The CERF Blog

The Eurozone is a confederation of 16 European countries. When joining, countries abandon control of their currency to the European Central Bank, and they agree to significant constraints on their monetary policy.

Why would they do this? Countries join hoping to benefit from increased trade efficiency and access to markets. Are the benefits of joining the Eurozone worth the costs? That depends on how correlated a country’s economy is with the Eurozone economy.

If a country’s economy is highly correlated with the Eurozone economy, then that country will be happy with the European Central Bank’s monetary policy, and the fiscal constraints will likely be relatively minor irritants. However, if a country’s economy is not highly correlated with the Eurozone economy, the European Central Bank’s monetary policy could be counter-productive, and the constraints on fiscal policy can be painful. It can put a country in a bind.

That is exactly where countries such as Spain and Greece find themselves today, in a bind. If they could, these countries would follow a much more expansive monetary policy and an expansive fiscal policy. The price they pay for membership is higher unemployment, a slower-growing economy, and the potential for social unrest. For these countries, joining the Eurozone is starting to look like a deal with the devil. We may see some countries leave.

The January United States jobs report contains mixed results that, to us, provide hints of a recovery to come. More on the recovery later. The bad news from the jobs report first: long term unemployed persons, (those who have been unemployed for 27 weeks or longer), climbed by about 500,000 to just under 6.5 million persons. Now for the good news: year-over-year job declines have been moderating for five months in a row. The declines peaked at five percent during July and August of 2009, and the January loss rate was only three percent. This is an improvement of 2.8 million jobs. The unemployment rate has been improving for three months now. It peaked at 10.1 percent October 2009 and is now 9.7 percent, having dropped 30 basis points in just the most recent month.

Finally, a few months ago jobs were being lost in virtually all sectors, but in this release there are a variety of sectors that are up. These include: Professional and Business Services, Retail Trade, and Durables Manufacturing, seasonally adjusted, from last month. The upticks in Professional/Business and Durables Goods manufacturing are particularly good for the household sector and the economy since these are decent-paying jobs.

There were a number of data revisions in this release. Contrary to some press reports, one should not worry too much about these revisions. The establishment survey revision, which drives the non-farm jobs data in charts below, impacted data starting in April of 2008. Our analysis of this data is based on relative changes either one month back or one year back and so do not go earlier than April of 2008. I.e. there is no break in the data we are analyzing. The household survey revision, which drives the unemployment rate data in charts below, impacted data starting in January of 2010. This might impact our analysis of the change from December 2009 to January 2010. However, the BLS uses the revised data and methodology to recalculate the December results, pages 6 and 7, and they find that the December unemployment rate estimate would not have changed and the implied change from December 2009 to January 2010 would not have changed.

We are tentatively encouraged by this press release. While jobs are still being lost, and while the long-term unemployed continue to rise, other aggregate indicators have been improving for at least a few months now, in some cases improvements have been occurring for almost a half a year. Keep in mind that jobs are still down from this time last year. So while we speak of a job market that is improving we are not quite speaking about a recovery yet. Recovery for us means job growth, which is not yet wide-spread. However, it is encouraging to see the job losses slowing down.

David Ricardo, the British economist who died in 1823, gave the world two deep economic insights. The first, the concept of comparative advantage, became economic gospel, used ever since to justify specialization and trade. The second, the concept of Ricardian Equivalence, has become almost as universally accepted.

Ricardian Equivalence asserts that only the amount of government spending matters, not how it is financed. This is the same thing as saying government debt does not matter. The logic is that taxpayers aren’t stupid. They see the debt as future taxes and save exactly what they need to pay the tax at some future date.

Now, Reinhart and Rogoff, in their highly recommended book “This Time is Different: Eight Centuries of Financial Folly,” provide evidence that high debt levels cause slower economic growth. They report a threshold: When debt exceeds 80 percent of GDP, gross product growth slows two percent. Today, David E Sanger, in a New York Times piece says “two numbers stand out as particularly stunning:”

“The first is the projected deficit in the coming year, nearly 11 percent of the country’s entire economic output. That is not unprecedented: During the Civil War, World War I and World War II, the United States ran soaring deficits, but usually with the expectation that they would come back down once peace was restored and war spending abated.

But the second number, buried deeper in the budget’s projections, is the one that really commands attention: By President Obama’s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years. In fact, in 2019 and 2020 — years after Mr. Obama has left the political scene, even if he serves two terms — they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.
For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded.
Or, as Mr. Obama’s chief economic adviser, Lawrence H. Summers, used to ask before he entered government a year ago, “How long can the world’s biggest borrower remain the world’s biggest power?””

These are clearly challenges to the concept of Ricardian Equivalence. So, why would Ricardian Equivalence not hold? I think the answer is that Ricardian Equivalence holds for relatively normal debt levels, but it falls apart at high debt levels. Why?
One reason may be that at very high debt levels it becomes clear that future generations will be paying a significant portion of the debt. To the extent that taxpayers value their own consumption over their decedents’ consumption, the motivation to save is reduced. Economists have long accepted a bequeath motive for savings. So, this argument is not particularly persuasive to me.
A more believable reason is the one implied by Reinhart and Rogoff and by Summers: High debt levels increase the probability of default or inflation, a slow form of default. This would explain both low savings levels and challenges from other governments.

Dan Hamilton & Mary Hanley

The January 27, 2010 DataQuick press release shows that California Notices of Default (NOD’s) fell from 111,689 in third quarter of 2009 to 84,568 in the fourth quarter of 2009. That is almost a 25 percent drop in NOD’s. NOD’s have been falling for three quarters now, which is a nice development. However, foreclosures rose for the third quarter in a row. Though the increase in foreclosures was not as large as the drop in NOD’s this steady increase in foreclosures indicates that all is not well in California’s residential real estate. As well, both NODs and Foreclosures remain historically high. See the charts below.

NOD’s falling from record highs is unquestionably good news. One has to wonder if the rapid decline is entirely due to home owners regaining their financial security or if some of it is due to seasonality. We note that in 2008 there was also drop in the last two quarters only to spike again in the first quarter of 2009. To investigate this farther, we seasonally adjusted the data. These results, blue line on charts below, indicate that foreclosures rose from about 48,000 during third quarter 2009 to 55,000 in fourth quarter 2009, a more sizable deterioration in the market. Otherwise, the seasonal adjustment process did not change the implications from the raw data very much.

The take-away from this data is that California NODs and Foreclosures remain historically high. As a result, residential real estate will continue to endure the damper on neighborhood quality and housing values. On the brighter side, if NODs continue to fall at the rate they did in fourth quarter, they will get down to very low levels in only three quarters. That would provide much needed support for the housing market.

Bill Watkins & Dan Hamilton

On January 26th, the blogger named Effective Demand commented on our January 25-th entry “Targeting Nominal GDP, Purchasing Homes, and Economic Recovery”. We thank you for your comment. We agree with you that too many people own homes, hard choices need to be made, and short sales or foreclosures must go on. Further, government programs to keep someone in their home who will eventually default anyhow are short-sighted.

You make the statement that the houses that exist are built in the wrong places, too far from job-centers. We agree with this, and purchasing homes in these markets would be a way to foster the re-equilibration process that, even with this plan, will take some time. The owners, we suggested local-area housing authorities, could rent them or use them to satisfy affordable-housing mandates.

You conclude by saying that we should “fix the economy and housing takes care of itself”. This recession is different. The problems started in housing, and were so deep and so lasting, the rest of the economy was pulled pretty far off its growth pedestal. Perhaps in “normal” recessions this conclusion makes sense, but perhaps not in this recession. We expect the economy will experience economic growth below its potential until the housing markets are repaired.

We are thrilled to see the first estimate of the 4th quarter GDP come in way above our forecast, but we wish we had forecast the change. We do expect to see the initial estimate revised down in subsequent releases.

Why did the GDP estimate come in so strong?

Mostly, it was investment. Fourth quarter 2009 private investment activity and consumption grew with such strength from third quarter that resulting fourth quarter GDP growth was a resounding 5.7 percent (annualized). The bulk of this growth, two-thirds of it, came from private sector investment activity. About ninety-percent of the private sector investment activity was driven by inventory spending.

Inventory changes have been negative since the second quarter of 2008, and it was massively negative during the first three quarters of 2009, as establishments corrected their stockpiles in light of the recession. Inventory change was still negative in fourth quarter, but was much less negative than in the third quarter, indicating increased spending to slow the inventory decline. See chart below.

The foreign trade sector and the government sector played little roles in driving fourth quarter economic growth. Trade contributed half a percent to overall GDP growth as export growth rose and import growth fell. Government sector expenditures actually contracted slightly during the fourth quarter of 2009.

These GDP growth results will improve people’s perceptions about the economy. Households, many of whom have volunteered to sit on the sidelines rather than make purchases, may now begin to move back into the arena of making purchases and investing in the future.

The future path of business inventories is very uncertain. We could see inventory changes increase again during 2010, providing further stimulus to GDP growth. Then again, the relatively weak 4th quarter retail sales may cause businesses to decrease target inventories. While we remained concerned about many weaknesses that remain in this economy, including residential real estate, commercial real estate, banking, and household balance sheets, our next United States forecast will likely be more optimistic.

Bill Watkins and Dan Hamilton

Scott Sumner maintains a blog in which he has argued that the FED should not target interest rates, but instead target nominal GDP. When the economy experiences a Liquidity Trap, as it arguably did in late 2008 and 2009, reducing the short-term target interest rate becomes ineffective as interest rates approach zero. Besides the traditional interest rate policy, in this recession the FED has also pursued a program of quantitative easing, including aggressive purchases of long-term debt securities. This new policy tool was Bernanke’s innovation, and we think it helped, especially during the second half of 2009.

While low short-term interest rates helped a bit, we believe the quantitative easing was the more effective policy tool. However, the FED could have done more. They could have targeted nominal GDP. How would they implement this policy? Obviously, they could not implement it via interest rate targeting.

They would buy things.

In this recession the best thing they could have bought would have been homes. Purchases of homes in areas hard-hit by foreclosures would have been especially helpful. Foreclosures kill a neighborhood like little else. They have and are causing continuing losses at Wall Street and at banks across the country. In turn, bank failures and weak banks are a continuing drag on the economy.

How might the Fed administer a real estate purchase program? They could use local housing authorities and agencies. The local housing authorities understand the communities they work in. They are already in existence in virtually every community, even small ones, and they know how to purchase and administer residential real estate. It is already the case that, in many areas, local area housing authorities have become the only active residential real estate developers, since the incentive for the private sector to provide new housing is very low.

Purchasing homes in hard-hit neighborhoods would restore the neighborhoods, provide a floor of support for residential real estate market activity, help with the growing demand for affordable housing, and help banks resurrect their balance sheets. It would foster a recovery.

The Oregon Employment Department’s Labor Market Information System released December 2009 jobs and employment data for Oregon’s counties today. In most respects, Central Oregon’s labor market is not significantly changed from November, and very close to our forecast.

The Bend MSA (Deschutes County) seasonally-adjusted unemployment rate fell from 14.2 percent in November to 14 percent in December. The Jefferson County unemployment measure fell from 14.4 to 14.1 percent, while the Crook County measure rose from 16.7 percent to 16.8 percent. The declines are due to labor force declines, and not new jobs.

Year-on-year non-farm jobs changes were negative for each of the three counties, which was the case in November. The year-on-year job declines moderated slightly for Crook County, from a 13.6 percent decline in November to a 11.1 percent decline in December. The year-on-year job declines for Deschutes County and Jefferson County were unchanged at 2.5 percent declines and 3.2 percent declines, respectively.

In Crook County, the year-on-year job declines are in all sectors except Retail Trade and Leisure/Hospitality, which is counter to the trends in the State and the United States. In Deschutes County, the year-on-year job declines are in all sectors except Leisure/Hospitality, Personal/Maintenance Services, and Government. In Jefferson County the year-on-year job declines are in only six sectors, in contrast to the State and the Nation. The non-declining sectors include: Construction, Wholesale Trade, Retail Trade, Technology, Education/Healthcare, Leisure/Hospitality, and Personal/Maintenance services.

Central Oregon’s job resilience in Leisure/Hospitality is due to tourism and December tourism at least as evidenced by this jobs report, is providing support to the Central Oregon economy. In part at least, this is due to better early-season ski conditions. Tourism will likely support the Central Oregon labor market for a few months yet to come, which is good news indeed.

We interpret the Central Oregon December jobs report as indicating the area is still “Bumping Along the Bottom”. However, if the non-tourism sectors can begin a process of recovery, then along with the strength in Tourism, the area’s economy could begin a nice recovery.

The December California jobs report, out today, shows that the seasonally-adjusted unemployment rate held steady from November at 12.4 percent. The year-on-year job declines subsided from November’s -4.2 percent to -3.9 percent in December. The annualized month-on-month job decline, which is very volatile, worsened from -1.5 percent in November to -3.2 percent in December.

Almost two-thirds of California’s 600,000 fewer jobs from December 2008 are accounted for by losses in only four sectors: Construction (-116,000), Manufacturing (-106,200), Trade (-109,200), and Professional/Business (-90,400). The public sector lost more than 44,000 jobs from December of 2008.

California’s job market appears to be bumping along the bottom of this recession. The question for the next year is the balance of public versus private sector. The private sector does appear to be improving while the public sector will likely worsen due mostly to budgetary problems at the state level. Given that the private sector is 83 percent of the total, it is likely that the improving private sector will offset the worsening public sector at a rate that implies that overall jobs will improve. However, these are just improvements, as year-on-year job growth will remain negative for at least a few more months.

Today’s Oregon jobs report for December shows mixed results in the State’s job market.  The OES’s Labor Market Information System provided the December estimates for the state this morning and will provide them for Oregon’s counties on Friday morning. 

The State’s Year-over-year job losses are improving a bit, from a loss of about five percent in November to a loss of 4.3 percent in December.  The seasonally adjusted unemployment rate rose about three tenths of a percent, from 10.7 percent to 11.0 percent.  The seasonally-adjusted non-farm job growth rate was actually up 0.2 percent in December, the first increase month-on-month in four months and one of only two cases of an increase during all of 2009. 

As with other areas that we cover, the year-on-year declines are in all sectors except (private) Education and Healthcare where this is being driven mainly by Healthcare.  For a variety of reasons, including overall population aging and inelasticity of demand, Healthcare has been somewhat resistant to the gale-force winds of this Great Recession.  The hardest-hit sectors in December were: Construction, Manufacturing, Retail Trade, Financial & Real Estate, Professional & Business, and Leisure & Hospitality.

We interpret the Oregon December jobs report as indicating the State is still “Bumping Along the Bottom”.  If the improvements in job growth continue then the status might change to “Recovery”.  Given the intrinsic volatility of monthly data, we will wait until a couple more months of data to verify that.