In recent testimony before the Financial Crisis Inquiry Commission, Fed Chairman Ben Bernanke confronted the "too-big-to-fail" problem head on. "If the crisis has a single lesson," he said, "it is that the too-big-to-fail problem must be resolved."
How did the US banking system get into this position? It used to be known as a system of small banks, and there are still nearly 4,000 community banks with assets under $100 million. However, most of the growth of banking in recent years has come from large, multi-bank holding companies. According to FDIC data, the 105 banks with more than $100 billion in assets hold 78 percent of all bank assets. Even more striking, just four banks, each with $1 trillion or more in assets, control 58% of all bank assets.
A bank is too big to fail if its failure would threaten the function of the whole banking system via losses to uninsured depositors, losses to counterparties on complex transactions, and general fear of dealing with all banks when even the largest are seen as vulnerable. When banks become aware that they are protected from to failure, they become subject to the problem of moral hazard. Knowing they will be bailed out when they get in trouble, they take too many risks. Confident of bailouts, investors, in turn, supply capital to the biggest banks at favorable rates, so the big grow ever bigger.
What can be done? One solution would be to break up the biggest banks into smaller institutions. Such measures were discussed, but rejected, during recent discussions of financial reform. Instead, the 2010 Dodd-Frank Act took a different approach. It attempted to eliminate moral hazard by instituting a new resolution mechanism for complex banking organizations that would allow even the largest institutions to be wound up without bailouts of management, shareholders, or counterparties.
Will it work? It all depends on credibility. "Simple declarations that the government will not assist firms in the future . . . will not be credible on their own," Bernanke said in his recent remarks. Declarations of intent need to be backed up not just by Dodd-Frank type resolution mechanisms, but by other measures as well, such as the stronger capital requirements expected under the forthcoming Basel III agreements.
Ultimately, though, we will not know if the new measures will work until they are tested. We will find out only when the next crisis strikes.
Follow this link to download a free set of classroom-ready slides discussing the too-big-to-fail problem.
Thursday, September 2, 2010
Friday, August 27, 2010
US GDP Growth for Q2 2010 Hit By Large Downward Revision
The growth rate of US real GDP was hit by an unusually large downward revision for the second quarter of 2010. The second estimate of Q2 GDP, released at the end of August by the Bureau of Economic Analysis, showed growth of just 1.6 percent from the previous quarter, compared with an advance estimate of 2.4 percent released at the end of July.
GDP data, which provide critical information to policy makers, are subject to a trade-off between accuracy and timeliness. The so-called advance estimate, released about three weeks after the end of each quarter, is based only about 45% on actual data for the quarter. The rest comes from models and projections. The average revision between the advance estimate and the third estimate, released about three months after the end of the quarter, is plus or minus 0.6 percentage points.
The 0.8 percentage point downward revision for the second Q2 2010 estimate was unusually large. The biggest single cause of the revision was faster than expected growth of imports, which outpaced steady, but slower, growth of exports. International trade is a frequent source of revisions to GDP data, since the advance GDP estimate contains little if any actual trade data for the reported quarter.
Follow this link to download a free set of classroom-ready slides covering the Q2 2010 GDP data revisions, and explaining the trade-off between timeliness and accuracy of data
GDP data, which provide critical information to policy makers, are subject to a trade-off between accuracy and timeliness. The so-called advance estimate, released about three weeks after the end of each quarter, is based only about 45% on actual data for the quarter. The rest comes from models and projections. The average revision between the advance estimate and the third estimate, released about three months after the end of the quarter, is plus or minus 0.6 percentage points.
The 0.8 percentage point downward revision for the second Q2 2010 estimate was unusually large. The biggest single cause of the revision was faster than expected growth of imports, which outpaced steady, but slower, growth of exports. International trade is a frequent source of revisions to GDP data, since the advance GDP estimate contains little if any actual trade data for the reported quarter.
Follow this link to download a free set of classroom-ready slides covering the Q2 2010 GDP data revisions, and explaining the trade-off between timeliness and accuracy of data
Thursday, August 26, 2010
The Economics of High-Speed Rail: Lessons for Policy Analysis
High-speed rail (HSR) is back in the news. Proponents see it as a cool but practical cure for economic and environmental ills. Opponents see it as a costly boondoggle. Why the huge range of opinion? What can we learn about policy analysis in general from the case of HSR?
Reduced energy use and pollution are among the most widely cited benefits of HSR. Advantages over road or air transport of up to six-to-one are widely cited. However, such data cannot be accepted uncritically.
First, the most favorable comparisons often look at emissions and energy use only in operation. A valid comparison should use life-cycle analysis that also includes energy use and emissions in infrastructure construction, vehicle manufacturing, and fuel production. HSR appears to retain an edge over air travel on a life-cycle basis, but the advantage is not as great, mainly because air travel requires less infrastructure investment per passenger mile.
Similarly, analysis of HSR should employ sensitivity analysis. The viability of HSR on any given route is highly sensitive to variables like passenger load factors per trip and total traffic density. Policy advocates often use inappropriate comparisons, citing data only from best or worst cases without looking at the specifics of proposed projects. City pairs that look superficially similar, like Chicago-St. Louis vs. Paris-Lyon, can turn out to have very different HSR potential.
Finally, one must beware of counting costs as benefits. Proponents of HSR often cite its job-creation potential, but labor and other inputs used in provision of HSR are costs, not benefits. Even when conditions warrant government stimulus spending of some kind, HSR should still compete on its merits with other potentially beneficial projects like renewing sewer and water systems, constructing schools, or expanding the power grid. Drawbacks of HSR as a candidate for stimulus spending include a long start-up time and spending commitments that extend over a period longer than a typical business cycle.
On balance, high-speed rail appears to lie somewhere between a transportation panacea and a hopeless boondoggle. Well-planned projects implemented under favorable conditions can potentially save energy, cut pollution, and improve service quality, but initial costs are high. HSR must compete on its merits with other public and private investment projects.
Follow this link for a free set of classroom-ready slides discussing the economics of high-speed rail and related lessons for policy analysis.
Reduced energy use and pollution are among the most widely cited benefits of HSR. Advantages over road or air transport of up to six-to-one are widely cited. However, such data cannot be accepted uncritically.
First, the most favorable comparisons often look at emissions and energy use only in operation. A valid comparison should use life-cycle analysis that also includes energy use and emissions in infrastructure construction, vehicle manufacturing, and fuel production. HSR appears to retain an edge over air travel on a life-cycle basis, but the advantage is not as great, mainly because air travel requires less infrastructure investment per passenger mile.
Similarly, analysis of HSR should employ sensitivity analysis. The viability of HSR on any given route is highly sensitive to variables like passenger load factors per trip and total traffic density. Policy advocates often use inappropriate comparisons, citing data only from best or worst cases without looking at the specifics of proposed projects. City pairs that look superficially similar, like Chicago-St. Louis vs. Paris-Lyon, can turn out to have very different HSR potential.
Finally, one must beware of counting costs as benefits. Proponents of HSR often cite its job-creation potential, but labor and other inputs used in provision of HSR are costs, not benefits. Even when conditions warrant government stimulus spending of some kind, HSR should still compete on its merits with other potentially beneficial projects like renewing sewer and water systems, constructing schools, or expanding the power grid. Drawbacks of HSR as a candidate for stimulus spending include a long start-up time and spending commitments that extend over a period longer than a typical business cycle.
On balance, high-speed rail appears to lie somewhere between a transportation panacea and a hopeless boondoggle. Well-planned projects implemented under favorable conditions can potentially save energy, cut pollution, and improve service quality, but initial costs are high. HSR must compete on its merits with other public and private investment projects.
Follow this link for a free set of classroom-ready slides discussing the economics of high-speed rail and related lessons for policy analysis.
Tuesday, August 17, 2010
A Natural Experiment in Demand Elasticity: Metered vs. Unmetered Electricity
Economists can't always conduct controlled experiments to test hypotheses about public policy, but sometimes experiments occur naturally. New York City electric rates provide an example. About 1.75 million New York apartments have metered electricity, paying an average of 21 cents per kilowatt hour, among the highest rates in the nation. At the same time, about 250,000 older apartments have unlimited, unmetered electric power included in the rent. A recent article by Sam Dolnick in The New York Times compares electricity use in the two types of apartments. The NYC experiment can be used to test three a priori hypotheses about the elasticity of demand for electricity.
First, demand might be completely inelastic. Although this hypothesis would not appeal to most economists, it reflects a line of argument often found in popular discussions. How many times have you heard someone say something like this: "Raising electric rates wouldn't help conservation. Rich people can afford to use as much as they want regardless of the price. And poor people would still need electricity to live, so raising the price would just make them poorer."
Second, demand might have constant elasticity. Because of their convenient mathematical form, constant elasticity curves are often used in empirical studies. Because they never intersect the axes, they imply that the quantity demanded would be unlimited if the price fell to zero.
Third, the demand curve might be linear. Textbooks are full of linear demand curves. Some people joke that is because lazy authors find them easier to draw. A linear demand curve implies that demand is finite even when the good is free.
Observations from the New York experiment shed light on these hypotheses. Demand is greater unmetered apartments. Some people do use electricity very wastefully, for example, running their air conditioners full blast while they are at work so that their cats will be comfortable. Still, demand does not increase without limit. Electric use is only about 30 percent higher in unmetered apartments than metered ones.
Taken together, these observations allow us to reject the hypotheses of perfect inelasticity and constant elasticity. Looks like the lazy old linear demand curve provides the best fit after all. And yes, skeptic, charging for electricity does provide an effective incentive for conservation.
Follow this link to download a free set of classroom-ready slides about metered vs. unmetered electricity in New York.
First, demand might be completely inelastic. Although this hypothesis would not appeal to most economists, it reflects a line of argument often found in popular discussions. How many times have you heard someone say something like this: "Raising electric rates wouldn't help conservation. Rich people can afford to use as much as they want regardless of the price. And poor people would still need electricity to live, so raising the price would just make them poorer."
Second, demand might have constant elasticity. Because of their convenient mathematical form, constant elasticity curves are often used in empirical studies. Because they never intersect the axes, they imply that the quantity demanded would be unlimited if the price fell to zero.
Third, the demand curve might be linear. Textbooks are full of linear demand curves. Some people joke that is because lazy authors find them easier to draw. A linear demand curve implies that demand is finite even when the good is free.
Observations from the New York experiment shed light on these hypotheses. Demand is greater unmetered apartments. Some people do use electricity very wastefully, for example, running their air conditioners full blast while they are at work so that their cats will be comfortable. Still, demand does not increase without limit. Electric use is only about 30 percent higher in unmetered apartments than metered ones.
Taken together, these observations allow us to reject the hypotheses of perfect inelasticity and constant elasticity. Looks like the lazy old linear demand curve provides the best fit after all. And yes, skeptic, charging for electricity does provide an effective incentive for conservation.
Follow this link to download a free set of classroom-ready slides about metered vs. unmetered electricity in New York.
Thursday, August 12, 2010
Using Productivity Data to Understand Employment Trends
A slowdown in productivity growth is not usually good news, but the dip in U.S. productivity in the second quarter of 2010 may have a silver lining. The 0.9 percent decline in productivity, and the data that underlie it, appear to indicate that the stage is now set for employment growth in the second half of the year.
Any improvement in the employment picture would be welcome. Although output has grown steadily since the apparent end of the recession in mid-2009, the unemployment rate, which remained stuck at 9.5 percent in July 2010, is only slightly below its peak. Some observers are describing this as a "jobless recovery."
Very strong growth of labor productivity is what has made the "jobless recovery" possible. Output per labor hour usually grows at about 2.5 percent per year, but in the early stages of the recovery, the annualized quarterly rate of productivity growth has surged to as high as 8 percent. Its decline in Q2 2010 was the first since 2008, indicating that employers are running out of ways to squeeze more output from the existing workforce.
Further evidence is found in the fact that hours per worker, which have climbed steadily during the early stages of recovery, are now above their pre-recession average level. If output continues to grow, employers are likely to need to hire additional workers, not just expand hours further.
In making any hiring decisions, employers will keep an eye on unit labor costs--labor costs adjusted both for changes in compensation and in productivity. Productivity fell by 0.9 percent in Q2, but compensation fell almost as much, 0.7 percent, so unit labor costs were essentially flat.
On balance, then, labor market data show an abundant supply of reasonably priced, productive labor, and an exhaustion of reserves produced by recession-driven labor hoarding. The groundwork is laid for employment growth to improve later this year if--and it is still a big if--there is sufficient demand for the output that newly hired workers can produce.
Follow this link to download a free set of classroom-ready slides including charts of the latest labor market data and a discussion of their interpretation.
Any improvement in the employment picture would be welcome. Although output has grown steadily since the apparent end of the recession in mid-2009, the unemployment rate, which remained stuck at 9.5 percent in July 2010, is only slightly below its peak. Some observers are describing this as a "jobless recovery."
Very strong growth of labor productivity is what has made the "jobless recovery" possible. Output per labor hour usually grows at about 2.5 percent per year, but in the early stages of the recovery, the annualized quarterly rate of productivity growth has surged to as high as 8 percent. Its decline in Q2 2010 was the first since 2008, indicating that employers are running out of ways to squeeze more output from the existing workforce.
Further evidence is found in the fact that hours per worker, which have climbed steadily during the early stages of recovery, are now above their pre-recession average level. If output continues to grow, employers are likely to need to hire additional workers, not just expand hours further.
In making any hiring decisions, employers will keep an eye on unit labor costs--labor costs adjusted both for changes in compensation and in productivity. Productivity fell by 0.9 percent in Q2, but compensation fell almost as much, 0.7 percent, so unit labor costs were essentially flat.
On balance, then, labor market data show an abundant supply of reasonably priced, productive labor, and an exhaustion of reserves produced by recession-driven labor hoarding. The groundwork is laid for employment growth to improve later this year if--and it is still a big if--there is sufficient demand for the output that newly hired workers can produce.
Follow this link to download a free set of classroom-ready slides including charts of the latest labor market data and a discussion of their interpretation.
Tuesday, August 10, 2010
Recommended Viewing: Two Treasury Secretaries on Taxes and the Economy
At a time when the two parties in Washington are barely speaking to each other, it is refreshing to hear two former Treasury Secretaries, one Democrat and one Republican, having a civilized conversation about taxes and the economy, and agreeing on a great deal. I recommend viewing the conversation between Robert Rubin and Paul O'Neil that took place on Fareed Zacharia's program GPS, broadcast on CNN, August 8, 2010. Here are some excerpts:
Participants:
Host: Fareed Zacharia (FZ)
Guest: Robert Rubin (RR), Treasury Secretary for President Bill Clinton, 1995-1999 and former Co-Chairman of Goldman Sachs
Guest: Paul O'Neil (PO), Treasury Secretary for George W. Bush, 2001-2001 and former Chairman and CEO of Alcoa
On fixing the economy:
FZ: If you could wave a magic wand, how would you create more demand in the economy?
PO: [I wish that the president and Congress would start] with things like fundamental tax reform. When I was Secretary of the Treasury, I was on this cause to create fundamental tax reform. Unfortunately my client [George W. Bush] didn’t agree with me. . . I kept saying that the tax code we have is proof that we are not an intelligent people, and it’s worse now than it was ten years ago when I was singing this song. . . When you think about how you get capital formation, fairness, the distribution of pain for public goods, if we have something simple instead of the current income tax and corporate tax, something simple like a VAT or a consumption based tax, I think that would create a basis for creating capital formation, and saving, as opposed to consuming everything in sight. . . No intelligent people would create a tax system like this if they were given the chance to create a system worthy of a people who need to free up resources that are being wasted.
RR: [If I had a magic wand] I would stay on roughly the current fiscal track . . . I wouldn’t do a major second stimulus, because I think it would run a risk of being counterproductive by creating a lot of uncertainty and undermining confidence. But at the same time, I would put in place a very serious beginning at deficit reduction that would take place at some specified time in the future, something like two years. It wouldn’t take place right now when the economy is still fragile, but if you could do it, and it was credible, and it was real, I think that would do a lot for confidence. But that is very easy to say and very hard to do.
On extending the Bush tax cuts
FZ: What would you do about the Bush tax cuts?
PO: I was strongly opposed to the Bush tax cuts that took place in 2003. That was one of the reasons I got fired, between that and saying there was no evidence of weapons of mass destruction in Iraq. First of all, I thought we needed the money to smooth the way for fundamental tax reform, reform of Social Security and Medicare. . . and getting ready to go to war in Iraq. I didn’t think we could afford another tax cut.
FZ: What do I think of the tax cuts now?
PO: I don’t think it’s the right issue. The issue is fundamental tax reform. If we let the tax cuts expire, are people going to say, hallelujah, everything is all right now with our tax system? Not me!
FZ: Should we just let [the Bush cuts] all expire?
RR “I’ll tell you what I would do. Number one, I would put on an estate tax right now, because there is no estate tax and I would fill that void. . . Number two, I would increase taxes on the top two brackets and put them back up to the Clinton rate. I think there is no supply side effect there. I would leave the middle class tax cuts in effect for a limited period because I think the probability is high that we will have slow and bumpy growth.
On political gridlock
RR: I think our country is at a crossroads, I think we have tremendous long-term strength [but] the political system has deteriorated substantially in its ability to work across party lines and make tough decisions.
PO: That may be a blessing in disguise because if they could agree on something, it would probably be negative to the people. . . It is really tragic what has happened to our political system and its inability to have even a civil conversation. . . It is insane that otherwise intelligent people could participate in this folly when the country is at risk.
Follow this link to view the conversation in full. The extracts given here are transcribed by Ed Dolan, not by CNN, and may contain minor transcription errors.
Participants:
Host: Fareed Zacharia (FZ)
Guest: Robert Rubin (RR), Treasury Secretary for President Bill Clinton, 1995-1999 and former Co-Chairman of Goldman Sachs
Guest: Paul O'Neil (PO), Treasury Secretary for George W. Bush, 2001-2001 and former Chairman and CEO of Alcoa
On fixing the economy:
FZ: If you could wave a magic wand, how would you create more demand in the economy?
PO: [I wish that the president and Congress would start] with things like fundamental tax reform. When I was Secretary of the Treasury, I was on this cause to create fundamental tax reform. Unfortunately my client [George W. Bush] didn’t agree with me. . . I kept saying that the tax code we have is proof that we are not an intelligent people, and it’s worse now than it was ten years ago when I was singing this song. . . When you think about how you get capital formation, fairness, the distribution of pain for public goods, if we have something simple instead of the current income tax and corporate tax, something simple like a VAT or a consumption based tax, I think that would create a basis for creating capital formation, and saving, as opposed to consuming everything in sight. . . No intelligent people would create a tax system like this if they were given the chance to create a system worthy of a people who need to free up resources that are being wasted.
RR: [If I had a magic wand] I would stay on roughly the current fiscal track . . . I wouldn’t do a major second stimulus, because I think it would run a risk of being counterproductive by creating a lot of uncertainty and undermining confidence. But at the same time, I would put in place a very serious beginning at deficit reduction that would take place at some specified time in the future, something like two years. It wouldn’t take place right now when the economy is still fragile, but if you could do it, and it was credible, and it was real, I think that would do a lot for confidence. But that is very easy to say and very hard to do.
On extending the Bush tax cuts
FZ: What would you do about the Bush tax cuts?
PO: I was strongly opposed to the Bush tax cuts that took place in 2003. That was one of the reasons I got fired, between that and saying there was no evidence of weapons of mass destruction in Iraq. First of all, I thought we needed the money to smooth the way for fundamental tax reform, reform of Social Security and Medicare. . . and getting ready to go to war in Iraq. I didn’t think we could afford another tax cut.
FZ: What do I think of the tax cuts now?
PO: I don’t think it’s the right issue. The issue is fundamental tax reform. If we let the tax cuts expire, are people going to say, hallelujah, everything is all right now with our tax system? Not me!
FZ: Should we just let [the Bush cuts] all expire?
RR “I’ll tell you what I would do. Number one, I would put on an estate tax right now, because there is no estate tax and I would fill that void. . . Number two, I would increase taxes on the top two brackets and put them back up to the Clinton rate. I think there is no supply side effect there. I would leave the middle class tax cuts in effect for a limited period because I think the probability is high that we will have slow and bumpy growth.
On political gridlock
RR: I think our country is at a crossroads, I think we have tremendous long-term strength [but] the political system has deteriorated substantially in its ability to work across party lines and make tough decisions.
PO: That may be a blessing in disguise because if they could agree on something, it would probably be negative to the people. . . It is really tragic what has happened to our political system and its inability to have even a civil conversation. . . It is insane that otherwise intelligent people could participate in this folly when the country is at risk.
Follow this link to view the conversation in full. The extracts given here are transcribed by Ed Dolan, not by CNN, and may contain minor transcription errors.
Friday, August 6, 2010
MV=PQ: A Resource for Economic Educators
I have recently added MV=PQ to my list of useful resources. Some good discussions, and a good place to look for links to academic research on topics relevant to your classes.
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