Macroeconomic Patterns and Stories

Dr. Edward E. Leamer
University of California
UCLA
Anderson School of Management
Global Economics & Management Area
110 Westwood Plaza
Los Angeles CA 90095-1481
edward.leamer@anderson.ucla.edu

 

Contents
Part I Introduction
1 Introduction: We Are Pattern-Seeking, Story-Telling Animals ....... 3
1.1 Advice:DoBothPatternsandStories ......................... 5
1.2 WeCanAlsoAnalyze ...................................... 7
1.3 Pictures,Words,andNumbers:InthatOrder ................... 9
1.4 AnalyticalThinking:IthinkICanHelp ....................... 10
1.4.1 Forecasting Is a Participant Sport . . . . ................. 10
1.4.2 Tell Someone About It: It Will Help You More
ThanThem........................................ 11
1.5 WhatNow?............................................... 11
1.6 Preview:TheKeyPattern ................................... 12
1.7 Data Sources . . . . . . . ....................................... 12
1.7.1 Updated Displays . . . . . . ............................ 13
1.8 Appendix: Statistical Science Is Severely Limited
in Its Applicability . . ....................................... 13
1.8.1 Was that 1969 Draft Lottery Random? Was It Fair? ...... 13
1.9 Conclusion . .............................................. 16
Part II Four Key Variables: Growth, Unemployment, Inflation and
Interest Rates
2 Gross Domestic Product ......................................... 19
2.1 Definitions ............................................... 19
2.1.1 GDP Is an Imperfect Measure of Economic/
Material Success ................................... 19
2.1.2 WhatDoThoseThreeLettersStandFor? .............. 22
2.1.3 What’s “Gross” About Gross Domestic Product? . . ...... 24
2.1.4 What’s “Real” About “Real GDP” and What Is
“Nominal” About “Nominal GDP”? . . ................. 24
ixx Contents
2.1.5 What Does SAAR Mean? . . . ........................ 27
2.1.6 What Is an Annualized Compound Rate of Growth? . . . . . 28
2.2 WhatDoesRealGDPLookLike?............................ 28
2.2.1 Does a Logarithmic Scale Help? The Narrow Corridor
ofUSGDPGrowth................................. 28
2.2.2 Four Pictures: What Does Growth of Real GDP
LookLike?........................................ 30
2.2.3 How Much Is $10 Trillion? Does Dividing by
EmploymentHelp?................................. 34
Appendix: The Index Number Problem and Chain Indexes . . . .......... 35
Appendix: The Seasonal in GDP Is Very Large . . . . . . ................. 36
3 The Components of GDP: C+I+G+X−M ...................... 39
3.1 HowMightGDPBeMeasured?.............................. 39
3.1.1 National Income and Employee Compensation . . . . ...... 40
3.2 HowIsGDPActuallyMeasured? ............................ 42
3.3 How Big Are the Components: C, I, G, X − M? ................ 44
3.3.1 Which Are the Most Volatile Components of GDP? . . . . . . 45
Appendix: GDP and National Income . . . ............................ 49
Appendix: Answer to Footnote Question ............................ 49
Appendix: A Better Way to Treat Imports and Exports ................. 49
4 Employment ................................................... 51
4.1 Labor Market Surveys . . . ................................... 51
4.1.1 CES:CurrentEmploymentStatistics .................. 52
4.1.2 CPS: Current Population Survey . . . . . ................. 56
4.1.3 Initial Jobless Claims . . . ............................ 59
4.2 Industry Composition of Payroll Jobs . ........................ 62
Appendix: Which to Rely on: Business-Reported Payroll Jobs
or Household-Reported People-at-Work . . . . . . ................. 62
5 Inflation and Interest Rates ...................................... 65
5.1 APriceIsaRatio.......................................... 66
5.2 TheConsumerPriceIndex(CPI)............................. 66
5.3 TwoViewsofInflation ..................................... 67
5.3.1 Homework........................................ 69
5.4 Interest Rates on Short-Term US Government
Securities . . . .............................................. 70
5.5 The Real Interest Rate: The Price of Durability
and the Compensation for Waiting ............................ 72
5.5.1 ALookattheData ................................. 73
5.6 Interest Rates on Long-Term US Government Securities and
Monetary Policy . . . . ....................................... 74
5.6.1 The Term Structure of Interest Rates: Theory . .......... 76
5.6.2 Real Returns on One-Year and Two-Year Treasuries . . . . . 80Contents xi
5.7 What Determines the Shape of the Yield Curve? . . . . . . .......... 82
5.7.1 Why Is the Yield Curve Generally Upward Sloping? . . . . . 82
5.7.2 Why Is the Yield Curve Sometimes Steep
andSometimesInverted?............................ 83
5.7.3 What Determines the Level (Not the Slope) of the Yield
Curve? ........................................... 85
Appendix: Q and A from BLS Web Site Regarding the CPI . . . .......... 86
Appendix: Risk Characteristics of Bonds ............................ 88
Summary................................................. 90
6 Extrapolative Forecasting ....................................... 91
6.1 RegressionTowardtheMean ................................ 91
6.2 Forecasting and Regression Toward the Mean . ................. 94
6.3 Persistence, Momentum . ................................... 96
6.4 PicturesthatHelptoUnderstandtheNumbers.................. 99
6.5 Stories that Help to Understand the Numbers . . ................. 99
Part III A Recession Symptoms
7 Unwanted Idleness: Recessions and Recoveries .....................103
7.1 WorkerIdleness:Unemployment.............................104
7.1.1 The NBER Definition of a Recession Isn’t So Great . . . . . 104
7.1.2 Identifying the Recessions in the Unemployment Data Is
Child’sPlay.......................................105
7.2 Capital Idleness: Capacity Utilization in Manufacturing . . . . ......107
7.3 Work Intensity: Hours per Week in Manufacturing . . . . ..........108
7.4 Five Episodes: Normal Growth, Sputters, Spurts,
RecessionsandRecoveries ..................................109
8 Recession Comparison Charts ...................................111
8.1 RecessionComparisons:EmploymentandOutput...............111
8.1.1 PayrollEmployment................................111
8.1.2 RealGDP.........................................113
8.2 Idleness ..................................................115
8.2.1 Household Unemployment Rate . . . . . .................115
8.2.2 Capacity Utilization in Manufacturing .................116
8.2.3 Hours per Week in Manufacturing . . . .................117
8.3 OtherIndicators ...........................................118
8.3.1 Industrial Production . . . ............................118
8.3.2 Employment in Manufacturing and Construction . . ......119
8.4 Numbers .................................................121xii Contents
9 Who Struggles and Who Does
Well in Recessions? .............................................123
9.1 Job Losses in Recessions Affect Some Sectors
MorethanOthers..........................................124
9.1.1 The 2001 Recession Was an Anomaly .................130
9.1.2 With that Anomalous 2001 Recession, What Will the
NextRecessionBeLike?............................132
9.2 Many Sectors Lose Profits in Recessions . . . . . .................133
Part III B Recession Stories
10 Idleness Stories .................................................139
10.1 How Do Economists Explain Unwanted Idleness? . . . . . ..........140
10.1.1 The Job Cycle Is Mostly Construction and Manufacturing 143
10.2 BrokenRelationships.......................................143
10.3 Soaking the Rich When Times Are Bad . . . . . . .................146
10.4 MakingDowiththeOldCar ................................149
10.5 APyrrhicVictoryofHopeOverReason.......................150
Appendix: Supply and Demand Models of Unemployment . . . ..........152
11 Cycle Stories ...................................................155
11.1 The Harrod-Samuelson Multiplier-Accelerator Model . ..........158
11.2 Some Acceleration Facts . ...................................160
11.3 The Supply Chain Bull-Whip ................................162
11.4 Rush to Exploit New Ideas . . . . . . ............................164
11.4.1 TheIntensiveMarginandtheExtensiveMargin.........164
11.4.2 The Simple Agronomy of an Idea Rush . . . . . . ..........167
11.4.3 Kondratieff Long Waves . ............................169
11.5 Ponzi Schemes and Asset Bubbles . . . . ........................170
11.5.1 Housing Bubbles . . . . . . . ............................171
Part III C Recession Early Warning Signs
12 Clues: Temporal Ordering of Components
of GDP ........................................................175
12.1 Help from Sherlock Holmes . . . . . ............................176
12.2 ContributionstoGDPGrowth ...............................177
12.2.1 NormalTrendContributionstoGDPGrowth ...........180
12.2.2 Abnormal Cumulatives . . ............................182
12.3 Average Temporal Orderings: It’s a Consumer Cycle,
NotaBusinessCycle.......................................183
12.4 Eight Consumer Cycles, a Disarmament Downturn,
and an Internet Rush Comeuppance . . . ........................186
12.4.1 The 1953 Department of Defense Downturn . . ..........190
12.4.2 The 2001 Internet Comeuppance . . . . . .................191
12.5 HousingFalsePositivesandFalseNegatives ...................195Contents xiii
12.6 A Story of the Consumer Cycle: Our Collective
BipolarDisease ...........................................196
12.7 Numbers, If the Pictures Are Not Enough . . . . . .................197
12.7.1 Regression Analyses to Support What the Pictures Say . . . 197
12.7.2 ASummaryTable..................................199
12.8 Summary.................................................201
Appendix: Normal Contributions in Three Episodes . . .................201
13 More Clues: Episodic Forecasting with Components of Conference
Board’s Index of Leading Indicators ..............................203
13.1 Components of the Leading Indicator Index . . . .................203
13.2 Forget that Expectations Variable .............................205
13.3 Only a Few of Those Components Predict
Oncoming Recessions . . . ...................................207
13.4 Combining the Components into an Overall Index . . . . ..........211
Appendix: Description of Leading Indicators .........................214
Part III D Recession Causes
14 The Art of Drawing Causal Inferences from Nonexperimental Data . . 219
14.1 PostHocErgoPropterHoc..................................219
14.2 Cause=Intervention .......................................221
14.2.1 Our Hypothetical Interventions Are Very Few. ..........222
14.3 There Are Many Roadblocks in the Way of
Causal Inferences . . . .......................................223
14.3.1 We Can Pretend to Draw Causal Inferences, Even If We
Cannot Do It . . . ...................................225
14.4 Use Biological, Not Mechanical Metaphors . . . .................226
15 In Search of Recession Causes ...................................231
15.1 What Are We Looking for? . . . . . . ............................232
15.2 Fiscal Policy Seems to Both Cause and
PreventRecessions.........................................235
15.2.1 The Department of Defense Is Implicated
in the 1953 and 1969 Downturns . . . . . .................235
15.2.2 Federal Taxation Might Matter . . . . . . .................238
15.3 The Causal Path Through Houses and Cars . . . .................239
15.3.1 HousingPredictsRecessions.........................240
15.3.2 Consumer Durables Spending Predicts Recessions . ......242
15.3.3 Housing and Consumer Durables Are Predicted
byInterestRates ...................................244
15.3.4 NotSoFast .......................................246
15.3.5 The Fed Raises Short-Term Interest Rates
at the Ends of Expansions . . . ........................248
15.3.6 Spillovers from Housing: The Wealth Effect or Not? . . . . . 254
15.3.7 Two Stories of How Monetary Policy Causes Recessions . 255xiv Contents
Appendix: Two More “Causes” . ...................................258
Oil Price Increases Preceded Some of the Recessions ..................258
Weakness in Exports Has Not Caused US Recessions . .................258
Part IV Expansions: With and Without Spurts
16 The Life Cycle of US Expansions:
Sputters and Spurts .............................................263
16.1 Production and Employment During Expansions . . . . . . ..........264
16.1.1 Real GDP Grows During Economic Expansions . . . ......264
16.1.2 Labor Markets Sometimes Tighten Twice
During Expansions . . . . . ............................266
16.1.3 CyclesinHoursandUnemployment ..................267
16.1.4 Spurt Comparison Graphs . . . ........................273
16.2 What Caused the Spurts? . ...................................274
16.2.1 A Big Fiscal Stimulus Has Three Times Rejuvenated
a Sputtering Economy . . ............................275
16.2.2 The Reagan Spurt Was Helped by Falling Interest Rates,
Falling Oil Prices and a Falling Value of the Dollar
(Which Stimulated Exports) . ........................277
16.2.3 Animal Spirits and the Mad Dash for the Web Drove the
Clinton Spurt . . . ...................................279
Appendix: Presidents and Fed Chairmen ............................280
Part V The Longer Run: Savings, Investment, Government Borrowing,
Foreign Lending and Your Home
17 Savings and Investment .........................................283
17.1 The NIPA Definition of Savings: It Is Not What You Think . ......283
17.1.1 Investments Are New Homes, New Offices, New
Factories,andNewEquipment .......................283
17.1.2 Flows and Not Stocks . . . ............................284
17.1.3 Savings Depends on What Consumption Is . . . ..........285
17.2 Do We Save Enough? . . . ...................................288
17.2.1 US Savings in 2004 . . . . ............................288
17.2.2 How Much Should We Save? ........................288
17.2.3 Do We Save Enough? . . . ............................290
17.3 Another Important Accounting Identity:
Savings=Investment.......................................291
17.3.1 USSavingsandInvestment ..........................292
17.3.2 What If There Is a Big Tax Cut and Public
SavingsDeclines?..................................295
17.4 Crowding Out, Ricardian Equivalence, or Twin
Deficits in the 1990s? . . . ...................................297Contents xv
18 Government ...................................................299
18.1 Government Purchases of Goods and Services Are Not as Great
asYouThink..............................................299
18.2 It’sTransfers..............................................300
18.2.1 TransfersAreDonealsobyStateGovernments .........302
18.2.2 Those Transfers Are Mostly Social Security, Medicare,
andMedicaid......................................303
18.2.3 TheStatesDoNotRunDeficits ......................305
18.3 An Accounting Scandal to Rival Enron: Phantom Assets Created
byGovernmentBorrowing ..................................305
18.4 The Outstanding Federal Debt Is Great Enough
toBeWorrisome ..........................................307
18.5 The Real Effect of the Federal Deficit: Trickle-Down
Social Responsibilities . . ...................................308
18.5.1 Beinga“Grown-Up” ...............................309
18.5.2 The Debate over the Privatization of Social Security Is
ConfusingAllofUs ................................310
19 The External Deficit and the Value of the Dollar Hu’s in Charge? ....313
19.1 An Important Accounting Identity: The Current
Account = The Capital Account . ............................314
19.2 What Determines the Value of the Dollar and
theExternalDeficit? .......................................318
19.2.1 The Exchange Rate . . . . . ............................318
19.2.2 The Real Exchange Rate ............................319
19.2.3 The Demand and Supply of US Dollars . . . . . . ..........321
19.2.4 USDeficits:GoodorBad?...........................322
19.3 How Can the US External Deficit Close? . . . . . .................323
19.3.1 Capital Account Adjustment: Foreign Investors
GoElsewhere .....................................325
19.3.2 Capital Account Adjustment: More US Savings . . . ......326
19.3.3 Current Account Adjustment: Barriers Against Imports . . . 326
20 The Ups and Downs of Real Estate Values .........................329
20.1 Household Assets and Liabilities . ............................329
20.2 ItIsNotRealUntilYouRealizeIt............................332
20.3 What Determines the Price and What Determines
theValueofYourHome? ...................................335
20.3.1 TheRentalMarketandtheOwnershipMarket ..........335
20.3.2 Do not Confuse the Rental Market and the
OwnershipMarket .................................336
20.3.3 Survivor Investing Can Temporarily Disconnect
EarningsandValuations.............................337
20.3.4 Survivor Investing Requires a Good Story ..............337xvi Contents
20.3.5 Fundamental Valuation Depends on the Growth
of Earnings and the Discount Rate . . . .................339
20.3.6 AHouseHasap/eRatio,Too ........................341
20.3.7 The p/r Ratios in US Cities . . ........................341
20.4 Some Realities of a Very Imperfect Ownership Market:
TheVeryPersistentGapBetweenValuesandPrices.............343
20.4.1 Home Appraisals: Bob’s $1 Million Tie . . . . . . ..........343
20.4.2 Hormones and Housing: It’s a Volume Cycle
NotaPriceCycle ..................................344
Appendix: Homework re the LA Market .............................349
Appendix: Home Ownership Data from the Survey
of Consumer Finances . . . ...................................350
Appendix: Rents or Asset Prices in the CPI? . ........................351
Owner-EquivalentRent.....................................351
Appendix: There Is no Such Thing as a Housing Shortage . . . . ..........352
Supply Restrictions Do not Guarantee that Prices Can
OnlyGoUp.......................................353
Index .............................................................355

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