suicide terrorists against Israeli targets between the years 2000 and 2006 we provide evidence on the correlation between economic conditions, the characteristics of suicide terrorists and the targets they attack. High levels of unemployment enable terror organizations to recruit more educated, mature and experienced suicide terrorists who in turn attack more important Israeli targets.

Randall Akee et al, IZA: Does More Money Make You Fat? The Effects of Quasi-experimental Income Transfers on Adolescent and Young Adult Obesity. We use quasi-experimental evidence from a government transfer program which exogenously increased incomes for one group of children while leaving the comparison group unaffected. The government transfer is a per capita disbursement to adult members of an American Indian tribe; non-Indians in the community do not receive these disbursements. Youths who resided in families that had high pre-treatment annual incomes experience no change in young adult obesity rates as a result of the income transfers, while the BMI of poorer children increases. Part of this effect is due to differential increases in height, as well as weight. An exogenous annual transfer of $4,000 per adult family member results in an almost 4 cm gain in height-for-age. The cumulative effects of the increase in household income persist for several years into young adulthood.