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.

Markets still react to Bernanke

Okay, I'm going to briefly weigh in again where I probably shouldn't---the macro situation.

Apparently in response to Bernanke's speech in Jackson Hole today, the stock market and treasury bills rallied modestly, and the 10-year T-bill rate fell over 6 basis points.  I suppose one could argue this was due to something else, but I don't see anything other explanation in the news.

Paul Krugman summarized Bernake's speech as:

1. Things are really, really bad.

2. The damage is cumulative; the longer this goes on, the worse the prospects for the future.

3. The Fed has the power to do a lot to help the economy.

4. While you can argue that there are costs to action, the case for major costs is quite weak, and in particular much weaker than the case for major benefits.

5. Therefore, what we at the Fed will do is, um, sit on our hands some more, and think very seriously about maybe, someday, doing something.

While Krugman greatly supports the Fed trying to do more, he has also expressed skepticism that they can help much when the economy is at the zero lower bound.

But I'd just like to point out that the market still seems to respond to Bernanke's most demure suggestions.  I mean, how much news was there in his Jackson Hole speech?  We all more-or-less knew that the Fed was looking to do more imminently anyway, and now he's nudged another inch in that direction.

If we extrapolate from this, I think it suggests the Fed can do a lot more.  It could do this by changing market expectations, by replacing point 5 in Krugman's summary with a clear and firm commitment for the next X years.  That commitment could be to hold rates where they are for a longer period of time, to target a higher long-run inflation rate,  a commitment to hold rates low until unemployment falls to 6 percent, or a commitment to achieve trend nominal GDP.

I don't think it matters much which commitment they choose.  But I believe that if the Fed were to make a bold commitment of continued easing the economy would recover quickly. It's a shame they probably won't do that.

Update: Slight clarification: I expect the Fed will do something, but whatever they do will be relatively modest.  Perhaps there will be more asset purchases or something.  But I rather doubt we'll see a strong commitment to longer term policy.

Brad Plumber writes what I think about the drought

Brad Plumber over at Ezra Klein's Wonkblog writes my thoughts better than I do :-)

While my comments about CAFO's in my post the other day are sure to offend many, I did try to choose my words carefully.  There are many ethical and environmental issues that surround CAFOs, and I'm not dismissing those issues. 

But we should be aware of indirect consequences of CAFOs.  Some of those indirect consequences can be good for feeding the world and even good for the environment.  It's only responsible to spell out all of those tradeoffs, and I see that as my job. There are good arguments to be made that modern industrial agriculture is good for the environment in much the same way as high-density urban living is good for the environment: by concentrating these activities we leave less of a footprint on the planet as a whole.

Incidentally, unlike the other guy in the news these days, I think "wonk" suits Wonkblog very well.

Sea Ice Extent

Sea ice extent is one of the more interesting barometers of climate change.

This year has been a record low, beating the previous record from 2007.  Extent is a little more than half the 1979-2000 median, or about 6 standard deviations below it.

From Justin Gillis's article today in the NYT:

“It’s hard even for people like me to believe, to see that climate change is actually doing what our worst fears dictated,” said Jennifer A. Francis, a Rutgers University scientist who studies the effect of sea ice on weather patterns. “It’s starting to give me chills, to tell you the truth.”....

....“It’s an example of how uncertainty is not our friend when it comes to climate-change risk,” said Michael E. Mann, a climate scientist at Pennsylvania State University. “In this case, the models were almost certainly too conservative in the changes they were projecting, probably because of important missing physics.”

What's the price of corn in your meat? Less than you think.

In my OpEd last week I had a lot of back and fourth with the editor.  I probably had too many statistics and my first draft was just too long.  I also should have provided background information up front for the statistics I wanted to present.

One thing that got dropped in the process was an explanation for why retail food prices will rise so little even though corn prices have increased 60 percent.  So much of our food is ultimately derived from corn, or from other commodities like wheat and soybeans whose prices track corn prices fairly closely.  But it still makes little difference.

Take meat, for example.  There are only 3-5 pounds of corn used to make an additional pound of beef, and between 2 and 3 pounds of corn for a pound of chicken or pork.   The calculation isn't particularly straightforward, but these numbers are probably about right ``on the margin," as economists like to say. This can vary a bit from operation to operation or how it's measured, but feed use efficiency has risen a lot over the last couple decades with the growth of confined animal feeding operations, or CAFOs.

Let's says 5 pounds of corn per pound of meat.  There are 56 pounds of corn in a bushel and since June prices have increased from about $5 to about $8 per bushel.  This means the amount corn in your quarter-pound burger have increased from about 11 cents to about 18 cents.  If there is market power by processing companies or retailers, retail prices would go up by less than this amount (this is basic microeconomics, but I'll save the details for another time).  So, you'll have to squint to see the effect of this year's drought on prices at grocery stores and restaurants.

There are lots of complaints about CAFOs being inhumane for animals.  That may be, but they are also extremely efficient at using resources.  Without CAFOs, you would see bigger prices in all kinds of food, and this year's heat and drought would have caused a larger price spike.  We would also be using more land in crop production globally, and be using more fertilizers that pollute water and all manner of other environmental problems that follow from crop production.  Many environmentalists don't like CAFO's but they may well be doing more good for the environment than eating grass-fed beef, unless the high price of grass fed beef causes you to eat less.  (Granted, grass-fed beef is probably healthier.)

Anyhow, the main point is that commodities are a tiny share of retail prices in developed economies.  Prices of most everything, including food, is made up primarily of labor and capital costs, plus rents to producers and retailers with market power.  The big concern for high commodity prices in the developed world where the commodity share of food expenditures is much, much greater and people spend a much larger share of their income on food.

(cross posted at G-FEED)

Are we coping with extreme heat better than the past?

I'm live at CNN.  This is the biggest splash I've ever had....

Extreme heat and droughts -- a recipe for world food woes

With extreme heat and the worst drought in half a century continuing to plague the farm states, there are important lessons to be learned for all of us -- farmers, consumers and the world's poorest populations alike -- about the effect of climate change.

The Agriculture Department announced this season's first major crop yield forecasts, and they weren't pretty: a nationwide average of 123.4 bushels of corn per acre, the lowest level since 1995. Soybean yield is expected to be low too, though not as bad as corn.

The United States, which is the world's largest producer and exporter of staple grains, is grappling with the biggest surprise in production shortfalls since the Dust Bowl of the 1930s. Certainly, this July surpassed July 1936 as the hottest month on record. 

So, how will the devastation affect U.S. crop farmers? .....

Forecasting Corn Yields

My colleague Wolfram Schlenker has developed forecasts for this year's corn yield based on weather through August 6.  We've been considered pessimists by some, since this model predicts really big declines in crop yields under projected climate change.  But this year we're the optimists: our model predicts a US yield only a 14 percent below trend. That's bad, but it's not nearly as bad as USDA's forecast last Friday of 25 percent below trend.

I'm replicating his post so you don't have to click through:

USDA today announced its forecast for corn yields. It might be fun to compare those forecast to one using a statistical model of corn yields that my colleague Michael Roberts and I have developed. It uses only four temperature variables (two temperature and two precipitation variables - if you want to read more, here's a link to the paper). The temperature variables in 2012 are shown here.

All weather variables in the model are season totals for March 1st - August 31st. The following graph combines actual weather observations for March 1st-August 6, 2012 with historic averages for August 7th-August 31st in each county.  Once the actual weather for the rest of August is realized, the predictions will obviously change dependent on whether it warmer or cooler than usual.

Should the Ethanol Mandate be Temporarily Suspended?

There seems to be a big push to roll back the ethanol mandate, at least temporarily, due to the crop losses and high prices for corn, soybeans and wheat we're experiencing this year.  See, for example, Colin Carter and Henry Miller's Op Ed in the New York Times.

How much would a temporary suspension of the mandate affect prices?

As I write, the future price for corn delivered in December 2012 is $7.95/bu.  The price for delivery in December 2013 is just $6.30.  So, there is no incentive to store commodities, and inventories are very low.  So, any reprieve on the demand side will push directly on this year's price. With regard to prices, it would be equivalent to reducing the size of crop losses.  If we lose 1/3 of the crop from heat and drought, and we reduce demand by 1/3 by temporarily halting ethanol production, we'd probably go back to early-Spring prices of around $4-5/bu.

One problem with this back-of-the-envelope calculation is that ethanol production is unlikely to stop completely just due to a temporary suspension of the mandate.  There are shutdown and startup costs, and a 10% ethanol blend is firmly in place.  So prices probably wouldn't fall back that far, but they would fall a lot.

In fact, I wouldn't be surprised if speculation about a temporary suspension of the mandate is already  folded into futures prices, at least partly.  It's hard to know what the odds of a repeal might be, but the market knows it's not zero.  And the worse are crop losses, the greater the odds of a temporary  suspension.

What's more subtle and potentially more interesting is that temporarily repealing the mandate would set a precedent that would affect futures prices and inventory demand going forward.  It would be interesting to evaluate an ethanol policy with a "safety valve" that would relax the mandate in the event prices exceeded some threshold.  This kind of analysis is more difficult. Nam Tran, a grad student at NCSU, is working on it.  I'll post his results here if and when he has them.

(Cross-posted on G-FEED)

A New Normal?

Over at G-FEED, short for Global Food, Environment and Economics Dynamics,  a new site and blog by an interdisciplinary group of scholars, David Lobell has offered his first post in which he considers whether this summer's heat wave is "the new normal."

I've done rough back-of-the-envelope extrapolations from earlier work that suggest, with respect to temperatures, this summer will be the new normal (average or expected outcome) in about 10-15 years.  Rainfall is a different story, but check out G-FEED...