A Real Limit to Farm Subsidies?

It looks like the Obama administration wants to put me out of business. Or at least force me to work more on research topics besides impacts of agricultural subsidies, which Obama wants to limit (hat tip to Tim Haab). I wouldn't complain about the change in research venue.

Here is the agriculture portion of the plan.

Here's CNN's coverage of the story:

On agriculture, wealthy farmers would get less money from the federal government -- and none, three years down the line -- under proposals in Obama's first budget.

Obama's proposed fiscal year 2010 budget "phases out direct payments over three years to farmers with sales revenue of more than $500,000 annually," according to the list.

At present, "direct payments are made to even large producers regardless of crop prices, losses or whether the land is still under production."

But according to the list, "Large farmers are well-positioned to replace those payments with alternative sources of income from emerging markets for environmental services, such as carbon sequestration, renewable energy production, and providing clean air, clean water, and wildlife habitat."

The new proposed budget cuts the Market Access Program which provides "funding for overseas brand promotion." It cuts cotton subsidies and "proposes to eliminate the requirement for the government to pay the storage costs of cotton that is put under loan by the USDA. Cotton is the only commodity for which this assistance is provided."

It looks like total payments will also be capped at (only) $250,000 per farmer.

One problem. In the past, caps on payments have been easy for farmers to get around. For purposes of bookkeeping, they just break the farm into pieces. One piece is owned by Papa Farmer, one for Mama Farmer, another for Johnny Farmer, and perhaps another for cousin Jenny Farmer. Here is a research paper by Barrett Kirwin who finds tell-tale signs of this reorganizations. Most of the evidence in anecdotal. But this figure from Kirwan is a little more than anecdotal:



Farms and farmers aren't quite the same thing. Farmers recieve payment; farms may be comprised of multiple farmers and earlier payment caps were tied to farmers (see Kirwan for details). Payment caps were mostly non-binding for wheat farms and farmers and the payment distributions look very similar--a nice bell shape. Rice farmers get huge payments by comparison and so they reach the payment cap far more frequently. And here we see the distribution of payments to farmers looks quite unlike that for farms--it has two humps, not one. The second hump coincidentally aligns just before the payment cap.

Or, maybe that's not a coincidence. It's likely these are farms reorganized into more farmers so as to avoid payment limits.

Maybe the Obama administration could write the rules very carefully so that such a thing could be avoided. I'm no lawyer, but I imagine this would be very difficult. So payment caps may sound nice to some. But it's hard for me to believe this policy, if actually implemented, will have any real influence whatsoever.

How misinformation about climate-change science spreads

Outsourced to Hilzoy at Obsidian Wings:

The Washington Post's "Multi-Layer Editing Process"

by hilzoy

I haven't written about George Will's factually challenged column from last Sunday, but I have been following the various refutations of mistakes he made. I have also been following the various requests for comment from the Washington Post, and wondering when the Post might respond. Now they have:

"Thank you for your e-mail. The Post’s ombudsman typically deals with issues involving the news pages. But I understand the point you and many e-mailers are making, and for that reason I sought clarification from the editorial page editors. Basically, I was told that the Post has a multi-layer editing process and checks facts to the fullest extent possible. In this instance, George Will’s column was checked by people he personally employs, as well as two editors at the Washington Post Writers Group, which syndicates Will; our op-ed page editor; and two copy editors. The University of Illinois center that Will cited has now said it doesn’t agree with his conclusion, but earlier this year it put out a statement that was among several sources for this column and that notes in part that "Observed global sea ice area, defined here as a sum of N. Hemisphere and S. Hemisphere sea ice areas, is near or slightly lower than those observed in late 1979,"

Best wishes,
Andy Alexander
Washington Post Ombudsman"

Until I read this, I had been under the impression that newspapers didn't do as much fact-checking as magazines, because of deadline pressure; and I had imagined that the inaccuracies in George Will's column might result from applying standards designed for reported stories to columns. But on reading that Will's column had been subjected to a "multi-layer editing process", and that this "process" had checked the facts "to the fullest extent possible", I realized that I had been wrong. Naturally, I clicked the link Mr. Alexander provided, and read it. Did he? I don't know what would be worse: that he did, and takes it to support Will, or that he didn't take his job seriously enough to bother.

Here's how George Will cited the Arctic Climate Research Center:

"As global levels of sea ice declined last year, many experts said this was evidence of man-made global warming. Since September, however, the increase in sea ice has been the fastest change, either up or down, since 1979, when satellite record-keeping began. According to the University of Illinois' Arctic Climate Research Center, global sea ice levels now equal those of 1979."

Here's the statement Mr. Alexander cites as "one of" Will's sources, including the sentence he specifically references. It's a response to an article in the Daily Tech called "Sea Ice Ends Year at Same Level as 1979":

"One important detail about the article in the Daily Tech is that the author is comparing the GLOBAL sea ice area from December 31, 2008 to same variable for December 31, 1979. In the context of climate change, GLOBAL sea ice area may not be the most relevant indicator. Almost all global climate models project a decrease in the Northern Hemisphere sea ice area over the next several decades under increasing greenhouse gas scenarios. But, the same model responses of the Southern Hemisphere sea ice are less certain. In fact, there have been some recent studies suggesting the amount of sea ice in the Southern Hemisphere may initially increase as a response to atmospheric warming through increased evaporation and subsequent snowfall onto the sea ice. (Details: http://www.sciencedaily.com/releases/2005/06/050630064726.htm )

Observed global sea ice area, defined here as a sum of N. Hemisphere and S. Hemisphere sea ice areas, is near or slightly lower than those observed in late 1979, as noted in the Daily Tech article. However, observed N. Hemisphere sea ice area is almost one million sq. km below values seen in late 1979 and S. Hemisphere sea ice area is about 0.5 million sq. km above that seen in late 1979, partly offsetting the N.Hemisphere reduction."

Where I come from, when someone writes something of the form: "P is not evidence for Q, and here's why", it is dishonest to quote that person saying P and use that quote as evidence for Q. If one of my students did this, I would grade her down considerably, and would drag her into my office for an unpleasant talk about basic scholarly standards. If she misused quotes in this way repeatedly, I might flunk her.

Will does this more than once. Since it's Will's only citation of a peer-reviewed journal I recognize, I checked the quote from Science in this passage:

"Although some disputed that the "cooling trend" could result in "a return to another ice age" (the Times, Sept. 14, 1975), others anticipated "a full-blown 10,000-year ice age" involving "extensive Northern Hemisphere glaciation" (Science News, March 1, 1975, and Science magazine, Dec. 10, 1976, respectively)."

It's from this paper (pdf, subscription wall.) Here is the bit Will cited in context:

"Future climate. Having presented evidence that major changes in past climate were associated with variations in the geometry of the earth's orbit, we should be able to predict the trend of future climate. Such forecasts must be qualified in two ways. First, they apply only to the natural component of future climatic trends -- and not to such anthropogenic effects as those due to the burning of fossil fuels. Second, they describe only the long-term trends, because they are linked to orbital variations with periods of 20,000 years and longer. Climatic oscillations at higher frequencies are not predicted.

One approach to forecasting the natural long-term climate trend is to estimate the time constants of response necessary to explain the observed phase relationships between orbital variation and climatic change, and then to use those time constants in an exponential-response model. When such a model is applied to Vernekar's astronomical projections, the results indicate that the long-term trend over the next 20,000 years is toward extensive Northern Hemisphere glaciation and cooler climate."

So that "extensive Northern Hemisphere glaciation" is (a) supposed to happen "over the next 20,000 years", not imminently, and (b), more importantly: it's a prediction that does not take into account anthropogenic changes in climate, like, um, those "due to the burning of fossil fuels". Which is to say, the kind of global warming we're now talking about.

The fact that this prediction specifically excludes anthropogenic climate change means that you cannot use it to say: those silly scientists; they used to believe that the earth was cooling, and now they think it's warming. When scientists say "if we don't take man-made changes to climate into account, the earth will get cooler over the next 20,000 years", this is completely consistent with saying: "however, when you factor in those man-made changes, the earth will get warmer", or "when you factor in those changes, we don't know", or any number of things.

If Will actually read these two articles, it's hard to see how he's not being deliberately deceptive by citing them as he did. If, as I suspect, he just got them from some set of climate change denialist talking points and didn't bother to actually check them out for himself, he's being irresponsible. All those people who supposedly fact-checked Will's article as part of the Post's "multi-layer editing process" -- "people [George Will] personally employs, as well as two editors at the Washington Post Writers Group, which syndicates Will; our op-ed page editor; and two copy editors" -- should be fired, either for not doing their job or for doing it utterly incompetently. These are hard times for newspapers; I wouldn't have thought they could afford more than one layer of an editing process that produces no discernible improvement in quality.

And Andy Alexander? He should read the cites George Will gives him before he sends them out, under his own name, in support of his paper's decision to publish Will's piece, if he doesn't want to be embarrassed like this again.

When news sources as reputable as the Washington Post behave this badly I begin to understand why so many intelligent people are so misinformed about the science of climate change.

A Twofer: Stimulus Plus a Commitement to Greenhouse Gas Reductions

Maybe someone has pointed this out already. But here goes anyway:

Committing to future CO2 emission reductions now, by either establishing a future carbon tax schedule or future cap-and-trade schedule, could have a strong stimulative effect in the short run. The reason is that owners of carbon-based fuels (oil, coal, and natural gas) would then have a huge incentive to extract resources more quickly in the short run before they are taxed or capped.

I strongly suspect this would cause energy prices to decline. Prices are not especially high at the moment but they are starting to edge up, and lower prices would be stimulative in the short run.

In any case, there is no reason to put a hold on climate policy because of the global recession. Just legislate policy that wouldn't kick in for another year or two and would then be phased in gradually.

Frontline: Inside the Meltdown

I just watched Frontline's "Inside the Meltdown."

No, I didn't learn anything new. But it was fun to watch. Frontline does nice job of dramatization. Maybe that's not too hard in this case: it has been a rather dramatic chain of events.

In watching this it did give me a certain amount of sympathy for Hank Paulson. He screwed up by not bailing out Lehman Brothers and I remember thinking that [might be the case] at the time. I think I wrote a comment to Tim Haab over at env-econ about this (Tim Haab was openly gleeful at the non-bailout of Lehman). Anyway, for a full-fledged true-believer like Paulson to take the steps he did take shows a certain amount of commitment, flexibility and open-mindedness that one wouldn't otherwise expect. Given his background and the nature of the administration for which he was working, I think his willingness to adapt to the circumstances was rather remarkable.

It terrifies me to think how bad things would look now if the Treasury and Fed hadn't intervened at all.

The Effects of U.S. Agricultural Subsidies

Except for the farmers that receive them, it's hard to find anybody who likes agricultural subsidies.

Certainly not economists. "Oppose Farm Subsidies" was Greg Mankiw's second point on his eight-point presidential platform designed to woo economists of all stripes. I'm sure an enterprising journalist could find some economist somewhere who loves agricultural subsidies and then write the usual he-said-she-said "expert opinions differ..." But even the nation's top newspapers write editorials regularly slamming agricultural subsidies. So do think tanks from the left (Environmental Working Group) to the right (Cato Institute).

The political economic calculation isn't very deep. Big agricultural subsidies are still small relative to everything else and these buy more than a handful of politicians in key Midwestern "swing" states. The political benefits are not huge, but certainly not trivial, and the cost, well, it's small potatoes compared to defense, social security, Iraq, stimulus, the bailouts, and just about everything else.

The big sticking point--the place where the subsidies may matter a lot--is that they seriously muck up trade negotiations. Agricultural subsidies have taken center stage in these debates for way too long. I think the overarching emphasis on agriculture is probably misplaced. I'm not that savvy on politics, but I do wonder if agricultural subsidies are something of a red herring--an easy way to slow free trade for other purposes.

Anyway.

Since so many have slammed agricultural subsidies, I'm not going to. I just don't see the point. What I'm going to try to do in a series of posts is simply describe what I've learned so far about the effects of agricultural subsidies in my own research. If you think about it a little bit, or go back and look at all the articles that decry agricultural subsidies, you will find many that count the billions handed out and many claims about dire consequences of those billions. Some, Michael Pollan being perhaps the most famous, claim we eat unhealthily because of subsidies. In general, you won't find reporting of clear evidence to support these claims.

A few warnings:

(1) I don't have a dog in this fight. For nearly eight years I worked for USDA's Economic Research Service. My goal, first and foremost, was to tap into their rich data bases, dig in, and find clear tell-tale evidence on the consequences of agricultural subsides. My impression was, and still is, that the USDA has vast amounts of data that has not been seriously analyzed and this represented great scholarly opportunity. My interest was (and is) mainly intellectual. I hope one day I might find facts so clear and so compelling that they will influence policy in a positive direction. But I'm not entirely sure at this point what a "positive direction" might be, at least in many cases.

(2) The answers to many questions are not especially clear. This shouldn't be too surprising. If the evidence were clear and compelling it would be clearly reported in all those newspaper editorials, books, etc.

(3) Despite a general scholarly dislike of agricultural subsidies, it's hard to see large blatant destructive forces stemming from most of them. Ethanol subsidies may be an exception, as are sugar policies, but the latter is mainly about trade restrictions not subsidies, and so it gets little press. Where economists worry first and foremost about efficiency, in light of the evidence, the most empirically persuasive argument against subsidies would seem to be their unfairness. Why do farmers get the cash and not other other small businesses or taxpayers in general?

The key questions as I see them

1) How much more does the U.S. actually produce of which crops due to which subsidies?
2) How much have world prices for staple commodities been effected by U.S. subsidies?
3) Are agricultural production costs higher due to subsides or have the subsidies slowed technological progress in agriculture?
4) Do agricultural subsidies affect the size or structure of farm business enterprises, ie., make farms larger or smaller?
5) Who ultimately receives the benefits from U.S. agricultural subsidies? The most viable candidates would seem to be (a) farmers and (b) landowners who lease their land to farmers (about half of agricultural cropland is leased).

My research on these topics was done in collaboration with colleagues at USDA: Nigel Key, Erik O'Donoghue, and Ruben Lubowski, as well as colleague at the University of Maryland, Barrett Kirwan. In covering these topics I will also discuss research by others.

Hopefully the first installment will come within the next week or so.

The right way to use private money to supplement public money when buying toxic waste

So the other day I posted about Ausubel and Cramton's proposal for buying toxic waste, aka mortgage-backed securities and other assets explicitly or implicitly tied to subprime mortgage debt rapidly going bad.

Nathan Higgins, who is working with Ausubel and Crampton (and is working with me on an unrelated project), sent me an email to clarify how private money would enter the auction process and why my suggestion is a bad idea. He writes:

Private capital would enter the market before the dynamic auction began. Interested parties submit demand schedules to the government. The total demand ... equal to government demand + all private buyer demand..... The private buyers thus get the same deal the government gets; no buyer plays a strategic role during the auction.

The problem with holding a second auction (to follow the government purchases) is that the Treasury is not very good at auctioning heterogeneous assets. The thing they are very experienced with is selling homogeneous assets to a set group of qualified bidders. In that auction N is always equal to 16 (I'm pretty sure about the number; might be 17, but I'm darn close) and Treasury holds totally separate auctions for all maturities. So we shouldn't expect that the Treasury will do a good job of putting stuff up for sale and earning a premium for taxpayers. The best way to include private capital is probably to simply include them in the first auction, thereby promising private capital the exact same deal that the government is getting as a monopolist.

Thanks Nathan. I guess I was thinking they could sell MBS one issue at a time, so the good would be homogeneous.

How to buy toxic waste

Lawrence Ausubel and Peter Cramton, two well-known auction theorists at the University of Maryland, are trying to talk Geithner into using an auction scheme to buy some of the so-called "troubled assets" from banks.

In this scheme, assets would be purchased using a descending clock auction. The idea is that the government decides to buy some portion of the outstanding troubled securities, say 50%. They start with a high price, say the face value of the bonds. All potential sellers announce how much they are willing to sell at that price. Presumably, at the initial price, all banks would want to sell all their bad assets, so this would facilitate transparency about what the banks actually own. Since supply would surely exceed demand, the price would be slowly lowered. As the price descends, sellers will begin to pull their assets. The price is lowered until supply equals the fixed quantity demanded.

Ausubel and Crampton have thought through many of the details and are rumored to be in discussions with the Treasury (see link above). They say there may be ways to invite private investors to the table--this part is a little vague.

I would suggest that the government act as the sole purchaser in this scheme and then immediately attempt to sell these assets using standard auctions the Treasury knows well, but with a reservation price equal to their purchase price. There may be no buyers. But I wouldn't be surprised if there were. This way the government might be able to immediately make a little cash for taxpayers.

Odds are this will not recapitalize the banks. But I think it would be a cost-effective and necessary first step.

Update: Yes, I realize this was kicked around awhile back under the first round of TARP spending. I just had reason to believe it might be coming back into play, and so that's why I mention it. Also, some folks around here may not know about it.

Don't take Census farm numbers seriously

The other day I had a somewhat technical post about the Agricultural Census and how the definition of a farm, and how it has implicitly changed over time, has a huge effect on farm numbers and the average size of farms.

The moral of the story: don't take Ag. Census numbers of small farms seriously. Most of what is changing is the definition of the farm, not the number or disposition of actual farms.

But it had to happen. Here is VERLYN KLINKENBORG of the New York Times getting it all (or at least mostly) wrong.

Good News From Iowa

Published: February 9, 2009

When I was born in 1952, there were 203,000 farms in Iowa, only 11,000 fewer than when my dad was born in 1926. By 2002, the number had dropped to about 90,000, with roughly the same acreage in production in a state with a population that had remained roughly the same. The national numbers followed the same track: fewer farms, bigger farms, less-diverse farms. To a lot of people, this looked like progress because the ideal of efficiency promulgated by the Department of Agriculture was bigger yields with fewer people.
This industrial notion of efficiency has always seemed terribly inefficient in other important ways: socially, culturally and environmentally. Too few people in a farming landscape means too little attention to the soil. It also means broken towns. The history of Iowa in the past 80 years has been the steady impoverishing of the rural landscape, a fact most easily grasped by the steadily dwindling number of farms.
So it comes as a pleasant surprise to find in the 2007 Census of Agriculture that the number of farms in Iowa has risen to 92,856, a level last seen in 1992. Some 4,000 new small farms have been created since 2002. These are very small farms, 9 acres or less, and they are producing a much wider array of crops than the rest of Iowa, which specializes in corn and soybeans. Most have very local markets, not Cargill and Archer Daniels Midland. And yet as new farms are being created, midsize farms go out of business. Consolidation at the highest level — big farms eating slightly smaller farms — continues.
These are interesting numbers — 4,000 Iowa farms under 9 acres and about 1,500 with 2,000 acres or more. Still more interesting is the age differential. The average age of the “principal operator” on a farm has crept upward to 56 years old. But those small farms are being run by young farmers.
In a very real sense, they are going back to an earlier model of farming in Iowa. The farms are more diverse, and so are the crops they grow. To me, this is where the new passion for local foods finds its real meaning, and the best news is that Iowa is not alone. Nationwide, there are some 300,000 new farms since 2002. And the farmers? More diverse than ever, including a higher number of women. This is a genuine source of hope for American agriculture.

VERLYN KLINKENBORG: I would encourage you to:

(1) Take a close look at the definition of a farm, note that this definition hasn't changed since 1974, and then call the folks at the Census and ask a lot of questions about how they go about counting farms with less than $2500 in sales or potential sales. Ask them how their efforts to count small farms have changed over the last 10 years. Try to get them to be precise about which changes were made with each Census.

(2) Click over to NASS or Bloomberg or even the New York Times financial page and look at commodity prices and see what happed to those prices between 2002 and 2007. Then think: If a bunch of $500 dollar "farms" (i.e. family homes with a nice vegetable garden) just didn't make the cut to be in the 2002 Census, do you suppose that in 2007 their "farm" might make it into the Census, even if it didn't change at all?

(3) Given what you learn about (1) & (2), please post an addendum or correction to your article in the New York Times.

Is bad market news good TARP news?

The DOW dropped over 4 percent today, apparently in response to Geithner's incomprehensible announcement about the new TARP plan. Most news stories seemed to take the drop as a sign that it's a bad plan.

I think not. Notice banks did much worse than average: BofA lost nearly 20%, Citi about 15%, American Expressn and JP Morgan about 10%. That signals the Treasury doesn't want taxpayer dollars going to bank equity. We want the money lent out. We want taxpayers to get a good deal on assets they buy. That means shareholds should lose. So the drop could be good news for the new TARP plan.

There seems to be a lot of uncertainty about the details of this plan but I don't think the market crash is bad news at all. It seems, at least, that they are trying to do this without giving a windfall to equity holders in the banks. At the same time, they're going to try to do it without nationalizing them. It will be hard to do both. We shall see...

A cool natural experiment idea

Andrew Gelman has a great natural experiment and he's throwing it out for someone to pick up. This is one of those rare $100 bills lying on the floor that aren't supposed to exist.

So, how long do you think before someone has a draft paper on this idea?

The link is also useful for understanding a key difference between so-called "structural" and "reduced-form" empirical economists.

A macroeconomic naif's questions are answered

I have no substantive questions or comments in response to this post by Jim Hamilton over at Econbrowser. All I can say, as a macroeconomic naif, is that it is by far the most sensible thing I've read amid copious pontificating in these difficult economic times. He addresses and answers almost every question I've had [1,2]. And his answers make a heck of a lot of sense to me.

Thank you Professor Hamilton.

I'll be curious to see how the real experts respond.

In case there are even one or two souls who visit this blog and wouldn't otherwise click on over to Econobrowser, here's his post in its entirety:

Update: One note on this I should mention for the record: I like Jim Hamilton's analysis a lot and would prefer he were writing the stimulus package and directing the Fed, or at least closely advising them. I do not claim, however, to have any political smarts whatsoever. So, since the real-world choice is politically constrained, I'm not sure whether the current package is or is not the right compromise.
________________________________________________________

The paradox of thrift

Or, how come you used to say that if consumers don't save more, it will wreck the economy, and now you say, if consumers do save more, it will wreck the economy?

For the record, I am certainly among those who had been suggesting that America's low saving rate was a significant problem. Let me begin by reviewing why I said that. Recall that we can separate the various components of GDP (Y) in terms of goods and services purchased by consumers (C), government purchases (G), investment spending (I), and net exports (X):

Y = C + I + G + X

Subtracting C and G from both sides of the equation,

Y - C - G = I + X

The two terms on the right-hand side are the critical determinants of what kind of economic future we'll have. Investment in plant and equipment is the single most important variable that will determine our future productivity and standard of living. And negative net exports, such as the U.S. has increasingly opted for over my lifetime, necessarily involves selling off our national assets and going further into debt to foreigners. The size of our current account deficit is large enough relative to GDP that, if this were any country other than the United States, I would worry that a currency crisis (a sudden flight from dollars) is a very real possibility. And even for the United States, it is something I for one do worry about.

U.S. net exports as a percentage of GDP. Data source: BEA Table 1.1.5.

From the equation above, if we want I + X to be bigger, we must want Y - C - G to be bigger as well. We can define private sector saving to be gross domestic income less consumption spending and net taxes paid:

private saving = Y - C - T.

Notice I'm using the same symbol Y for both GDP and GDI, since the two are conceptually the same-- every dollar of production necessarily generates a dollar of income. There is a statistical discrepancy between the actual measures available for GDP and GDI, though these are not relevant for the longer run issues I'm discussing here. We likewise can define "public saving" to be the excess of the government's receipts over its expenditures,

public saving = T - G,

and national saving to be the sum of private and public saving:

national saving = Y - C - T + T - G = Y - C - G.

In other words,

national saving = I + X

This equation is an accounting identity, as well as a condition that has to characterize equilibrium in any coherent macroeconomic model. Hence my longstanding advocacy of measures to raise the private saving rate or lower the federal deficit.

So then, aren't I delighted that consumers are now, finally, saving more?

Personal saving as a percentage of disposable personal income. Data source: BEA Table 2.1.

Well, no. It is one thing to identify a higher national saving rate as the long-term goal, and quite another thing to try to get there overnight in the form of a sudden drop in consumption spending. Here I am very much taking the side of Brad DeLong ([1],[2]) and Arnold Kling and against Eugene Fama ([1], [2]) and John Cochrane. The relevant question is whether, in response to an abrupt decrease in consumption spending such as we're now experiencing, some of the other variables (most importantly, Y) might adjust in response as well. It is certainly true that in a very simple economic setting-- for example, an economy that consists of a single farm producing only one good-- the decision to save more of your income (leave some of your wheat unconsumed) is necessarily identical to the decision to invest more (save the wheat for later). And one can write down more complicated models in which economic actors and markets adjust in a way to see through the veil of production and exchange and make sure it is I + X that adjusts in response to a higher saving rate, and not Y.

But it's also possible to write down models in which there are significant frictions that cause the adjusting to come in the form of lower Y in response to lower demand. The traditional such friction is the textbook Keynesian notion that wages and prices fail to adjust. In such models, responding to the lower C by increasing G may succeed in mitigating the loss in Y. Though here I must agree with Cochrane that those same models imply that if monetary policy could stimulate aggregate demand, that would achieve the same objective. I am definitely of the view that it is within the current power of the Federal Reserve to stimulate demand, and have urged the Fed to try to aim for a 3% inflation rate over the next several years.

But where I may disagree with some of my colleagues is in their presumption that wage or price rigidities are the core frictions that are responsible for producing the present situation. I have in my research instead stressed technological frictions. For example, when spending on cars abruptly falls, there is a physical, technological challenge with getting the specialized labor and capital formerly employed in manufacturing cars into some alternative activity. In my mind, it is a mistake to pretend that any federal program is capable of immediately re-employing those resources into an alternative, equally productive enterprise. More fundamentally, I have suggested that our present situation is as if someone had quite successfully sabotaged the basic functionality of our financial system. Until we once again have a financial sector that can successfully allocate credit to worthy projects, we're not possibly going to be able to produce as much in the way or real goods and services, no matter what the level of aggregate demand or stimulus package might be. In terms of the textbook Keynesian models that people play with, I'm suggesting that "potential" GDP growth for 2009:Q1-- that growth rate which, if we try to exceed it by stimulating aggregate demand, we primarily just get more inflation-- is in fact a negative number. I do not accept the proposition that there is a level of government spending-- however large a number you choose to suggest-- that will prevent the unemployment rate from rising above 8%. But I do believe that if the government borrows a sufficiently large amount, we will have to worry in a very concrete way about what will sustain the foreign demand for U.S. assets.

What, then, do I propose? The first principle that's quite clear to me is that drops in state and local government spending, or increases in state and local taxes, are a likely response to the current situation and are clearly counterproductive. Hence I've advocated ([1], [2]) additional federal borrowing in order to provide unrestricted block grants to states. That's a simple, effective plan that could and should be immediately implemented, while still preserving complete flexibility in responding to our serious longer run challenges.

I also am very comfortable endorsing additional government investment in infrastructure for which the argument can be made that the facilities could make a significant contribution to future productivity. At the top of my personal list would be investments in the electricity transmission grid, mass transit, and basic scientific research.

And unquestionably the number 1 priority for the federal government should be to restore a functioning financial sector. That in my mind should be done in a way that maximizes the return on any taxpayer funds invested.

But rushing through new government spending plans, just for the sake of spending? Count me off of that bandwagon.

Carbon Taxes or a Cap-and-Trade Permit Scheme?

Robert Stavins opened his new blog with a call for serious policy to curb greenhouse gas emissions. It's well worth reading the whole thing. Here's the meat in the middle:

The only politically feasible approach that can make a real dent in the problem is a comprehensive, upstream cap-and-trade system to reduce carbon dioxide emissions 50 to 80 percent below 1990 levels by 2050. The declining cap will increase the cost of polluting, thereby discouraging the use of the most carbon-intensive fossil fuels and providing powerful incentives for energy conservation and technology innovation.

The system could start with a 50-50 split of auctioned and free allowances, gradually moving to 100% auction over 25 years. To establish political support in the short term, free allowances should be targeted to sectors that are most burdened by the policy. And the auction revenue — which will increase over time — can be used to compensate low-income consumers, finance research and development, reduce the federal deficit, or cut taxes.

The best option may be to make the program revenue-neutral by returning all of the auction revenue to citizens through direct cash dividends or annual tax credits. This can go a long way towards making the legislation palatable to Republicans and Democrats alike who are reticent to take any actions that even resemble a tax increase.

By making the overall emissions cap gradually become more stringent over time, costs can be greatly reduced by avoiding premature retirement of existing capital stock, reducing vulnerability to siting bottlenecks, and ensuring that long-lived capital investments incorporate appropriate advanced technology.

Still, the costs of meaningful action will be significant, with impacts on gross domestic product eventually reaching up to 1 percent per year. But the longer the world waits to begin taking serious action, the more ambitious will emission reduction targets inevitably become, as atmospheric greenhouse gases continue to accumulate.

I like the revenue-neutral part--someting Stavins has advocated in the past. But some carbon permits may be allocated rather than auctioned, limiting revenues somewhat--that will surely be part of the negotiating process.

Stavins argues for a cap-and-trade system, which is what most economists have long advocated. Some argue instead for a carbon tax. At present I don't have a strong opinion on the matter. But for those who are interested, the latest issue of REEP has a nice symposium on this topic. I especially like the article by Nathaniel Keohane of EDF (one of Stavins' former students, I think).

To a first approximation, both of these approaches do the same thing: they put a price on the marginal unit of CO2 emissions that doesn't currently exist. Taxes do this directly--the tax becomes the price of carbon. A cap-and-trade system fixes quantity of emissions and a secondary market for emissions permits effectively sets the market price for carbon. Both can achieve emission reductions in a reasonably efficient and market-friendly way.

Two good alternatives. Which to choose? These kinds of questions keep environmental economists employed.

I've always liked taxes, but for admittedly superficial reasons. I like taxes because they are simple. I think implementing a cap-and-trade will be somewhat more costly. But I imagine the biggest cost will be tracking down all the carbon, including sequestrations and emissions from agriculture and forestry. This would be necessary for both approaches.

There are other considerations. One is that if we want to be really strict about meeting a particular emissions goal, it will be hard to get the tax just right. If the tax is too low, we'll emit too much; if the tax is too high, we may emit too little, incurring more costs than necessary to hit the target. Under cap-and-trade, we just set the cap at the target and we're done.

Why might we want a firm target level of emissions? Well, there's probably a tipping point toward accelerated global warming. For example, as snow and ice recedes from mountains and polar regions less sunlight is reflected, which causes more heat absorption and more warming. No one is sure about where the tipping point might. Some say it may be as little as 2 degrees Celcius, in which case shutting down CO2 emissions before its too late will be very tough to do.

The other main reason for a cap and trade system is supposed political feasibility. This may be. I'm really not sure. I was surprised to learn recently that Exxon is now favoring a tax over cap-and-trade system. This surprised me a lot. But that fact does make me wonder whether cap-and-trade is actually more politically feasible. We need to learn more about why Exxon has this preference.

Welcome to the the blogosphere Professor Stavins! I look forward to reading more from you.

2007 Agricultural Census, and note of caution

When working at USDA I did a lot of research using county-level and micro files of the Agricultural Census. I'm anxious to dig into the latest, but I probably won't have time until summer.

The statistics from the Agricultural Census that I see reported most are (1) the number of farms and (2) average farm size. From Farmpolicy.com, here's the announcement:

A news release issued yesterday by USDA provided a broad overview of the report, which is conducted every five years, and stated that, “The number of farms in the United States has grown 4 percent and the operators of those farms have become more diverse in the past five years, according to results of the 2007 Census of Agriculture released today by the U.S. Department of Agriculture’s National Agricultural Statistics Service (NASS).”
The release added that, “The 2007 Census counted 2,204,792 farms in the United States, a net increase of 75,810 farms. Nearly 300,000 new farms have begun operation since the last census in 2002. Compared to all farms nationwide, these new farms tend to have more diversified production, fewer acres, lower sales and younger operators who also work off-farm.”

These numbers, while factually correct, could be extremely misleading.

You see, both depend importantly on the definition of a farm.

A farm is a farm, you say? No. If you define a farm as anyone with an herb garden or a tomato plant, then the average farm is about like the average household. The actual definition of a farm is not quite that generous. But it's close, and getting more generous with time: it's a place that has sales or potential sales of $1000. This definition has been constant, in nominal dollars, for 35 years.


What's not mentioned explicitly is that USDA has also been working harder and harder to find and count hiding $1000 potential farms. Most of these guys don't know they're farms and so they can be hard to find and difficult to entice to return their census forms. So non-response rates are growing, mostly for tiny farms that probably don't realize they're farms in the first place.

Non-response? No problem. USDA just uses weights to account for the non-response which boosts the officially reported number of farms.

An interesting tidbit: the 2002 census officially counted more farms than the 1997 census, but if you look at official changes in farm numbers, they went down. How could that be? Well, they changed the weights to count more of the micro farms they thought were probably hiding out there and that caused the numbers to go up in 2002. When they count changes they keep weights constant.

All of this may seem trivial, and on some level it is. But farm numbers do matter for allocation of funding from USDA-CSREES across states. It also matters for some research findings. For example, there have been wide reports of farm households deriving an increasing share of their income from off farm. But mostly reverses the truth. Rather, the census is counting more households as farms, and since these "new farms" derive nearly all their income off farm (indeed, probably don't even think of themselves as farms), the aggregate share of off-farm income has been rising.

It's the definition that's been changing much more than the actual disposition of farms.

Before USDA took over and the Census Bureau managed the Ag. Census, they wanted to restrict the definition of a farm to a place with $10,000 in sales or potential sales. This was in the mid-1990s. Since this seemingly innocuous change would have halved the number of farms and had a significant influence on the distribution of federal money to the states, it wasn't going to happen. I'm unsure about the details but I think this is a key reason the Ag. Census moved from the Census Bureau to USDA.

Anyhow, this little article explains how much all of this matters.

The point is that despite the "growing number of farms," agricultural production is actually becoming far more concentrated in fewer much larger farms. So it's important not to miss this part of the announcement:

“The latest census figures show a continuation in the trend towards more small and very large farms and fewer mid-sized operations. Between 2002 and 2007, the number of farms with sales of less than $2,500 increased by 74,000. The number of farms with sales of more than $500,000 grew by 46,000 during the same period,” USDA said.

Robert Stavins starts a blog

Robert Stavins, an excellent and prolific environmental economist at Harvard, has started a blog.

(will also be added to my blogroll).

This promises to be a very welcome addition.

To have any relevance whatsoever I'm going to need to put more weight on the 'grains' side of 'greed, green and grains', because only agricultural economics now seems underserved.

Krugman's lessons from Japan

With the usual caveat that I'm not a macroeconomist, I find what Paul Krugman wrote about Japan 10 years ago to be especially, perhaps uniquely, relevant to the current situation.

Here is his page that collects his writings on the subject.

Given our current situation is remarkably similar, except worldwide and thus likely worse, it seems like an especially salient perspective.

Here are a couple selected quotes from those writings:

TIME ON THE CROSS: CAN FISCAL STIMULUS SAVE JAPAN?

Japan is currently engaged in the largest peacetime fiscal stimulus in history, with a budget deficit of around 10 percent of GDP. And this stimulus is working in the narrow sense that it has headed off the imminent risk of a deflationary spiral, and generated some economic growth. On the other hand, deficits this size cannot be continued over the long haul; Japan now has Italian (or Belgian) levels of internal debt, together with large implicit liabilities associated with its awkward demographics. So the current strategy can work in the larger sense only if it succeeds in jump-starting the economy, in eventually generating a self-sustaining recovery that persists even after the stimulus is phased out.

Is this likely? The phrase "self-sustaining recovery" trips lightly off the tongue of economic officials; but it is in fact a remarkably exotic idea....

When, then, can fiscal stimulus work as a long-run solution? There seem to be two possible answers. The first is that deficit spending can serve as a bridge over troubled waters.....

It's actually hard to come up with good examples of this kind of fiscal program - maybe Sweden's efforts to ride out the first oil shock in the mid-70s. In the case of Japan, a starry-eyed optimist might argue that restructuring of Japanese banks and corporations will eventually create a "new economy" that generates a lot of investment. A more likely scenario, however, is that the prolonged process of restructuring will keep consumers nervous and if anything depress demand. That cavalry may be a long time in coming.

What continues to amaze me is this: Japan's current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do - even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy - the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance - are rejected as dangerously radical and unbecoming of a dignified economy. (My emphasis)

Now our budget deficit isn't close to 10% of GDP yet. But the way things are going it easily could be within a couple years. And according to Krugman (and many others), output will almost surely remain below GDP potential for many years. "What comes after the stimulus?" he asked in November:

For the coming year, and probably well beyond, the economy will be on life support — sustained by massive fiscal stimulus. (Either that, or we’ll be in a very deep slump.) But eventually the economy will have to come off life support. What will take the place of the stimulus?

I don’t really know the answer...

Consumption probably isn’t going back to a 2007 share of GDP — savings are back. So what will fill the gap, once the stimulus is gone? Housing? Not for a long time. Business investment? Hard to see why. The natural thing would be to trade lower consumption for a smaller trade deficit.

But that’s going to be hard if the rest of the world is also in a slump, and in particular if emerging markets are facing currency crises.

Sound similar? What was Krugman's proposed solution for Japan? Inflation targeting.

Rumors suggest that the Bank of Japan may actually be considering adopting some form of inflation targeting, with a positive upper bound. This is good news, because it means that the Japanese are finally starting to understand the nature of their situation. But do they still get it? I am not sure, because the numbers being floated are almost surely too low. And in that case perhaps they still don't get it - because the basic logic of a liquidity trap says that the choice facing a country in such a trap is between a significant positive rate of inflation and grinding deflation. There is no middle ground.

The point is simple, but apparently hard to grasp. Suppose that the equilibrium real interest rate - the rate at which savings and investment, including net foreign investment, would be equal at full employment - is negative. (As I have tried to explain, in Japan: still trapped , that is what a liquidity trap is all about). And suppose also that prices do not fall quickly in the face of unemployment. Then if the expected inflation rate is too small to allow a low enough real interest rate - if, for example, the economy "needs" a minus 3 real interest rate, and expected inflation is only 1 percent - the actual result will be an underemployed economy, and hence continuing slow deflation. This will soon mean that the inflation target loses credibility, and you are back where you started.

So an inflation target can work only if it is high enough that, if believed, it would produce a strong enough economy to actually generate inflation. A target that is set too low is doomed to failure.

This is why people who want to water down proposals for "managed inflation" - why can't we just aim for price stability, or 1 percent inflation, instead? - are missing the point. As I tried to say in my original piece on Japan's trap , the deflationary pressures we actually see in Japan represent an economy that is "trying" to achieve the inflation it needs, by reducing current prices compared with expected future levels; the reason the economy is depressed is that such deflation does not come quickly and painlessly.

I know that all of this is painful to think about; policymakers are certainly not used to dealing with such paradoxical-sounding problems, and their instinct is always to go for some sort of middle ground. But the law of the excluded middle here is not some abstract professorial quibble. It is the unavoidable conclusion of any reasonable analysis.

So let me say it in capitals:

INFLATION TARGETING IN JAPAN WILL FAIL UNLESS THE TARGET IS SET HIGH ENOUGH.

Okay. So I read this and look at the situation now and I wonder why there isn't as much or more talk about inflation targeting as there is about fiscal stimulus. Granted, our budget situation and the size of the stimulus, placed in proper perspective, are not at quite the levels of Japan in the nineties. But it's hard to see how we won't be there soon.

I'm not anti-stimulus. But when I look at graphs like this and this, I cannot believe that this stimulus package, no matter how massive it may seem, will do the trick.

So I google news "inflation targeting" and I get 126 hits. Most are about South Africa. This statement from Charles Plosser is about all I can find about the U.S. Fed. Pretty cautious, no? I thought Ben Bernanke was Mr. Inflation Targeting? Google news "fiscal stimulus" and there are 13,397 hits.

And not a word from Krugman about inflation targeting. Even though he's seriously worried about deflation (here and here).

Can someone please tell me what I'm missing here?

More armchair macroeconomist blogging

The other day I was complaining about a low level of macroeconomic debate. Among the ramblings, I thought:

(1) So-called "Treasury view" arguments by famous economists were seriously unconvincing and embarrassing to the profession (I didn't say that, but I think it was implied).

(2) There should be more debate about the merits of vigorous, unconventional monetary policy vis-a-vis fiscal stimulus.

(3) There should be more serious discussion about particular stimulus policies, not just tax-cuts vs. spending, but the particulars of how taxes would be cut and spending would be implemented.

(4) Bank bailouts could be a lot more effective and tax-payer friendly.

I am pleased to report (to myself and a handful of possible followers) that things seem to have improved a bit on points 1-3. Point 4 looks uglier every day, but others are writing about this a lot, so I'll focus on the positive:

Silly arguments along the lines of (1) seem to be dying (slowly).

With regard to (2): Here is Brad Delong, considering the options. While Delong's prolific and supremely intelligent blogging is routinely awe inspiring, somehow I find his argument against printing money a little thin and dismissive. Times are getting desperate. And the Fed can easily reverse its money-printing ways if things get out of hand. Here is Robert Lucas arguing for more vigorous monetary policy--now that's a more sensible position coming from the Chicago School! It's a heck of a lot better than silly perfect-markets story when the economy is losing 5-700,000 jobs a month. Here's Brad Delong responding to Lucas. I'd still like to see what Krugman has to say. He's made a couple oblique references, and he doesn't seem to dislike the idea of unconventional monetary policy. Mostly he seems to prefer not talking about it. Why is that? His recent emphasis on deflation, to me anyway, screams for the printing press.

With regard to (3) we're seeing more discussion of multipliers. Even the senators on the hill seem to be talking about it more seriously. Here is Menzie Chinn giving us the gory details beneath the various ways of estimating multipliers. But there remains a disappointing lack of discussion of finer design issues. My comment to Menzie Chinn was:

I'm not a macroeconomist but studied some of this stuff once upon a lifetime.

Can/do these models differentiate the way stimulus is implemented? Or is spending just spending and a tax cut just a tax cut?

I ask because I would think the details would matter a lot. Like a tax credit for new investment spending differs from a corporate tax rate cut which differs from an income tax break which differs from a payroll tax break. Or like government spending on infrastructure development differs from extending unemployment benefits which differs from subsidizing car purchases which differs from subsidizing the wages of all new hires by firms.

It does seem, to me anyway, that too much of the discussion is on tax cuts versus spending. It seems more relevant to talk about the details of how these things would be implemented.

Indeed, I can imaging tax-cut/spending alternatives that, in effect, would seem nearly identical.

Don't you think spending and/or tax cuts, if done creatively, might induce much larger multipliers that historical data/models would indicate? Sadly, developing evidence for such creative policies, no matter how conceptually compelling, would seem difficult, given paucity or nonexistent data and the large aggregates used in macro analysis. But please do educate me if I'm wrong and you are so compelled.

Very nice post, by the way.

I think my gut instincts were right. Menzie replied:

Some models would make the distinctions you do highlight, but the more formal general equilibrium models would probably not be able to handle these fine distinctions.

It's so cool that Jim Hamilton and Menzie Chinn actually reply to comments when their blog gets some 2600 visits per day. Here is Mark Thoma's link to Menzie plus his comments about why we know so little about multipliers.

Anyway, I don't think there is much historical precedent for the current situation, and thus limited evidence to work with. It's going to take some good common-sense thinking combined with historical evidence to achieve the best policy. And under the circumstances, some creative risk taking seems in order, too.

Here at NCSU, we've been told all our grad student funding will be cut off. This makes me sad as we have a remarkably good crop of 25 first-year PhDs and I'd hate to see any of them cut off. I guess that means I'll be writing more grant proposals...

If we're hurting, I hate to think how bad it is in the trenches outside academia. The charts at Calculated Risk sure are ugly.

Is moral hazard easier to hide when the risk-premium is low?

It is easy to be angry and blame the "fiendish monsters" on Wall Street for the financial crisis and the broad economic downturn. It might even be easy to blame the financial geniuses, the founders of modern asset pricing theory and Long Term Capital Management--you know, Merton, Scholes, Engle, and the legion of financial economists and econometricians that used their ideas and extended their tools to develop and price an exploding array of financial derivatives.

This blame comes too easy. While it is easy to blame, it's much harder to fully understand.

I do not believe the root cause of this crisis was deliberate fiendishness or obvious stupidity. I expect there were few Madoffs on Wall Street. The question is what facilitated opportunities for the explosion of derivatives trading and Madoff types. Why were so many very smart people fooled into this frenzy?

An instinct of mine is that a lot of it has to do the with the large equity premium, the puzzle that Merha and Prescott discovered and no one has been able to satisfactorily explain. The puzzle is that, despite current events, stocks earn a large premium over safer investments like treasury bills. That risk comes with a reward isn't such a puzzle. The puzzle is that the premium risk earns is so large that it simply cannot exist in any known model of an economy with at least a few reasonably risk tolerant and non-liquidity constrained people.

Some financial economists, unable to explain this risk premium, decided to try capitalizing on it. At a very basic level, the thing to do if you have a reasonable tolerance for risk is to borrow all the money you can and invest it in stocks. You may win sometimes and you may lose sometimes, but in the long run you will surely make good return. If you could borrow a trillion or two at 4% and make the long run market return of 8, 9, or 10% on the market, you get astoundingly rich very quickly.

This simplifies things a bit. But just a little. The financial "geniuses" thought this was money lying on the table that needed to be picked up. In picking it up it would make financial markets more efficient, spreading risk wider and better, and simultaneously facilitate financing of homes and business enterprises never financed before because risk tolerance was so low. I'm sure these guys thought they were doing the world a favor by making a gazillion dollars.

I'm completely serious here. In theory, these guys were right.

In trying to exploit this risk premium the risk premium shrank. That's what a bubble is--it's asset prices rising so high that expected future dividends become smaller relative to price. During the bubble, the premium probably shrank to about the levels our textbook models would suggest. Some might say it shrank more than that, but it's hard to tell.

Anyway. It now seems financial markets need a big risk premium in order to operate well. I wonder if when the risk premium gets too low, moral hazards (fiendish Madoff behavior) is easier to hide. This is because when low returns are expected amid great volatility, it's harder to tell whether, after a bad year, managers of mutual funds, hedge funds and firms just got unlucky or whether they raided the cash register.

Whether or not managers actually raid the cash register isn't necessarily important. Because if people fear they might be raiding the cash register, and thus fear the expected returns are not really the low but reasonable return they expected, but actually something much lower, they will pull their money out and put it back in the slightly lower-return safe investment.

And as those nervous types withdraw their money from risky assets, asset prices fall, and more get nervous about managers raiding the cash register and so they withdraw, causing asset prices to fall further, and so on.

The key thing here is that the temptation to commit moral hazards and the ease of hiding moral hazards is going to be much greater the lower the risk premium is. And for this reason, low risk premiums are not sustainable. On the other hand, high risk premiums are not sustainable either because financial types will see the money lying all over the floor and start to pick it up.

We might like to think there was a nice stable equilibrium in the middle with a medium return on risky assets. But is that necessarily true? I'm not so sure it is. Because it could be that the incidence of moral hazard is extremely sensitive to the size of the risk premium. And this could make markets extremely unstable around that happy medium if it does exist. So the economy cycles between low risk premiums and huge risk premiums. We boom and we bust. And those who time it right get insanely rich. The rest of us live with the cycle.

Sorry, I had to throw that out. I'll try to stick on topic with Greed, Green, and Grains...

Counting ALL the carbon in climate policies

One of the most difficult challenges in curbing greenhouse gas emissions is recognizing that CO2 emissions are influenced by more than fossil fuel consumption. About 20 percent of excess carbon emissions come from deforestation. Trees and plants breathe CO2, and that can make a big difference.

If we ignore this, corn-based ethanol might look climate friendly. If we account for it, we're better off using gasoline, at least when it comes to total carbon emissions. This was an important point made by Searchinger et al. in Science last year. Ethanol production drives up commodity prices, which encourages farmers to clear forests to plant more crops. One could argue with some of the details of Searchinger, but the overall conclusion is hard to dismiss.

If we can price carbon sequestrations as well as carbon emissions, and make it global, everything works out fine. If we don't price carbon sequestered from trees and plants, then emission reductions in one place might slip out somewhere else. Like squeezing a balloon.

Whether we use taxes or a cap-and-trade system, this is going to be one of the messy details that needs to be sorted out. It will be hard enough counting and pricing fossil fuel use. Counting and pricing carbon in agriculture and forestry will be much harder.

Here is Ruben Lubowski, a good friend and coauthor of mine, testifying before the Senate on "carbon offsets" about 8 months ago. He's on a 2-year leave of absence from USDA working at the Environmental Defense Fund.