Archive for February 13th, 2009

Forecasting in recessions

February 13, 2009

St Louis Fed has released this short research note evaluating performance of private sector forecasters. It says:

During a recession, the mean squared errors (MSEs) associated with forecasts of GDP growth and the unemployment rate are 0.58 and 1.95, respectively. In each case, the MSEs are four times larger than those made when the economy is not in a recession. Even if the very large errors during and immediately after the 1981 recession are omitted from the calculations, the MSEs are still roughly twice as large—a smaller but still significant difference.

One main contributor to the deterioration in the forecasts is an inability to detect turning points—that period when the economy shifts from being in a recession to not being in a recession—and vice versa. Another contributor is a clear bias in the forecasts during a recession. Forecasts of GDP growth and the unemployment rate both generally tend to be overly optimistic: Forecasts of GDP growth tend to be too high, whereas those for the unemployment rate tend to be too low. Perhaps not surprisingly, the degree of accuracy of the two series tends to move together; the correlation between the two series is roughly 80 percent.

Deserves a 🙂 This is precisely the finding of this Prakash Loungiani study as well. Forecasters failed to anticipate Japan slump as well and only when the economic situation looked really bad, were the forecasts revised downwards. My research on India growth also seems to point the same – forecasters revise predictions only when actual numbers change.

US Fiscal Stimulus – stimulates in short-term, shaky in long term

February 13, 2009

CBO has released its estimates of the US Fiscal Stimulus plan. CBO Director’s Blog explains it here.  (I found another study which compares the two stimulus plans – one debated by House of Reps and other by senate.)

The estimates points that the plan would be helpful in short-term but long-term implications are too shaky. Why?

In contrast to its positive near-term macroeconomic effects, the legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth as government bonds rather than in a form that can be used to finance private investment, the increased debt would tend to reduce the stock of productive private capital. In economic parlance, the debt would “crowd out” private investment. (Crowding out is unlikely to occur in the short run under current conditions, because most firms are lowering investment in response to reduced demand, which stimulus can offset in part.)

How much is Crowding out?

CBO’s basic assumption is that, in the long run, each dollar of additional debt crowds out about a third of a dollar’s worth of private domestic capital (with the remainder of the rise in debt offset by increases in private saving and inflows of foreign capital).

It adds crowding out could be minimised if govt invests in infrastructure and research now as it would lead to improvement in poutput later on. However, the catch is that govt should be able to spend the extra debt as efficiently as private sector does.


Taking all of the short- and long-run effects into account, CBO estimates that the legislation implies an increase in GDP relative to the agency’s baseline forecast of between 1.4 percent and 3.8 percent by the fourth quarter of 2009, between 1.1 percent and 3.3 percent by the fourth quarter of 2010, between 0.4 percent and 1.3 percent by the fourth quarter of 2011, and declining amounts in later years (see Table 1). Beyond 2014, the legislation is estimated to reduce GDP by between zero and 0.2 percent.

Correspondingly, the legislation would increase employment by 0.8 million to 2.3 million by the fourth quarter of 2009, by 1.2 million to 3.6 million by the fourth quarter of 2010, by 0.6 million to 1.9 million by the fourth quarter of 2011, and by declining numbers in later years. The effect on employment is never estimated to be negative, despite lower GDP in later years, because CBO expects that the U.S. labor market will be at nearly full employment in the long run.

The reduction in GDP is therefore estimated to be reflected in lower wages rather than lower mployment, as workers will be less productive because the capital stock is smaller.

Interesting Stuff. What is more interesting is the fact that the GDP gap (difference between potential vs projected) would be negative till 2013 (high estimate) or 2014 (low estimate). US economy would under-perform for quite some time.

Barro on Fiscal Multipliers and Krugman

February 13, 2009

Robert Barro, a noted Growth Economist had written an article in WSJ on the fiscal multipliers. His main idea is that tax cuts are better than government spending and a fiscal stimulus should focus on the former. The government spending works but only in war times.

Why tax-cuts are more stimulative?

I don’t think it is really confusing at all, because when you cut taxes there are two different effects. One is that you cut tax rates, and therefore give people incentives to do things like work and produce more and pay more — maybe, depending on what kind of taxes. And then you also maybe give people more income. This income effect is the one that’s related to this Keynesian multiplier argument, where it’s usually argued that government spending should have a bigger effect. So that’s the income effect. But the tax-rate effect, inducing people to do things like work and produce more and invest more, is a whole separate effect, and that could easily be much bigger than the multiplier thing, than the income thing.  

He is also working on a study that tries to differentiate between the two effects in each of the fiscal stimulus used in crisis times.

He also says the current package is garbage :

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much

He does not like the Obama team either

Well, presumably Larry Summers is not an idiot.

[laughs] That is another conversation. I have known him for 25 years, and I have opinions about that.

Well, presumably Christina Romer is not an idiot if you’re…

They’ve brought in some reasonable people in terms of economic advisors. I don’t know what impact they’re having, and I suppose they have different views on Keynesian macroeconomics than I have. But I’m giving you my opinion about it.

I think Geithner is a good appointment. I think he’s going to focus on what really matters, which is the financial system and the housing market. That’s where they should be putting their efforts. That’s where the problems came from.

He also takes on Krugman:

Do you read Paul Krugman’s blog?

Just when he writes nasty individual comments that people forward.

Oh, well he wrote a series of posts saying he thought the World War II spending evidence was not good, for a variety of reasons, but I guess…

He said elsewhere that it was good and that it was what got us out of the depression. He just says whatever is convenient for his political argument. He doesn’t behave like an economist. And the guy has never done any work in Keynesian macroeconomics, which I actually did. He has never even done any work on that. His work is in trade stuff. He did excellent work, but it has nothing to do with what he’s writing about.

I’m not in a position to…

No, of course not.

I’m not in a position to know things like the degree to which Paul Krugman counts as a relevant expert on new Keynesian economics.

He hasn’t done any work on that. Greg Mankiw has worked in that area. 

Economists always disagree and this is a disagreement between one of the best we have. 

Anyways, the idea behind the post was not to point the fights but to point out the difference between two types of fiscal multipliers. Moreover, it is useful to think about them in terms of the 2 effects in work – incentive effect and income effect. Any fiscal stimulus plan should try and do both – change incentives for people to come forward and spend/invest and provide incomes so that people can do the first.

Assorted Links

February 13, 2009

1. WSJ Blog points to research on US family finances

2. CBB points immigration could be a solution to the crisis

3. MR points about a new soft drink launch in India

4. Nudges points what a nudge cafeteria would be like

5. Mankiw points to a nice graph on US unemployment situation

6. FinProf points to a  new Cow joke 🙂

7. IGMB pointsto top economists decoding Geithner plan

8. CTB points to a research paper which says collapse of i-banks in US was not a once in a century event.

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