Macroeconomic Patterns and Stories

Macroeconomic Patterns and Stories

Contents Parti Introduction 1 Introduction: We Are Pattern-Seeking, Story-Telling Animals 3 1.1 Advice: Do Both Patterns and Stories 5 1.2 We Can Also Analyze 7 1.3 Pictures, Words, and Numbers: In that Order 9 1.4 Analytical Thinking: I think I Can Help 10 1.4.1 Forecasting Is a Participant Sport 10 1.4.2 Tell Someone About It: It Will Help You More Than Them 11 1.5 WhatNow? 11 1.6 Preview: The Key Pattern 12 1.7 Data Sources 12 1.7.1 Updated Displays 13 1.8 Appendix: Statistical Science Is Severely Limited in Its Applicability 13 1.8.1 Was that 1969 Draft Lottery Random? Was It Fair? 13 1.9 Conclusion 16 Part II Four Key Variables: Growth, Unemployment, Inflation and Interest Rates 2 Gross Domestic Product 19 2.1 Definitions 19 2.1.1 GDP Is an Imperfect Measure of Economic/ Material Success 19 2.1.2 What Do Those Three Letters Stand For? 22 2.1.3 What's "Gross" About Gross Domestic Product? 24 2.1.4 What's "Real" About "Real GDP" and What Is "Nominal" About "Nominal GDP"? 24

x Contents 2.1.5 What Does SAAR Mean? 27 2.1.6 What Is an Annualized Compound Rate of Growth? 28 2.2 What Does Real GDP Look Like? 28 2.2.1 Does a Logarithmic Scale Help? The Narrow Corridor of US GDP Growth 28 2.2.2 Four Pictures: What Does Growth of Real GDP Look Like? 30 2.2.3 How Much Is $10 Trillion? Does Dividing by Employment Help? 34 Appendix: The Index Number Problem and Chain Indexes 35 Appendix: The Seasonal in GDP Is Very Large 36 3 The Components of GDP: C + I + G + X-M 39 3.1 How Might GDP Be Measured? 39 3.1.1 National Income and Employee Compensation 40 3.2 How Is GDP Actually Measured? 42 3.3 How Big Are the Components: C, I, G, X - M? 44 3.3.1 Which Are the Most Volatile Components of GDP? 45 Appendix: GDP and National Income 49 Appendix: Answer to Footnote Question 49 Appendix: A Better Way to Treat Imports and Exports 49 4 Employment 51 4.1 Labor Market Surveys 51 4.1.1 CES: Current Employment Statistics 52 4.1.2 CPS: Current Population Survey 56 4.1.3 Initial Jobless Claims 59 4.2 Industry Composition of Payroll Jobs 62 Appendix: Which to Rely on: Business-Reported Payroll Jobs or Household-Reported People-at-Work 62 5 Inflation and Interest Rates 65 5.1 A Price Is a Ratio 66 5.2 The Consumer Price Index (CPI) 66 5.3 Two Views of Inflation 67 5.3.1 Homework 69 5.4 Interest Rates on Short-Term US Government Securities 70 5.5 The Real Interest Rate: The Price of Durability and the Compensation for Waiting 72 5.5.1 A Look at the Data 73 5.6 Interest Rates on Long-Term US Government Securities and Monetary Policy 74 5.6.1 The Term Structure of Interest Rates: Theory 76 5.6.2 Real Returns on One-Year and Two-Year Treasuries 80

Contents xi 5.7 What Determines the Shape of the Yield Curve? 82 5.7.1 Why Is the Yield Curve Generally Upward Sloping? 82 5.7.2 Why Is the Yield Curve Sometimes Steep and Sometimes Inverted? 83 5.7.3 What Determines the Level (Not the Slope) of the Yield Curve? 85 Appendix: Q and A from BLS Web Site Regarding the CPI 86 Appendix: Risk Characteristics of Bonds 88 Summary 90 6 Extrapolative Forecasting 91 6.1 Regression Toward the Mean 91 6.2 Forecasting and Regression Toward the Mean 94 6.3 Persistence, Momentum 96 6.4 Pictures that Help to Understand the Numbers 99 6.5 Stories that Help to Understand the Numbers 99 Part III A Recession Symptoms 7 Unwanted Idleness: Recessions and Recoveries 103 7.1 Worker Idleness: Unemployment 104 7.1.1 The NBER Definition of a Recession Isn't So Great 104 7.1.2 Identifying the Recessions in the Unemployment Data Is Child's Play 105 7.2 Capital Idleness: Capacity Utilization in Manufacturing 107 7.3 Work Intensity: Hours per Week in Manufacturing 108 7.4 Five Episodes: Normal Growth, Sputters, Spurts, Recessions and Recoveries 109 8 Recession Comparison Charts Ill 8.1 Recession Comparisons: Employment and Output Ill 8.1.1 Payroll Employment Ill 8.1.2 Real GDP 113 8.2 Idleness 115 8.2.1 Household Unemployment Rate 115 8.2.2 Capacity Utilization in Manufacturing 116 8.2.3 Hours per Week in Manufacturing 117 8.3 Other Indicators 118 8.3.1 Industrial Production 118 8.3.2 Employment in Manufacturing and Construction 119 8.4 Numbers 121

xii - 4 Contents 9 Who Struggles and Who Does Well in Recessions? 123 9.1 Job Losses in Recessions Affect Some Sectors More than Others 124 9.1.1 The 2001 Recession Was an Anomaly 130 9.1.2 With that Anomalous 2001 Recession, What Will the Next Recession Be Like? 132 9.2 Many Sectors Lose Profits in Recessions 133 Part III B Recession Stories 10 Idleness Stories 139 10.4 How Do Economists Explain Unwanted Idleness? 140 10.1.1 The Job Cycle Is Mostly Construction and Manufacturing 143 10.2 Broken Relationships 143 10.3 Soaking the Rich When Times Are Bad 146 10.4 Making Do with the Old Car 149 10.5 A Pyrrhic Victory of Hope Over Reason 150 Appendix: Supply and Demand Models of Unemployment 152 11 Cycle Stories 155 11.1 The Harrod-Samuelson Multiplier-Accelerator Model 158 11.2 Some Acceleration Facts 160 11.3 The Supply Chain Bull-Whip 162 11.4 Rush to Exploit New Ideas 164 11.4.1 The Intensive Margin and the Extensive Margin 164 11.4.2 The Simple Agronomy of an Idea Rush 167 11.4.3 Kondratieff Long Waves 169 11.5 Ponzi Schemes and Asset Bubbles 170 11.5.1 Housing Bubbles 171 Part III C Recession Early Warning Signs 12 Clues: Temporal Ordering of Components of GDP 175 12.1 Help from Sherlock Holmes 176 12.2 Contributions to GDP Growth 177 12.2.1 Normal Trend Contributions to GDP Growth 180 12.2.2 Abnormal Cumulatives 182 12.3 Average Temporal Orderings: It's a Consumer Cycle, Not a Business Cycle 183 12.4 Eight Consumer Cycles, a Disarmament Downturn, and an Internet Rush Comeuppance 186 12.4.1 The 1953 Department of Defense Downturn 190 12.4.2 The 2001 Internet Comeuppance 191 12.5 Housing False Positives and False Negatives 195

Contents xiii 12.6 A Story of the Consumer Cycle: Our Collective Bipolar Disease 196 12.7 Numbers, If the Pictures Are Not Enough 197 12.1 A Regression Analyses to Support What the Pictures Say... 197 12.7.2 A Summary Table 199 12.8 Summary 201 Appendix: Normal Contributions in Three Episodes 201 13 More Clues: Episodic Forecasting with Components of Conference Board's Index of Leading Indicators 203 13.1 Components of the Leading Indicator Index 203 13.2 Forget that Expectations Variable 205 13.3 Only a Few of Those Components Predict Oncoming Recessions 207 13.4 Combining the Components into an Overall Index 211 Appendix: Description of Leading Indicators 214 Part III D Recession Causes 14 The Art of Drawing Causal Inferences from Nonexperimental Data.. 219 14.1 Post Hoc Ergo Propter Hoc 219 14.2 Cause = Intervention 221 14.2.1 Our Hypothetical Interventions Are Very Few 222 14.3 There Are Many Roadblocks in the Way of Causal Inferences 223 14.3.1 We Can Pretend to Draw Causal Inferences, Even If We Cannot Do It 225 14.4 Use Biological, Not Mechanical Metaphors 226 15 In Search of Recession Causes 231 15.1 What Are We Looking for? 232 15.2 Fiscal Policy Seems to Both Cause and Prevent Recessions 235 15.2.1 The Department of Defense Is Implicated in the 1953 and 1969 Downturns 235 15.2.2 Federal Taxation Might Matter 238 15.3 The Causal Path Through Houses and Cars 239 15.3.1 Housing Predicts Recessions 240 15.3.2 Consumer Durables Spending Predicts Recessions 242 15.3.3 Housing and Consumer Durables Are Predicted by Interest Rates 244 15.3.4 Not So Fast 246 15.3.5 The Fed Raises Short-Term Interest Rates at the Ends of Expansions 248 15.3.6 Spillovers from Housing: The Wealth Effect or Not? 254 15.3.7 Two Stories of How Monetary Policy Causes Recessions. 255

xiv Contents Appendix: Two More "Causes" 258 Oil Price Increases Preceded Some of the Recessions 258 Weakness in Exports Has Not Caused US Recessions 258 Part IV Expansions: With and Without Spurts 16 The Life Cycle of US Expansions: Sputters and Spurts 263 16.1 Production and Employment During Expansions 264 16.1.1 Real GDP Grows During Economic Expansions 264 16.1.2 Labor Markets Sometimes Tighten Twice During Expansions 266 16.1.3 Cycles in Hours and Unemployment 267 16.1.4 Spurt Comparison Graphs 273 16.2 What Caused the Spurts? 274 16.2.1 A Big Fiscal Stimulus Has Three Times Rejuvenated a Sputtering Economy 275 16.2.2 The Reagan Spurt Was Helped by Falling Interest Rates, Falling Oil Prices and a Falling Value of the Dollar (Which Stimulated Exports) 277 16.2.3 Animal Spirits and the Mad Dash for the Web Drove the Clinton Spurt 279 Appendix: Presidents and Fed Chairmen 280 Part V The Longer Run: Savings, Investment, Government Borrowing, Foreign Lending and Your Home 17 Savings and Investment 283 17.1 The NIPA Definition of Savings: It Is Not What You Think 283 17.1.1 Investments Are New Homes, New Offices, New Factories, and New Equipment 283 17.1.2 Flows and Not Stocks 284 17.1.3 Savings Depends on What Consumption Is 285 17.2 Do We Save Enough? 288 17.2.1 US Savings in 2004 288 17.2.2 How Much Should We Save? 288 17.2.3 Do We Save Enough? 290 17.3 Another Important Accounting Identity: Savings = Investment 291 17.3.1 US Savings and Investment 292 17.3.2 What If There Is a Big Tax Cut and Public Savings Declines? 295 17.4 Crowding Out, Ricardian Equivalence, or Twin Deficits in the 1990s? 297

Contents xv 18 Government 299 18.1 Government Purchases of Goods and Services Are Not as Great as You Think 299 18.2 It's Transfers 300 18.2.1 Transfers Are Done also by State Governments 302 18.2.2 Those Transfers Are Mostly Social Security, Medicare, and Medicaid 303 18.2.3 The States Do Not Run Deficits 305 18.3 An Accounting Scandal to Rival Enron: Phantom Assets Created by Government Borrowing 305 18.4 The Outstanding Federal Debt Is Great Enough to Be Worrisome 307 18.5 The Real Effect of the Federal Deficit: Trickle-Down Social Responsibilities 308 18.5.1 Being a "Grown-Up" 309 18.5.2 The Debate over the Privatization of Social Security Is Confusing All of Us 310 19 The External Deficit and the Value of the Dollar Hu's in Charge? 313 19.1 An Important Accounting Identity: The Current Account = The Capital Account 314 19.2 What Determines the Value of the Dollar and the External Deficit? 318 19.2.1 The Exchange Rate 318 19.2.2 The Real Exchange Rate 319 19.2.3 The Demand and Supply of US Dollars 321 19.2.4 US Deficits: Good or Bad? 322 19.3 How Can the US External Deficit Close? 323 19.3.1 Capital Account Adjustment: Foreign Investors Go Elsewhere 325 19.3.2 Capital Account Adjustment: More US Savings 326 19.3.3 Current Account Adjustment: Barriers Against Imports... 326 20 The Ups and Downs of Real Estate Values 329 20.1 Household Assets and Liabilities 329 20.2 It Is Not Real Until You Realize It 332 20.3 What Determines the Price and What Determines the Value of Your Home? 335 20.3.1 The Rental Market and the Ownership Market 335 20.3.2 Do not Confuse the Rental Market and the Ownership Market 336 20.3.3 Survivor Investing Can Temporarily Disconnect Earnings and Valuations 337 20.3.4 Survivor Investing Requires a Good Story 337

xvi Contents 20.3.5 Fundamental Valuation Depends on the Growth of Earnings and the Discount Rate 339 20.3.6 A House Has a p/e Ratio, Too 341 20.3.7 The p/r Ratios in US Cities 341 20.4 Some Realities of a Very Imperfect Ownership Market: The Very Persistent Gap Between Values and Prices 343 20.4.1 Home Appraisals: Bob's $1 Million Tie 343 20.4.2 Hormones and Housing: It's a Volume Cycle Not a Price Cycle 344 Appendix: Homework re the LA Market 349 Appendix: Home Ownership Data from the Survey of Consumer Finances 350 Appendix: Rents or Asset Prices in the CPI? 351 Owner-Equivalent Rent 351 Appendix: There Is no Such Thing as a Housing Shortage 352 Supply Restrictions Do not Guarantee that Prices Can Only Go Up 353 Index 355