What Is Economics Good For?

By ALEX ROSENBERG and TYLER CURTAIN

Recent debates over who is most qualified to serve as the next chairman of the Federal Reserve have focused on more than just the candidates’ theory-driven economic expertise. They have touched on matters of personality and character as well. This is as it should be. Given the nature of economies, and our ability to understand them, the task of the Fed’s next leader will be more a matter of craft and wisdom than of science.
When we put a satellite in orbit around Mars, we have the scientific knowledge that guarantees accuracy and precision in the prediction of its orbit. Achieving a comparable level of certainty about the outcomes of an economy is far dicier.
The fact that the discipline of economics hasn’t helped us improve our predictive abilities suggests it is still far from being a science, and may never be. Still, the misperceptions persist. A student who graduates with a degree in economics leaves college with a bachelor of science, but possesses nothing so firm as the student of the real world processes of chemistry or even agriculture.
Before the 1970s, the discussion of how to make economics a science was left mostly to economists. But like war, which is too important to be left to the generals, economics was too important to be left to the Nobel-winning members of the University of Chicago faculty. Over time, the question of why economics has not (yet) qualified as a science has become an obsession among theorists, including philosophers of science like us.
It’s easy to understand why economics might be mistaken for science. It uses quantitative expression in mathematics and the succinct statement of its theories in axioms and derived “theorems,” so economics looks a lot like the models of science we are familiar with from physics. Its approach to economic outcomes — determined from the choices of a large number of “atomic” individuals — recalls the way atomic theory explains chemical reactions. Economics employs partial differential equations like those in a Black-Scholes account of derivatives markets, equations that look remarkably like ones familiar from physics. The trouble with economics is that it lacks the most important of science’s characteristics — a record of improvement in predictive range and accuracy.
This is what makes economics a subject of special interest among philosophers of science. None of our models of science really fit economics at all.
The irony is that for a long time economists announced a semiofficial allegiance to Karl Popper’s demand for falsifiability as the litmus test for science, and adopted Milton Friedman’s thesis that the only thing that mattered in science was predictive power. Mr. Friedman was reacting to a criticism made by Marxist economists and historical economists that mathematical economics was useless because it made so many idealized assumptions about economic processes: perfect rationality, infinite divisibility of commodities, constant returns to scale, complete information, no price setting.
Mr. Friedman argued that false assumptions didn’t matter any more in economics than they did in physics. Like the “ideal gas,” “frictionless plane” and “center of gravity” in physics, idealizations in economics are both harmless and necessary. They are indispensable calculating devices and approximations that enable the economist to make predictions about markets, industries and economies the way they enable physicists to predict eclipses and tides, or prevent bridge collapses and power failures.
But economics has never been able to show the record of improvement in predictive successes that physical science has shown through its use of harmless idealizations. In fact, when it comes to economic theory’s track record, there isn’t much predictive success to speak of at all.
Moreover, many economists don’t seem troubled when they make predictions that go wrong. Readers of Paul Krugman and other like-minded commentators are familiar with their repeated complaints about the refusal of economists to revise their theories in the face of recalcitrant facts. Philosophers of science are puzzled by the same question. What is economics up to if it isn’t interested enough in predictive success to adjust its theories the way a science does when its predictions go wrong?
Unlike the physical world, the domain of economics includes a wide range of social “constructions” — institutions like markets and objects like currency and stock shares — that even when idealized don’t behave uniformly. They are made up of unrecognized but artificial conventions that people persistently change and even destroy in ways that no social scientist can really anticipate. We can exploit gravity, but we can’t change it or destroy it. No one can say the same for the socially constructed causes and effects of our choices that economics deals with.
Another factor economics has never been able to tame is science itself. These are the drivers of economic growth, the “creative destruction” of capitalism. But no one can predict the direction of scientific discovery and its technological application. That was Popper’s key insight. Philosophers and historians of science like Thomas S. Kuhn have helped us see why scientific paradigm shifts seem to come almost out of nowhere. As the rate of acceleration of innovation increases, the prospects of an economic theory that tames the economy’s most powerful forces must diminish — and with it, any hope of improvements in prediction declines as well.
SO if predictive power is not in the cards for economics, what is it good for?
Social and political philosophers have helped us answer this question, and so understand what economics is really all about. Since Hobbes, philosophers have been concerned about the design and management of institutions that will protect us from “the knave” within us all, those parts of our selves tempted to opportunism, free riding and generally avoiding the costs of civil life while securing its benefits. Hobbes and, later, Hume — along with modern philosophers like John Rawls and Robert Nozick — recognized that an economic approach had much to contribute to the design and creative management of such institutions. Fixing bad economic and political institutions (concentrations of power, collusions and monopolies), improving good ones (like the Fed’s open-market operations), designing new ones (like electromagnetic bandwidth auctions), in the private and public sectors, are all attainable tasks of economic theory.
Which brings us back to the Fed. An effective chair of the central bank will be one who understands that economics is not yet a science and may never be. At this point it is a craft, to be executed with wisdom, not algorithms, in the design and management of institutions. What made Ben S. Bernanke, the current chairman, successful was his willingness to use methods — like “quantitative easing,” buying bonds to lower long-term interest rates — that demanded a feeling for the economy, one that mere rational-expectations macroeconomics would have denied him.
For the foreseeable future economic theory should be understood more on the model of music theory than Newtonian theory. The Fed chairman must, like a first violinist tuning the orchestra, have the rare ear to fine-tune complexity (probably a Keynesian ability to fine-tune at that). Like musicians’, economists’ expertise is still a matter of craft. They must avoid the hubris of thinking their theory is perfectly suited to the task, while employing it wisely enough to produce some harmony amid the cacophony.

Does the World Need an Inflation ?

Many economists have suggested over the past few years that there are essentially two policies that would help the developed countries out of their present situation of large deficits, large sovereign debt and low growth. Many have dared suggest that a combination of financial repression and moderate inflation are the path to salvation. Financial repression occurs when the Fed (Central Banks) maintain an artificially low interest rate . This lowers the burden of servicing the sovereign debt substantially. Ex: If the US national debt of $15 Trillion is to be financed at an average interest rate of say 7% then over a $1 trillion worth of interest will have to be paid each year. If on the other had the average interest rate is to be about 1% then refinancing burden would be only $150 billion i.e. a drop of about $900 billion. That is not bad. What do you think?

The following is a brief article by Professor Scott Summer at Waltham Bentley University.

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THERE have recently been a number of calls for a higher inflation target. The proponents claim that this would stimulate economic growth and also ease sovereign-debt crises. I have mixed feelings about these proposals. There are clear advantages to adopting more expansionary monetary policies in the US, Europe, and Japan, but it’s a mistake to target inflation directly, or even to describe the advantages of monetary stimulus in terms of higher inflation.

Inflation can rise due to either supply or demand-side factors. Because most consumers visualise inflation as a supply-side phenomenon (implicitly holding their own nominal income constant) they see inflation as a problem, not a solution. Thus any calls for a higher inflation target are likely to be highly controversial, which makes it unlikely they would be adopted by conservative central bankers.

A much better solution to frankly admit what a growing number of economists are saying; inflation targeting was a mistake from the beginning, and the major central banks should instead be targeting nominal income growth (preferably level targeting). All of the advantages of higher inflation (economic stimulus, lower real debt loads, etc.) are actually more closely linked to rising nominal incomes. A switch to NGDP targeting would not require the major central banks to adopt a new and higher inflation target, with the associated loss of credibility. Instead they should estimate an NGDP target likely to produce 2% inflation in the long run, that is, an NGDP growth rate target of perhaps 4.5% per year in the US, 4% in Europe, and 2.5% in Japan. If the central bank believes there is a need for some “catch-up growth” (and surely that’s the case in the US and Europe, then they should start the trend line from 2008 or 2009, to allow for higher NGDP growth for the next several years.

Some might argue that this is just a back door way of raising the inflation target. Not so. Inflation targeting is what got us into this mess. If we had been targeting NGDP in 2008, level targeting, then monetary policy would have been far more stimulative, the recession would have been much milder, and the sovereign debt crisis would have been confined to Greece and perhaps one other country. We don’t need an expedient like a temporarily higher inflation target, which will further erode central bank credibility. Rather we need an entirely new policy rule, a rule that will be so robust that it doesn’t have to be abandoned every time we face a recession or a debt crisis. A rule that is consistent with 2% inflation in the long run. Nominal income targeting is the policy rule that is most likely to fit that description.

For Richer for Poorer.

As probably many of you know, there is a cloud hanging over the future of the US and many other countries, the cloud of wealth concentration. There is nothing in life that will not be affected by this phenomenon. It obviously affects our allocation of resources and  it will have tremendous influence on who gets what. It would affect the relations between the social classes and could lead to social unrest if we allow the fissure between the haves and have nots to increase. The following is only one part of an excellent article that speaks to this issue.

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Growing inequality is one of the biggest social, economic and political challenges of our time. But it is not inevitable, says Zanny Minton Beddoes

Oct 13th 2012 | from the print edition of The Economist

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IN 1889, AT the height of America’s first Gilded Age, George Vanderbilt II, grandson of the original railway magnate, set out to build a country estate in the Blue Ridge mountains of North Carolina. He hired the most prominent architect of the time, toured the chateaux of the Loire for inspiration, laid a railway to bring in limestone from Indiana and employed more than 1,000 labourers. Six years later “Biltmore” was completed. With 250 rooms spread over 175,000 square feet (16,000 square metres), the mansion was 300 times bigger than the average dwelling of its day. It had central heating, an indoor swimming pool, a bowling alley, lifts and an intercom system at a time when most American homes had neither electricity nor indoor plumbing.

A bit over a century later, America’s second Gilded Age has nothing quite like the Vanderbilt extravaganza. Bill Gates’s home near Seattle is full of high-tech gizmos, but, at 66,000 square feet, it is a mere 30 times bigger than the average modern American home. Disparities in wealth are less visible in Americans’ everyday lives today than they were a century ago. Even poor people have televisions, air conditioners and cars.

But appearances deceive. The democratisation of living standards has masked a dramatic concentration of incomes over the past 30 years, on a scale that matches, or even exceeds, the first Gilded Age. Including capital gains, the share of national income going to the richest 1% of Americans has doubled since 1980, from 10% to 20%, roughly where it was a century ago. Even more striking, the share going to the top 0.01%—some 16,000 families with an average income of $24m—has quadrupled, from just over 1% to almost 5%. That is a bigger slice of the national pie than the top 0.01% received 100 years ago.
This is an extraordinary development, and it is not confined to America. Many countries, including Britain, Canada, China, India and even egalitarian Sweden, have seen a rise in the share of national income taken by the top 1%. The numbers of the ultra-wealthy have soared around the globe. According to Forbes magazine’s rich list, America has some 421 billionaires, Russia 96, China 95 and India 48. The world’s richest man is a Mexican (Carlos Slim, worth some $69 billion). The world’s largest new house belongs to an Indian. Mukesh Ambani’s 27-storey skyscraper in Mumbai occupies 400,000 square feet, making it 1,300 times bigger than the average shack in the slums that surround it.

The concentration of wealth at the very top is part of a much broader rise in disparities all along the income distribution. The best-known way of measuring inequality is the Gini coefficient, named after an Italian statistician called Corrado Gini. It aggregates the gaps between people’s incomes into a single measure. If everyone in a group has the same income, the Gini coefficient is 0; if all income goes to one person, it is 1.
The level of inequality differs widely around the world. Emerging economies are more unequal than rich ones. Scandinavian countries have the smallest income disparities, with a Gini coefficient for disposable income of around 0.25. At the other end of the spectrum the world’s most unequal, such as South Africa, register Ginis of around 0.6. (Because of the way the scale is constructed, a modest-sounding difference in the Gini ratio implies a big difference in inequality.)

Employment Conundrum

As soon as the US government released the unemployment results for September showing that nonfarm employment increased by 114,000 (anemic) but yet the rate of unemployment dropped substantially from 8.1 to 7.8 many of the conservative politicians and econimic analysts cried foul. Jack Welsh, the former GE CEO tweeted"If you can't debate then you fix the numbers"  and a CNBC personality said: "I told you that they would get the number below 8% just before the elections". All of the above comes under the category of sour grapes. No one who knows anything about the BLS would ever make such an accusation because it is baseless and is something that will be next to impossible to achieve . Over 50 different individuals work on these figures and not a single one has the power to manipulate them. The following is a great explanation of what the unemployment figures mean, as presented by Greg Manikw one of "star" economists in the US.


If you go to the recent release from the BLS, you can find these two sentences a few paragraphs apart:

Total employment rose by 873,000 in September.

Total nonfarm payroll employment increased by 114,000 in September.

To a layman, this may seem confusing.  The first statement suggests a robust labor market, the second a more lackluster one.  What is going on?

The issue is that there are two surveys.  The first estimate of employment comes from the survey of households; the second is from the survey of establishments.  I thought readers might like to hear what my favorite intermediate macro textbook says about this issue.  Here is an excerpt:

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Because the BLS conducts two surveys of labor-market conditions, it produces two measures of total employment. From the household survey, it obtains an estimate of the number of people who say they are working. From the establishment survey, it obtains an estimate of the number of workers firms have on their payrolls.

One might expect these two measures of employment to be identical, but that is not the case. Although they are positively correlated, the two measures can diverge, especially over short periods of time. A particularly large divergence occurred in the early 2000s, as the economy recovered from the recession of 2001. From November 2001 to August 2003, the establishment survey showed a decline in employment of 1.0 million, while the household survey showed an increase of 1.4 million. Some commentators said the economy was experiencing a “jobless recovery,” but this description applied only to the establishment data, not to the household data.

Why might these two measures of employment diverge? Part of the explanation is that the surveys measure different things. For example, a person who runs his or her own business is self-employed. The household survey counts that person as working, whereas the establishment survey does not because that person does not show up on any firm’s payroll. As another example, a person who holds two jobs is counted as one employed person in the household survey but is counted twice in the establishment survey because that person would show up on the payroll of two firms.

Another part of the explanation for the divergence is that surveys are imperfect. For example, when new firms start up, it may take some time before those firms are included in the establishment survey. The BLS tries to estimate employment at start-ups, but the model it uses to produce these estimates is one possible source of error. A different problem arises from how the household survey extrapolates employment among the surveyed households to the entire population. If the BLS uses incorrect estimates of the size of the population, these errors will be reflected in its estimates of household employment. One possible source of incorrect population estimates is changes in the rate of immigration, both legal and illegal.

In the end, the divergence between the household and establishment surveys from 2001 to 2003 remains a mystery. Some economists believe that the establishment survey is the more accurate one because it has a larger sample. Yet one recent study suggests that the best measure of employment is an average of the two surveys. [George Perry, “Gauging Employment: Is the Professional Wisdom Wrong?,” Brookings Papers on Economic Activity (2005): 2.]

More important than the specifics of these surveys or this particular episode when they diverged is the broader lesson: all economic statistics are imperfect. Although they contain valuable information about what is happening in the economy, each one should be interpreted with a healthy dose of caution and a bit of skepticism.

QE3 and the Economy

 

Fed’s Evans Says QE3 Will Make Economy More Resilient

By Joshua Zumbrun and Mark Clothier - Sep 18, 2012

Federal Reserve Bank of Chicago President Charles Evans said the central bank’s third round of quantitative easing will help the economy keep growing despite headwinds from Europe’s debt crisis as well as potential U.S. tax increases and spending cuts.
“Given the slow and fragile recovery, the large resource gaps that still exist, and the large risks we face, it remains clear that we needed a more resilient economy,” Evans said today according to prepared text of a speech in Ann Arbor, Michigan. The Fed’s actions last week “provided a more accommodative monetary policy that can help us achieve such resilience.”
Evans has been among the most outspoken advocates for additional monetary stimulus from the Fed in the past year. In an Aug. 27 speech he called for the Federal Open Market Committee to engage in open-ended asset purchases, a strategy that was adopted by the Fed in its Sept. 13 decision to purchase $40 billion a month in mortgage debt until the labor market improves.
“We’re going to look at the labor market and the way the economy is going and also inflation pressures, and if it seems like we need to continue to do this, we’ll continue to do this next year,” Evans said in response to audience questions.

Operation Twist

The central bank will have to consider continuing the mortgage-debt purchases into 2013 and should purchase additional Treasuries once the central bank’s Operation Twist program expires in December, Evans said.
The Fed maintained Operation Twist, selling about $45 billion of short-term Treasury securities a month and buying about $45 billion of longer-term Treasuries, even as it began purchasing $40 billion a month of mortgage-backed securities.
Evans told reporters after the speech that a pace of $85 billion in mortgage-backed securities and Treasury securities may be appropriate into 2013.
“We’re looking for stronger employment growth, some beginning declines in the unemployment rate and stronger growth,” Evans said. “I’d be surprised if we would see enough evidence of that by the end of this year. So under that conditioning, I would expect that we would continue at something like an $85 billion pace of purchases post December.”
The Chicago Fed chief renewed his call for the policy makers to provide accommodation as long as unemployment remains above 7 percent and the inflation outlook is under 3 percent. Evans said that although the Fed did not adopt this policy last week he supports the QE3 decision “wholeheartedly.”

Disappointing Growth

Evans said the Fed’s actions will help strengthen a pace of growth that has been “disappointing” and help counteract “greater downside risks posed by the slowdown in global economic growth, the economic turmoil in Europe and the fast- approaching U.S. fiscal cliff.” If Congress doesn’t act, more than $600 billion in automatic tax increases and spending cuts will take effect starting in January.
Evans raised his growth and inflation forecasts in response to the Fed’s new program and now sees the unemployment rate falling faster, the policy maker told reporters.
“My own projections did have somewhat stronger growth because of that,” Evans said. “If I’m looking for -- as one benchmark -- seeing the unemployment rate fall below 7 percent, I think it will happen much sooner than if we had not undertaken that action.”

‘Heroic Forecast’

Evans said unemployment could fall below 7 percent by the end of 2014.
“I don’t think that’s a heroic forecast,” he said.
The FOMC took action last week following a Sept. 7 Labor Department report showing the economy added 96,000 jobs in August. The unemployment rate dropped to 8.1 percent from 8.3 percent as 368,000 people left the labor force.
Evans said that the central bank’s policy has been unable to have its full effect on the economy because not all mortgage holders have been able to refinance.
“We’ve been fighting against a variety of issues that are clogging the effectiveness of the monetary policy transmission channel,” Evans said in response to audience questions. “Normally it’s the case that when you have such a large amount of monetary stimulus in place we would have seen an enormous refinancing wave of mortgages.”

Underwater Borrowers

Yet many borrowers who are underwater, or owe more on their mortgage than the value of their home, are unable to refinance and “if there were adjustments made in those refinancing programs we could deliver much more effectiveness of our policy accommodation,” he said.
In addition to undertaking QE3, the Fed said last week that economic conditions would likely warrant holding their target interest rate near zero through at least mid-2015, extending a previous date of late 2014. The Fed said low interest rates will remain appropriate for a “considerable time” after growth strengthens.
The Fed is contending with a slowing economy. Gross domestic product climbed by 1.7 percent in the second quarter, down from 2 percent in the first quarter and 4.1 percent in the fourth quarter of last year.

Highly Accommodative

“Stating that we expect to keep a highly accommodative stance for policy for a considerable time after the recovery strengthens is an important reassurance to households and businesses that Fed policy will not tighten prematurely,” Evans said.
Stocks and commodities have rallied since the Fed said on Aug. 1 that it would “provide additional accommodation as needed to promote a stronger economic recovery,” foreshadowing the launch of QE3 last week.
The Standard & Poor’s 500 (SPX) Index rose 6.3 percent from Aug. 1 to yesterday. The S&P GSCI index of 24 commodities has risen 6.4 percent in that time period.
Evans said the Fed should be willing to risk a little more inflation in order to help improve the labor market. The Fed should “not be resistant” to policies that lower unemployment closer to its longer-run level “but run the risk of inflation running only a few tenths above our 2 percent goal.”
Evans, 54, became president of the Chicago Fed in 2007 after serving as the bank’s director of research. Fed presidents rotate voting on monetary policy with Evans voting next year.

The Coming Economic Boom

                                                      The Coming Boom in the US

           Roger Altman has written an OpEd in the Financial Times in which he argued that a Boom is coming our way in the United States for the following five reasons. Please read and comment . Be sure to use your real name, Non Anons!!!
  

Rising home prices. Home prices are rising in half of the major housing markets in the U.S.

Booming energy production. Gas and oil production in the U.S. has increased at “breathtaking” rates.

Financial sector health. The banking sector, nearly nationalized while on its deathbed just a few years ago, has recovered faster than anyone thought possible.

Competitiveness. A few years ago, we were becoming a post-industrial nation. Now we’re back in the game of making big, hard things.

Budget balancing. Here Altman gets a bit partisan, predicting that an Obama re-election could result in a budget deal that brings down our mounting debt levels.

What Needs To Be Done To Cut The Deficit

I was about to write a brief post that sums up the difficulty of eliminating the federal budget deficit when I ran across a rather lengthy but a very clearly written article by Chris Farrell of the Market Money fame program on Public Radio. I think that you will benefit from reading his unabridged post. As this article makes clear and as we have hinted at in class the most significant obstacle to overcome; not that the others are easy; is the level of expenditures related to Medicare.




The size of the federal deficit is repeated so often by politicians and the news media that it's easy to become numb to the sheer magnitude of the number — an estimated $1.29 trillion for the fiscal year which ended on September 30, according to the new figures released today by the Obama Administration.

While that's a drop from the record $1.4 trillion deficit recorded for fiscal 2009, it's still the second largest deficit in history. No one is happy about the tidal wave of red ink:

* The issue helped Tea Party activists angry about out the deficit to seize the political spotlight.
* The Republican's "Pledge to America" promises to "stop out-of-control spending and reduce the size of government" if the party wins big in the November mid-term elections.
* President Obama on a recent stop in Richmond, Va., talked about the need to "get control of our budget.

Here's the rub: The deficit-hating oratory is heated but the deficit-reducing specifics are glaringly absent.

"The turn hasn't gone from highlighting the deficit to actually doing something about it," says Maya MacGuineas, president of the Committee for a Responsible Federal Budget in Washington, D.C. Adds Veronique de Rugy, senior research fellow at the Marcatus Center at George Mason University: "We are still in the realm of rhetoric."

The reason for the reluctance? Simple political calculation. As the late Nobel laureate Milton Friedman was fond of saying, "there is no free lunch." Or, as Mick Jagger of the Rolling Stones, a graduate of the London School of Economics, put it, "you can't always get what you want."

Eventually, however, the size and rapid growth of the deficit mean that it will have to be dealt with and that painful trade-offs will have to be made. The only real question is whether those decisions get made before the U.S. tumbles into a fiscal crisis.

"Those who say this won't be good for me because I'll pay higher taxes or I'll get a smaller benefit ignore the fact that we can't keep doing what we're doing," says James Horney Center on Budget and Policy Priorities.

So what are the realistic options? You won't get many details from the majority of the politicians up for election on Nov. 2, but here are some of the ideas making the rounds in Washington:

Let the Bush Tax Cuts Expire

It's easy to fall into deep despair about the deficit, but Obama's former budget director, Peter Orszag, recently grabbed the fiscal spotlight with a remarkably easy solution: Let the 2001 and 2003 tax cuts expire for everyone.

By allowing taxes to return to the pre-Bush era levels for taxpayers, the federal budget would be close to balance by 2015.

"If we actually ended the Bush-era tax cuts, that would pretty much do it," Orszag said in an interview with CNN's Fareed Zakaria. "If you do a bit on the spending side and then end the tax cuts, you pretty much get there."

The virtue of this approach is that it doesn't require any special legislation or deal-cutting among special interest groups. Congress could then devote its legislative energy to addressing major reforms needed in entitlement programs like Medicare, Medicaid and Social Security, which everyone agrees is necessary.

That said, the idea is DOA. One reason is the risk that higher taxes could send a fragile economy spiraling lower. But the politics may be even more important. Since the earliest days of his campaign, President Obama has committed to not raise taxes on any family earning less than $250,000. Going back on that pledge could be electoral suicide —especially as Republicans are vehemently against all tax hikes. Still, it's an intriguing litmus test to see how serious a politician is about addressing the problem.

What About Other Tax Changes?

Few dispute that America's income tax code is Byzantine, a complicated stew chock full of credits, deductions, phase-ins and phase-outs. Reigning in these so-called "tax expenditures" that clutter up the federal tax code could go a long way toward attacking the deficit "Tax expenditures are bad tax policy," says MacGuineas. She and others point out that a tax credit that reduces Uncle Sam's revenues causes the deficit to rise just as surely as does a spending increase — it's just more politically palatable.

For example, Martin Feldstein, economist at Harvard University and former chairman of the White House Council of Economic Advisors under President Reagan, estimates that simply reducing the size of tax expenditures from the current 6 percent to 4 percent of GDP would bring the projected 2020 debt down from 90 percent to 72 percent.

Sounds good, right? Who doesn't want a cleaner, less complicated tax code (especially come April)? Problem is, these loopholes support many activities people like. For instance, the education credit helps parents save for the high cost of college. The mortgage interest deduction is almost sacred to homeowners. The child care tax credit can be a much needed boon to new parents.

What's more, many Republicans look at moves toward reducing tax expenditures as the equivalent of a tax hike.

Entitlement Reform

America is aging, with the leading edge of the baby boom generation reaching its retirement years. It's well-known that to eventually bring the long-term deficit under control, the government will have to address the three main entitlement programs -- Social Security, Medicare and Medicaid.

Now, despite rhetoric to the contrary, there really is no Social Security crisis. There's financial trouble down the road but it's manageable. Still, the general outline of a compromise for shoring up Social Security's finances has emerged in recent years. It essentially relies on hiking the retirement age, lifting the cap on annual wages subject to the payroll tax, and making the cost of living index less generous. (The Congressional Budget Office offers a list of options in its July 2010 report, Social Security Policy Options at http://www.cbo.gov/ftpdocs/115xx/doc11580/07-01-SSOptions_forWeb.pdf.). Yet many people don't buy into the compromise because it means retiring later or paying more in taxes. Ultimately, however, one — or both — will likely have to happen.

The real long-term budget pressure comes from higher health care spending. To give a sense of the scale of the problem, the benchmark 75-year projection by the Social Security Trustees guesstimates the cost of Medicare alone will swell to 11.4 percent of gross domestic product in 2083 — 94 percent larger than Social Security's cost. "We need to slow the rate of growth in healthcare," says Horney.

He's right, but the kinds of changes in healthcare required to do so will make the controversy over Obamacare a stroll through the park. Salaried doctors? Universal healthcare? Healthcare vouchers for everyone? The debate has only begun.

Cut Back on Defense Spending

Defense accounts for 20 percent of the budget. Last April Defense Secretary Robert Gates targeted more than 20 programs for termination or cutbacks, and the Defense Department is looking for more cuts. A reduction the nation's nuclear arsenal and missile defense systems could end up on the table, while military compensation is another possible target. The reason: military personnel earn average cash compensation that beats 75 percent of their civilian peers of comparable age and education . Benefits are also better than for most civilian jobs. One solution would be to cap the growth future in military compensation at the rate prevailing in the rest of the economy.

"The U.S. spends the biggest share in the world on defense," says the Marcatus Center's de Rugy. "We can cut it a lot."

Yet slashing into defense spending is always difficult, especially with troops at war in Afghanistan and still engaged in a mission in Iraq. Cuts in defense programs also quickly translate into job losses elsewhere in the economy as military contractors cutback — something few politicians willingly allow without a fight.

A Baseline Scenario

Here's one way to start thinking through the trade-offs. A centrist approach was released on Sept. 30 by William Galston of the Brookings Institution and MacGuineas. Their goal is to get debt back down to 60 percent of GDP by the end of the current decade. Their blueprint relies half on spending cuts and half on raising taxes.(http://www.brookings.edu/papers/2010/0930_public_debt_galston.aspx ) They would do everything from slashing deep into defense spending to embracing carbon taxes.

Others would take a very different tack, however. De Rugy, for one, is against raising taxes to tackle the deficit. Instead, she advocates pushing a lot of federal responsibilities back to the states, such as education and transportation, as well as pushing entitlements more toward a private voucher system.

Where do you stand? Would you cut spending? If so which programs would get trimmed? Would you raise taxes? Which ones? Change entitlements? How?

And then there are these questions: When -- if ever -- will politicians stake their fortunes on backing concrete solutions? And if they do, will voters reward them for taking action?

Nobel Prize in Economics 2010

2010 did not look very promising for US citizens as far as the 2010 Nobel prizes go. At times most of the Nobel laureates turn out to be US citizens but none of the awards this year was given to an American until today. The last prize is the one given in Economics and two of the recepients are American while the third is a British Cypriot.

The Economics award went this year to Peter Diamond, Dale Mortensen and Christopher Pissarides for their work on unemployment. The three professors will share the $1.5 million prize that was established in 1968 by the Royal Sweedish Academy of Sciences.

The Academy praised in its statement the work that the three award recepients had done in explaining how job vacancies and wages react to economic policy and government regulation.

"According to a classical view of the market, buyers and sellers find one another immediately, without cost, and have perfect information about the prices of all goods and services... But this is not what happens in the real world," the prize committee said in a statement.

It said the trio's work enhanced understanding of "search markets" where frictions exist as demands of some buyers are not met and some sellers cannot sell as much as they want.

This could involve simple cases of a buyer and a seller of a product as well as more complex relations between employers and job seekers, or between firms and suppliers.

On the labor market, the laureates' models help understand how unemployment, job vacancies and wages are affected by regulation and economic policy, including the size of jobless benefits, the committee said.

Their theories can also be applied to housing markets, as both vacancies and the time to sell a home vary over time.

Who Is Rich?

Wealth is often confused with income although they are different concepts. Wealth is a stock, it measures what has been accumulated as of a particular point in time. Income on the other hand is a flow, it measure the rate at which ones income flows in a certain period of time, say a year.

As is to be expected wealth is much more concentrated than income in the US. The results of the 2010 census confirmed what many have feared for a while. The top 20% of wage earners get 49.5% of all wages in the US while the lowest 20% of the labour force has to settle for a miserly 3%. If these figures are not jarring enough then please note that the top 1 % of Americans receive 24% of income when in 1915 the top 1% took away 18% of income.What is most disturbing about this disparity is the fact that a large proportion of children are caught in this unforgiving circle of poverty. It is estimated that 37% of the children in the nation are covered by Medicaid.

If you guessed that wealth is even more inequitably distributed then you would be right. The latest studies suggest that the top 20% of Americans own 85% of the wealth in the land while the top 1% claim 35% of the wealth of the nation. As the above figures suggest the bottom 80% of the Americans have to split the remaining 15% of wealth, and yes that means that the bottom half have no net worth .

The recent discussions regarding whether the Bush tax cuts should be renewed and if so for whom is very much related to the income and wealth distribution in the US. Some politicians favour making the tax cuts permanent while others believe that the tax cuts should be renewed only for those households making up to $250,000 a year. The popular rationale for this income level is that people who earn this much are not wealthy. But a quick examination of income distribution reveals that households whose annual income is $250,000 belong to the topd 2.5% of all Americans. Are we suggesting the there is no difference between those that make $50,000 per year and those that make five times as much? I am afraid that we are suggesting just that.
So what do you think? What income level qualifies an individual to be privileged?

Downhill With The GOP

The following Paul Krugman column appeared in the Sept 23, 2010 issue of the NYT. Paul Krugman, as you all know is a Nobel laureate in Economics and one of the most widely read NYT OpEd page regulars. Read this article for a quick analysis about the Republican "Pledge to Amaerica".

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Once upon a time, a Latin American political party promised to help motorists save money on gasoline. How? By building highways that ran only downhill.

I’ve always liked that story, but the truth is that the party received hardly any votes. And that means that the joke is really on us. For these days one of America’s two great political parties routinely makes equally nonsensical promises. Never mind the war on terror, the party’s main concern seems to be the war on arithmetic. And this party has a better than even chance of retaking at least one house of Congress this November.

Banana republic, here we come.

On Thursday, House Republicans released their “Pledge to America,” supposedly outlining their policy agenda. In essence, what they say is, “Deficits are a terrible thing. Let’s make them much bigger.” The document repeatedly condemns federal debt — 16 times, by my count. But the main substantive policy proposal is to make the Bush tax cuts permanent, which independent estimates say would add about $3.7 trillion to the debt over the next decade — about $700 billion more than the Obama administration’s tax proposals.

True, the document talks about the need to cut spending. But as far as I can see, there’s only one specific cut proposed — canceling the rest of the Troubled Asset Relief Program, which Republicans claim (implausibly) would save $16 billion. That’s less than half of 1 percent of the budget cost of those tax cuts. As for the rest, everything must be cut, in ways not specified — “except for common-sense exceptions for seniors, veterans, and our troops.” In other words, Social Security, Medicare and the defense budget are off-limits.

So what’s left? Howard Gleckman of the nonpartisan Tax Policy Center has done the math. As he points out, the only way to balance the budget by 2020, while simultaneously (a) making the Bush tax cuts permanent and (b) protecting all the programs Republicans say they won’t cut, is to completely abolish the rest of the federal government: “No more national parks, no more Small Business Administration loans, no more export subsidies, no more N.I.H. No more Medicaid (one-third of its budget pays for long-term care for our parents and others with disabilities). No more child health or child nutrition programs. No more highway construction. No more homeland security. Oh, and no more Congress.”

The “pledge,” then, is nonsense. But isn’t that true of all political platforms? The answer is, not to anything like the same extent. Many independent analysts believe that the Obama administration’s long-run budget projections are somewhat too optimistic — but, if so, it’s a matter of technical details. Neither President Obama nor any other leading Democrat, as far as I can recall, has ever claimed that up is down, that you can sharply reduce revenue, protect all the programs voters like, and still balance the budget.

And the G.O.P. itself used to make more sense than it does now. Ronald Reagan’s claim that cutting taxes would actually increase revenue was wishful thinking, but at least he had some kind of theory behind his proposals. When former President George W. Bush campaigned for big tax cuts in 2000, he claimed that these cuts were affordable given (unrealistic) projections of future budget surpluses. Now, however, Republicans aren’t even pretending that their numbers add up.

So how did we get to the point where one of our two major political parties isn’t even trying to make sense?

The answer isn’t a secret. The late Irving Kristol, one of the intellectual godfathers of modern conservatism, once wrote frankly about why he threw his support behind tax cuts that would worsen the budget deficit: his task, as he saw it, was to create a Republican majority, “so political effectiveness was the priority, not the accounting deficiencies of government.” In short, say whatever it takes to gain power. That’s a philosophy that now, more than ever, holds sway in the movement Kristol helped shape.

And what happens once the movement achieves the power it seeks? The answer, presumably, is that it turns to its real, not-so-secret agenda, which mainly involves privatizing and dismantling Medicare and Social Security.

Realistically, though, Republicans aren’t going to have the power to enact their true agenda any time soon — if ever. Remember, the Bush administration’s attack on Social Security was a fiasco, despite its large majority in Congress — and it actually increased Medicare spending.

So the clear and present danger isn’t that the G.O.P. will be able to achieve its long-run goals. It is, rather, that Republicans will gain just enough power to make the country ungovernable, unable to address its fiscal problems or anything else in a serious way. As I said, banana republic, here we come.

How Important Is the Stock Market for the Average Retiree?

Contrary to most of what you hear on the radio and you read in newspapers and magazines the typical American retiree is not as dependent on the performance of the stock market as many people think. The following is a table of the sources of income among the second quartile of older Americans, that is, from the 50th to the 75th percentile:

Social Security benefits....... 54.60%
Pensions....................... 22.00%
Earnings....................... 11.70%
Assets......................... 09.00%
Other Income................... 02.60%
Public Assistance.............. 00.30%


As the above table illustrates very clearly this group — which is above median, although not at the top — is highly dependent on Social Security benefits for more than half of their income.Asset income is, on the other hand , is rather small. Obviously as one moves down to the third quartile and then the fifth quartile then the share of income derived from the stock market disappears.

Of course the portion of income derived from pensions is affected by the stock market but for most Americans the day to day fluctuations in stock prices are not as seminal as those on Wall Street would like us to believe that they are. What do you think?

HDI 2009 CPI components

Although the GDP was not developed to measure the level; of welfare of a society it has been often used to imply that a larger GDP/Capita means a better quality of life. There have been many efforts over the years to adjust the GDP and/or modify it is such a way as to make it responsive to some of the criticisms leveled at it.

One of the most successful efforts at creating an alternative measure of welfare is the Human Development Index (HDI) that was introduced 20 years ago. The HDI is a relatively simple index that combines the money measure of the GDP/Capita, life expectancy at birth and degree of literacy to rank countries relative to the combined score that they attain. Obviously the highest possible score is 1. This kind of ranking raises the importance of heath care services in addition to education but it deemphasizes the role of money income as the most important factor in determining the quality of life. The final rankings demonstrate clearly that it is possible to have a relatively low GDP/capita and yet enjoy a high quality of life if the access to health care results in longer and healthier life combined with a high degree of literacy.

Those among you who are interested in the latest such report by the UNDP should visit the following web site for the full report and all its data:

http://hdr.undp.org/en/statistics/



Components of Consumer Price Index

The Bureau of Labor Statistics provides the following description of the major eight categories and 200 categories that are currently used in computing the CPI.
"
Major groups and examples of categories in each are as follows:

* FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)

* HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)

* APPAREL (men's shirts and sweaters, women's dresses, jewelry)

* TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

* MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)

* RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);

* EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);

* OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses)."

Eight out of Ten Ain't Bad.

No one can doubt that the economic meltdown that started in the United States a couple of years ago and then spread all over the globe has been a wrenching experience. Tens of millions have lost their jobs, retirement plans had to be adjusted, poverty has increased, malnutrition has become more widely spread and governments have had to bailout banks, automobile manufacturing giants, subsidize agriculture and mortgages. Besides all the painful current adjustments that individuals and households have had to make, the future does not look to be very clear either, considering all the additional borrowing that governments had to undertake. As of this writting the US national debt is 12 Trillion dollars ( $12,000,000,000,000)and is slated to keep on increasing. What would be the effect of such a high level of indebtedness on both the domestic and ultimately the world economy is still not clear.

As a result of the severity of the global economic contraction many are questioning the viability of capitalism as it is currently structured. One inevitable result of these discussions is the emergence of the view that the US dominance is ending and that the unipolar moment has already come and gone. All of the above might prove to be true but as Mark Twain once said" The report of my death has been exaggerated".

American military power has been challenged in Iraq and Afghanistan, its political power is being challenged in Iran, the Arab world, parts of Latin America and in Eastern Europe. All of that while the value of the dollar sets new lows on the foreign exchange markets on a daily basis and its moral leadership is often questioned in the halls of the United Nations and in the Climate Change negotiations.

Yet inspite of all the above "negativism" eight of the top ten Global Brands according to the rankings by Business Week are common American household names. The results of these rankings come close to an unprecedented sweep and a recognition of American ingenuity and ability to innovate but it is also a clear demonstration of interdependence and a growing integration of the world economy.

The following is the list of the Top Ten:

1. Coca Cola (KO)
2. IBM (IBM)
3. Microsoft (MSFT)
4. GE (GE)
5. Nokia (NOK)
6. McDonald’s (MCD)
7. Google (GOOG)
8. Toyota (TM)
9. Intel (INTC)
10. Disney (DIS)

Do we need another stimulus?

The following is the full transcript of A Conscience of a Liberal of Oct. 3, 2009. Please read very carefully. Paul Krugman, the Nobel laureate, is not pleased with the latest unemployment report. What does the future hold?
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Obama’s Anzio

I’m late on this, due to festschrifting. But another bad employment report yesterday. I’m feeling pretty bleak about this.

And the worst of it is that it was more or less predictable. I went back to my first blog post — January 6, 2009 — worrying that the Obama economic plan was too cautious. I wrote:

This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”

Let’s hope I’ve got this wrong.

Alas, I didn’t have it wrong — except that unemployment will, if we’re lucky, peak around 10 percent, not 9.

There was a lot of talk about health care being Obama’s Waterloo. It won’t, I think and hope. But stimulus is starting to look like Obama’s Anzio — the battle in which the American commander got himself into terrible trouble by being too cautious.

And right now Obama is pinned down in his too-small beachhead, taking heavy casualties.

Green Shoots

As has been expected this prolonged period of economic decline has been the most severe and the longest downturn in the last 80 years. Unemployment is approaching 10 %, the Federal deficit is setting new records and so is the projected national debt. But many economists, including Mr. Bernanke of the Federal Reserves have been talking increasingly about “green shoots”.
The fact of the matter is that there have been many “green shoots” sightings but most have proven to be almost as elusive as the UFO variety. Although home sales of both existing and new homes have been on the increase for a few months they seem to have stalled during August and durable good orders were below expectations. Add to the above the fear generated from what are the long run implications of the massive amounts of money that has been printed (read inflation and weak dollar) and the high prospects for a jobless slow rebound and the greenness of these shoots start to pale. They are not dead yet but the short term expectations should be tempered until the quality of the “sighting” improve.


I would be interested in your opinion of the movie "Capitalism: A Love Story" if you have seen it.

Would You Buy American Iron?

As difficult as it might be to believe,at one time, American made cars used to account for over 90% of the cars on the road in the US of A. Actually at times, GM's share alone was close to 60%. Fast forward to last year when GM and Chrysler filed for bankruptcy under chapter 11 and were able to avoid liquidation only with massive help from the federal government. Ford fared better but could not avoid receiving some major body blows that left it gasping for air.

Most analysts seem to think that Ford has learned its expensive lesson and is on the road to recovery but the jury is still out regarding the prospects for GM and Chrysler. Many think that GM will survive and possibly prosper but as a much smaller company than it used to be. GM had to shed Saab, Hummer, Pontiac, Saturn and they had to sell their stake in Suzuki and most of Opel. Chrysler on the other hand is eliminating marginal models such as the Pacifica and the Viper. The real question is whether GM and Chrysler will survive or whether all the tens of billions of dollars spent by the feds were for naught.
The next two years will be instrumental to the industry. Ford is planning to become profitable late next year or by early 2011 by the latest as a result of its new line of cars. GM hopes to break even when the market for new cars climbs back to 11.5 million units a year. They are hoping to ride the buz from from the plug in Volt next year while Chrysler is counting on the Fiat cars that could start appearing in the show rooms in a year from now.

A quick review of some of car magazines and car reviewers for the new model year seems to show that the American car companies have a fighting chance. Four of the most important new cars are :

Buick Lacrosse

Ford Taurus especially the SHO

Ford Fusion Hybrid

Chevrolet Equinox

Have you looked at any of these models and if so would you buy any of them? It is going to be your purchasing habit that will decide the fate of Detroit over the next 3-5 years. What do you think, would any or all of the 3 American car manufacturers survive and prosper?

It Is Time To End GDP Fetishism

Most common discussions, by all kinds of media outlets all over the world, of the concept of social welfare of a particular society never fail to mention the state of the Gross Domestic Product, the GDP. This all popular macroeconomic variable has grown, despite its enormous shortcomings, to become a metric of what it was not designed to be in the first place. Very simply stated, the GDP is a money measure of the value of final goods and services that are produced by a particular society. Note that the concept does not pretend to say anything about the level of welfare but is only the summation of all what is produced without even deducting the damage that ensue from such levels of production and consumption . A simple common example might help illustrate this absurdity. If during a particular year, the number of expensive medical procedures undertaken in a state increases then the overall size of its GDP increases also. So if the GDP is such a good indicator of the social level of welfare then why not promote cigarette smoking in order to increase the incidence of lung cancer which will keep the surgeons busy and lead to a large rate of growth in the GDP? Of course such a policy would be rejected by all. But isn’t this exactly what we do when we allow firms to dump their toxic wastes into rivers and when we encourage workers to commute long distances from where they reside to their place of work. The concept is rife with problems that are too many to list and that economists and environmentalists have been pointing out for decades chief among them is the inability of GDP per capita to say anything about the all important income distribution. Wouldn’t it be more important to learn who had access to the increased output rather than to just say that output went up? It has often been the case that the all the growth in the GDP accrues to a small group of privileged economic class when ¾ of the population has in reality lost ground.
Environmentalists in general and environmental economists in particular have been in the forefront of an unremitting attack on the method of assembling national income statistics and in particular the GDP. These efforts have been helped over two decades ago by the work of Amartya Sen, the Noble laureate in Economics, through his pioneering work on how to measure poverty and social well being. His work has led, among other things, to the increasingly popular Human Development Index by the United Nations. The HDI ranks countries by creating an index that takes into consideration the level of GDP per capita but combines that with measures of literacy and life expectancy. As a result it becomes possible to rank a country with high literacy rate and a high life expectancy above one that enjoys a higher GDP per capita but lags in the other two indicators.
Two days ago Joseph Stiglitz, another Noble laureate in Economics, a Professor of Economics at Columbia University and an ex Chief Economist of the world Bank has joined ranks with the above group of advocates for a change in National Income Accounting. He called, in his capacity as a member of a group advising president Sarkozy of France, upon world economic leaders to “avoid GDP fetishism and… to stay away from that.” What a welcome message during these perilous economic times in a world that is clearly not sustainable. Bravo Dr. Stiglitz.
So what are the implications of such a change? You tell me. Is a growing GDP, accompanied by a growing poverty rate, inequitable distribution of income , larger public debt, higher unemployment, less electric power, a construction boom for the super wealthy, privatized public beaches, low minimum wage, environmental degradation in all fields and rampant corruption a sign of social justice and better social welfare?

Latest Income Statistics

The following are some of the highlights from the most recent study released by the US Census:

Real median household income fell between 2007 and 2008,and the decline was widespread.
Median income fell for family and nonfamily households, native- and foreign-born households, households in 3 of the 4 regions, and households of each race category and those of Hispanic origin. These declines in income coincide with the recession that started in December 2007.

The poverty rate increased between 2007 and 2008.

The percentage of uninsured in 2008 was not statistically different from 2007, while the number of uninsured increased between 2007 and 2008.

These results, though widespread, were not uniform across groups. For example, between 2007 and 2008, real median income was statistically unchanged for households maintained
by a person 65 years old and over but declined for households maintained
by people of all other age group categories. Additionally, the poverty rate increased for children under 18 and for people 18 to 64 but remained statistically
unchanged for people 65 and over.

Income Distribution

The lowest quintile of households had incomes of $20,712 or less; those in the second quintile had incomes of $20,713 to $39,000; those in the third quintile had incomes of $39,001 to $62,725; those in the fourth quintile had incomes of $62,726 to $100,240;
and those in the highest quintile had incomes of $100,241or more.

It is safe to assume that the data for 2009 would show the same trend i.e. a drop in median income and an increase in the poverty rate. Some even fear that the jobless recovery might even be with us at least for a portion of 2010.

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And The Beat Goes On

It is at times like these that we need to be reminded of what Alexander Pope once wrote:"Hope springs eternal in the human breast". As difficult as it might be we need to know that adversity carries within it the seeds of an equal or greater benefit. It all depends on how we react to the challenges that are facing us.

Unfortunately most observers think that the current economic crisis has not hit bottom yet. Whether it is the stock market or whether it is the real economy the daily deluge of news point to some more rough times ahead.

What does the future hold?
It is difficult to see any uplifting indicators besides the "leak" that both Citi and Bank of America have had two profitable months so far in2009 , on an operating basis. Besides that our only hope is that the stimulus will kick in within the next few months and that its effects will be sustainable. But realism demands that we take a look at the real financial and macro economic indicators. Once we do that then what do we find:

(1) The over 600,000 monthly job loses will not come to a sudden halt. They would continue for some time to come. Unemployment rate is already at 8.1%

(2) The factory capacity utilization for the month of February was at a historical low of 67.4%. This simply means that we have 1/3 of our factories mothballed.

(3)Home prices have fallen a lot so far but they have not hit bottom yet. That carries negative connotations for both consumers and the balance sheets of the large banks.

(4) Many on Wall Street are raising the argument that the current Price to Earnings ratio has not fallen as much as it usually does in major crisis , such as the 1981 recession or obviously the great Depression. Is there a 500 Dow Jones Industrial average in our future?

(5) And last but not least China is already voicing its serious concerns about the value of the dollar. A loss of confidence in the greenback will be disastrous.