Reposting from my Forbes blog: the debate on Debt and GDP

My two cents:

Within the past day or so, economics conversations have been all about Rogoff and Reinhart and their critics, Herndon, Ash and Pollin.  The Rogoff and Reinhart (RR) paper purported to show that countries with more debt grow more slowly than countries with less; Herndon, Ash and Pollen (HAP) show that Rogoff and Reinhart’s data contains mistakes, and there is not much dispute about whether Herndon, Ash and Pollin’s corrections are right–they are.

HAP also do a pretty good job of showing that connections between debt to gdp ratio are not robust–they are sensitive to time period and country.  But they do not ask the question about direction of causality between debt and growth (page 3):

For the purposes of this discussion, we follow RR in assuming that causation runs from public debt to GDP growth. RR concludes, “At the very minimum, this would suggest that traditional debt management issues should be at the forefront of public policy concerns” (RR 2010a p. 578). In other work (see, for example, Reinhart and Rogo (2011)), Reinhart and Rogo acknowledge the potential for reverse causality, i.e., that weak economic growth may increase debt by reducing tax revenue and increasing public expenditures. RR 2010a and 2010b, however, make clear that the implied direction of causation runs from public debt to GDP growth.

But the question of direction matters a lot.  Consider a country whose GDP weakens–both tax revenues fall and social spending (on things like unemployment insurance) rises.  This means that in the absence of a policy change, weak GDP leads to higher debt.

There is a simple way to take a first cut at the question of direction of causation–by using a technique known as Granger Causality.  The set up is to try to explain something (such as GDP growth) by looking at its own lagged values and the lagged values of another variable (such as debt-to-GDP ratio).  I took the  data set in Herndon, Ash and Pollen and ran Granger tests using one lag explaining real GDP growth and debt-to-GDP ratios; I ran separate regressions for each country in the data set. I tested for significance at the 90 percent level of confidence.  I am happy to share my results with anyone who is interested (richarkg@usc.edu).

In the tests where I was exploring whether debt-to-GDP “caused” GDP growth, I found that debt’s impact was negative in five countries (Austria, Germany,Italy, Japan and Portugal); positive in four countries (Australia, Canada, New Zealand and Norway), and zero in 11 countries (Belgium, Denmark, Finland, France, Greece, Ireland, the Netherlands, Spain, Sweden, the UK and the US; although France was close to being statistically negative).

RR emphasize that there is a critical point at which debt becomes toxic, and that is at a debt-to-GDP ratio of more than 90 percent.  Doing Granger tests using this variable (on “on-off switch” for a country being at greater than 90 percent), we find that the impact of greater than 90 percent debt on GDP growth is positive in two cases (Australia and New Zealand), and is not statistically different from zero in eight cases (Belgium, Canada, Greece, Ireland, Japan, the UK and the US).  Ten countries have not had debt-to-GDP ratios above 90 percent.

When we look in the other direction, however, the impact of GDP growth on debt is negative 12 times (Australia, Austria, Belgium, Denmark, Finland, Germany, Greece, Ireland, Italy, Japan, Netherlands, and Sweden) and is not statistically different from zero in the eight other countries (Canada, France, New Zealand, Norway, Portugal, Spain, the UK and the US).  Reverse causality IS a big issue here, and until it is really sorted out, we can’t say what the true, structural relationship between GDP and debt really is.

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I am at http://www.forbes.com/sites/richardgreen/2013/03/13/california-has-a-shortage-of-rental-housing/.

Why not worry about the deficit right now?

Because if I did my math right, Federal Government interest payments are at a long-term low relative to GDP. [Update, after looking more closely, I see that the source of the data--the US Treasury--includes state and local interest payments as well]. Consider the chart below:

Federal Government Interest Expense on Debt Outstanding Relative to GDP

The numerator is annual Federal Government interest payments, which come from here.  I am pretty sure these numbers are in nominal dollars.  The denominator comes from the BEA, and is in nominal dollars. Years are fiscal years.

Note that interest rates would have to double for us to be in the situation we were in the late 1980s, the end of the (ahem) Reagan Administration.  Do we ultimately need a steady state in which debt to GDP doesn't rise?  Absolutely.  Just not tomorrow.

The American People agree with George Orwell

This video presents what the American people consider to be the ideal wealth distribution.  At 2:47, the narrator notes that under this ideal distribution, "the wealthiest folks are about 10 to 20 times better off than the poorest Americans."

George Orwell in Why I Write:

2. Incomes. Limitation of incomes implies the fixing of a minimum wage, which implies a managed internal currency based simply on the amount of consumption goods available. And this again implies a stricter rationing scheme than is now in operation. It is no use at this stage of the world's history to suggest that all human beings should have exactly equal incomes. It has been shown over and over again that without some kind of money reward there is no incentive to undertake certain jobs. On the other hand the money reward need not be very large. In practice it is impossible that earnings should be limited quite as rigidly as I have suggested. There will always be anomalies and evasions. But there is no reason why ten to one should not be the maximum normal variation. And within those limits some sense of equality is possible. A man with Ј3 a week and a man with £1,500 a year can feel themselves fellow creatures, which the Duke of Westminster and the sleepers on the Embankment benches cannot.

Good for Greg Mankiw...

..for supporting marriage equality.

Why is the luxury housing market recovering so well?

The fashionable thing to say is because of foreign money.  I suspect the actual reason is that the one percent have gotten 122 percent of the recovery (h/t/ Tim Noah).

The demand curve for housing among the rich has shifted out.

The future of efficient transportation

Might look like this:

I heard a lecture from Alain Bertaud on how networked, scheduled transportation is not a good solution for many people--even in poor parts of the world.  And I can testify that auto rickshaws are often the best way to get around cities in India--they are quick, cheap, and when fueled by natural gas, environmentally not too bad (those with two stroke engines are a whole other matter).

One of the most provocative things I learned from Alain is that buses are often less fuel efficient than cars--for a bus system to work, they have to run at periods where demand is fairly low.     As it happens, while sitting at dinner in downtown Los Angeles last night, we watched bus after bus on 6th Street go by nearly empty.

Where's the monopsony?

President Obama, Paul Krugman and Robert Reich have all been pushing for an increase in the minimum wage.  I want to agree with them, and Krugman is certainly correct that the preponderance of empirical evidence shows that the minimum wage's impact on total employment is negligible.

But the question is, why?  Krugman's statement that human beings are not Manhattan apartments is true, and allows him to support the minimum wage while being appropriately skeptical of rent control, but it doesn't give a satisfactory answer as to why putting a floor on the price of labor would not create excess supply of labor.

There is in economic theory a set of circumstances, however, under which an increase in the minimum wage might raise employment.  If an employer has a market largely to itself--if it has monopsony power--then it will both pay its workers less than their productivity warrants and not hire enough workers to be at the most efficient level of employment.  Raising the minimum wage would then both increase pay and induce more workers into the labor market, hence increasing employment.  If government could nail the minimum wage to the marginal revenue product of the least productive  workers, the minimum wage could produce a first-best outcome--one where pay and employment levels were efficient.

For the argument to work, the demand for labor needn't be perfectly monopsonistic, but rather less than perfectly competitive.  The fact that wages and labor productivity seem to have less and less to do with each other is evidence that the demand for labor is not competitive, but it would be nice to have further, detailed evidence of the industrial organization of labor demand.  

Should college be subsidized?

Mark Thoma has a very nice piece today about how Cal State-Chico changed his life.  One of the reasons it changed his life is that he could afford it--it cost $100 per semester when he went there.  The story is heartwarming, to say the least.

I have always struggled with how much college should be subsidized.  People who go to college almost certainly create positive externalities, and so Pigou would say there should be some subsidy.  But people who go to college also earn substantially more over their lifetimes than those who don't.  Low income people who pay state sales taxes thus subsidize high income people.  Hence the idea that people graduate with debt seems reasonable to me, because the value they get from college far exceeds what they need to invest in college, and it means they are reducing the tax burden of those who don't go to college [I should note that I was among the lucky people whose parents paid for college, so perhaps I am in no position to comment].  On the other hand, if high prices keep 18 year olds from going to college, one of the most important routes to social mobility is blocked.

In any event, a government economist friend of mine has the obvious solution to the problem of the regressive nature of subsidizing college: progressive taxes.  

Will smart phones be the end of built in automobile NAV systems?

Four years ago, my wife bought me car for my birthday.  She reasoned that as a newly minted Angeleno, I would be spending more time in my car than ever before (she was right), and so that I might tire of my slightly beat-up Corolla.

She got me a Honda Accord with all the trimmings, including a NAV device, which I enjoyed very much.  And four years later, I continue to love the car.  But I recently downloaded WAZE to my phone.  WAZE provides crowd-sourced information on traffic, and allows one to find the fastest route from place to place with remarkable dependability.  It provides turn by turn directions, but will change the directions on the fly when traffic conditions change, a regular feature of life in LA.

WAZE is, by the way, a free app.  It also takes us one small step closer to self-driving cars.  By guess is the built-in NAV system, as it currently exists, is a dinosaur.

Bankers and tail events

I participated in a panel last note hosted by the German American Business Association.  Overall, I had a nice time.

But before the panel, a managing director from a very large bank gave a speech, and he was trying to make some sort of point about tail risk.  The example he used is going to jail in Monopoly, an event for which the average probability is four percent.

Maybe I am being picky here, but two points.  One: four percent is not that far out on the tail.  I suppose it would be good if banks tried to avoid things that happen four percent of the time or less.  Two, and more important: random events in Monopoly come from a finite state space, so risk can be completely characterized.  We know with a great deal of certainly the probabilities of particular events happening in Monopoly.

Banks have to deal with uncertainty--random shocks that are not easily characterized by well defined distributions of outcomes.  The Monopoly metaphor is thus a bad one.

Does Modigliani-Miller apply to countries?

If it does, the capital structure of the US is just fine.  Current GDP is 15.8 trillion.  Let's apply a  real discount rate of 4 percent (which is probably high, given that the yield on 10-years TIP is negative), and assume a real long-term growth of 2 percent (which is likely low).  This means the country is worth about $316 trillion (this figure includes human capital as well as asset values).

Total debt outstanding in the US, public and private, is $55 trillion.  So we are about 17 percent debt funded, which means we are about 83 percent equity funded.  This should be OK.  What I am missing here?

(note: it was Matthew Yglesias' Slate piece today that got me thinking along these lines).

  

Steve Oliner shows that it takes too damn long to build things in California

The set-up:

Recent research, which I conducted with Jonathan Millar of the Federal Reserve Board and Daniel Sichel of Wellesley College..... presents the first comprehensive estimates of planning times for commercial construction projects across the United States. We analyze roughly 82,000 projects nationwide for which planning was initiated  between 1999 and 2010, using data obtained from CBRE Econometric Advisors/Dodge Pipeline. The projects in the dataset include office buildings, retail stores, warehouses, and hotels. About 95 percent of these projects involve the construction of a new building; the remainder are additions or alterations to an existing building or conversions to a new use.

They find that average planning time in the US for a commercial building is 17 months.   But the longest planning times are in California and the Northeast.  Planning times in some California MSAs are about a year longer than the national average.  This makes California's economy less nimble than others.

This is not about whether or not there should be strong rules to protect the environment--California needs such rules.  This is about making rules straightforward and predictable, and allowing economic agents to behave quickly within the rules.  My hypothesis is that it is California's clumsy implementation of planning, more than anything else, that puts it at a needless disadvantage relative to Texas.

It's the G.

After I saw the weak 4th quarter GDP number reported this morning, I went to the National Income and Products Accounts website, where I found that in the 4th quarter, government expenditures and investment has declined by 6.6 percent on a seasonally adjusted annualized rate and that defense spending had dropped 22.2 percent, again, on a SAAR.

Can this possibly be correct?  I am wondering if there is some anomaly in the data.

An update of my tinker-toy model of housing starts and GDP

We had pretty robust growth in housing starts in December:

A few months ago, I suggested that we could have second quarter GDP growth of 2.9 percent.  I am now revising that to greater than 3 percent growth (the point estimate is 3.2 percent).  We'll see how things turn out....

I didn't think Phil Mickelson's Tax Rate Could be > 60 percent

From the Tax Foundation:

Mickelson lives outside of San Diego so he is subject to one of the highest tax rates in the country, but it doesn’t appear to be quite that high.  Gerald Prante and Austin John total up all the top tax rates on wage income in the 50 states and they do find California has the highest at 51.9 percent:

"For example, the 51.9% top METR [marginal effective tax rate] for wage income in California for 2013 under the Fiscal Cliff scenario is equal to the 39.6% federal income tax rate plus the new 13.3% top state income tax rate in California minus the deductibility of state taxes against one’s federal taxes (5.27%) plus the marginal tax rate effect of Pease returning (1.18%) plus the current 1.45% Medicare employee tax plus the new 0.9% tax on Medicare plus the current 1.45% Medicare employer tax which we assume is borne by workers in the form of reduced after-tax wages. The sum of these tax rates, which equals 52.6%, is then divided by 1.0145 (1 + Medicare employer tax) because by assuming that the incidence of the Medicare employer tax is borne by workers, we must add back the employer contribution to the worker’s income. The final METR figure is thereby 51.9%."

It’s not clear how Mickelson is getting to 62 percent, since there is no other income tax at the local level in or around San Diego. 

Do higher marginal tax rates lead superstar athletes to play less often?

Let's think, for a moment, about why people want more money:

(1) To buy stuff.

(2) To keep score.

(3) To accumulate power.

Perhaps there are others, but these seem to me to be the big three.

OK, so there seem to be two kinds of athletes in the world (with respect to consumption):

(I) Those with entourages.
(II) Those without entourages.

It takes an entourage for superstar athletes to spend all the money they make--it would otherwise be hard to spend an eight figure money quickly enough (people can even afford private jets at those incomes).

So let's think about those with entourages.  If their taxes go up, they will actually have to work harder to keep their entourages.  That should mean they play more, not less.

For those without entourages, the marginal utility of consumption must be zero--this is the implication of not being able to spend all your money.  So their incentives must arise from reasons (2) and (3).

Scorekeeping is independent of taxes.  If an athlete wants to say he/she has the most winnings, they will have an incentive to play more games.

That leaves power.  Higher marginal taxes reduce the ability of high income people to accumulate power, which may mean they work/play less.  I don't know that this is entirely a bad thing. 

Morris Davis gives a talk where he shows that fewer American homeowners think they are underwater than actually are

Morris--along with Erwan Quintin--calculates median house prices by MSA using the American Community Survey from 2006-2010.  Because the ACS samples all houses, the change in price from year to year is largely not biased by the change in composition of the housing stock (the only change comes via new construction and home improvements--and the US had little of either from 2008-2010).  As such, the calculation, which is based on what people think their house is worth, is in some ways superior to house price indexes, which inevitably suffer from composition bias, even when their designers make admirable efforts to mitigate such bias.

In his talk, Morris showed that people thought the value of their houses went down substantially less than Case-Shiller implies.  Where Case-Shiller or people are right is not particularly important to mortgage performance, because people will not default if they think their house is worth more than their house.  Those who are forced to move for economic reasons might find themselves unpleasantly surprised, and may wind up selling (now) through a short-sale.  But it is possible that the reason many underwater borrowers are not walking away is that they think they are not under water.

City of New Orleans

In one of those lovely, serendipitous moments in life, I was flying over the Gulf of Mexico near New Orleans while reading Tom Fitzmorris's Hungrytown.  The city, alit at night, on the south bank of a black Lake Pontchartrain, looked beautiful, and the Fitzmorris book made me hungry as it relayed the history of the city's unique cuisine.

In the wake of Katrina, Ed Glaeser was pointed in his evaluation of New Orleans as an economic entity.

The 2000 Census reported that more than 27 percent of New Orleans residents
were in poverty (relative to 12 percent for the U.S. as a whole). Median family
income was only 64 percent of the median family income in the U.S.

In 2004, according to the American Community Survey, the unemployment rate
for the city was over 11 percent. And New Orleans’ housing prices, prehurricane,
remained far below those of the nation as a whole, providing further
evidence of weak pre-existing demand for living in the city.

By most objective measures, the city, pre-hurricane, was not doing a good job of
taking care of its poorer residents. For most students of urban distress, New
Orleans was a problem, not an ideal. Poverty and continuing economic decline
fed upon each other, delivering despair to many of the city’s residents.

In light of all this, Ed argued that providing cash to residents of New Orleans might be superior economic policy to rebuilding New Orleans.

Were he talking about any other city, I think Ed would almost certainly be right.  But somehow, it seems to me, if we were to have lost New Orleans, we as a country would have lost something beyond an economic agglomeration.  Its continuing contributions to American culture--through food and music both--have provided a positive externality to the remainder of the country that it has not been able to internalize through revenue, and the country owes it something for that.  Perhaps the cost of losing these contributions would have been less than the cost of rebuilding, but I am skeptical.

There are days when I wish Wordperfect 5.1 was still around

That is all.