Knowing and Making

...and why the Bank of England and Fed are right to have done so already. I'm not talking about whether the European Central Bank should directly buy eurozone government bonds. This causes a moral hazard problem - it might encourage governments to be profligate and reduce incentives for structural reform. It's, at the very least, debatable. I'm talking about a more general question: why should central banks print money in a recession? This post won't have much new to say to macroeconomists, but it attempts to address a concern of many non-economists - won't printing money just cause more inflation? First, let's run a thought experiment. Imagine that your national government has decided that profligate use of fossil fuels is a problem. Probably because of the risk of climate change. Instead of using a carbon tax, the government decides to restrict the supply of oil coming into the country. It could allow more oil in if necessary - in fact it has a large res...

Some news has been creeping in which gives us a picture of the British economy that's gradually becoming clearer. First, from the ONS via David Smith : Business investment for the first quarter of 2010 is estimated to be 6.0 per cent higher than the previous quarter. From the same source, some news on public borrowing: ...in December, the Treasury preducted public sector net borrowing for 2009-10 of £178 billion on the definition it uses. The latest figures from the Office for National Statistics show a downward revision to the outturn, taking it to £156 billion...At one time people were predicting figures as high as £220 billion. Recent growth estimates are decent (though not outstanding) too: Gross Domestic Product (GDP) increased 0.2 per cent in the first quarter of 2010, compared with an increase of 0.4 per cent in the previous quarter. There was a concern prior to the release that growth might be negative, due to heavy snow in January and February. So growth of 0.2%, thou...

Robert Peston has been working hard reporting on results from RBS and Lloyds the last couple of days. A couple of points. He claims that taxpayer's money has gone down the drain at RBS, because: we as taxpayers put in £25.5bn of new equity into this bank last autumn...but...the equity of this bank has increased by less than £16bn to £80bn. So almost £10bn of the £25.5bn we've only just put into RBS has already been wiped out by losses. Well, that's half true. £10 billion has indeed been wiped out by losses. But it's not £10 billion of our  money, it's £10 billion of the former shareholders'  money. Our £45.5 billion has bought 84% of that £80 billion in equity, a £67.2 billion asset. The reason we're not in profit yet is because the market is still applying a discount due to uncertainty over future losses. We don't know if those losses will happen yet - it depends mainly on economic recovery - but on the book value of the bank, we got a good a...

I don't have time to write a detailed post today so let me do something slightly unfair by picking holes in somebody else's. Stephanie Flanders writes about (among other things) the risk to UK exports posed by the slowing eurozone economy. Germany seems to have had no growth at all, the Italian economy shrank by another 0.2%, and Spain by 0.1%. Between them, those three countries accounted for 15% of UK exports in 2008. Sounds terrible. But wait, there is a little bit of good news to partly make up for it: British exports to China were 53% higher last month than in January 2009. But they start from a very, very low base: just 2% of our exports went to China in 2008. In total, about 12% went to the Brics - with about 75% going to advanced economies, primarily the the US and the EU. Solid growth in Europe is a necessary condition for a healthy recovery in the UK. So the latest weak numbers from across the channel have given the MPC one more reason to keep the door to further...

Stephanie Flanders points out some huge discrepancies in the labour market between older and younger workers, and between the current recession and that of the early 90s. But of the 16-17-year-olds not in full-time education, nearly 41% were economically inactive during the last quarter of 2009. Back in 1992, the figure was less than 15%. ...consider the following astonishing fact. In the second quarter of 1992, two-thirds - 65% - of 16-17-year-olds who were not in full-time education were reported to have a job. Now the figure is 35%. These figures are startling and, especially having got used to economic statistics measured in increments (unemployment 2% higher, inflation 1% lower), really worrying. What's more - though Stephanie surprisingly does not point this out - there is a very clear suspect here: the minimum wage. Like all card-carrying bleeding-hearted liberals, I was in favour of the UK's minimum wage when it was introduced in 1997. I did have some minor rese...

Something just struck me when reading Scott Sumner's latest (this often happens - if you're genuinely interested in macroeconomics and not subscribed to Scott's blog yet, you should be). For instance, if wages are sticky it may lead to suboptimal real wage movements. The reason why we think inflation is good for solving recessions is we believe it helps to overcome wage stickiness (NGDP, Scott's preferred target, does the same but also has a useful extra effect on the incentives for, and risks of, investment). In other words, recessions sometimes happen when people are in jobs which are no longer as productive as they used to be (or making products that people don't want so much). In a completely efficient market, their wages would fall, product prices could fall too, some people would move to other jobs and supply and demand would balance at the point of highest output. But in reality it's hard to reduce wages - because of both employment contracts and hab...

Do we implicitly extrapolate, unconsciously, from how we make a single trade to how we behave in markets generally? We have a basic need to fix the price of a transaction for long enough for the trade to complete. If I agree to buy this beer from you for £3.40, and by the time it's finished pouring, the price might be £3.75 (or indeed £2.90) neither of us is likely to buy or sell much beer. For a transaction of this kind to work, the terms should be known in advance to both parties and remain the same for the duration of the trade. And with our minds' amazing capacity to extrapolate, it's not such a big leap from there to the expectation that prices will remain stable over a slightly longer period of time (an hour, a day, a month, a year?) Whatever learning mechanism creates this stability of expectations over the duration of a single transaction can surely be fooled into expecting the same thing for a bit longer. This is reinforced by the tentative and exploratory nature ...

There's lots of Bryan Caplan I don't agree with, but I can't deny he has some interesting ideas and a good way of thinking about them. The connection between growth and ideas is not so much logical as psychological. It is not logical for people to embrace counter-productive ideas just because conditions are getting worse, but they seem to do it anyway. This is from a paper on idea traps which is the concept that a society can get stuck in a sub-optimal equilibrium where the economic ideas that it runs on are flawed, but do not self-correct. My own experience of this is a paradox based in the economic situation in the UK right now. Logically, when there is low demand in an economy companies with a fixed cost base should spend more on sales and marketing. (This might not apply to firms which can easily scale down their costs - you can argue that the marginal return on sales spending is lower and therefore the optimal spend is less. But most companies are retaining most of th...

Too many people in recent weeks have concentrated on the differences between professional economists' thoughts about the recession and recovery. Are there green shoots? Is the economy still shrinking? Is it shrinking slower than it did? Is the rate of slowing of shrinkage increasing or decreasing? What does the historical record show, in contrast with the economic models of Keynes, Lucas or Krugman? Too much information! I think it's time for a survey of non-professionals. These are people out in the real world, after all - none of your ivory tower theorising from them. I'm going to start with the comments on today's Robert Peston blog , which give some real insight into the political and economic factors behind where we are today. Why do you think this great country is in this awful mess:- 1. Labour Government 2. Gordon Brown 3. Prime minister Peter Mandleson The only way we can start to even think about recovery is by getting rid of the above. The banks are waiting, b...

Unlike some people , I managed to get tickets for Paul Krugman's series of lectures at the London School of Economics this week. It's been very interesting, and has already reached the news. Yesterday he announced that he expected the recession to officially end this summer, and the Dow Jones index immediately jumped about 70 points. Ironically, Krugman said in the same lecture that the stockmarket is not a signal of recovery - though he didn't quite say that the stockmarket wouldn't respond to signals of a recovery. I think the phrase was "what the hell does the stockmarket know". Oddly, the Bloomberg report of yesterday's comments (which portrayed them positively) has been replaced with a much more pessimistic report of what Krugman said tonight. Yesterday, this link read: June 8 (Bloomberg) — The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said. “I would not be surprised if the officia...

I met someone last week who is starting a new business related to outplacement - which, in case you haven't met that piece of jargon, is " the process of helping to find new employment for redundant workers, especially executives ". It led me to wonder whether the labour market is more efficient nowadays - at least among professionals and younger people. In theory, information technology and the Internet should make it easier to find suitable jobs and also quicker to fill them with suitable candidates. If this is true, a recovery from recession should be faster. Here's why: All realistic models of the labour market will include some unfilled positions in new or evolving businesses. Any business as it changes to meet newly identified demand will create new positions (of course, other positions will be eliminated too - so there are always unemployed people as well as unfilled posts. The state of the economy will determine whether there are more of one or the other). Mar...

Via Stephanie Flanders, the IMF starts to give us a way to estimate the return on investment of recent financial bailouts from various countries. Apart from anything else, this may help to silence some of the complaints from people offended at us "giving" money to banks to "bail them out". There are two different ways to calculate ROI: first, what is the cost and benefit to the state as an entity, and second, what is the cost and benefit to the economy as a whole. Note that the 'cost' here does not refer to the entire cost of the crisis in lost economic output or reduced asset prices - because most of that is a sunk cost and our decisions can have no impact on it. It refers to costs specifically incurred by explicit decisions taken to rescue financial institutions. In the case of the UK, the cost to the state (according to the IMF) of the bailouts is about 9% of GDP or £130 billion. The return will include: Whatever is gained from selling off government sta...

There are a few things I want to comment on today, but I'll start with a quick analysis of the latest Krugman-Mankiw debate. The Obama administration projects that when the recession ends, growth will be faster than the long-term average, as the economy catches up with its permanent trend. This is called the trend-stationary assumption -  Paul Krugman supports it  and  Greg Mankiw disagrees , citing an alternative hypothesis called unit-root . Though I often disagree with Mankiw, this time I fear he is right. Both parties are citing different analyses of historical data. In economics, data is always easy to argue about, especially macroeconomic time series data of which there are rarely enough to make unambiguous inferences. Neither are going into detail about their answer in terms of an underlying theoretical model. Of course, models are also easy to argue about, but in this case it seems relatively easy to at least expose the implicit assumptions, if not to know which are right...

Stephanie Flanders (and earlier, Tim Harford ) raise an interesting question today. As they point out, changes in individual circumstances tend to dominate the macroeconomic aggregates - increases and decreases in individual income are usually much greater than the 3% increase or decrease in the output of the whole economy. Of course, a 3% decline in GDP means that a few more incomes have fallen than risen - but on the face of it, this is a minor effect. So what explanations could there be for the fact that we worry so much about recessions? First, some of the effects are very visible. Lots of people lose their jobs - and a million more people out of work will always create some high-profile news stories. Second and related, the media (and the public) select stories which confirm their overall narrative. Any newspaper whose main focus of the last two weeks was on the 9,000 new jobs at KFC rather than the 850 job losses at Mini would not look credible - its narrative would be out of st...

My friend Margie, who's at business school, is less optimistic than me about the recession. She thinks things will be dismal for a long time yet. However, she's still considering starting a business when her course is finished. So what kind of company would you recommend starting up in a recession? And if I'm right after all and the recovery starts soon, what sort of companies would be especially successful in a recovering economy? Please suggest your answers in the comments, or by email to leigh@inon.com and I'll post a selection. The best recommendation wins a free skinny latte (other coffees are available).

It's been accepted by most analysts for years that the global car industry has substantial overcapacity and that factory closures, or even closures of whole companies, are needed. Now BMW is cutting 850 jobs at its Mini plant - even though Mini sales are up this year. So is this a good thing? Probably not - at least not right now - because it causes a reduction in aggregate demand, and that means reduced GDP growth, or a deeper recession. But that's true of capacity reductions at any time. So why would it have been good before and not good now? What is the difference? The first thing to understand is why a cut would have been desirable. Let's imagine that, in more normal times, a car company (Chrysler for example) shuts down. The immediate beneficiaries of a company closing would be the other car companies. With less competition they could sustain higher prices; some people who would have bought Chryslers will now buy other cars, boosting both revenue and profits at the re...

Synthesising the whole stimulus debate into a few lines, there seem to be a small number of messages: Stimulus is good because it gets idle resources producing something Stimulus is bad because it moves productive resources into less productive use Stimulus is bad because its cost has to be paid back, reducing future efficiency Stimulus won't work because rational consumers will save as much as the government spends Stimulus is good/bad because government spending is efficient/inefficient These messages are not necessarily contradictory - some of them are orthogonal. The truth of each assertion all depends on your model of how the economy works - and especially on one big factor: how much friction is there? In an economy without friction, much of the argument would disappear. Idle resources would be immediately reallocated to some other use, since there is always somebody with savings that they could switch to consumption. Prices would adjust. Resources would always go to the most ...

Greg Mankiw asks us to spare a thought for the top ten percent of earners who apparently bear the main burden of the economic downturn. I wish he had figured out how to measure whose utility  has been hurt the most, as opposed to just whose consumption  has fallen. Unfortunately this is a blind spot of many economists. Poor people simply get more value out of a dollar than rich people. This also means that they are hurt more by a smaller fall in income. Diminishing marginal returns have been part of economic theory for two hundred years, so I'm not sure why people keep forgetting it.

Another article (this time by Niall Ferguson, of whom more later) on the too-much-debt theory. The subtitle is: "Governments cling to the delusion that a crisis of excess debt can be solved by creating more debt". Well, this isn't a crisis of excess debt. To the extent that credit problems are responsible for the recession, it is a reduction  in the availability of credit that has triggered it. Ferguson may think that companies and individuals owe too much. But who do they owe it to? Er, other companies and individuals! He doesn't present much evidence for the "too much" theory, except an assertion: The Western world is suffering a crisis of excessive indebtedness. Governments, corporations and households are groaning under unprecedented debt burdens. Average household debt has reached 141% of disposable income in the United States and 177% in Britain. Worst of all are the banks. Some of the best-known names in American and European finance have liabilities...