What’s Going On With Inventories?

One of the weirdly under-discussed features of the current macroeconomic situation is the huge role of inventories in the recovery. I read a lot of economics blogs — there are a lot more I don’t read — and at least sporadically the business press, and I’ve hardly seen this discussed at all. But check it out:

The orange line is the change in GDP, the blue line is the contribution of inventory changes. (Sorry it’s fuzzy. I’m technologically hopeless.) Since the end of the recession, 62 percent of GDP growth has been accounted for by inventories. Inventories have accounted for the majority of GDP growth in four of the five post-recession quarters; in the fifth, they were 48 percent. There’s really no precedent for this. It’s not unusual for inventories to be the main source of growth in one post-recession quarter, but never in the past 50 years have they accounted for half of GDP growth for two quarters in a row, let alone for five. [1]

The question then is, what’s it mean. Honestly? I don’t know.

The natural theory is that it’s supply chain risk and credit risk. When you’re not confident you’re regular suppliers will still be in business a few months from now, you want to keep a stash of whatever inputs you depend on them for on hand. And as transactions move toward a cash-on-the-barrelhead basis, everyone has to hold more goods in stock (along with more cash, but that’s happening too.)

But I suspect there are better answers, if one understood the concrete realities underlying the BEA statistics. Any of you hypothetical readers have ideas?

[1] The first post-war recovery in 1947-48 saw inventories play a similarly large role. I doubt the reasons were the same.

Is There Really a European Sovereign Debt Crisis?

The past few months have seen a flurry of articles warning that the next stage of the financial crisis will be a flight from sovereign debt, specifically in the European periphery. Even people who don’t believe in confidence fairies when it comes to the US or the UK accept the conventional wisdom that financing the deficit of the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) is a problem — that there is simply no way to convince the public to hold the amount of debt these countries will have to issue in the absence of austerity. For these countries, it’s sadly conceded, in the absence of the option of devaluation the hard exigencies of the bond market leaves them no choice but slash spending and force down wages. But is it true? Here are the relevant debts and deficits, in billions of euros (not percent of GDP, for reasons that will be clear in a moment.)
General Government Debt and Net Borrowing

2010 2009 2008
Greece Net debt 259 230 199
Net borrowing 19 32 18
Ireland Net debt 86 58 41
Net borrowing 28 23 13
Italy Net debt 1542 1473 1395
Net borrowing 80 80 42
Portugal Net debt 135 121 105
Net borrowing 12 16 5
Spain Net debt 1051 1054 1088
Net borrowing 97 118 44
PIIGS Net debt 3073 2936 2828
Net borrowing 236 269 122

Source: IMF, World Economic Outlook (General government here includes all levels of government; “net” means that intra-government borrowing is excluded.) As we can see, deficits approximately doubled in the PIIGS countries between 2008 and 2009, and stabilized in 2010. But how big are these deficits? Are they, for example, big compared with the balance sheet of the European Central Bank?
ECB Assets (billions of euros)

4th week of October of…
2010 2009 2008 2007 2006 2005
Euro-area bank loans 547 701 831 451 444 389
Euro-area securities 471 361 153 133 121 133
Total assets 1878 1786 1958 1249 1119 999

Source: ECB, Weekly Financial Statements In passing, it’s interesting how different the balance sheet of the ECB looks from the Fed’s especially before the crisis. While the asset side of the Fed’s balance sheet, at least until three years ago, consists almost entirely of treasury bills, the ECB has more lending to banks, much more foreign exchange reserves, much more gold (about 10 percent of its pre-crisis assets!) and relatively little in the way of securities. For present purposes, though, two points stand out. First, the ECB increased its security holdings by E320 billion over the past two years, or E160 billion a year. This is equal to two-thirds of the total annual borrowing of the PIIGS countries. So in principle the ECB would only have to increase its current rate of securities purchases by 50 percent to meet the entire borrowing needs of the five threatened countries. Second, looking now at stocks rather than flows, the ECB increased its balance sheet about about 1 trillion euros between 2005 and 2008. Another similar increase would allow the ECB to purchase one-third of the entire outstanding debt of the PIIGS countries. Interestingly, this is very similar to the increase in the Fed’s balance sheet over the same period. More to the point, it’s well within the range that has been suggested as an appropriate size for a second round of quantitative easing (QE2). Now, I’m not suggesting that the ECB should actually finance all new borrowing by ECB countries facing crises, or try to monetize a substantial portion of their existing debt. For one thing, there’s no need to; presumably even modest additional purchases would be enough to convince private actors to hold the debt at a reasonable price, if the ECB made it clear it stood ready to do more. I’m just saying that the frequently-heard argument that the governments of Southern Europe are “too big to save” isn’t obviously true. It seems more likely that any European QE2 — quantitative easing in its current use, remember, just means big central bank purchases of long-dated government debt — that had appreciable macroeconomic effects would be more than enough to solve the sovereign debt problem as well. Of course people (or their equivalents in the world of respectable business opinion) get very upset when you suggest that a government debt problem can be solved by just monetizing it. Oh, they say, but that’s inflationary. Maybe; but in the current context that’s an argument for it, rather than against it. And given that the 2005-2008 expansion of the ECB balance sheet didn’t produce any noticeable upward pressure on prices, it;s hard to see why another comparable one would. OK, they say, but what about the incentives? Why should governments ever show fiscal discipline if they know the ECB will just bail them out when they get in trouble? And there’s the heart of the matter, I think. It’s not that Greece, Spain, and the rest need tough austerity because they can’t be bailed out; rather, they won’t be bailed out in order to force them to implement austerity. The metaphor you sometimes see for the European sovereign debt situation is of mountain climbers roped together above a cliff. If one falls, it goes, the others can hold him up. But if they don’t act quickly and more fall, then the ones still holding on may be pulled down themselves if they don’t cut their companions loose. Maybe a more apt analogy would be that the climbers up top have a powerful winch, securely bolted to the rock; they could pull up the danglers just by turning a crank. But they wonder, wouldn’t it be better to leave them hanging, to teach them a lesson?

EDIT: The counterargument is that, while there is no technical problem with the ECB guaranteeing the financing of budget gaps in peripheral Europe, this would exacerbate the anti-democratic character of Euorpean institutions by giving the ECB a quasi-fiscal role. This is a trickier question.

Abject Patience

Aldous Huxley says, “The abject patience of the oppressed is perhaps the most inexplicable, as it is also the most important, fact in all history.”

I thought of that today when I came across this story, which really must be read to be believed. And if you read the fantastic work that Mike Konczal and a few other left bloggers are doing on the foreclosure crisis, it’s clear that what happened here is shocking and horrifying but not especially unusual. All over the country, people’s homes are quite simply being stolen from them by banks and other creatures from the financial sector.

But the most disturbing part isn’t the mortgage servicers evicting people from their homes with no clear title or other legal basis. It is the homeowners themselves. The “good” ones most of all.

Tina Kimmel was told by Citi, her lender, that she qualified for a trial loan modification under HAMP. Then after seven months of paying the lower amount as instructed, she was told without explanation she did not qualify and would be considered in default if she didn’t make all the back payments with interest and penalties. She paid them. Then Citi said they wouldn’t accept her money, she was being foreclosed. She kept paying. Without informing her they sold her mortgage to Carrington Mortgage Services, which told her that all they knew was she was in foreclosure and it was up to her, not Citi, to give them documentation on anything else regarding her loan. She gave it. And that while they were deciding whether to evict her, she’d have to keep paying. She paid. Next thing she heard was a sheriff’s notice on her door, announcing the house would be auctioned in three weeks. At the last minute, she paid the $13,000 — borrowed from family and friends — that Carrington was demanding for her nonexistent missed payments, and was allowed to keep her house.

She did everything the banks told her to. She’s proud of that. Shouldn’t she be ashamed?

I don’t know that much about mortgages or mortgage fraud. But one thing I do know is that the Citis and the Carringtons will keep stealing houses as long as the victims think it’s their duty to do whatever it takes to satisfy them, and to peacefully move out if they fail.

One can’t help wondering how many houses would have to end up mysteriously burned a few days after an eviction, to make the banks find loan modifications suddenly quite attractive. But instead we get Tina Kimmel, stakhanovite bill-payer.

Roubini, Deflationist

Last week, Nouriel Roubini wrote a somewhat puzzling op-ed in the Washington Post, in support of a payroll tax cut as a stimulus measure.

It’s a rather strange argument, or mix of arguments, since he’s never clear whether it’s a demand-side or supply-side policy. For example, he argues both that the cut should be higher for low-income workers (since they have a higher propensity to consume), and that “to maximize the incentives for private-sector hiring, there should be sharper reductions to the payroll taxes paid by employers than for those paid by employees.”

But let’s take the supply-side half of Roubini’s argument at face value. Suppose a payroll tax cut lowered the cost of labor to employers. Is it so obvious that would increase employment?

The implicit model Roubini is using is the one every undergraduate learns, of a firm in a perfectly competitive market with increasing marginal costs. But in the real world firms face downward-sloping demand curves, especially in recessions. So the only way a reduction of labor costs can increase hiring is if it allows firms to lower costs, i.e. contributes to deflation. Does Roubini really think that more deflation is what the economy needs? (Does he even realize that’s what he’s arguing?)

This, anyway, was my reaction when I read the piece. But it wouldn’t be worth dragging out a week-old op-ed to take shots at, if my friend Arin hadn’t pointed out a recent NY Fed working paper by Gauti Eggerston making exactly this point. From the abstract: “Tax cuts can deepen a recession if the short term nominal interest rate is zero, according to a standard New Keynesian business cycle model. An example of a contractionary tax cut is a reduction in taxes on wages. This tax cut deepens a recession because it increases deflationary pressures.” The paper itself involves building up a complicated model from microfoundations (that’s why Eggerston gets paid the big bucks) but the underlying intuition is the same: The only way a decrease in labor costs can lead to increased hiring is by lowering prices, and under current conditions lower prices can only mean lower aggregate demand.

As Arin points out, the incoherence of the argument for payroll tax cuts may be precisely their appeal. People who think unemployment is the result of inadequate demand and people who think it’s the result of lazy, overpaid workers (i.e. it’s “structural”) can both support them, even though the arguments are incompatible. (People who don’t scruple too much over consistency can even make both arguments at once.) But if macroeconomic policy is limited to stuff that can be supported with bad arguments, we shouldn’t be surprised if the results are disappointing. That lower labor costs don’t help in a recession is, I guess, another lesson from the Great Depression that will have to be learned again.

As for Roubini, it’s hard to improve on Jamie Galbraith’s very diplomatic judgment: I cannot discern his methods.

Does fiscal policy need to be paid for in advance?

Let’s be clear: Paul Krugman is a national treasure. On fiscal policy – and politics generally – he has been saying exactly what should be said, clearly and forcefully, and just as important, from a platform that people can’t ignore. No one of remotely his stature has been as clear or consistent a critic of the Administration from the left. That said, his economics can be … problematic. I don’t know if it’s just because I’m interested in trade, or if, ironically but perhaps more likely, it’s because it’s where he made most of his own contributions, but it’s on international economics that Krugman seems most committed to orthodoxy, and correspondingly out of tune with reality. Case in point: This blog post, where he notes, correctly, that the most consistent expansionary response to the crisis has been in Asia, and then goes on to endorse the suggestion of David Pilling (in the Financial Times) that today’s Asian stimulus is the reward for fiscal rectitude in previous years:

Deficit spending is what you should do only when the economy is depressed and interest rates are at or near the zero lower bound. When times are good, you should be paying debt down. Pilling: “The scale of Asia’s stimulus may have matched, even surpassed, the west. But the context has been entirely different. Asian governments had plumped-up their fiscal cushions after the 1997 crisis, building a formidable pool of reserves. … when the crunch came, they had the wherewithal to spend.”

I’m sorry, but this is just wrong. First of all, let’s look at stimulus spending and earlier fiscal stances in various Asian countries:

Country Fiscal stimulus 2008 Average fiscal surplus, 1998-2007 Average fiscal surplus, 2003-2007
Malaysia 0.9 -1.72 -1.72
India 1.5 -5.50 -2.93
Indonesia 2.7 10.04 10.04
Australia 4.4 -3.00 -1.65
Philippines 4.5 -0.69 -0.69
Korea, Rep. of 5.4 0.98 1.20
New Zealand 5.9 -2.10 -2.23
Thailand 7.7 -4.80


Singapore 8 -1.34 -1.93
China 13.5 2.70 4.69
Japan 14.6 -0.80 -0.95

See that striking correlation between prior surpluses and stimulus spending? Yeah, me neither. It’s true that some countries, like China and Korea, show prior surpluses and big stimulus. But others that are pursuing expansionary policy have had fiscal deficits for years, like Japan (as Krugman should know as well as anyone.) Empirically, the Krugman-Pilling argument that in Asia, fiscal surpluses paved the way for fiscal stimulus just does not hold up.
No, what’s allowed Asian countries to respond aggressively to the crisis is not their (mostly nonexistent) fiscal surpluses, but their current account surpluses. Unlike in past crises (or lots of countries in the current crisis, especially on the periphery of Europe) they are not dependent on private capital inflows, so they are under no pressure to undertake contractionary policy to maintain external balance. The case of Korea is exemplary. True, it was running a fiscal surplus prior to the crisis — but it was also running a fiscal surplus in the mid-1990s prior to the Asian Crisis, to which it responded with brutal austerity. The difference was that the current account was in deficit then, and in surplus this time. The fiscal position was irrelevant.(Incidentally, Pilling literally does not seem to realize there is a difference between a current account surplus and a fiscal surplus. That’s why he’s able to write something like “Asian governments had plumped-up their fiscal cushions after the 1997 crisis, building a formidable pool of reserves,” without realizing it’s a non sequitur.)What about the larger argument, that good Keynesian governments should engage in the precautionary accumulation of financial assets in good times to finance demand-boosting spending in bad times? Krugman himself admits that the Bush deficits are not a binding constraint on fiscal policy today, which is rather a blow to his argument. More broadly, it’s far from clear that there is any meaningful sense in which the existing level of public debt affects the space for fiscal policy. The argument for prudential saving might apply to the government of a premodern or underdeveloped country, which rests on a narrow fiscal base; but if substantial excess capacity exists in an industrialized country the government always can mobilize it. (Matt Yglesias gets this, even if Krugman does not.) As for the traditional Keynesian argument for federal surpluses in boom times, it has nothing to do with precautionary accumulation of financial assets, and everything to do with preventing aggregate demand from running ahead of aggregate supply.In the end, I suspect this idea of paid-in-advance Keynesianism says less about his intellectual weaknesses than about his institutional commitments. As a certified big-name economist, you have to make some concessions to orthodoxy if you don’t want to see your intellectual capital devalued. And what orthodoxy demands now — above all from those who want more expansionary policy — is gestures of somber concern with future deficits. (If not austerity today, at least austerity tomorrow.) With a few honorable exceptions, even left-leaning economists seem happy to comply.