Unemployment, Small Business, Quantitative Easing, and More

The Fed’s quantitative easing programs did indeed lower interest rates, but more so for Treasuries and mortgage-backed securities than for other kinds of debt. Small businesses are overrated as job creators. Extended unemployment insurance does increase unemployment rates, but not that much.

Those are just a few of the findings from papers presented today at the Brookings Institution’s twice-yearly conference, Brookings Papers on Economic Activity.

Courtesy of a Brookings release, here are brief summaries of five papers discussed today:

In Recession and the Costs of Lost Jobs, authors Steve Davis of the University of Chicago and Til von Wachter of Columbia University find that when mass-layoffs occur in good economic times, men with 3 or more years of job tenure suffer a $65,000 loss in the lifetime value of their earnings (a fall of about 10%), relative to otherwise similar workers who retain their jobs. But in a recession, a similar shock causes workers to lose $112,000 in the lifetime value of their future earnings (or about 19%).  The authors also track worker perceptions about layoff risks, job-finding prospects, and the likelihood of wage cuts, finding a tremendous increase in worker anxieties about their labor market prospects after the financial crisis of 2008.  This heightened anxiety continues today, they find.  Davis and von Wachter also show that prior economic employment models have been unable to address the facts about the earnings losses associated with job loss, yet those earnings impacts appear to be one of the main reasons that individuals and policymakers are so concerned with recessions and unemployment.  Finally, they note that pro-growth policies may be the most efficient and cost-effective means available to policymakers to alleviate the hardships experienced by displaced workers.

In What Do Small Businesses Do authors Erik Hurst and Benjamin Wild Pugsley of the University of Chicago overturn the conventional wisdom about the role of small business, finding that they aren’t the job engine most believe them to be. Most small business owners neither expect nor desire to grow or innovate, but rather intend to provide an existing service to an existing customer base.  Analyzing new survey data, the authors find that, instead, it is non-financial reasons — such as work flexibility and the desire to be one’s own boss – that are the most common reason that entrepreneurs start their own business. Hurst and Pugsley note this behavior is consistent with the industry characteristics of the majority of small businesses, which are concentrated among skilled craftsmen, lawyers, real estate agents, doctors, small shopkeepers, and restaurateurs.  They conclude that standard theories of entrepreneurship may be misguided and result in sub-optimal public policy, suggesting that subsidies for small businesses may be better spent if they are targeted to businesses that expect to grow and innovate, rather than small businesses in general.  They laud the partnership between the US Small Business Administration and venture capital firms as an example of strong targeted public policy.

In Unemployment Insurance and Job Search in the Great Recession, Jesse Rothstein of the University of California, Berkeley finds that recent extensions to the period in which the unemployed can draw unemployment benefits had a significant but small negative effect on the probability that eligible unemployed would exit unemployment, and that the effect is mainly concentrated among the long-term unemployed. Rothstein calculates that without those extensions, the unemployment rate would have been about 0.2-0.6 percentage points lower—a much smaller impact than implied by previous analyses, and that the long-term unemployment rate would have been even lower. He finds that half or more of these impacts are due to the unemployed remaining in the labor force rather than reductions in the chances of finding employment. As a result, Rothstein suggests that a generous extension of UI benefit in deep recessions should last until the labor market is strong again, thus giving displaced workers a realistic chance of finding new employment before their benefits expire.

In The Effects of Quantitative Easing on Interest Rates, Arvind Krishnamurthy and Annette Vissing-Jorgensen of Northwestern University show that the Federal Reserve’s recent quantitative easing (QE) programs (“QE1” and “QE2”) did in fact significantly lower interest rates on Treasury securities, as well as GSE bonds and highly rated corporate bonds.  They also find that such programs affect interest rates differently depending on which assets are purchased: QE1, which involved the purchase of mortgage-backed securities (MBS) in addition to Treasury securities, significantly lowered MBS rates, whereas QE2, which focused exclusively on Treasury securities, had little effect on MBS rates.  The authors identify several channels through which QE affects interest rates: first, QE increases the premium paid for assets with low-default risk (and thus lowers rates on these assets), by reducing the supply of such assets available to investors; second, QE drives down interest rates broadly by signaling a commitment by the Federal Reserve to keep interest rates low for a long period; and third, when QE involves purchases of mortgage-related assets, it lowers rates on such assets by affecting the price of mortgage-specific risk.  Because QE does not affect all long-term interest rates equally, examining the impact of a QE policy that focuses on purchases of Treasury securities on long-term Treasury rates is likely to overstate the program’s impact on the long-term corporate and mortgage interest rates that all relevant to investment and housing demand.  Interestingly, the results about having the Fed use its communication channel alone – that is, signaling its intentions – might be having a significant impact on rates without having the Fed actually take on the risks associated with increasing its balance sheet. The authors also conclude that expected inflation increased substantially due to QE1 and modestly due to QE2, implying that reductions in real rates were larger than reductions in nominal rates. 

In Practical Monetary Policy: Examples from Sweden and the United States, Lars E.O. Svensson, the Deputy Governor of the Swedish Central Bank (Sveriges Riksbank) analyzes the actions of the U.S. Federal Reserve and the Swedish Riksbank during and after the summer of 2010, looking for evidence that perhaps central banks make mistakes. In that time period, both the Fed and Riksbank forecasts for inflation were below their target and their forecasts for unemployment were above the sustainable unemployment rate, suggesting that more expansionary policy was warranted. However, the Riksbank tightened policy while the Federal Reserve held rates steady. Although the Swedish economy developed better than expected, and the U.S. economy developed worse than anticipated, Svensson argues that these developments were the result of external factors — not, in fact, the nations’ respective monetary policies. The Riksbank benefited from higher-than-anticipated domestic and export demand, upward revisions of GDP data, and a lack of structural problems. On the other hand, the Fed had to contend with fiscal policy problems, a slower housing market recovery, and substantial downward revisions of GDP data. The author concludes that the Riksbank’s decision to tighten policy is difficult to justify, while the Federal Reserve’s decision not to tighten was appropriate, although there is also a case to be made that they should have eased more.

The Dark Side of Brazil’s Economic Rise

Over at the Wall Street Journal, John Lyons delves into some of the economic challenges facing Brazil, including the strong real I mentioned yesterday:

But while foreign investment is mostly a good thing, there are downsides. The abundance of cash has helped fund riskier bank loans and fueled a potential real-estate bubble. By some measures, the Brazilian real is now the world’s most overvalued currency, and many local factories aren’t competitive in global markets.

Daily life has become so expensive that movies, taxis and even a can of Coke cost more in São Paulo than in New York. Rio de Janeiro apartment prices have doubled since 2008, and office space in São Paulo is suddenly more expensive than Manhattan. In many cases, investment banks must pay their Brazilian bankers and analysts more than they would get doing the same job in New York.

Some executives in Brazil fret that the cost of doing business has risen so fast that their country may be unable to become the manufacturing power it has aspired to be for generations. “Ever since I was a little girl I always heard Brazil was the country of the future. Now that the future is here, I am starting to fear it will be brief,” said Cynthia Benedetto, the chief financial officer of Brazil’s flagship manufacturing firm, Embraer SA, the world’s No. 3 jet maker. Embraer, a major exporter, says it is investing in equipment to lower its labor costs at home and opening more plants abroad.

If you are interested in Brazil’s economy, please read the whole thing.


Visiting Brazil? Skip the Amazon and Head to the Pantanal

Posting has been light in recent weeks thanks to a two-week sojourn in Brazil and a week recovering therefrom.

I mostly turned off my inner economist to get in touch with my inner Darwin. So I have only a handful of economic observations:

  • After arriving in Rio, the car that picked us up was made in China, fueled by ethanol, and just as nice as a Subaru.
  • The weakness of the dollar vs. the real was noticeable.
  • Economic growth often poses environmental challenges. That’s certainly true in Brazil. But we also encountered repeated stories of how economic growth and conservation can be complements. Jaguars, for example, can be worth more alive than dead thanks to ecotourism. And the ease of getting jobs in the formal sector has reduced hunting pressure in some areas, sparking a virtuous cycle: more deer and more jaguars.

Like many first-timers, we visited Rio, Sao Paulo (briefly), and Iguacu Falls. But the highlight was three full days in the Pantanal.

To which you might ask, “the Panta-what?”

The Pantanal. It’s one of the world’s largest wetlands, home to jaguars, giant anteaters, innumerable birds, and the world’s densest concentration of crocodilians (the Yacare Caimans pictured above).

If you are into wildlife, the Pantanal is way more fun than the Amazon. Why? Because it’s easy to see critters when savannah mixes with small forests. In the Amazon, in contrast, many of the best birds and mammals are up in the tree canopy, 100+ feet above your head. In three days in the southern Pantanal, we saw 22 species of mammals and close to 150 species of birds (including Toco Toucans), many more than on a comparable trip to the Amazon.

For those into such things, my wife and I have a travel blog here and posted photos here. No jaguar photos, though. We heard them call at night and saw their tracks. But we didn’t see any (we did see an Ocelot). Clearly we will have to go back.

Regulatory Uncertainty and Our Weak Economy

Over at the Economist’s Free Exchange blog, Grep Ip offers an excellent, balanced analysis of regulatory uncertainty and our weak economy. Here’s a short excerpt:

How much of our economic malaise can be blamed on regulatory uncertainty? Conservatives argue that a wave of Obama administration regulations and the threat of more to come are the primary hindrance to business confidence and hiring. Liberals say that the weak economy is far more important and that any regulations being enacted more than pay for themselves in economic terms.

I’ve been struggling with this question for months and have found the debate frustrating: the terminology is wrong and the subject poorly framed, the evidence fragmentary and unhelpful, and generalisations are rampant. So what follows are a few thoughts that I think clarify the debate, though without necessarily resolving it.

First, it is not “uncertainty” per se that bothers business. Whether uncertainty is unwelcome depends entirely on what’s at stake. What would you prefer: 100% probability of dying next year, or 50%? Most of us would choose the latter. Similarly, business would prefer zero probability of a burdensome new rule, but if that’s not possible, would certainly take 50% probability over 100%. The administration’s decision to delay implementation of a new ozone standard perpetuates uncertainty. Business welcomed it nonetheless because now they do not have to spend money to meet it for at least two years, and perhaps forever if in the interim a new president chooses never to implement it. Does the Federal Reserve create some uncertainty when it undertakes quantitative easing? Probably, but in the process it makes the stability of inflation around 2% much more certain, and that, most businesses would say, is a reasonable trade-off.

Second, “regulation” doesn’t capture the breadth of government activity that affects business confidence, investment and hiring. The threat that America might default must surely have been one of the most toxic sources of uncertainty America’s political classes have yet inflicted on the economy, something you’ll see mentioned in the Federal Reserve’s latest beige book. This speaks to a more deep-rooted alienation between business and Washington.

Read the whole thing, it’s the best treatment I’ve seen.