A bad GDP revision that's actually good

So today they released a revised GDP growth rate for the Spring quarter that was 1.3%, down from an initial estimate of 1.7%.  The revision was blamed mainly on the heat/drought that devastated crop production in the Midwest.

Now, that crop devastation was bad news for the world as a whole, but I'm not so sure it was bad for the narrow interests of the US. We're the world's largest exporter of staple food commodities, and commodity prices went up a whole lot as a result of the losses. Further, those higher crop prices will stick around at least until next year, boosting farm incomes considerably.  So, ironically, the U.S. is probably better off as a result of a bad harvest. Real GDP doesn't reflect the price benefit of exports because real GDP holds prices fixed at a baseline level, so it just measures the physical losses of the crop.

This is quite unusual, I think, for a downward revision of this magnitude to actually be a good thing.  But let me emphasize again:  that's good for the US, not the world as a whole.

Anyhow, since the revision really had to do with the weather and not general recovery, probably only helps the financial position of people living here, and the revision in job counts was all positive, I'm not surprised the stock market went up.

Best economics blog post ever: macro division

I had to save this link in an easy-to-find place, so here it is:

EconTrolls: An Illustrated Bestiary

Is what's good for you also good for the planet?

In an OpEd today, Dean Ornish reviews some of the science about eating healthy.  Ornish is famous for curing heart disease through diet and lifestyle change rather than with drugs or bypass surgery.  He's also famous for challenging the Atkins diet, which may help some people lose weight, but is still unhealthy.

Anyhow, one sentence in his OpEd struck me because I think it's what many people presume be true, but I'm not sure whether it really is.  Here it is, in context:

WHAT you eat is as important as what you exclude — your diet needs to be high in healthful carbs like fruits, vegetables, whole grains, legumes, soy products in natural, unrefined forms and some fish, like salmon. There are hundreds of thousands of health-enhancing substances in these foods. And what’s good for you is good for the planet.

[my emphasis]

I'm sure Ornish is right about what's really healthy.  But is it true that what's good for you is good for the environment?  I'd guess he's referring mainly to meat consumption, especially fatty red meat.  Red meat is bad for you and can be costly in the sense that it takes more caloric energy to sustain animals than if one were to consume whole grains, and cut animals out of the picture.

As a first cut, this seems right.  But we are also quite efficient and producing corn and soybeans for animal feed, and we've grown amazingly efficient (some might say inhumane) in the way we raise animals so as to minimize their movement and caloric consumption and thus maximize conversion of feed grains into meat.

And so I wonder: if we were to eat more fruits, vegetables, whole grains and fish, would that ultimately be better for the planet?  For one, I rather doubt we're nearly as efficient producing calories from fruits and vegetables as we are from corn and soybeans.  Grass-fed, free-range beef may be healthier than corn-fed beef, but it may well be worse for the planet, because it generally uses more land and resources.  And we have all kinds of challenges with sustainably harvesting and farming fish.

Anyway, there is a subculture (organic, eat local, grass-fed animals, etc.) that often goes hand-in-hand with the culture of eating more whole grains, fresh fruits and veggies, fish, etc.  This culture seems to  presume these foods are not only the healthier but also better for the environment.  In some cases this is probably true; in other cases it's probably not.  It's a question that probably deserves more scrutiny.

Discount rates and inequality

The other day I commented about the importance and ambiguity of discount rates when estimating the social cost of CO2 emissions.

One key issue that it seems resource/environmental economists have largely ignored is the link between inequality and discount rates.

First, some more background.  To focus cleanly on tradeoffs over time, nearly all the work in this area uses a representative-agent model that imagines society as a mythical aggregated individual deciding how much to consume today versus tomorrow. Within these models, equilibrium interest rates (i.e., discount rates) are intimately tied to consumption growth, which we imagine to be roughly equal to growth in GDP per capita.  Since historically that growth has been steady, leaders in environmental economics, including luminaries like William Nordhaus and Robert Pindyck, prefer the use of higher discount rates because they presume our ancestors descendents will be so much richer than we are.  Even Weitzman, who prefers very low discount rates, uses the representative agent model.

There are many ways in which these representative agent models oversimplify the world.  That simplification is feature, not a bug---it's necessary for getting our collective heads around tough problems.

But here's a particular rub with the representative agent model: while GDP growth generally has a steady upward trajectory (recent experience exempted), median consumption, income and wealth seems to have flatlined in the U.S. since the 1970s.  Extrapolating from that, it's hard to imagine most of our ancestors descendents necessarily being much better off than we are.

Now, it's true that interest rates are more reasonably tied to growth in the mean or the aggregate sum than to growth in the median.  But I think the fact that growth has not been and is unlikely to be anywhere near equal over the next 30 to 100 years should give us some pause.

We need more careful work connecting inequality with long-run discount rates, especially when thinking about the right price for greenhouse gas emissions.

Following Ben's lead

So Japan, seeing the boom in US stocks and the decline in the dollar with Ben Bernanke's QE3, decides to do the same.  After all, Japan has been struggling with a near deflationary economy for two decades, and what the Fed just did was what economists have been saying Japan should do for a long time.

Now, with the dollar and yen falling relative to the euro, it's going to put more pressure on the European Central Bank.  If ECB doesn't loosen as well, the strength of the euro will hamper their exports, and putting headwinds on their already stagnating economy.

And so I expect it may go.  Now that the U.S. is pushing harder on monetary policy, I think others will too, all the more if it seems to be working.

Inflation here we come.  I don't mean hyperinflation; I mean an extra point or two or three more inflation not this year or perhaps even next year, but in two or three years.  And this may be enough to get consumption and investment going again in the nearer term.

Discount rates and the social cost of carbon

Joanna Foster at the New York Times Green Blog discusses how discount rates affect estimates of the social cost of carbon---the "price" we all would have to pay for emissions to bring them down to an efficient level.  A new study suggests we should use a lower discount rate, which indicates much higher carbon prices.  Michael Greenstone, who led a study by the President's CEA, seemed to think the rate his study used was just fine.

A little background:  There are many assumptions that go into estimating the social cost of carbon.  We need to think about impacts of climate change on sea level rise, agriculture, coral reefs, fisheries, recreation, human health and on and on, each of which is controversial in its own right.  But the biggest overarching assumption is, by far, the choice of discount rate, which coverts projected future benefits and costs into today's dollars.

The starting point for thinking about discount rates is to look at real interest rates, which equal nominal rates minus expected inflation.  In theory, real rates should be tied, first and foremost, to projected economic growth.  The idea is that the richer we become, the less we will value additional wealth, and so the more we'd prefer a dollar today when we are relatively poorer over a dollar tomorrow when we expect to be relatively richer.

So, if we expect our offspring to be much richer than we are, we should use a higher discount rate and a much lower price of carbon, because our descendents will be able to absorb the costs climate change much more easily than we can afford preventing the change. If we expect little growth, the discount rate should be lower, the price of carbon emissions would be higher, and we should work harder now to reduce emissions.

Using data to project long-run real interest rates is difficult because we don't have particularly good measures in history, since nominal rates combine expectations about inflation and future real rates.  But since the late 1990s, we can observe long-run real rates on inflation-indexed treasury bills. These rates are now at the lowest in history, and if we had inflation-indexed bonds going back to the 1960s, today might still be the lowest.  From FRED, here's the available history of 5, 10 and 30-year inflation indexed bonds.

The old saw in economics is that baseline real growth is on the order of 2 percent per year.  That rate also roughly matches the data for 10-year rates prior to crisis.  Since then, however, real rates have steadily declined and are now firmly negative for 5-year and 10-year rates, while the 30-year rate is at about 1/2 %.

I see two ways to interpret these data.  One is that this is just what happens in a really bad recession, and in the long run we'll pull out of this and get back to 2% real rates.  Another is that expectations about growth have become a lot more dismal.  After all, the 30-year rates mostly cover a period well beyond current business-cycle considerations, and even these are relatively tiny 1/2%.

(Incidentally, the sharp decline at the end, especially for the 5-year, was the intended effect of Fed's recent action)

My guess is that the combination of these two things like  explain the low rates: this is still a bad recession and expectations about the long-run future have declined as well.

Anyhow, to the extent that we believe long-run rates are down because expectations for long-run growth are down, and that these rates are accurate reflections of the future, I'd say the discount rates used in pricing carbon emissions are probably too high.

The question is, where's the rethink in policy analysis given rates have fallen so much in recent years?

Consider:  the 30-year rate above, at 1/2%, is smaller than any rate being considered.  And that doesn't take risk premiums or uncertainty into account, and both of these theoretically push the rate lower.  The risk premium is negative because investments in curbing emissions will pay off most if climate change turns out to be worse than expected.   Weitzman has a nice piece showing why discount rate uncertainty means we should err on the low side.

Given the data, and the basic reasoning here, I was disappointed to see Greenstone brush off the issue so casually. It's the critical question and one that should be continually revisited.

Tyler Cowen on World Hunger

Tyler Cowen writes about lagging productivity growth in agriculture, headwinds due to the organic/locavore movement, high fertilizer prices and poor infrastructure in Africa, the destructiveness of trade restrictions, the problems with ethanol policy and why we need to give more respect to agricultural economists.   Thanks, Tyler ;-)

Especially if you're in the DC area, be sure to check out Cowen's ethnic dining guide.

Climate change adaptation: Lessons from 2012

Here's David Lobell at the Chicago Council on Global Affairs:

For all of the talk about the need to adapt to climate change, we still know fairly little about two basic questions: what works best, and how much can adaptation deliver? ....

Why don’t we know more? It would be easy to blame our ignorance on complacency. There is a tendency to marvel at the progress made in agriculture in the past 50 years, and assume it can handle anything....

It is also tempting to blame ignorance on inexperience. After all, many people continue to view climate change as something to deal with in the future. But the evidence is clear that climate has already been changing over the past 30 years in most agricultural areas, and farmers are doubtlessly trying to adapt. Up until now, the United States was an exception to that trend. But the 2012 drought has changed that, and projections indicate that years like this will be increasingly common in the coming decades.

.... why was US agriculture not better prepared for the 2012 drought? And did anything work well that can be scaled up?

A lot has changed in US agriculture since the 1988 drought, and many of the changes were textbook examples of what should help to reduce impacts of hot summers. Farmers now sow corn and soybeans more than a week earlier on average, and use longer maturing varieties than in 1988. Advances in cold tolerance along with spring warming trends allowed corn to expand in northern states where temperatures are cooler.... Carbon dioxide levels, which improve crop water use efficiency, have increased by more than 10% since 1988. And farmers have begun to grow drought tolerant seeds that were unavailable in 1988.

Yet when the 2012 drought arrived, with fairly similar characteristics to 1988, impacts on crop yields were roughly the same. Corn yields are expected to be about 25% below trend, close to the 28% drop in 1988.

What can we learn from this experience? It is too early to say anything definitive, but two explanations seem plausible.....

[see link for the rest]

Fed Policy or the Weather?

Stephan Karlson cherry picks August's measure of inflation and writes

the Fed stated that money supply rose 0.3% the latest week alone, causing the annualized 3 month gain to increase to 8.6% and the yearly gain to increase to 7%.

And then the U.S. consumer price index rose 0.6% (annualized 7.4%) in August.

He didn't put the month's inflation numbers in longer-run context, or relative to other measures like the "core" inflation which removes food and energy.  He nevertheless concludes

So, it is clear that unless the European debt crisis again worsens and again causes a surge in demand for dollar  assets, there will be a big increase in price inflation soon.

So, here is a graph that does put August's inflation numbers in context. Blue is monthly percent change in the CPI and red is the monthly percent change "core" CPI, which removes food and energy (which are more volatile).

The two obvious points: (1) the monthly CPI is crazy variable; (2) the recent spike in the CPI was all energy and food; everything else declined.

Maybe, just maybe, the pattern can be explained by the drought and heat we experienced this summer, which caused some big crop losses.  I think it's safe to say monetary policy didn't have much to do with it.

Originally the title to Karlson's post was "Inflation, Inflation, Inflation!" It's a little more tame now. 

The Fed Pulls the Trigger

Wow.  I didn't think the Fed would do this.  But they did:

“A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens,"

And I'm glad they did it.  It's not inflation targeting or nominal GDP targeting, but it's more-or-less a commitment to be irresponsible.  (I personally don't like that characterization, because I think this is the responsible thing for the Fed to do.)

Anyway, they are testing a big idea here.  We'll see if it works.

Why is FAO's food price index up only 6% ?

In today's NYT, we have a report about a weak monsoon and crop devastation in India:

"Drought has devastated crops around the world this year, including corn and soybeans in the United States, wheat in Russia and Australia and soybeans in Brazil and Argentina. This has contributed to a 6 percent rise in global food prices from June to July, according to United Nations data"

Corn is up about 60 percent since June, wheat and soybeans are up respectively about 25 and 16 percent.  The production weighted average of these three crops usually tracks the FAO index pretty well.  Here's a plot of US prices for these three key staples and FAO's food price index. (I made this graph a little while ago, so it doesn't include last month's spike.)

So why is FAO food price index up just 6% (the implicit reference in the NYT article) given the much larger spikes in corn, soybeans and wheat?

Rice prices--another key staple--remains subdued due to large inventory buildups in India and other places.

Still, I don't get it.

I hope this means the world is dealing with crop shortfalls better than in 2008.  Maybe other relatively minor crops are making up the difference. But I wonder if it's just a matter of time before the FAO index shows a larger spike as well.

Does the Fed really have a commitment problem?

This is a followup to my last post:

Here is a more nuanced explanation of Krugman's views on monetary stimulus at the zero lower bound, which I think I had already understood and mostly agree with.  I differ from Krugman (with admittedly little authority) in thinking that it shouldn't be hard for the Fed to make a credible commitment to future easing if they wanted to.  If Bernanke said the word, and explained precisely how he would do it, I believe markets would respond immediately, and the broader economy wouldn't be far behind.  Continued market movements in response to Bernanke's leanings are a hint of that influence.

Yes, it's true, if Bernanke did it Congress would howl in protest and haul him up to Capital Hill and berate him for debasing the currency, etc.  So?  They're doing that anyway. And if Romney wins Bernanke will lose his job and his influence anyway, despite being a Republican.

A long time ago (almost 2 years!) I explained my reasoning about the commitment issue.  I was similarly befuddled by Robert Hall's take on it.  (Also see the update at the bottom of this post.)

The political, intellectual and philosophical obstacles of what Krugman describes as the "first stage" strike me as the greater challenge, which is why I was critical early on about his discussing this less than stimulus. It seemed to me that stimulus of the necessary magnitude was never politically viable, and Krugman had more sway with intellectuals---the FOMC---than with political calculations around stimulus.  And he can use his fabulous writing skill and wide influence to explain the issue to the broader public.  His magazine piece seemed to shift toward this emphasis.  But that was just six months ago.