OCTOBER 22 2010

Daniel L. Thornton, Fed St Louis: Would QE2 Have a Significant Effect on Economic Growth, Employment, or Inflation? Recently Gagnon et al. used several methods to investigate the effect of the FOMC’s announced securities purchases ($1.725 trillion) on the 10-year Treasury yield, which they estimate to be in the range of 38 to 82 basis points. Some commentators (e.g., Narayana Kocherlakota, president of the Minneapolis Fed) have suggested QE2’s effect on Treasury yields may be “muted” because financial markets are functioning much better than they were in the spring of 2009. There is another reason that the effect on interest rates could be small. Banks are currently holding about $1 trillion in excess reserves rather than making loans and increasing the supply of credit to the non-banking segment of the credit market. It is possible—perhaps even likely—that almost all of any increase in the supply of credit associated with QE2 simply would be held by banks as excess reserves. Even if QE2 did affect interest rates, many believe that the effect on output or employment would be small. One reason is that even in normal times, investment spending is not particularly responsive to changes in interest rates: Investment spending depends more on the economic outlook. Consequently, some analysts believe that reducing interest rates modestly from their already historically low levels is unlikely to stimulate aggregate demand.

Edward Hugh, Fistful of Euros Blog: An Unusual But Interesting Argument Which May Help To Understand Why QE2 Is Now Almost Inevitable. Push to shove time has come, I fear, and if this reading is right then it is no exaggeration to say that a protracted and rigourously implemented round of QE2 in the United States could put so much pressure on the euro that the common currency would be put in danger of shattering under the pressure. Japan is already heading back into recession, as the yen is pushed to ever higher levels, and Germany, where the economy has been slowing since its June high, could easily follow Japan into recession as the fourth quarter advances.

Menzie D. Chinn, Kavan J. Kucko, NBER: The Predictive Power of the Yield Curve across Countries and Time. In recent years, there has been renewed interest in the yield curve (or alternatively, the term premium) as a predictor of future economic activity. In this paper, we re-examine the evidence for this predictor, both for the United States, as well as European countries. We examine the sensitivity of the results to the selection of countries, and time periods. We find that the predictive power of the yield curve has deteriorated in recent years. However there is reason to believe that European country models perform better than non-European countries when using more recent data. In addition, the yield curve proves to have predictive power even after accounting for other leading indicators of economic activity.

Yiping Huang, China Center for Economic Research: A currency war the US cannot win. A new currency war is looming. The US Congress has already passed a bill for imposing currency import tariffs, although becoming an actual policy is still a long shot. Tim Geithner is urging the IMF and the international community to play more active roles in promoting more flexible exchange-rate regimes. Martin Wolf, following up the ideas of Gros (2010), prefers capital market restrictions, such as preventing China from purchasing US Treasury bills, as a way of avoiding trade sanctions the fight with ‘stubborn’ China (Wolf 2010). Fred Bergsten proposed countervailing currency intervention for the US to sell dollars to offset China’s intervention in foreign exchange markets (Bergsten 2010). And Paul Krugman has long advised the US government to declare trade war with China (Krugman 2010a, 2010b). This column argues that the US did not emerge victorious from the last currency war with Japan, and against China the chances are even slimmer.

J. W. Mason, New Deal Blog: How Much Will Currency Policies Really Affect Our Economy? In recent years, US imports from China have run around 2 percent of GDP, and US exports to China a bit under 0.5 percent. So even if we assume that (1) a change in the nominal exchange rate is reflected one for one in the real exchange rate, i.e. that it doesn’t affect Chinese prices or wages at all; (2) a change in the real exchange rate is passed one for one into prices of Chinese imports in the US; (3) Chinese goods compete only with American-made goods, and not with those of other exporters; and (4) the price elasticity of US imports from China is an implausibly high 1.5; then a 20 percent appreciation of the Chinese currency only provides a boost to US demand of less than one half of one percent of GDP in total, spread out over several years.

Ricardo Caballero, VoxEU: Feasible global rebalancing: A case for monitored and temporary dual exchange rates. Emerging markets with large trade surpluses are reluctant to heed calls for them to help with global aggregate-demand rebalancing by appreciating their currencies. They fear harm to their export-led development and sudden reversals of capital inflows in the future. Here one of the world’s most innovative macroeconomists suggests a way to square the circle: A dual exchange-rate system that would shield their exporters while fostering imports.

Murat Tasci, Fed Cleveland: The Ins and Outs of Unemployment in the Long Run: A New Estimate for the Natural Rate? In this paper, we present a simple, reduced form model of comovements in real activity and unemployment flows and use it to uncover the trend changes in these flows, which determine the trend in the unemployment rate. We argue that this trend rate has several key features that are reminiscent of a “natural rate.” We show that the natural rate, measured this way, has been relatively stable in the last decade, even after the last recession hit the U.S. economy. This relatively muted change was due to two opposing trend changes: On one hand, the trend in the job-finding rate, after being relatively stable for decades, declined by a significant margin in the last decade, pushing trend unemployment up. On the other hand, the separation rate has somewhat offset this effect with a continued secular decline since the early 1980s. We also show that, contrary to businesscycle frequency movements, most of the low-frequency variation in the unemployment rate could be accounted for by changes in the trend of separation rates, not job-finding rates. The notable exception is the last decade, when clear trend changes in both flows imply opposing effects on the trend unemployment rate and slower worker reallocation in the U.S. economy.

DG ECFIN: Monitoring tax revenues and tax reforms in EU Member States 2010. The crisis has not only impacted on the level of tax revenue but also on its composition. In the period from 2007 to 2010, the tax composition in terms of the type of tax levied shifted towards social security contributions and away from direct taxes as the revenue from the latter has been most affected by the crisis. The shift in the tax structure has been rather modest in recent years in most Member States. This might partly be due to the distributional effects of potential tax shifts and political economy reasons. Some reforms may also have been held back by a lack of coordination at the EU level since cross-border spillover effects may constrain the taxing capacity of an individual Member State.

Katherine Mangu-Ward, Reason: Statistically Speaking, My High School Sucked. NBC, the Gates Foundation, and a bunch of other folks have put together a pretty nifty little school data project: The Education Nation Scorecard. Put in a school, and it spits out a handy-dandy graphical interface that tells you how the school stacks up against other schools, the district against other districts, the state against other states, and the country against other countries. You can get the comparisons for graduation rates, along with a variety of test scores for various grade levels.

Edward L. Glaeser, Boston Globe: Political power. Elected leaders can’t transform; the best they can do is muddle through. We don’t applaud today’s mayors, like Boston’s Thomas Menino, New York’s Michael Bloomberg, and Chicago’s Richard Daley, as charismatic paladins. We value them because they are urban mechanics, who get the snow plowed and the garbage cleared. Their political parties are almost an afterthought — we primarily value their competence. Cities are much the better because less colorful doers have replaced rhetorically-gifted dreamers. Our state and national governments would also benefit if elections held fewer promises of paradise, and more commitments to service-related benchmarks.

Olivier Bargain, IZA: Back to the Future: Decomposition Analysis of Distributive Policies Using Behavioural Simulations. When actual reforms are motivated by work incentives, it is also crucial to evaluate behavioural responses and the distributional consequences thereof. For that purpose, we embed counterfactual simulations in a formal framework based on the Shapley value decomposition and quantify the relative roles of (i) tax-benefit policy changes (direct policy effect), (ii) labour supply responses to the policy reforms (indirect effect) and (iii) all other factors affecting income distribution over time. An application to the UK shows that the redistributive reforms of the 1998-2001 period have offset the increase in inequality that would have occurred otherwise. They also contribute to a strong decline in child poverty and poverty amongst single parent households. In the latter group, a third of the headcount povert! y reduction (and half of the reduction in the depth of poverty) is on account of the very large incentive effect of policy changes.

Patricia Cohen, NY Times: Culture of Poverty’ Makes a Comeback. For more than 40 years, social scientists investigating the causes of poverty have tended to treat cultural explanations like Lord Voldemort: That Which Must Not Be Named. The reticence was a legacy of the ugly battles that erupted after Daniel Patrick Moynihan, then an assistant labor secretary in the Johnson administration, introduced the idea of a “culture of poverty” to the public in a startling 1965 report. Although Moynihan didn’t coin the phrase..., his description of the urban black family as caught in an inescapable “tangle of pathology” of unmarried mothers and welfare dependency was seen as attributing self-perpetuating moral deficiencies to black people, as if blaming them for their own misfortune. Now, after decades of silence, these scholars are speaking openly about you-know-what, conceding that culture and persistent poverty are enmeshed. With these studies come many new and varied definitions of culture, but they all differ from the ’60s-era model in these crucial respects: Today, social scientists are rejecting the notion of a monolithic and unchanging culture of poverty. And they attribute destructive attitudes and behavior not to inherent moral character but to sustained racism and isolation.

Chris Dillow, Stumbling and Mumbling Blog: Human nature & economic recovery. Norm alludes to the thesis that there is no such thing as human nature. Coincidentally, though, two recent papers suggest that a common nature might contain fewer features than generally thought. Joe Henrich and colleagues show that there is significant variation in behaviour across peoples. For example, whereas Americans are prone to the Mueller-Lyer illusion - which line is longer in my picture? - foragers in the Kalahari are not. Also, results of ultimatum game experiments differ hugely across tribes, with Americans making much higher offers than the Hadze in Tanzania or Tsimane in Bolivia. In many ways (not all), he shows, our idea of what is “human nature” is in fact drawn from a very unrepresentative sample of “weird” (western, educated, industrialized, rich and democratic) people. Roberta Dessi and Xiaojian Zhao contrasts North Americans to Japanese. North Americans value self-esteem and are prone to overconfidence, whereas the Japanese are much less so. To the Japanese, shame plays a bigger role than it does for North Americans. Could this be a reason to hope that the US can escape Japan’s “lost decade(s)“ fate?