First, I agree with Mark Thoma that Mr. Posner apparently has little understanding of macroeconomics, either of old-style Keynesian type, or the new(er) real business cycle type, or certainly New Keynesian approaches. His charge that her current pronouncements are at sharp variance with her earlier academic work really makes me wonder if he's read any of Dr. Romer's previous work. I suspect that he's taken at face value the conservative mis-apprehension that her tax cut paper contradicts the view that government expenditures can have an impact on growth. As I've explained in my responses to reader comments here, Romer and Romer (2008) provided estimates of tax cut multipliers, but no spending multipliers. Hence, a comparison of instrument efficacy is not feasible (comparing multipliers across methodologies can be done, but would be inappropriate).

Second, I would not pass a student out of intermediate macro who wrote in an exam:

The impact of the public-works program on investment is more complicated. But suppose, plausibly in a serious economic downturn such as the one that we're in at present (and that was even more serious back when the stimulus bill was enacted), that a great deal of investment is in the form of passive savings, such as demand deposits and Treasury securities, because people and companies are anxious about their economic prospects, and they want safe savings, rather than savings that would be at risk because invested in entrepreneurial projects.

As Mark Thoma points out, this is confusing a financial investment with physical investment in a NIPA sense.

This confusion tells me that anybody writing far outside their area of expertise should think twice, consult a textbook or two, before committing virtual pen to virtual paper. (I'm not saying one shouldn't write outside of one's area of research expertise on a weblog -- just one has to be careful).

Third, before he pontificates on what economists who work in the government should or should not be doing, I think Mr. Posner should read Martin Feldstein's discussion of how the CEA works ("The Council of Economic Advisers and Economic Advising in the United States," The Economic Journal, Vol. 102, No. 414 (Sep., 1992), pp. 1223-1234 [JSTORE pdf]; excerpt here). Here's a quote:

Although the CEA is physically as well as operationally part of the White House complex (CEA offices are in the Old Executive Office Building adjacent to the White House and within the same security cordon), the economic staff functions in a completely professional and nonpartisan way. My very able and distinguished staff included Larry Summers, who was prominent as chief economic adviser to presidential candidate Michael Dukakis.

The tradition of professionalist is so strong that even in a presidential election year the CEA chairman appoints members of the staff for the coming academic year with the clear understanding that they will continue to serve even if the party in power loses the presidential election. ...

My limited observations, having been a staff economist in the situation mentioned in the last paragraph, is that CEA members (nominated by the President and confirmed by the Senate) do not "leave behind their academic scruples" when they move from academia to government service. That doesn't mean that I think they're correct in their analyses -- just that what they believed when they came in is pretty close to what they say in public. (After all, silence is also an option.)

Fourth, I think any blog post (let alone paper) should be internally consistent. Consider Mr. Posner's (approving) statement:

Most economists, however, believe that it is unrealistic to suppose that people have enough information about the future to adjust their current behavior to expectations of higher taxes, inflation, devaluation, or other possible consequences of an increase in the national debt. There is too much uncertainty.

Then, he says two paragraphs later:

But Romer actually gives some credence to the unrealistic picture of the far-sighted consumer or businessman by arguing that recipients of tax credits authorized by the stimulus bill will spend rather than save the tax-credit money because they will assume that the credits are permanent.

But if in fact consumers do not look forward (as Mr. Posner argues, not as Dr. Romer argues), they will only respond to current changes in disposable income, and in fact the multiplier will look pretty big.

(Actually, I find the biggest problem with Mr. Posner's argument here is that the failure of consumers to respond in a fashion consistent with unencumbered intertemporal optimization w/perfect certainty is not due only to uncertainty, but also liquidity constraints, as well as possibly more exotic utility functions.)

Fifth, Mr. Posner should read a bit more widely. He states:

Romer argues in her talk that by the end of the second quarter of this year, $100 billion of stimulus money had been spent. That is a suspiciously round number, and it is unclear how it was arrived at; but let us assume it is accurate. She then argues that this small expenditure--about two-thirds of one percent of the Gross Domestic Product--is responsible for the fact that the decline in GDP fell (on an annualized basis) from 6.2 percent in the first quarter of the year to 1 percent in the second quarter (though the latter figure is likely to be readjusted upwards).

This assertion is groundless. No one has the faintest idea what effect the stimulus has had.

As someone who had to "fact-check" numbers going into White House policy documents and speeches on occassion, I can say that the numbers are verifiable regardless of Administration (whether they are interpreted in an appropriate fashion is a fair question).

But the more substantive question is whether the math is so nonsensical. As I showed quite clearly in this post, the number Dr. Romer obtained was easily calculated and plausible.

Sixth, my impression is that former CEA staffers and members that have become bloggers are pretty careful with the numbers and analytics -- certainly more so than Mr. Posner. These include Jeff Frankel, Paul Krugman (notwithstanding Mr. Posner's barbs), Andy Samwick, Diane Lim Rogers, and Nouriel Roubini. (see this post for former gov't/Fed economists who became bloggers.)

Martin Feldstein has recently raised the possibility that we might experience a relapse into recession in 2010 (a perfect symmetrical W), with the next dip in 2010. In my view, this means (1) we should have opted for a bigger and better composed stimulus package, and (2) the timing of expenditures in the stimulus package might not be as problematic as many commentators have indicated.

"I think we"re going to see a temporary substantial improvement," Feldstein, the former head of the National Bureau of Economic Research and a Reagan administration adviser, said today in an interview on Bloomberg Radio. "I emphasize the words temporary and substantial."

Feldstein -- a member of the private panel that dates the start of recessions and recoveries -- suggested the economy will contract into next year, and that the pattern of economic turnaround will be more of a seesaw than what he called "a beautiful symmetrical W."

Interestingly, neither the OECD nor Deutsche Bank project such a "W" shaped trajectory. Nor do any of the forecasters in the May WSJ survey.

That doesn't rule out the possibility of this occurring. I can think of several reasons for thinking a W shaped recession would be plausible. The most plausible in my mind would be if the world economy failed to rebound sufficiently to provide enough externally generated aggregate demand via exports. The other possibility is that monetary policy tightens too soon, as inflation hawks press their case (see FRBSF President Janet Yellen's assessment, as well as this post).

The Timing of Stimulus Spending, Again

At this juncture, it's useful to recall that the peak in spending would be in FY2010. As shown in this figure from this post, roughly half of the stimulus occurs in from October 2009 to September 2010.

I know that there's going to be a big group of commentators who will argue the multiplier is 0, but I'll go with the CBO and assert there will be some impact of indeterminate amount. In addition, if the critics who have argued that the spending is occurring much too slowly are correct [0], then the actual spending will more likely occur in this "dip" period that Feldstein is predicting. (Previously, I argued that the recession was likely to be long, so speed would not be of the essence [1]).

Mendacity Alert

Figure 1 also demonstrates why the critics of the stimulus bill that cite today's nonfarm payroll losses are being disingenuous. It was understood that most of the spending would not occur in FY2009, and even that which occurred within FY2009 would be toward the end of the year. (Really, did anyone expect the impact to be discernable in four months after the bill's passage?).

The series in Figure 3 are plotted in log terms. This means that changes in the slope indicate changes in the percentage rate of change in the indices. The fact that the slopes for the blue and green lines means the rate of deterioration in employment is declining. However, there was little evidence before that the labor market was improving even before this morning's release [2], and that point is reiterated today by Jeff Frankel.

Interestingly, if the critics of the stimulus bill focus on changes in trends post ARRA [i] [ii] [iii], they might regret it in the future (well, assuming they're interested in internal consistency of argument). That's because the rate of GDP decline does look like it's stabilizing in 2009Q2, at least based on early readings from e-forecasting and Macroeconomic Advisers. (Once again, the series are plotted in log terms, so changes in slope can be identified as changes in the percentage growth rates.)

Valid, and Not so Valid, Criticisms of the Stimulus Bill

I do think the one big failings of the stimulus package that I highlighted back in March is now coming to light: the cut in the transfers to states that came about as a result of the compromise with the Senate Republican moderates [3]. As the states grapple with truly challenging budget shortfalls [4] [5] [6], they are cutting spending and raising taxes – exactly the measures that the textbooks say are not ideal from a countercyclical stabilization policy standpoint.

One digression on bureaucratic procedures. In the day before yesterday's NYT, David Leonhart chastises the Administration for using models that were too optimistic. I certainly agree in retrospect the Administration's baseline forecast was too optimistic. Two observations: First, it's important to realize that the end-February assessments were based upon early January forecasts completed by the previous (Bush) Administration, and finalized on February 3 [7]. When taken in that light, I don't believe the forecasts were that much out of line with private sector forecasts [8]. Second, (in my limited experience) if one is to deviate from a model, it helps to have a formal alternative model to use. It's not clear to me an alternative formal model that had widespread acceptance exists, so, it's all fine and good to say a more pessimistic model should've been used, but it's hard to make a case for that in a bureaucratic setting, especially if it deviated from the Blue Chip.

"The data are pretty clear that we are not in a recession," Council of Economic Advisers Chairman Edward Lazear told a meeting of editors and reporters from the Wall Street Journal and Dow Jones Newswires.

...

"I would be very surprised if the NBER, looking back at this period, would date this as a recession," Mr. Lazear said. There are even indications that revised first-quarter estimates would be slightly stronger than 0.6%. "The optimists seem to have been closer to right on that than the pessimists," he said.

Just to reiterate, that quote is from May 2008.

Here's a picture of GDP and gross domestic income (as suggested by Jim in this post, and noted in the BCDC announcement).

I thought at the time Ed Lazear would regret those remarks. But Lazear's views were not unique. Here are some additional quotes of interest, hoisted from the comments sections in Econbrowser:

From March 2008, in response to my worries about 2008H2 growth:

While the financial market turmoil and dysfunctional credit markets are significant wild cards, interest rates are so low (and could be 2.25% this week!) that you have to think that growth later this year and into '09 should be positive, if not strong.

Yet another:

The Macroeconomic Advisers monthly real GDP index rose to a record high in December. It fell in October but rebounded in November and December.

Preliminary indicators suggest it rose again in January.

I get a sense that some academic economists are actually rooting for a recession, a way of punishing the country for having elected Bush.

...

In other words, looking at data too close to the candidate turning point can easily lead to subsequently embarrassing remarks. Nonetheless, the specific dating of the recession to December 2007 has spurred lots of queries about whether it matters, when (i) the recession is so much in evidence, and (ii) whether any greater importance should be accorded to a declaration by the NBER as opposed to any other group or individuals. Here are some thoughts on both questions, augmented with some retrospective views.

First, to the question of whether it matters that there's a declaration. Here, I turn to Jeffrey Frankel, who is on the NBER BCDC, but is speaking on his own behalf:

We sometimes hear the question "Who needs the NBER Committee anyway?" This question most often comes in one of two forms:

(a) Everyone in the real world has known that the economy has been in a recession for some time. In past cycles, media reports have sometimes taken the line "Ivy Tower Eggheads Finally Figure Out What Everybody Else Has Known All Along." The implicit critique is that the committee takes too long after the event -- typically almost a year -- to make its declaration. One short answer is that our job is to be definitive, authoritative, but not fast. We don’t want to have to revise our dating of the peaks and troughs later, in part because it would sow confusion among those who rely on them (from econometric researchers to political speechwriters). GDP and other official statistics are often revised after the fact, for example. We leave it to others -- pundits, forecasters, consulting companies, financial newsletters, and so on -- to try to get there first. We deliberately get there last.

(b) The other form taken by the question "Who needs the NBER committee?" runs as follows: "The rule of thumb is simple: two consecutive negative quarters of GDP growth. Why complicate things?" The Frequently Asked Questions segment of the BCDC announcement answers this in detail. For now, observe simply that questions (a) and (b) are inconsistent with each other. As of December 1, 2008, the US economy has not yet experienced two consecutive negative quarters. So an argument that we should wait for two consecutive quarters (critique b) is the opposite of the critique that we should have acknowledged a recession before now (critique a).

Taking Frankel's points into account, we can then move to the second question, whether it matters that NBER BCDC makes the determination. Think back to the two-quarter rule of thumb. Why is it a "rule of thumb"? Because the data are revised over time -- most importantly GDP -- the two quarter (sometimes defined as a "technical recession") is heavily reliant upon the series that is most subject to revision. I've discussed the importance of revisions numerous times in this context: [1], [2], [3], [4], [5].

Another motivation is to recall that the NBER is a research group, and not a policy group, trying to identify for historical purposes the ebb and flow of activity. In any case, we want to place the responsibility for identifying peaks and troughs in economic activity in the hands of a disinterested group, and not in -- say -- the government. (I'll add that it's an auspicious group: "Robert Hall, Stanford University (chair); Martin Feldstein, Harvard University and NBER President Emeritus; Jeffrey Frankel, Harvard University; Robert Gordon, Northwestern University; James Poterba, MIT and NBER President; David Romer, University of California, Berkeley; and Victor Zarnowitz, the Conference Board. Christina Romer of the University of California, Berkeley, resigned from the committee on November 25, 2008, and did not participate in its deliberations of November 28.")

(For those wondering why NBER gets to declare the recession dates, one hint is that it was NBER researchers Burns and Mitchell (1946) who developed the lens through which "cycles" experienced in industrial economies were perceived. For the inquisitive, here is a link to the volume which summarized that research: Burns, Arthur F. and Wesley C. Mitchell, Measuring Business Cycles (NBER, 1946).)

This is why I think so much of the commentary, saying that this was all obvious, not only demonstrates a distressing level of ignorance, but also a juvenile approach to discourse (see e.g., here). Yes, it was pretty obvious that we were in a recession, but when it began is something that could have been placed at any number of dates. We will have a similar debate when we starting thinking about dating the trough.

I think it's also of interest to look back at whether we should be so surprised. I'll focus on the debate that occupied our attention months ago: whether the yield spread had predictive power for future economic activity. Well, now we can conclude the answer was yes. The inversion in August 2006 predates the recession's beginning by about 16 months.

Now, what we don't know is how well the prediction holds cross-country. This graph from a March 2007 post suggests it will work for Europe (we'll have to see what CEPR says, although current forecasts seem pretty definitive).

Here's a cross-country snapshot from an October 2007 post.

Australia and the UK seemed to be conforming to the prediction from the yield curve. Canada so far has failed to experience negative growth, and so might be thought to also conform to the prediction of yield curve -- at least so far.

Technorati Tags: yield spread, GDP, gross domestic income, recession, term premium, data revisions, NBER, and Business Cycle Dating Committee.

Today, we're fortunate to have Jeff Frankel, Harpel Professor at Harvard's Kennedy School of Government, as a guest blogger. His blog is here.

The possibility that some Gulf states, particularly the UAE, might abandon their long-time pegs to the dollar is getting increasing attention (from Martin Feldstein and Brad Setser, for instance). It makes sense. The combination of high oil prices, rapid growth, a tightly fixed exchange rate, and the big depreciation of the dollar against other currencies (especially the euro, important for Gulf imports) was always going to be a recipe for strong money inflows and inflation in these countries. The economic dynamism -- most striking in Dubai -- is admirable and fascinating, but also now clearly indicative of overheating. Indeed inflation, as predicted, has risen alarmingly. Among other ill effects, it is producing unrest among immigrant workers. An appreciation of the dirham and riyal is the obvious solution.

Most often discussed as an alternative to the dollar peg is a peg to a basket of major currencies. This would be an improvement. Kuwait, for example, made this switch a couple of years ago.

But a basket peg does not address the fact that when oil prices rise generally (not just against the dollar), as in recent years, monetary policy is constrained to be looser than it should be. Similarly, when oil prices fall generally (not just against the dollar), as in the 1990s, monetary policy is constrained to be tighter than it should be. A floating exchange rate would be the traditional alternative, on the theory that the currency would then automatically appreciate when oil prices rise and depreciate when they fall. But there are serious disadvantages to small open countries floating, such as the loss of a nominal anchor for monetary policy. Today's reigning orthodoxy is to add an inflation target as the new nominal anchor. But this doesn't solve the problem if the price index is the CPI, which gives little weight to oil, the biggest sector in production and exports.

I believe that a better solution would be to include the price of oil in the basket of currencies to which the Gulf currencies would peg. I have laid out the case elsewhere. (I call it PEP, for Peg the Export Price [pdf]) I was pleased to see recently that the Financial Times mentioned this option approvingly ("Dollar-pegged Out," July 7):

"The Gulf needs to peg to something. A first step (after revaluation) would be to peg to a basket of currencies that included the euro and the yen. A bolder step would be to include the price of oil in that basket, so that currencies would appreciate when oil is strong, and depreciate when it is weak."