Friday, October 23, 2009

Romer and Reality

Perhaps it would be a good thing to keep CEA head Romer in DC because that way she would not be capable of educating any more economists. In fact it may be good to get all economists to the White House and close down the departments and just let the trade wither away.

CEA head Romer testified before Congress yesterday and she stated:

"There is no question that the past year has been one of enormous challenges for the American economy. The recession that began in December 2007 has been the worst we have faced since the Great Depression. The suffering it has brought to American workers and their families has been terrible. The toll that it has taken on American businesses has been great across the spectrum—affecting firms both large and small; those in services as well as manufacturing; and firms in every state and community."

Her facts are just plain wrong. Unemployment and GDP changes are still below prior recessions and this is nowhere near the Depression. I remember the Nixon collapse when at MIT the Aero Department was down to 5 students and there were no recruiters at the student placement center, none, zero. The NY Times ads for jobs was zero, that was when everything was in the paper, no Internet, the job section had been eliminated! Then there was Carter in 1980 and I bought my NJ house with an 18.5% mortgage! The credit card rates were lower! Romer is just not connected with what has happened in the economic world! Try the Telecom bust, try the collapse of Thailand and Russia in 1998, I was there with my companies. You just adjust and pray that the economists just stay away!

She in a self serving was states:

"A key causal factor in both downturns was a decline in household wealth that lowered consumer spending. In 1929, however, the crash of the stock market in October mainly reversed a large run-up in stock prices that had taken place between June and August, and house prices declined only slightly. As a result, household wealth fell by just 3 percent between December 1928 and December 1929. In 2008, in contrast, stock prices fell 24 percent in September and October alone, and house prices fell 9 percent over the year. All told, household wealth fell 17 percent between December 2007 and December 2008, more than five times the decline in 1929."

The reason now is home values which had exploded to unheard of levels and are now back to where they were in 200%. Frankly where they should have been. The second factor is that many people now have 401Ks where in 1929 few people had any retirement. She is comparing apples to oranges.

She presents her new projections in the following chart.



















We have combined and reformatted her data. The GDP change is based upon little if any data and her projections on unemployment although dire are likewise baseless.

As to inflation she states:

"Some have expressed concern that the unprecedented monetary actions taken by the Federal Reserve and the similarly unprecedented fiscal actions taken by Congress and the Administration have created conditions likely to result in inflation.

Such concerns are unwarranted in the near and medium term. Historically for the United States, the main determinant of movements in inflation is the relationship between output and the economy’s productive capacity, with additional influences from oil price movements and other supply disturbances. When output and employment are high relative to the economy’s comfortable capacity, inflation rises, as it did in the late 1960s and late 1970s. When output and employment are low relative to capacity, inflation falls, as it usually does during and after recessions.

The behavior of inflation so far over the recession and forecasts of its likely behavior going forward fit with this view. Figure 6 shows inflation measured using both the consumer price index, which is highly influenced by the behavior of food and energy prices, and the GDP price index, which is less influenced by these volatile components. The figure shows that both measures of inflation have fallen over the course of the recession. Economic theory and evidence suggests that there is a relationship between monetary expansion or budget deficits and inflation, but that it operates via the demand for goods: rapid money growth and large budget deficits lead to inflation when they fuel a growth in demand beyond the economy’s normal capacity."

She continues:

"Measures of expected inflation, whether from professional forecasters (such as the one shown in the chart), surveys of consumers, or inferences based on interest rates on inflation-protected securities, all show that expectations of inflation remain subdued. Indeed, it appears that the major reason that actual and expected inflation have not fallen further is that the Federal Reserve’s record of inflation control over the past quarter century has kept inflation expectations well anchored. Even stronger evidence that a large expansion of central bank reserves and budget deficits in a weak economy do not lead to inflation comes from Japan."

Yet she fails to take into account the fact that we now have a 92% Government Debt to GDP and if the current Administration continues it will be 130-140% at then end of 2012! That will be unsustainable and it will most likely be that factor driving inflation. Add to that the fact that we rely so strongly upon China which holds almost 25% of our public debt then we have truly real problems if they allow their currency to float. The dollar will collapse and as they say, you have seen nothing yet. Romer is working with a Samuelson 1970 economic model, the world is linked and it will be that linking that will driven everything down unless spending us dramatically curtailed.