Russ Roberts

Barro on Disasters

EconTalk Episode with Robert Barro
Hosted by Russ Roberts
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Robert Barro of Harvard University and Stanford University's Hoover Institution talks about disasters--significant national and international catastrophes such as the Great Depression, war, and the flu epidemic in the early part of the 20th century. What do we know about these disasters? What is the likelihood of a catastrophic financial crisis in the United States? How serious is the current economic situation in the United States? The conversation also includes discussions of economic stimulus, tax policy, and the recent worldwide rise in commodity prices.

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0:36Intro. Disasters, macroeconomic perspective. Great Depression of the 1930s, looking across countries and history. World War II, WWI. Many countries had declines in GDP and consumption following WWII. Significant death rates and destruction of their capital on their own soil. Widely believed view is that it's an advantage to have your factories and capital stock destroyed because then you can rebuild with the latest technology: Germany, Japan. There is evidence of recoveries after major disasters, periods where you grow at an above-normal rate. But on net it's a very negative experience; effect tends to persist for a long time. I wouldn't recommend it. Death rate: Loss of physical capital is easy to see, death is easy to see, but loss of human capital is not. Innovators from one's own country. Terrible toll on creativity. Not much evidence that having twice as many people contributes to higher growth. Theoretically possible but not much evidence. Ideas people have accumulated are in fact not destroyed by war, part of why you get recoveries. Health related mortality element, Influenza Epidemic, 1918-1920, does show up as a macro-type effect. Partly conjecture, have to separate it from effect of WWI. U.S. does have a major recession with a bottom in 1921, decline of 15%. World Cup event--people stop working, take more leisure, and don't make it up elsewhere. Influenza Epidemic--work not made up elsewhere, affected people in their prime work years. Severely curtailed transportation, people tried to avoid spread of disease. Joint work with Jose Ursua, Harvard. Data quality varies across countries.
10:48How contagious are economic disasters worldwide? Are they interrelated? War, death rates. Other events are more of a financial nature, Great Depression was pretty much a worldwide one, contagion across countries. Asian financial crisis in the late 1990s spread across countries but it didn't affect most developed countries, but did involve Russia in 1998. In 1980s, Latin American debt crisis. 1987 global stock market crash didn't seem to have much in terms of macro consequences. To what do we attribute the relative stability of the economy? Business cycle seems to be smoother. Is that true and why? Seems smoother in last few decades. Monetary policy has improved, central banks, more price stability. But also luck: 2% per year probability, so expect such large events only twice a century. The fact that we haven't seen a big one could just be good fortune. Some relates to wartime, so what is the chance of having a war as big as the World Wars.
14:30Financial question: though the Fed is doing a better job in the last 25 years. Is it just a bad draw out of the urn, animal spirits, or mismanagement of economic policy? Current situation scary, maybe 5% or 10% chance it is financially worrisome. Mortgage finance, could blame government policy, not so much Fed, that encouraged expansion of the residential mortgage market, encouraging banks to lend to poor people, nice American dream but adverse consequences in terms of riskiness. Risks are correlated, underappreciated that these risks were really general. Fannie Mae and Freddie Mac: encouraging home ownership and making it easier to borrow. Too big to fail. But suppose they did fail. Investors lose their money, harder to borrow to buy a house. But is it a cascade of bad things happening? Housing prices are falling, considered scary. If you own a house it's bad; but if you are buying a house it's good. What's the worry? Fannie Mae, Freddie Mac: nobody's saying they are concerned bailing out the stockholders. Government backing is about what's going on with respect to the mortgage market. Government through these two entities has been the major player in the mortgage market; economists have warned for years about this, inefficient market, probably too much investment in housing. Proposals over 20-30 years about lessening the government involvement. Problem is that the whole financial sector puts up with a lot of difficulty all at once if the government pulls out. Concern is return to the Great Depression, where financial markets weren't operating. What to do with these institutions.
21:37Great Depression. Bernanke is a student of the Great Depression, awkward if one occurred on his watch. Spiraling of financial markets out of control, loss of confidence, runs on banks, sudden contraction of the money supply, Fed at the time didn't know what to do and contracted more at a time when it should have been expanding. Are we talking about a larger loss of confidence in the ability of people to keep their promises? Radical actions that the Federal Reserve has been taking: Bear Stearns, J.P. Morgan Chase takeover. Fed has used up a lot of its natural ability to acquire funny-looking paper. Can always start printing money, but that wasn't supposed to be the idea. The Fed has a concern about a meltdown. Two dimensions about this crisis. One is the financial aspect, housing mortgage markets. Second is commodity markets. Most raw materials prices are up by a factor of three in last few years, and energy is not only one. Metals, grains. In production raw material prices prices are up in relative terms. Ethanol policy. Hindrance in terms of production but also a concern because we don't know exactly why it's happening. Adds to worries. Stories, like great economic development in China. Go in the right direction, but it's not something that's just the last three years. China and India have been growing rapidly for a long time, since 1970s and 1990s respectively. One argument: the reason they've not caused a recession so far is that our economy is more diversified: ex post story telling. Ex ante story telling is really what we want to get good at. If you said to an economist a few years ago there's going to be a 30% increase in the price of gas, he'd predict a big recession based on similar experience in the 1970s. In fact, the economy's still growing, though slow down. If you go back to the oil price increases in the 1970s and early '80s, they were clearly supply disruptions. Today, oil, copper, iron price increases: if they are from increases in demand you wouldn't expect a recession. But this gets back to why it's troubling that we don't know what's really causing these relative price increases. Some stories of supply disruptions, Iraq, but doesn't look like the 1970s and 1980s. It may be that some of it is coming more from the demand side. If we are currently in a recession it's marginal, though some industries, sectors are deeply troubled. As of yet we have not crossed the threshold of being in a recession.
32:01Probability of something really bad happening: indicator, one thing you expect when things are really bad is demand for safe things, safe havens goes up. See that in terms of the yields on Treasury securities, inflation indexed Treasury bonds, real returns close to zero or even negative. Indicator of perception of bad environment, threatening. Is it related to exchange rates? Aren't both the Treasury bonds and euro situations consistent with concern that inflation will take a major leap in the U.S., purely monetary? Can get a good reading on what the financial markets think about inflation. Compare standard nominal securities with indexed securities. Look at 10-year ordinary U.S. Treasuries with 10-year indexed Treasuries: inflation prediction has gone up about half a percentage point. Up enough for Fed to be concerned, but not yet a major disaster. Gold prices, commodity prices are less direct. Returns on both unindexed and indexed Treasuries has gone down. Spread has gone up some.
35:50Commodities. Political scientist predicted: of course Obama's going to win because the average citizen is so depressed about the state of the economy. Not a good idea to look at one price; other things are not up as much or are down. Consumer and Producer price indexes are not going up by 300%. Inflation has gone up in the world, 8% in China; India roughly similar. In the U.S. and Europe, inflation rates have ticked up but are not really high. So gasoline and iron ore price increases are relative price phenomenon, not purely nominal reflections of overall inflation. But what people think about the economy overall in the U.S., people are not real happy about the economy and incumbents tend to suffer from that. Predicts McCain will win, predicts Congressional results will differ from Presidential result; not based on much economics though. This podcast is in July of 2008, on the record, prediction against both the polls and the betting markets. Consumer confidence, future health of the economy. Effect rather than a cause, not much evidence that it's a separate influence. Fallacies: oil prices high because of speculation. Doug Rivers podcast, many people blame high oil prices on speculators. Funny inconsistency. Whole idea about speculation is what you think about the future. If you change your policy so people can start drilling in Alaska, you expect that to have an impact today on the price. Used to be more support for the idea that you don't do a lot of drilling there, environmental idea. That tradeoff changes when the price of oil triples. Nuclear power, coal. Political policy stances are changing. Taping on Stanford campus; gas station nearby has dropped prices in the last week. Days of cheap gas may or may not be over. Menlo Park, nearby, Tesla dealership has opened--new electric car, $109,000. Goes fast, but limited range, 200 miles between charges, can only go about 110 miles. Long waiting list, but can't make very many of them, about 4 a month.
44:40Oil is the commodity that people observe most readily because they frequently buy gasoline. Copper prices not as easily noticed, but maybe copper has a bigger economic effect. Corn, ethanol disaster; appears that we know the reason, but since both supply and demand are moving we may just be ex post theorizing. Archer Daniels Midland. Ethanol program though is not big enough to be causing the whole effect. Ripple effect, plant more corn means planting less of other things. Going out to look at the acreage. Rice prices explainable by corn planting? Rice in California, but still seems unlikely that the ethanol program is the entire cause of the size of the price increase.
48:01Stimulus package, sending modest checks, Keynesian argument. Evidence against it: if you ask people ex ante they say they are going to save it, ex post they say they saved it. Ricardian equivalence: the money for the stimulus package has to come from somewhere, budget constraint, appears to have come from borrowing. No real wealth created by this kind of program; expect people to spend based on their idea of their long-run wealth or income, so predict little stimulative effect. Contrast that with 2003 economic program, focused on rates, cut marginal income tax rates, reduced tax on capital income. Good in terms of long run growth, worked in terms of the timing of the recession. Number of things from that package that will be lapsing. Ricardian equivalence wealth effect: stimulus package was targeted to middle and low income, paid for by future taxpayers, who are different people in general. Top 1% of income earners pays about 40% of the income taxes in America. Claim of some is that people who are going to pay are in the future and they don't anticipate that, so others will go out and spend now. Short run shifting is not a major impact empirically. Payroll tax, substantial source of government revenue now, illusion that it is funding Social Security. Ricardian equivalence: taxing a dollar today vs. government borrowing a dollar today have same economic impact, holding government expenditure fixed. Changing only the way you are paying for it. Payroll tax is brilliantly efficient system, relatively little deadweight loss. Value added tax also efficient. Danger of an efficient tax is you are tempted to use it a lot. Not even 5% of revenue is generated by people in the bottom half of income. Social Security.
59:59Reduction of marginal tax rates: any evidence that it's an important determinant of economic activity? Does impending repeal of the 2003 tax cut provisions have an effect today--2010? Reagan, phased tax cut in 1980s; Bush 2001 tax cuts, promises of even more cuts in the future. Contractionary effect. Recessions of those years could have been compounded by that, people waiting for future lower rates to work harder. 2003 different--put in cuts and got rid of the effect for the future cuts. As you get closer to the date when things are going to go back it would discourage people from investing. Work more today.

COMMENTS (9 to date)
Unit writes:

I'll venture that we are now feeling the economic effects of 9/11 and the subsequent tightening of controls on international trade shipments and internal transactions. In a sense the "disaster" has already occurred. Not so much because of the immediate damage, but because of the people's, and hence the government's, emotional response.

David Youngberg writes:

I'd say a lot of the rise in prices is due to the rise of developing countries. We could reconcile the difference in time effects because many industries don't run at full capacity. As China and India (and others) grew, productivity approached capacity. These industries would attempt to expand capacity but evenutally demand would catch up and exceed it. Prices rise with delay. It's not everything, but it's a big chunk of the story.

siredge writes:

During the show, the comment was made that the bottom 50% of taxpayers or American individuals only pay 5% of the taxes. Is that adjusted for the negative income taxes (courtesy of refundable tax credits like the child tax credit and the earned income credit) that many of these people receive? Also, is that figure based on the population of the United States or people filing tax returns?

Thanks.

Russ Roberts writes:

siredge,

I think it is not adjusted for negative taxes. The population is taxpayers, not population. I'll try and get a link up to the numbers for you.

Russ Roberts writes:

Siredge,

In 2006 (the latest data), the bottom 50% of taxpaying units (out of a total of about 68 million returns) paid just under 3% of the federal individual income taxes:

http://www.taxfoundation.org/publications/show/250.html

Chris writes:

I like that this podcast touches on the difference between oil price shocks in the 70s and today. The previous price shock was the result of result of actual and perceived supply side constriction. Today's oil price shock is more of an example of demand rising faster than supply.
The difference is important because this demand side push on price is the result of expanding production requiring greater input.

tw writes:

Your discussion of the 1970s oil situation (recession) vs. today's situation (still not a recession) got me to thinking about the differences about how our government managed the situation.

Then: As best I recall, they implemented measures to keep the prices down, and all that did was predictably create shortages given where the true equilibrium price was.

Today: For the most part, they're letting prices float and are bickering about which, if any, restrictions on supply to lift.

So why a recession then vs. no recession today? Could it be because the shortages created long, long lines and people and businesses therefore had to devote huge amounts of time to obtaining gas - at least some of the opportunity cost of that time had to be lost productivity, right? And on a macro scale, that would certainly have a crippling effect on an economy.

Today, we're still putting in the hours of productivity...we're just spending more of the spoils of our productive time on gas. In fact, some of us may have to devote more of our time to work in place of leisure, and that translates to more productivity. So no recession....yet.

Do you think that this could indeed be such a factor, or am I overestimating the possible effect here? In any event, I enjoyed the podcast, as usual.

Schepp writes:

Interesting as usual. I am really interested in Ricardian Equivalents was intrigued when it was brought up.

I did have some questions:

When the government provides rebates do they also sell bonds to cover those costs?

Is there a lag between the issuance of refunds as compared to when the Fed sells the bonds?

Are government spending induced inflation and government bond sales are Ricardian equivalents?

paul muzzey writes:

Hi Russ:

Your website is an absolute treasure trove of economic information! Keep up the great work.

When listening to the podcast with Robert Barro, I was confused about your "take" on Fannie and Freddie. It seemed that you didn't think the failure of these organizations would be that big a deal to the economy--painful to their shareholders indeed, and another blow to the mortgage back security market--but not much beyond this.
If I'm correct in assessing your position, I think you are missing the key point here. The debt issued by the FNMA and FHLMC is substantial and much of that debt is tucked away within the securities portfolios of banks. If FNMA and FHLMC were allowed to fail, and their bonds got crushed in the process, this would be a serious blow to the banking system--especially in light of the fact that the securities portfolio within banks is supposed to be the "safe" segment of a bank's balance sheet.

Whether we like it or not, the moral hazard of these two beasts which many economists have been warning about for years is indeed very real. Letting them go under like any other organization that makes bad bets is sadly, frought with substantial systemic risk.

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