FEBRUARY 11 2011

Tim Duy's Fed Watch: Acceleration Alert. The January employment report was a mess, but the sharp drop in unemployment is difficult to ignore, especially given the general better-than-expected tone of recent data.  At this junction, I believe it is reasonable to believe that overall activity will prove to be better than expected by Federal Reserve policymakers. Still, an upward revision to the forecast does not alone imply that Bernanke & Co. will find it imperative to return to the question of when to tighten.  The output gap remains strikingly large for an economy in expansion since the middle of 2009.  That should be sufficient to leave the baseline forecast of steady policy intact.  But incoming data suggests the balance of risks is no longer on the side of disappointment.  It may be that, for the first time in four or five years, the pessimists will need to find a new hobby.

Ragu Rajan, Fault Lines Blog: Why did economists not spot the crisis? At the height of the financial crisis, the Queen of England asked my friends at the London School of Economics a simple question, but one for which there is no easy answer: Why did academic economists fail to foresee the crisis? There have been several responses to that query. One is that economists simply lacked models that could account for the behavior that led to the crisis. Another is that economists were blinkered by an ideology according to which a free and unfettered market could do no wrong. Finally, an answer that is gaining ground is that the system bribed economists to stay silent. In my view, the truth lies elsewhere. I would argue that three factors largely explain our collective failure: specialization, the difficulty of forecasting, and the disengagement of much of the profession from the real world.

James Feyrer, Bruce Sacerdote, NBER: Did the Stimulus Stimulate? We use state and county level variation to examine the impact of the American Readjustment and Recovery Act on employment. A cross state analysis suggests that one additional job was created by each $170,000 in stimulus spending. Time series analysis at the state level suggests a smaller response with a per job cost of about $400,000. These results imply Keynesian multipliers between 0.5 and 1.0, somewhat lower than those assumed by the administration. However, the overall results mask considerable variation for different types of spending. Grants to states for education do not appear to have created any additional jobs. Support programs for low income households and infrastructure spending are found to be highly expansionary. Estimates excluding education spending suggest fiscal policy multipliers of about 2.0 with per job cost of under $100,000.

Silvio Contessi, St Louis Fed: Are Bank Reserves and Bank Lending Connected? Large increases in excess reserves have prompted some analysts to argue that depository institutions are “hoarding cash,” thereby impeding the growth of lending and slowing the recovery from the 2007-09 recession. Analysis of the cross-sectional data suggests that some banks may be maintaining such large reserve positions as a precautionary hedge in an uncertain environment. Many banks, especially smaller ones, likely recall the autumn of 2008 when repurchase agreement (repo) markets closed and, absent Federal Reserve actions, liquidity was unavailable at any price. As long as the strength of the recovery remains uncertain, there are few other investment opportunities, after adjusting for risk and taxes, with anticipated returns greater than the near-zero interest (currently 0.25 percent) the Federal Reserve pays on deposits.

Barkley Rosser, EconoSpeak Blog: Does Economics Explain The Current Arab Uprising? No Arab country that is a major oil exporter (or earns the vast majority of its export earnings from oil) is seeing an uprising. Oil prices have risen, and it would appear that most of the leaders of the countries exporting lots of oil have been clever enough to sufficiently distribute the rising earnings from this so as to tamp down any incipient unhappiness about dictatorship or monarchy or excessive friendliness with the US. Those more strongly dependent on food imports and thus suffering shocks that especially impact the poorer parts of their populations have almost all had uprisings.

Paul Krugman, NYT: Droughts, Floods and Food. While several factors have contributed to soaring food prices, what really stands out is the extent to which severe weather events have disrupted agricultural production. And these severe weather events are exactly the kind of thing we’d expect to see as rising concentrations of greenhouse gases change our climate — which means that the current food price surge may be just the beginning. Now, to some extent soaring food prices are part of a general commodity boom: the prices of many raw materials, running the gamut from aluminum to zinc, have been rising rapidly since early 2009, mainly thanks to rapid industrial growth in emerging markets. But the link between industrial growth and demand is a lot clearer for, say, copper than it is for food. Except in very poor countries, rising incomes don’t have much effect on how much people eat.

Aida Caldera Sánchez, Åsa Johansson, OECD: The Price Responsiveness of Housing Supply in OECD Countries. The responsiveness of housing supply to changes in prices bears important implications for the evolution of housing prices and the speed of adjustment of housing markets. This paper estimates the long-run price elasticity of new housing supply in 21 OECD countries based on a stock-flow model of the housing market estimated within an error correction framework. Estimates suggest that housing supply responsiveness to price changes varies substantially across countries. New housing supply is relatively more flexible in North America and some Nordic countries, while it is more rigid in continental European countries and in the United Kingdom. The responsiveness of housing supply depends not only on national geographical and urban characteristics but also on policies, such as land use and planning regulations. The estimates are broadly in line with the limited available evidence on the responsiveness of housing supply in OECD countries.

Olivier Bargain et al, IZA: Tax-Benefit Systems in Europe and the US: Between Equity and Efficiency. Whether observed differences in redistributive policies across countries are the result of differences in social preferences or efficiency constraints is an important question that paves the debate about the optimality of welfare regimes. To shed new light on this question, we estimate labor supply elasticities on microdata and adopt an inverted optimal tax approach to characterize the redistributive preferences embodied in the welfare systems of 17 EU countries and the US. Implicit social welfare functions are broadly compatible with the fiction of an optimizing Paretian social planner. Some exceptions due to generous demogrant transfers are consistent with the ignorance of behavioral responses by some European governments and are partly corrected by recent policy developments. Heterogeneity in leisure-consumption preferences somewhat affect the international comparison in degrees of revealed inequality aversion, but differences in social preferences are significant only be! tween broad groups of countries.

Hans Bloemen, Stefan Hochguertel, Marloes Lammers: Job Search Requirements for Older Unemployed: Transitions to Employment, Early Retirement and Disability Benefits. In this paper, we use a recent policy change in the Netherlands to study how changes in search requirements for the older unemployed affect their transition rates to employment, early retirement and sickness/disability benefits. The reform, becoming effective on January 1st 2004, required the elderly to formally report their job search efforts to the employment office in order to avoid a (temporary) cut in benefits. Before the new law was passed, unemployed were allowed to stop all search activity at the moment they turned 57.5. Estimating various duration models using difference-in-difference and regression discontinuity approaches, we find that for several groups of individuals that were affected by the policy change, the stricter search requirements did significantly increase their entry rate into employment. However, we also find evidence of a higher outflow to sickness/disability insurance schemes, a presumably unwanted side-effect of the policy change.

Luigi Guiso, Aldo Rustichini, EUI: Understanding the size and profitability of firms: The role of a biological factor. We collect information on prenatal testosterone in a large sample of entrepreneurs by measuring the length of their 2th to 4th fingers in face to face interviews. Entrepreneurs with higher exposure to prenatal testosterone (lower second to fourth digit ratio) manage larger firms, are matched with larger firms when acquire control and experience faster average growth over the years they manage the firm. However, firms run by high prenatal testosterone entrepreneurs have lower profitability as measured by return on assets and return on sales. We also find that prenatal testosterone is correlated with elicited measures of entrepreneurial skills such as ability to stand work effort and optimism and the latter are correlated with firm size. This evidence suggests entrepreneurial ability has a biological component and is consistent with models of the size distribution of firms based on entrepreneurial ability once entrepreneurs utility is allowed to depend both on pro fits and size per se.

Kenneth Rogoff, Project Syndicate: The Inequality Wildcard. The problems facing Egypt and Tunisia today are far more profound than in many other countries. Corruption and failure to embrace meaningful political reform have become acute shortcomings. Yet it would be very wrong to suppose that gaping inequality is stable as long as it arises through innovation and growth. How, exactly, will change unfold, and what form will a new social compact ultimately assume? It is difficult to speculate, though in most countries, the process will be peaceful and democratic. What is clear is that inequality is not just a long-term issue. Concerns about the impact of income inequality are already constraining fiscal and monetary policy in developed and developing countries alike as they attempt to extricate themselves from the hyper-stimulative policies adopted during the financial crisis. More importantly, it is very likely that countries’ abilities to navigate the rising social tensions generated by gaping inequality could separate the winners and losers in the next round of globalization. Inequality is the big wildcard in the next decade of global growth, and not just in North Africa.

Larry Hardesty, MIT News: Why do some countries’ economies grow faster? One of the Media Lab’s newest faculty members is adapting the mathematical tools of statistical physics to study development economics. Hidalgo and Hausmann have found that GDP correlates pretty well with diversity of outputs, but it correlates much better with diversity of inputs. And the cases where the correlation breaks down could actually be more interesting than the cases where it holds, because they could indicate economies poised for growth. In 1970, for instance, the Korean economy had much greater diversity of inputs, according to Hidalgo’s measure, than the Peruvian economy; but Peru had twice Korea’s GDP per capita. Over the next 30 years, the relative diversity of inputs in the two countries’ economies stayed more or less the same, but by 2003, Korea had four times Peru’s GDP per capita.