December 31, 2011
I Just Got Here, but I Know Trouble When I See It
By N. GREGORY MANKIW, CHRISTINA D. ROMER; TYLER COWEN; ROBERT H. FRANK; ROBERT J. SHILLER and RICHARD H. THALER
BELIEVE it or not, times are getting better.
At least that’s what the dry statistics keep telling us. Industrial production, G.D.P. — the kind of figures that Washington and Wall Street sweat over — suggest that the economy is on the mend.
Yet if we go beyond the Beltway and the Battery, to where most of American life is lived, the numbers don’t always add up. Yes, the Great Recession officially ended in 2009. But many millions of Americans are out of work or cannot find full-time jobs. Home prices are wobbly. The foreclosure crisis drags on. And the Occupy movement’s campaign against “the 1 percent” has underscored the ravages of income inequality.
It was, as always, a year of ups and downs in business. Washington said the nation’s AAA rating was safe, but Standard & Poor’s concluded that it wasn’t. Europe insisted that its currency was sound, but investors worry that it isn’t. Wall Street seemed perpetually on edge. After so many wild days, the American stock market ended 2011 about where it began.
On this side of the Atlantic, aftershocks of the financial crisis of 2008-9 are still reverberating, though the worst has passed. Now, how Europe’s economic troubles play out may determine whether job growth here finally picks up enough to make up for all the lost ground — and whether that 401(k) is richer or poorer next Jan. 1.
Where to go from here? And how to face the challenges ahead? Sunday Business asked the six economists who write the Economic View column to do a little blue-sky thinking on issues as varied as the Fed, Europe and housing. You won’t find stock tips. But if 2011 was any guide, the best advice for 2012 may be this: Hold tight.
Dear Mr. Bernanke:
Please Tell Us More
N. GREGORY MANKIW A professor of economics at Harvard, he is advising Mitt Romney in the campaign for the Republican presidential nomination.
WHAT can we do to get this economy going?
That’s the question Ben Bernanke and his colleagues at the Federal Reserve must be asking.
Officially, the recession ended a while ago. But with unemployment lingering above 8 percent, it still feels as if we’re mired in a slump.
The Fed’s typical response to lackluster growth is to reduce short-term interest rates. To its credit, it did that — quickly and drastically — as the recession unfolded in 2007 and 2008. Then it took various unconventional steps to push down long-term rates, including those on mortgages. Mr. Bernanke deserves more credit than anyone for preventing the financial crisis from turning into a second Great Depression.
Now, the key will be managing expectations. Financial markets always look ahead, albeit imperfectly. They not only care what the Fed does today but also about what it will do tomorrow. With official short-term rates already near zero, what the Fed does this year will be less important than what policy makers say they will do next year — or the year after that.
A crucial question is how quickly the Fed will raise interest rates as the economy recovers. So far, Fed policy makers have said they expect to keep rates “exceptionally low” at least until mid-2013. There has even been talk about extending that time frame by a year, to mid-2014.
But Charles I. Plosser, the president of the Federal Reserve Bank of Philadelphia, was right when he said recently that “policy needs to be contingent on the economy, not the calendar.” The key to managing expectations will be spelling out this contingency plan in more detail. That is, what does the Fed need to see before it starts raising rates again?
Unfortunately, economists don’t offer simple and unequivocal advice. Some suggest watching the overall inflation rate. Others say to watch inflation, but to exclude volatile food and energy prices. And still others advise targeting nominal gross domestic product, which weights inflation and economic growth equally.
Forging a consensus among members of Federal Open Market Committee, which sets monetary policy, won’t be easy. In fact, it may well be impossible. But the more clarity the Fed offers about its contingency plans, the better off we’ll all be in the years ahead.
Two Big Problems,
Two Ready Solutions
CHRISTINA D. ROMER An economics professor at the University of California, Berkeley, she was chairwoman of President Obama’s Council of Economic Advisers.
THE United States faces two daunting economic problems: an unsustainable long-run budget deficit and persistent high unemployment. Both demand aggressive action in the form of fiscal policy.
Waiting until after the November elections, as seems likely, would be irresponsible. It is also unnecessary, since there are plans to address both problems that should command bipartisan support.
On the deficit, the big worry isn’t the current shortfall, which is projected to decline sharply as the economy recovers. Rather, it’s the long-run outlook. Over the next 20 to 30 years, rising health care costs and the retirement of the baby boomers are projected to cause deficits that make the current one look puny. At the rate we’re going, the United States would almost surely default on its debt one day. And like the costs of maintaining a home, the costs of dealing with our budget problems will only grow if we wait.
We already have a blueprint for a bipartisan solution. The Bowles-Simpson Commission hashed out a sensible plan of spending cuts, entitlement program reforms and revenue increases that would shave $4 trillion off the deficit over the next decade. It shares the pain of needed deficit reduction, while protecting the most vulnerable and maintaining investments in our future productivity. Congress should take up the commission’s recommendation the first day it returns in January.
But we can’t focus on the deficit alone. Persistent unemployment is destroying the lives and wasting the talents of more than 13 million Americans. Worse, the longer that people remain out of work, the more likely they are to suffer a permanent loss of skills and withdraw from the labor force.
Despite heated rhetoric to the contrary, the evidence that fiscal stimulus raises employment and lowers joblessness is stronger than ever. And pairing additional strong stimulus with a plan to reduce the deficit would likely pack a particularly powerful punch for confidence and spending.
The payroll tax cut for workers and employers and the extended unemployment insurance that President Obama proposed last September would help put people back to work.
But even better would be measures that increase employment today, while also leaving us with something of lasting value. Because many people worry about increasing the role of the federal government, why not give substantial federal funds to state and local governments for public investment? Tell them that the money has to be used for either physical infrastructure like roads, bridges and airports, or for human infrastructure like education, job training and scientific research. Then let the states, cities and towns figure out what would work best for their citizens. Ronald Reagan once said that “there are simple answers — there just are not easy ones.” What needs to happen on fiscal policy is relatively straightforward. The hard part is getting politicians to do it.
Thickening Clouds
Over Europe
TYLER COWEN A professor of economics at George Mason University.
HOW, and when, will Europe get out of its mess?
The short answer is this: not anytime soon, and not without more pain. The longer that Europe’s troubles last, the worse and more insidious they become. Insolvent governments, troubled banks, divisive politics, painful austerity — the list of problems is formidable already.
The best-case outlook is that the euro zone will, in effect, grow its way out of this crisis. The European Central Bank is now extending unlimited loans to banks in the 17 nations of the European Union that use the euro, provided that those banks put up collateral. The loans don’t have to be paid back for three years, by which time it is hoped that steady growth will have returned.
In theory, these loans should ensure that Europe’s banks stay liquid. Some of these banks, in turn, are already lending money to their national governments, and others may be forced to. In the short run, this will help keep euro zone governments funded, too.
If the economy starts growing again before the loans are due, the central bank’s efforts to fix the Continent’s solvency problems will have succeeded. The plan will have relieved pressure in the money markets and on the banks, since they would be backed by wealthier, more credible governments. We would probably have to write off Greece, but, under this circumstance, other euro zone countries would avoid a major financial crisis.
There are, however, several darker possibilities. One is that the economies of some major euro zone nations will continue to stagnate. In per-capita terms, Italy is already poorer than it was 12 years ago, so maybe it’s stuck in a slow-growth mode. If that’s the case, more borrowing from the European Central Bank is simply stretching an unsustainable situation.
Eventually, the central bank would have to let it be known that it is not expecting its money back. In this case, banks in weak nations would probably be unable to raise funds from the private sector. Confidence would evaporate. Some countries would end up abandoning the euro and printing their own currency to keep their promises to bank depositors and bondholders. The consequences could be disastrous, not only for Europe, but for the global economy.
A second danger would arise in Europe if an election, probably in a smaller country, gave rise to a government that repudiated the euro. Then, too, all bets would be off.
My guess — and guess is the right word — is that odds of this ending well are about one in three. Otherwise, fasten your seat belts.
Why 2 Paychecks
Are Barely Enough
ROBERT H. FRANK An economics professor at the Johnson Graduate School of Management at Cornell University.
WHY do many middle-class families now struggle to get by on two paychecks, whereas most got by on just one back in the 1950s and ’60s?
The answer, according to “The Two-Income Trap,” by Elizabeth Warren and Amelia Warren Tyagi, is that many second paychecks today go toward financing a largely fruitless bidding war for homes in good school districts.
Parents naturally want to send their kids to good schools. But quality is relative. Because the best schools tend to be those serving expensive neighborhoods, parents must outbid 50 percent of other parents with the same goal just to send their children to a school of average quality.
How hard is that? I constructed a measure I call the toil index. It tracks the number of hours a median earner must work each month to earn the implicit rent for the median-priced house.
From 1950 to 1970, when incomes were growing at about the same rate for families up and down the income ladder, the toil index actually declined slightly. But since 1970 — a period during which income inequality has grown — the toil index has risen sharply.
The increase in two-earner households explains only part of it. The climb in the toil index was also driven by the easy credit that fueled the housing bubble, as well as by an expenditure cascade in housing caused by growing income disparities.
Since 1970, the top 1 percent have captured most of the income growth in the nation. Like everyone else, the rich spend more on housing when they have more money. High-end houses become bigger and fancier. That shifts the frame of reference for the near rich, and so on down the income ladder. Because the median hourly wage, adjusted for inflation, has been falling, there’s really no other way to explain why the median new house built in the United States in 2007 was about 50 percent larger than its counterpart in 1970.
The increase in the toil index has been spectacular. From a postwar low of 41 hours a month in 1970, it rose to more than 100 hours in 2005. Although it has fallen since the housing bubble burst, the middle-class squeeze persists.
Growing income disparities don’t just make the 99 percent angry. They also raise the cost of achieving basic goals.
A Tax Credit to Fix
A Housing Mess
ROBERT J. SHILLER A professor of economics and finance at Yale.
WE used to talk a lot about helping homeowners in trouble.
Instead, the bankers were bailed out — and now we hardly talk at all about aiding ordinary Americans.
Yet the problems facing homeowners today are even bigger than they were in the dark days of the financial crisis. According to the S.& P./Case-Shiller 20-city Home Price Index, home prices have fallen 13.2 percent since Lehman Brothers collapsed in September 2008. Over the same period, of course, unemployment has climbed.
In other words, more homeowners are underwater on their mortgages — and more Americans are out of work. And home prices are still falling.
So we need to overcome the sense that real help is impossible — and to think about approaches that might be politically feasible. Despite concern over our national debt and a general distaste for spending taxpayer dollars on people who may have been less responsible, there are some potential solutions.
Prof. Richard K. Green, director of the Lusk Center for Real Estate at the University of Southern California, has proposed changing the tax system so that it offers stronger, more targeted encouragement for homeownership by focusing on people who might be giving up the dream of buying any home at all. The current mortgage interest deduction, Professor Green argues, based on his work with Prof. Andrew Reschovsky of the University of Wisconsin, is mostly an incentive for relatively wealthy people to build bigger houses, rather than for people of modest means to buy a home. It also provides a strong incentive only for people in high tax brackets, who benefit more because of their higher marginal tax rates, and who tend to itemize because the standard deduction is less advantageous for them.
Professor Green wants to offer more help for lower-income taxpayers. He suggests creating a refundable tax credit as a percentage of mortgage interest payments, one that could be used even by those who take the standard deduction. This credit, presumably with some dollar limit, would be available to all homeowners. (That is in contrast to the HARP 2.0 mortgage refinancing program from the Obama administration; it is available, arbitrarily, only to those with Fannie Mae and Freddie Mac mortgages.) Professor Green proposes paying for this change by gradually phasing out the existing mortgage interest deduction.
Homeownership fosters citizenship, builds stronger families and communities, encourages active participation in the economy and, ultimately, bolsters economic confidence. Professor Green’s proposal is an example of a change that wouldn’t smack of a bailout, but would help vulnerable people who are losing hope in the American Dream.
The Answer Starts
With a Salad Bar
RICHARD H. THALER A professor of economics and behavioral science at the Booth School of Business at the University of Chicago.
IN case you’ve forgotten, we have a crisis in health care spending. But employers can help us deal with it — and save themselves some money — with a few nudges.
The thesis of “Nudge,” which Cass R. Sunstein and I wrote in 2008, is that “choice architects” can often help people achieve their goals simply by making the necessary steps easier. As choice architects, employers can do a lot to improve their workers’ health. That, in turn, can lead to more productive workers who have fewer sick days and cost less to insure.
Where to start? First, make it easier to eat well while at work. That doesn’t mean limiting the cafeteria menu to tofu and cauliflower. It means offering various healthful, tasty options that are featured prominently. Put an attractive salad bar including some healthy proteins before the burger line, for instance, and subsidize the healthy food.
Second, make it easier to get some exercise during the workday. Walking just 30 minutes a day provides noticeable health benefits. Some ambitious companies have installed treadmills with workstations, but there are lower-cost solutions. Even a small to midsize business can probably arrange a discount at a health club.
You don’t have to leave work to get some exercise. A good place to start is on the stairs. Walking a few flights several times a day is a good start on that 30 minutes. To entice workers, companies should make their stairwells attractive and fun. Add music, murals or graffiti contests. Or try lotteries with a chance to win any time you walk up or down one flight. Finally, better align health insurance incentives with behavior. One of the biggest health care problems is that patients don’t keep up with their medications, even those that might save their lives. Why charge people who’ve had heart attacks a co-payment when they fill prescriptions that reduce the chance of another attack? Instead, make those prescriptions free and use technology to remind them to take their medicine, either with a text message or a pillbox that starts beeping if you forget to take your pills.
And here’s a practice we should use more often: Offer insurance discounts to reward healthy behavior. Saving $500 on a premium is a good incentive to quit smoking or lose some weight.
My New Year’s resolution is to take at least two walking meetings a week. How about you?
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