Tag: Macroeconomics

Will Rising Government Debt Hurt Growth?

Every January America’s economists gather for their annual conference. There are far more papers than one could ever read (or want to read), so you need a strategy to choose the most important.

In recent years, your optimal strategy should have included the papers by Carmen Reinhart and Ken Rogoff (see, e.g., this prescient paper from 2008). And so it is again in 2010.

This year’s installment is a paper that examines how government debt levels relate to economic growth and inflation. Their key finding? High levels of government debt have a substantial economic cost. In developed economies, that cost is weak economic growth. In emerging economies, that cost is weak economic growth and high inflation.

The growth findings are nicely illustrated in the following table from their paper:

Developed economies that have high levels of government debt (90% of GDP or more) have much lower rates of economic growth; for example, their median rate of growth has been a mere 1.6%, much less than the 3 to 4% growth of countries with lower debt levels. The same pattern holds for emerging economies, as well. (The third panel shows that high levels of public and private external debt also reduce growth, but the sample there includes only emerging economies.)

As R&R note, these results are particularly important today given the rapid growth in government debts around the world. In the United States, for example, debt will probably end the year around 60% of GDP, with no sign of stopping. The good news is that we are still relatively far from the 90% level that R&R identify as problematic. The bad news is that current policies will get us close to that level in less than a decade. For example, the Peterson-Pew Commission on Budget Reform recently projected that current policies would lift the debt-to-GDP ratio to 85% by 2018.

That’s too close for comfort.

Q3 Growth Revised Down Again, Now 2.2%

Q3 keeps looking weaker. The original estimate of Q3 GDP growth came in at a healthy 3.5% annual pace. The second estimate was a respectable 2.8%. And this morning, the Bureau of Economic Analysis released its third estimate: an underwhelming 2.2%.

Growth of 2.2% is, of course, much better than the sharp declines in the previous four quarters. But it is still a disappointment.

As usual, I think a useful way to summarize the drivers of Q3 growth is to look at the contributions:

If you compare these figures to those in the BEA’s second estimate, you will see that the latest revision was spread across several categories. Consumers, housing, equipment and software, structures, and inventories were all revised slightly downward.

In principle, the solid growth in consumer spending and housing investment in Q3 should be promising signs, given their previous weakness. However, both were boosted by temporary stimulus efforts. Cash-for-clunkers lifted consumer auto sales in Q3, for example, but we should expect some payback in Q4. Meanwhile, the tax credit for new home buyers helped housing investment record its first increase since late 2005, but some of that may have come at the expense of future housing investment (because potential home owners accelerated purchases when they thought the credit was going to expire; it’s since been extended and broadened).

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 2.9% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.0 percentage points (70% x 2.8%, allowing for some rounding) to third quarter growth.

An Encouraging Jobs Report

This morning’s jobs report was encouraging not only in its headline figures, but also in its details:

  • Payrolls fell by 11,000 in November, the smallest decline since the recession began.
  • The unemployment rate declined to 10.0%, down from 10.2% in October.
  • Jobs losses in September and October were smaller than previously reported (by a combined 159,000).
  • Average weekly hours increased from 33.0 to 33.2.
  • Temporary help services, often viewed as leading indicator, added more than 52,000 jobs.
  • The underemployment rate (U-6) dropped from 17.5% to 17.2%.

In short, almost all the key measures moved in the right direction in November (the one disappointing figure was average hourly earnings, which increased only a penny in November).

It’s possible that some of these figures were helped by seasonal factors (last November was so bad that the seasonal adjustment process might give a little extra boost to this November’s figures). But the breadth of better news–including the revisions and the hours–gives me some confidence that these data do reflect real improvements in the labor market.

Still, we shouldn’t get too excited. We need the economy to add jobs–preferably 100s of thousands–each month if we are ever going to get unemployment down, so losing 11,000 is still bad news in an absolute sense. But today’s report is a step in the right direction.

Myths of Holiday Shopping

The holiday shopping season is now underway. According to the Wall Street Journal, consumers spent about $10.66 billion on Black Friday, a smidgen higher than last year.

And what does that portend for the holiday season and the economy overall? Short answer: No one knows.

As Karen Dynan notes in today’s Washington Post, the link between Black Friday sales and holiday sales isn’t as tight as many people think. And the link between holiday sales and the overall economy is even weaker. Those are two of the “5 Myths about Holiday Spending Sprees” that Karen identifies.

Her bottom line? “Much of the conventional wisdom linking holiday spending and the health of our economy turns out to have been exaggerated.”

Q3 Growth Revised Down to 2.8%

As expected, the Bureau of Economic Analysis revised down its estimate of Q3 GDP growth. BEA’s second estimate pegs growth at a 2.8% annual pace in Q3, down from 3.5% in the advance estimate.

The revision was driven by three main factors: consumer spending and business investment in structures were weaker than previously estimated, while imports were stronger.

As usual, I think a useful way to summarize the drivers of Q3 growth is to look at the contributions:

In principle, the solid growth in consumer spending and housing investment should be promising signs, given their previous weakness. However, both were boosted by temporary stimulus efforts. Cash-for-clunkers lifted consumer auto sales in Q3, for example, but we should expect some payback in Q4. Meanwhile, the tax credit for new home buyers helped housing investment record its first increase since late 2005, but some of that may have come at the expense of future housing investment (because potential home owners accelerated purchases when they thought the credit was going to expire; it’s since been extended and broadened).

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 2.9% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.1 percentage points (70% x 2.9%, allowing for some rounding) to third quarter growth.

Deja Vu All Over Again?

Earlier this week, the Treasury released its quarterly update about its borrowing requirements and its strategy for meeting them. I haven’t had time to review all the documents, but I did skim through the minutes of the meeting of the Treasury Borrowing Advisory Committee (TBAC), which was held on November 3.

This pair of paragraphs particularly caught my attention (my emphasis added):

The Committee then turned to a presentation by one of its members on the likely form of the Federal Reserve’s exit strategy and the implications for the Treasury’s borrowing program resulting from that strategy.

The presenting member began by noting the importance of the exit strategy for financial markets and fiscal authorities. It was noted that the near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies, and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield. Treasury securities have benefitted from the resultant increase in demand, but riskier assets have benefitted even more. According to the member, the greater decline in the indices for investment grade and high-yield corporate debt relative to 10-year Treasuries and current coupon mortgages display this reach for yield. A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero.

Yes, our old friend the reach for yield. Back in pre-crisis days, the reach for yield would often be viewed as evidence that the monetary transmission mechanism was working well, with low short-term rates providing a real boost to the economy. Now, however, we are all-too-familiar with the downside of the reach for yield: unsustainable booms in longer-term assets.

Is this deja vu all over again? I don’t know. But those paragraphs certainly didn’t make me feel more comfortable about our recovery.

P.S. I should also note that the TBAC endorsed greater reliance on Treasury Inflation Protected Securities (TIPS), as well as moving from 20-year TIPS to 30-year TIPS. These recommendations paralleled some similar ones released back in September by the GAO.

Booms, Busts, and the Leverage Cycle

Over the Wall Street Journal, Mark Whitehouse has a nice piece on John Geanakoplos, a finance guru in the worlds of both academia and Wall Street. Over the past ten years, he’s been exploring how leverage and the value of collateral can drive booms and busts in financial markets.

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His research was sparked by the challenges his investment fund faced after the demise of Long-Term Capital Management in 1998:

A lender to the fund where Mr. Geanakoplos was a partner abruptly demanded more margin on a loan. The event, which nearly toppled the fund as the partners scrambled to raise cash by selling securities, drove home to Mr. Geanakoplos how margins could work two ways — stimulating asset buying as they go lower, but forcing fire sales as they rise.

In a 2000 academic paper, Mr. Geanakoplos offered a theory. He said that when banks set margins very low, lending more against a given amount of collateral, they have a powerful effect on a specific group of investors. These are buyers, whether hedge funds or aspiring homeowners, who for various reasons place a higher value on a given type of collateral. He called them “natural buyers.”

Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets. But if a jolt of bad news makes lenders uncertain about the immediate future, they raise margins, forcing the leveraged optimists to sell. That triggers a downward spiral as falling prices and rising margins reinforce one another. Banks can stifle the economy as they become wary of lending under any circumstances.

“It was evident to me that there was a cycle going on, not just in my little market, but all over the world,” says Mr. Geanakoplos, who is still a partner at Ellington Capital. The “leverage cycle,” he called it.

Well worth a read.

GDP Growth Returns in Q3

As expected, the economy grew at a healthy pace in the third quarter, expanding at a 3.5% annual pace according to this morning’s data from the Bureau of Economic Analysis.

Among the highlights:

  • Consumer spending grew at a 3.4% pace, the fastest since the first quarter of 2007. A substantial fraction of that growth reflects vehicle purchases, which were temporarily boosted by the cash-for-clunkers program.
  • Residential investment grew for the first time since late 2005, driven in part by the tax credit for new homebuyers.
  • Imports rose for the first time in two years. Most of that increase came from goods, which is consistent with the idea that auto imports increased in response to cash-for-clunkers.

You may notice a trend here, as government policies had a significant effect on the pattern of growth in the third quarter.

As I’ve mentioned before, I think one of the best ways to understand the pattern of growth is to look at the contributions that each major sector made to the overall growth rate:

Q3 Growth Contributions (2009 Advance)

As you can see, consumers, inventories, and exports were the main drivers of Q3 growth, while imports were the main drag.

Q3 represents a striking change from Q2 (shown in the next chart), when the economy contracted at a 0.7% pace and private spending was weak across the board:

Broad Weakness in Q2 GDP (Third)

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending rose at a 3.4% pace in the third quarter. Putting those figures together, we say that consumer spending contributed about 2.4 percentage points (70% x 3.4%, allowing for some rounding) to third quarter growth.

Manufacturing on the Upswing

Earlier today, the Federal Reserve released its latest data on industrial production. Bottom line: production over the past three months has been surprisingly strong. Growth in September was more than expected, and the previous month was revised upward.

Industrial production has now increased for three straight months, as has a slightly narrower measure, manufacturing production:

Manufacturing IP - September

As you can see, manufacturing production turned consistently negative in January of 2008 and then fell off a cliff toward the end of the year. After declining in 17 of 18 months (driving manufacturing production down a total of 17%), manufacturing production has now risen for three straight months (for a cumulative rebound of about 3%).

Manufacturing still has a long way to go. But the recent strength in industrial production, generally, and manufacturing, specifically, adds weight to the view that the recession may have ended early this summer. (Recall that the last recession ended in November 2001, even though job losses continued long afterward.)