FOMC | Krugman and the Liquidity Trap

On December 18, 2008, I reported on a speech by Laurence Meyer of Macroeconomic Advisors in which he said that after the December 16 Federal Open Market Committee statement, the FOMC could go on vacation for two years. In other words, by going to the zero (actually 0-0.25 percent) interest rate policy, the Fed was out of ammunition in the battle for recovery from the financial meltdown. In other words, the United States was in the Japanese liquidity trap.

Paul Krugman wrote an article in 1998 for Brookings with two other economists on the Japanese liquidity trap. In 1999 he posted his prescient thoughts about the possibility of a Japanese-style liquidity trap happening in the United States. He reviewed the assumptions of the traditional IS-LM model and concluded that at the zero-interest bound characteristic of the liquidity trap, the central bank has little power. In order to change expectations, he argues that inflation targeting is the solution - the central bank should plan on a certain degree of significant inflation. That will impose a negative interest rate on passive owners of liquid assets. It will force them to hunt for yield higher than the inflation rate and - assuming the banking system is working properly (which it was not doing in the first decade of this century) - that will prompt owners of liquid assets to invest. Krugman posted again on the liquidity trap in 2010 but with no mention of inflation targeting.

Interestingly, the 12th edition of Baumol and Blinder, Economics: Principles and Policy (South-Western, 2012, 2011) does not include anything specific about the IS-LM model. (Co-author Alan Blinder was formerly Vice Chairman of the Federal Reserve Board.)  The book does not include "zero-interest" or "zero bound" or "liquidity trap" in its index. But it does have  a box on inflation targeting (p. 695), noting that the current Fed Chairman, Ben Bernanke, was a "big advocate" of inflation when he was a Princeton professor. The British Chancellor of the Exchequer sets an inflation target (currently 2 percent) and the Bank of England is required to work towards meeting that target. Stanford Professor John Taylor showed during the Chairmanship of Alan Greenspan that the Fed's decisions could be replicated with a simple guideline, the "Taylor Rule": (1) When the inflation rate is above 2 percent, raise the real interest rate proportionately above 2 percent. (2) When there is a recessionary gap, reduce the real interest rate below 2 percent proportionate to the recession. Baumol and Blinder note that "No central bank uses the Taylor rule as a mechanical rule." But it is a useful guide to what is actually going on.

IRENE | Is It One of Top Ten U.S. Catastrophes?

The New York Times today has Irene pegged as one of the "top 10 costliest catastrophes in the nation's history". To rank losses over time, they must at a minimum be adjusted for inflation. Irene imposed huge losses on many communities, but does it rank among the "Top 10 costliest catastrophes in the nation's history"? At the $7-$10 billion total cited in the article, no way. If the losses remain in this range after all reports are in, Irene will not even rank among the top ten Atlantic Coast hurricanes.
Adjusting for inflation only:
- The tenth costliest hurricane since 1900 was Betsy in 1965, with $11.2 billion in 2010 dollars.
- Katrina ranks #1 at $105.8 billion.
Adjusting for population growth and wealth per capita as well as inflation, as two experts argue is needed to compare the data on a fair basis:
- The costliest hurricane since 1900 was the 1926 Great Miami hurricane, with losses of $164.8 billion in 2010 dollars.
- Katrina is second at $113.4 billion.
- The Galveston 1900 hurricane is the third most severe, with a loss of $104.3 billion.
- The tenth costliest was Hurricane Donna in 1960, with a loss of $28.2 billion in 2010 dollars.
SOURCE: Eric S. Blake (National Hurricane Center) and Ethan J. Gibney (National Climatic Data Center), The Deadliest, Costliest and Most Intense U.S. Tropical Cyclones from 1851 to 2010, April 2011, Table 3b, p.11.

IRENE | How Bad Was She? Metrics

Wall of Water, East Hampton
My photo, August 28, 2011

A day after Hurrican Irene was downgraded to a Tropical Storm, 21 fatalities have been reported. Each of these  deaths represents a family tragedy and a huge loss for survivors. But in the business of measuring the economic impact of events–which I actively engaged in for 13 years while serving as Chief Economist for the New York City Comptroller–fatalities are one way to assess damage.

The Fatalities Metric

The latest report of fatalities as I write was issued at  1:16 am August 29 by CNN, with a total of 21 deaths in eight states–six in North Carolina, four in Virginia, four in Pennsylvania, three in New York State, and one each in four other states visited by Hurricane Irene.

The three fatalities in New York State were in (1) Spring Valley, Rockland Co., where a 50-year-old Good Samaritan electrocuted as he attempted to assist two people seeking to escape downed electrical wires, (2) New Scotland, Albany Co., where a woman was recovered after drowning in an overflowing creek, and (3) Bellport Bay, Suffolk Co., where a windsurfer drowned. The windsurfer death is assumed to be connected to a surge from Irene, but this may be revised.  New deaths may also be reported today as offices open and more information is shared.

Note that no fatalities have been reported in New York City, which has suffered from extensive flooding. The City Government took great precautions to evacuate people from low-lying areas and to discourage travel.

How does 21 deaths compare with loss of life in other hurricanes? The five deadliest Atlantic hurricanes since 1900 are (based on Black and Gibney, 2011, Table 3b, part 2, p. 11):

1. Galveston, TX, 1900, Category 4, 8,000-12,000 deaths.
2. Lake Okeechobee, FL, 1928, Category 4, 2,500-3,000 deaths.
3. Katrina, 2005, Category 3, 1,200 deaths.
4. Florida Keys, 1919, Category 4, 600 deaths (287 on land).
5. Long Island Express (Great New England), 1938, Category 3, 600 deaths (256 on land).

The Economic Damage Metric

Of course, the deadliest hurricanes are not always the most expensive to sustain and repair. Pielke et al. (R. A. Pielke, Jr., J. Gratz, C.W. Landsea, D. Collins, M. Saunders, and R. Musulin, 2008: "Normalized Hurricane Damages in the U.S.: 1900-2005." Natural Hazards Review, 9, 29-42, cited in Blake and Gibney, 2011) adjust historical data for inflation to 2010, wealth per capita and population. The ten costliest Atlantic hurricanes are listed below with their estimated damage. Note that earlier estimates are generally based on physical damage only, whereas later economic impact numbers include impacts such as business-interruption costs.

The economic impact on New York City of business interruption is great, but fortunately Hurricane Irene arrived in NYC on a weekend, when the impact is less serious than on a weekday. A major factor in business interruption is the cancellation of a reported 9,000 flights at NYC area airports as well as suspension of rail and bus services in the region.

Here is the list of the ten costliest hurricanes, in $billions of 2010 dollars:
1. Great Miami, 1926        164.8
2. Katrina, 2005                 113.4
3. Galveston, 1900             104.3
4. Galveston, 1915               71.4
5. Andrew, 1992                  60.5
6. L.I. Express, 1938            41.1
7. SW Florida, 1944             40.6
8. Lake Okeechobee, 1928   35.3
9. Ike, 2008                          29.5
10. Donna, 1960                   28.2

Of the five hurricanes with the greatest loss of life, four are on this list. The one that is missing is the Category 5 Florida Keys hurricane of 1919.

Equecat is estimating insurance claims of $1.5-3 billion. Kinetic Analysis Corp., a consulting firm in Silver Spring, MD that was estimating insurance losses at $14 billion several days ago, has cut its insurance losses estimate by more than 80 percent, to $2.6 billion, on losses from the storm of $7 billion. If business-interruption costs are added to physical losses, this number might be on the low side.

But compared with the fatalities and losses for the ten hurricanes with the largest damages, Hurricane Irene has not turned out to be one of the big ones, something to be thankful for.

Mayor Bloomberg’s Evacuation - Panicky, Politic or Prudent?

Mayor Michael Bloomberg ordered New York City’s first-ever mandatory evacuation to take place by 5 pm Saturday. More than 370,000 people were told to leave low-lying areas in “Zone A” of the City’s evacuation map, including:
- Battery Park City, Manhattan
- Coney Island and Manhattan Beach, Brooklyn
- Far Rockaway and Beach Channel, Queens
- South Beach and Midland Beach, Staten Island.

After the deadline on Saturday, the Mayor said that Hurricane Irene had reached the city. “The time for evacuation is over. Everyone should now go inside.”

By 2 am Sunday, the National Weather Service was predicting that Hurricane Irene would most likely hit land to the east of New York City and would be downgraded to a tropical storm. (See map.)

So - did the Mayor overreact in ordering an evacuation of so many people?

Here are seven points to consider:

1. The Mayor had no way to know for sure where or how hard the hurricane would hit or exactly where. The chances were good that it would slam into NYC.

2. He was setting an example for other officials in New York State and in other states by preparing for the worst.

3. The Mayor surely did not want a repeat of the charge of inadequate preparation that followed the December 2010 snow storm.

4. Hurricanes are rare enough in the NYC latitude that the Mayor could realistically expect never to have to declare another such emergency during the remainder of his administration. The only five major hurricanes (maximum winds of 111 mph or higher, i.e., Category 3, 4 or 5) to threaten New York State since 1900 were the Long Island Express hurricane of September 1938, the post-D-Day hurricane of September 1944, Carol in August 1954, Donna in September 1960 and Gloria in September 1985. Two other hurricanes were Category 1 in New York State – Agnes in June 1972 and Belle in August 1976. Some of these hurricanes didn’t come within 75 miles of NYC. Since 1851, only five have come that close.

5. Even when wind speeds are down below the 74 mph Category 1 level, the possibility that tornadoes could emerge is ever-present. A tornado watch was announced for Sunday morning. Based on the Saffir/Simpson Hurricane Wind Scale (see Table 1 in source).

6. The Hurricane Evacuation Map is impressive. The Mayor is surely proud of this emergency planning tool. Irene is an opportunity for him to test it. An evacuation drill would get nowhere. The threat of a hurricane is a good opportunity to try out the system.

7. Above all, the threat of flooding is real regardless of wind speed. The high precipitation expected in NYC means that a flood watch continues until noon on Sunday.

I think the Mayor did the right thing. To generate information that might be useful for preparing for the next threat of a natural disaster, the Mayor should report fully and soon on the extent of compliance with the evacuation order. We need to know what the challenges are for people to evacuate and how these challenges might be met.

NYC Seeks to Grow Jobs through Incubators

It wasn't a big national event. New York City Mayor Bloomberg visited the Entrepreneur Space in Queens, New York last week. With him were City Council Speaker Christine Quinn, Rep. Carolyn Maloney and other elected officials. The main coverage was a local story by the Queens Gazette and a press release and a YouTube clip posted by the Mayor.

However, this visit should get national attention. Bloomberg, after all, knows a thing or two about how to create jobs. Back in 1981, when there weren't a lot of incubators and in the midst of a Fed-induced inflation-fighting recession, Michael Bloomberg parlayed his $10 million Salamon Brothers severance and his shares into a giant company. Last I checked, Bloomberg L.P. had 9,000 employees in the New York City area alone (a lot more than the entire staff of the U.S. Senate). Also, by bringing more transparency to capital markets, the company argues with some basis that it is contributing to growth of jobs outside of New York.

The nation is stuck in liquidity doldrums that Japan has made famous. Creating jobs is today's public-policy Priority One, the Tea Party's debt exorcisers notwithstanding. Mr. Bloomberg’s skill at building a business empire from scratch inspired scared New Yorkers to vote for him after 9/11. They elected an entrepreneur as mayor with the expectation that a successful business leader would surely would help the City hold on to its jobs and create new ones.

So what is the Mayor doing now, ten years after 9/11 and 30 years after he launched his business? He is recognizing the importance encouraging entrepreneurship, and he is also recognizing the fact that few wannabe entrepreneurs have the startup capital he began with, or the training he received at Salamon Brothers.

To assist new entrepreneurs, in 2009 Mayor Bloomberg launched nine business incubators thoughout NYC, hosting more than 500 start-up businesses and more than 800 jobs. The incubatees have raised $39 million in private capital so far. Many are graduating from their incubators.

Some New York City incubators are even exporting their support skills elsewhere. Green Spaces, a green incubator that started in Brooklyn has cloned itself in Manhattan and has now extended its efforts to Colorado, backing the Green Route Festival this Saturday in Denver.

The Entrepreneur Space in Queens is a good example of an incubator. It allows local food-oriented companies to avoid investing in their own commercial grade kitchens. For a fee, it provides four such kitchens, meeting Health Department standards, shared 24 hours a day by 120 businesses. The companies produce organic dog biscuits, ethnic foods, and pies, cakes and cookies. The kitchens are also used by catering services. The public-private Entrepreneur Space partnership includes incubator services funded by New York City - low-cost workstations, mentoring programs and job training.

Excerpts from comments of three elected officials who were on the tour of the incubator follow:

City Council Speaker Quinn:

These workspaces are groundbreaking initiatives, aiding culinary entrepreneurs to expand their businesses while bolstering the multibillion dollar food industry in New York City.

Mayor Bloomberg:

When we launched the first business incubator in 2009 to make it easier for entrepreneurs to turn their ideas into local businesses and jobs, we pledged to open more if it was successful. Now, we’re identifying opportunities to expand the program even further. We want New York City to be the most welcoming city in the country for people who want to start a business.

Rep. Maloney:

I agree wholeheartedly with President Obama that Congress needs to get moving to support job creation: we need to reauthorize the cut in payroll taxes we approved in the last Congress, which will give families an extra $1,000 per year, on average. I’d like to commend Mayor Bloomberg on the success of New York’s business incubators. The small businesses taking root here are truly the future of New York. This kind of innovation is one of the reasons New York is doing better than the national average.

Congratulations to the Mayor. Recent reports suggest that the New York City area has passed Boston in the amount of venture capital money it is raising. NYC is now second only to the Bay Area. Together, NYC and Boston VC funding exceeds what is going into the Bay Area. The hot areas for VC funding are web-focused tech companies. Just as demand from Wall Street drove growth of NYC’s tech companies in the 1990s, today the driver, says Dave Broadwin of Foley Hoag, is the advertising industry.

NYC needs to do everything we can to encourage entrepreneurship in tech development and every industry!

The S&P Ruckus and the Real Policy Challenge

The S&P downgrade was signaled well in advance, so it should not have come as a surprise. Paul Krugman takes a no-holds-barred position today that yes, the United States is a mess, but no, S&P is not the organization to rely on for this evaluation, since its laxity during the mortgage-finance bubble contributed to the meltdown and triggered the Great Recession. A neat summary of blogviews by economists is at Curious Capitalist. 

My Comment: Since U.S. Treasuries have been the global gold standard for risk-free debt, it is odd to think of them as rating less than AAA. For a rating agency to downgrade the debt in the way it did smacks of petulance over the way Congress conducted the debate. That should not be any business of S&P. The American voter will deal with that in 2012.

What strikes me as sad is that the unnecessary debt-ceiling debate precipitated the downgrade. The U.S. Government should remain focused on the 13.9 million unemployed Americans and the 9.1 percent unemployment rate. Demanding more cuts in spending now will not be helpful unless a package of job incentives is passed ASAP. What ought to have precipitated a rating-agency downgrade of U.S. debt, on technical grounds, was the exclusion of the Iraq and Afghanistan wars from the Federal budget, pushing this spending into the deficit and add to the U.S. debt. Or a downgrade for running up of deficits during the good years of 2004-2006 years unemployment was below 6 percent and falling. But that was when S&P was otherwise preoccupied, selling AAA ratings of evil baskets of CDOs. S&P is about six years late and a couple of trillion dollars off the mark.

NYC & LA | Counterfeit Goods

Counterfeit iPods etc. confiscated in Los Angeles

A November 2004 report by the New York City Comptroller's Office estimated that $23 billion was spent on counterfeit goods in NYC in 2003.

This was an estimate not just of counterfeit goods sold on NYC  streets, although such sales at the time were highly visible, for example up and down Broadway. The estimate also included:

• Counterfeit goods sold in stores. 
• Wholesale trade in NYC of counterfeit goods trans-shipped to places as far away as the Dominican Republic and Ohio. 
• Out-of-town shipments. A raid on a Chelsea warehouse found a huge volume of counterfeit goods being packaged for shipment out of town.
• Wholesale buying by out-of-town resellers. A Broadway warehouse was raided and found to be a major shopping center for wholesale buyers who brought their goods out in black plastic bags to load into waiting trucks.

It's not hard to hide in plain sight as a value-added counterfeiter in NYC. I was once included on a police raid targeting a small private house in Queens. A small group of people was making pirate CDs, packaging them in plastic "jewel cases" along with the usual inserts for delivery to retail CD sellers. The copying was done on up-to-date towers that could produce 20 copies from one master in a few minutes.

The cardboard boxes that the jewel cases came in were reused for shipment out, but the CD boxes remained, so it was easy to estimate the volume of CDs that were being shipped out. The empty boxes not yet trashed/recycled had contained hundreds of thousands of blank CDs.

An August 2011 "Nightline" story shows that Los Angeles has joined New York as a major trans-shipment and retail center for counterfeit goods. Counterfeit clothing and other branded goods are sold both on the street and in stores, to both retail and wholesale customers.

Counterfeiting may sound like a "victimless" crime, but it is not. When the goods are fake prescription drugs, fake sunglasses, fake auto parts or bootleg toys or food, they bypass certification or safety inspections. They also bypass sales taxes, which is a reason prices can be much lower than legitimate products. State and local governments are hard-pressed to pay for the services they provide and tax-evaders reduce revenues and force up the cost of collecting taxes.

The impact on brands is sometimes debated. Knockoffs can be described as promoting the products they try to duplicate. A parent may buy a knockoff for a young child. The extent of competition is determined by the cross-elasticity of demand, i.e., the extent to which the knockoff is a complement to the genuine item or is a substitute:

• If it is a substitute, sales of counterfeit goods harm sales of the genuine item. Example: Someone intending to buy a genuine Vuitton bag for a pre-teen daughter sees a vendor selling counterfeit bags and decides to save some money. This is a threat to the brands, because the availability ofthe counterfeit means that a sale of the genuine item was not made.
• If it is a complement, sales of counterfeit goods do not harm sales of the genuine item. Example: A woman who has just bought a genuine Rolex watch on Fifth Avenue for herself, sees a vendor selling fake Rolex watches and buys one for her pre-teen daughter (she would never have purchased a genuine one because her daughter is likely to lose it). This is less of a threat to the brands.

Brands that do not spend money to track and expose counterfeiters are in danger of seeing their reputation tarnished. Why should a consumer buy a high-status watch if counterfeits are available at huge discounts on the street? The stakes posed by counterfeiting are high.