Feldstein Advocates Surge in Defense Spending

Martin Feldstein says Defense Spending Would Be Great Stimulus:

As President-elect Barack Obama and his economic advisers recognize, countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment that is now under way. Without that rise in government spending, the economic downturn would be deeper and longer. Although tax cuts for individuals and businesses can help, government spending will have to do the heavy lifting. That's why the Obama team will propose a package of about $300 billion a year in additional federal government outlays and grants to states and local governments ... A temporary rise in DOD spending on supplies, equipment and manpower should be a significant part of that increase in overall government outlays. The same applies to the Department of Homeland Security, to the FBI, and to other parts of the national intelligence community. The increase in government spending needs to be a short-term surge with greater outlays in 2009 and 2010 but then tailing off sharply in 2011 when the economy should be almost back to its prerecession level of activity. Buying military supplies and equipment, including a variety of off-the-shelf dual use items, can easily fit this surge pattern.

Feldstein’s call for some surge in government purchases with a scaling back when we reach full employment strikes me as good macroeconomics. However, we can do the same thing with public schools, bridges, and roads. Of course, I had a similar reaction to something Bill Kristol wrote.

Merry Christmas from the forest in Tasmania

A human being is a part of the whole, called by us the 'Universe' - a part limited in time and space. He experiences himself, his thoughts and feelings, as something separated from the rest - a kind of optical delusion of his consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest to us. Our task must be to free ourselves by widening our circle of compassion to embrace all living creatures and the whole of Nature in its beauty.

Albert Einstein

The Hubbard-Mayer Proposal to Nationalize Housing Finance – Can the Government Make Money on Socialism?

James Kwak has a nice discussion of a proposal that Brad DeLong endorses thusly:

We are drifting toward nationalizing housing finance. And as long as the government can borrow at the Treasury rate it can buy up and refinance the country's stock of mortgages without paying a dime in the long run. The largest risk-arb operation in history--and since the government can mobilize the entire risk-bearing capacity of America, a very low-risk one

According to the Federal Reserve, long-term mortgage rates are near 5.2 percent so the Hubbard-Meyer proposal is to finance them at rates well below current market rates with long-term Treasury rates are near 2.5 percent. How much of this difference represents the expected return premium that Brad hints at versus the expected losses from default, which the government will inherent? I’m not sure but Kwak offers us the following:

One question is whether the loans will be sustainable. Hubbard and Mayer say that 1.9% is more than enough because the ordinary spread is 1.6%. But these are not ordinary times, and even if the plan does help turn around the economy, we are probably looking at 1-2 more years of rising unemployment and resulting defaults. Furthermore, conforming mortgages rates are already down to 5.2% (thanks in part to the Fed talking rates down), so Fannie and Freddie could face the problem of getting stuck with riskier mortgages while the private sector keeps the better ones.

While this discussion does not answer the question, it does suggest that default risk today is higher that the historical spreads that Hubbard and Mayer are relying upon.

The Griots

"I was .. out walking toward Lycabettus, crossing for one more time the empty ''bombed'' streets, and the looted stores, having the most confused feelings. As the words of Mao ''Great unrest excellent condition'' suddenly hit my mind..." [1]

"What we face in Greece, it is not a simple reaction to the murdering of the young student Alexis Grigoropoulos, but something that we could describe as a general exegersis, somehow simular to what happened in Los Angeles in 96 or in Brixton in the 80's." [2]

"a group seen by an overwhelming majority in society as monstrous has itself labelled other people as monsters who can be attacked with impunity." [3]



[1] GRIOTS _day 4
Wednesday, 10 December 2008
Pictures from fucked up generation blog

[2] GRIOTS _day 2
Monday 8 December
http://foldedin.blogspot.com/

[3] Folded-in and The making of Balkan wars:The game at Monsters exhibition in Dresden. MONSTERS. Part II: Beat the Monsters!
http://foldedin.blogspot.com/
Thursday, 13 November 2008

Oil and Iraq: The Latest

As the Sunni insurgency in Iraq gradually dies down, ethnic and religious conflicts tied to oil are becoming more central, as reported by Ben Lando at Iraqi Oil Report, http://www.iraqoilreport.com. The northern cities of Mosul, and especially Kirkuk, remain violent, flashpoints partly because the struggle between Kurds, Arabs, and Turkmen for control, also involves control of a major oil producing center, with the Kurdish Regional Government already cutting its own separate oil deals with outside companies. Lando also reports that there is a move on now in southern Basra to vote on attaining autonomy, which would allow that region, where most of the rest of the oil is, to cut its own deals separate from the central government. Meanwhile the collapse of oil prices means the central government will probably go from running a budget surplus this year to a deficit, with cutbacks in reconstruction spending, although having been so far down, Iraq may be in better shape than other oil exporters, such as Russia, who needs $70 per barrel to balance its budget (and has had its stock market drop by 80% this year), or even Saudi Arabia who needs the now-too-high $40 per barrel, same price the oil companies reputedly have used to make their long term production investments.

Speaking of oil prices, this is an area where I was partly right, but did not go nearly far enough. So, in late spring, sometime after the price moved above $120 per barrel, I told a local TV station that it was looking like a speculative bubble, and the price could easily go down, "maybe even below $90 per barrel, although probably not below $70, and we will never see $2 per gallon for gas in the US again." Ooops! Wrong again. At least I recently talked a friend out of buying a six month forward contract on oil when it was at $53 per barrel, warning it could go as low as $25, which may yet also prove too high. But then, in 1930, at the beginning of the Great Depression, after the great East Texas oil field was discovered, the price fell in a six month period from about $1 per barrel to about 5 cents. A similar drop now would take it down to a bit over $7 per barrel from the peak of $147 in July, but then I am not expecting a find of an easy to pump oil field on the magnitude of the now largely depleted East Texas one.



Hidden conclusion here.

Notable

"We are not in a recession. We are not even in a depression. We are at the end of an era." -- Robert Paterson (by way of James Fallows).

THE FUNDAMENTALS ARE SOUND: A MaxSpeak Flashback

by the Sandwichman

To commemorate finding $800 in an ATM yesterday, from May 2006: THE FUNDAMENTALS ARE SOUND by the Sandwichman. The story of a poor sandwich-man from Lithuania who found a fortune in a snow bank, went nuts and ended up back where he started, told entirely in headlines.

It's Friday in Tokyo and the Nikkei is down 2.4%
as the Yen rises to a 8-month high against the Dollar.

Gold hit a 26-year high of $728 an ounce
before closing at $721.50 in New York,
while the Dow Jones Industrial Average
"plunged" 142 points on Thursday.

It's time for the Sandwichman to make a prediction:

The stock market will not crash on Friday!

However, just in case it does,
below the jump is an improbable story,
told completely in headlines,
about a poor sandwich-man
who found a fortune in stock certificates
in a snow bank on Wall Street.

——————————
'Sandwich Man' Restores $45,000
To Brokers but Goes Unrewarded
—————
$1-a-Day Sign Carrier Finds Wallet
in Snow Outside Stock
Exchange and Gives It to Policeman
— Owners of Stock
Think Recompense, if Any,
Is Up to Surety Company.
—————
$1-A-DAY MAN FINDS
$45,000 IN STOCKS
—————
Wouldn’t Keep Real Money Either.
—————
Once Found $60 at Dance.

——————————
REWARDS SHOWER
ON ‘SANDWICH’ MAN
—————
Finder of $45,000 Securities
Gets $105 Cash and Promise
of Clothing and Job.
—————
WEEPS AT PRESENTATION
—————
Surety Concern Also Will Give
Him $20 for Next 10 Weeks
— Banker Among Donors.
—————
Saw 'Sandwich” Man in Gale.
—————
Surety Concern to Give $275.
—————
Gets $25 More.

——————————
FINDER OF $42,000
'IN WALL ST.' NOW
—————
'Sandwich' Man Lays
Aside His Boards to Take Job
as a Broker's Messenger.
—————
EATS WITH NEW EMPLOYER

—————
Trips to Haberdashery and a

Barber Shop Complete His
Busy Day Downtown.
—————
Reports on New Job Today.
—————
More Gifts Are Sent in.
——————————
'SANDWICH MAN' HELD
IN PSYCHOPATHIC WARD
—————
After 'Look' at Him,
One Man Drops Dead

——————————
LUCK BRINGS WOE
TO 'SANDWICH MAN'

—————
Finder of $45,000,
Glorified for
Honesty, Is Deranged by
Sudden Affluence.

—————
RICHER DIET MAY BE CAUSE
—————

Doctors Hope for Recovery of
Former Derelict Whose ‘Look’
Killed an Associate

——————————
THE TOO IMPROBABLE.
——————————
SANDWICH MAN UNCHANGED
Tests on Greges at Bellevue Not
Yet Completed.
——————————
DELUSIONS ENDED FOR
SANDWICH MAN
—————
Finder of $45,000, Who Rose
to Sudden Riches and Fame,
Leaves Bellevue Today.
—————
BUT DOCTORS ADVISE REST
—————
Frank Greges, However, Says He
Is ‘Full of Pep’ and Wants
to Get Back to Job

——————————
‘SANDWICH MAN'
GOES HOME IN TAXI
—————
He Leaves Bellevue to 'Take It
Easy' on Rewards for His
Return of Securities.
—————
PHYSICIAN GIVES HIM $5
—————
With This ‘Change’ in Pocket,
He Poses for Photographers,
Then Rides Off on $1.20 Trip

——————————
‘SANDWICH MAN'
RETURNS TO BEAT
—————
Greges Carries Boards Once
More After Touch of Fame
for Restoring $45,000.
—————
PHILOSOPHICAL ABOUT IT
——————
Has ‘Maybe a Couple Hundred
Dollars’ of His Rewards for
Honesty — Snubs Farm Work

Fiscal Stimulus of $850 Billion Over Two Years

Me thinks Lori Montgomery needs a new calculator:

President-elect Barack Obama and congressional Democrats have entered discussions over an economic stimulus package that could grow to include $850 billion in new spending and tax cuts over the next two years ... Obama is putting together a package of $670 billion to $770 billion but that he expects additions by Congress to jack up the total to about $850 billion, or 6 percent of the nation's economy.

GDP is about $14.4 trillion per annum so $850 billion over two years is just under 3 percent – not 6 percent. Aside from this nitpicking on my part, there is some interesting information in this story:

A package of that size - which would include at least $100 billion for cash-strapped state governments and more than $350 billion for investments in infrastructure, alternative energy and other priorities - is a significant increase over the numbers previously contemplated by Democrats. It would exceed the $700 billion bailout of the U.S. financial system, as well as the annual budget for the Pentagon ... Furman and Schiliro said the package would include $100 billion to help states cover the expanding cost of Medicaid, the federal health program for the poor. With more than half of states reporting budget shortfalls this year, the package also could include big increases in state block grants and other programs intended to help local governments avoid layoffs or tax increases.

Uh oh – I have to nitpick again. First of all, it is true that defense spending is running at something near $700 billion per year so how is $850 billion over two years a larger figure? And if the extra cost of Medicaid eats up all of the $100 billion devoted to “cash-strapped state governments”, then what is left over to address what we discussed here? Maybe Ms. Montgomery needs more than a new calculator. Maybe she needs a better editor.

Not Quite Radical

Minus the amazement about the money multiplier, this proposal published in Yes! Magazine bears a superficial resemblance to mine. The big difference, of course, is that Brown would have the good citizens assume responsibility for all the liabilities of the banking system she would seize. This is why I have argued against bank nationalization and for new public institutions to take their place. A minor note: Germany is a somewhat more substantial instance of public banking than North Dakota. Not that I have anything against North Dakota. In fact, we’re having their weather right now in the Pacific Northwest.

Sandwichman Finds $800 in ATM

by the Sandwichman

Times are tough. But not so tough that some people won't go and withdraw 800 bucks from an ATM machine and then forget to take the money (and the withdrawal slip)! Of course I did the right thing and turned the money over to the credit union where the bank machine was. Coincidentally, there was a story in the New York Times in the 1930s about a sandwich man who found $45,000 in securities in a snow bank on Wall Street. I did a post on that story on MaxSpeak. I'll have to see if I can dig it up again.

The End of Federal Reserve Open Market Operations As We Knew Them

It is being widely noted that the latest Fed interest rate cut pretty much uses up that tool for stimulating the economy, even though zero is a floor only in convention, and we have seen negative interest rates in fact. But there is more going on here than has been remarked on. To a substantial degree the latest Fed move involves covering up how seriously it has lost its ability to control the federal funds rate, its supposed main policy tool. The latest cut to 0-.25% simply moves the target down to where the actual ffr has been in recent weeks, well below the previous target of 1%.

The deeper problem is that the recent turmoil and decline of interest rates to near zero is collapsing the repo market. This point was made on Dec. 16 in "Ultra-low US rates undermine repo market" by Michael Mackenzie, also linked to on marginal revolution by Tyler Cowen. MacKenzie stresses the general problems for liquidity in financial markets arising from this collapse, but did not note the rarely made point that this has been the market where the Fed has generally carried out its open market operations that control the ffr. So, the collapse of this market may well be why the Fed has been unable to control the ffr, which fact they may now be trying to cover up. MacKenzie notes that a major problem in the repo market is that people borrowing securities from dealers are not returning them on time, leading to "failed trades." Also, the low rates leave too small spreads for the dealers to engage in intermediation. In any case, the Fed has lost its favorite policy tool.

Local Government Spending Cuts – This is Why We Need Federal Revenue Sharing

Our graph, which shows the share of GDP from both revenues and expenditures of our state & local governments from 1999 to current, has a surprise – at least for me. While we often hear about the pro-cyclical nature of state & local fiscal policy, expenditures have appeared to be countercyclical – but this might change:

The worst budget crisis in decades is forcing states to cut funding to cash-strapped cities, which already are slashing police, firefighters and other services … In today's recession, both state and local revenues are suffering across the board. In the past 30 years, state spending has grown by an average of 6.3%. States cut a total of 0.1% from their budgets for fiscal 2009, which ends in June; the faltering economy is increasing projected deficits in the coming months. States are facing $30 billion in budget deficits for the current fiscal year, according to the Fiscal Survey of States released this week by the National Governors Association and National Association of State Budget Officers. That figure is likely to grow in the coming months. Twenty-two states, including Georgia, California and Nevada, already have cut spending from their 2009 budget. This week Minnesota's governor and legislators said cities and counties can expect aid to decrease soon. The state is coping with estimated shortfalls of $426 million for this year and $5 billion for the two-year budget period that begins in July. New York Gov. David Paterson's budget proposal, released this week, would cut about $240 million in aid to New York City.

The story continues with all sorts of suggestions as to how to avoid the spending reductions. All good ideas but state & local governments are often restricted from running deficits so the best idea seems to be Federal revenue sharing as the states appear to be ready to reduce their aid to the local governments.

Never Say Never

by Sandwichman,

Over at TPM, in reply to prompting by the Sandwichman, Randall Wray wrote:

Work week reduction (or "work sharing") has never, anywhere, eliminated involuntary unemployment and underemployment; indeed, it has never had a significant effect. That reserve army of the unemployed persisted despite reduction to the 12 hour day, the 10 hour day, and the 8 hour day. It will persist even if we can move to the 6 hour day.

Meanwhile, Dean Baker wrote that one of two simple answers to the problem of secular stagnation was:

Work fewer hours - while workers in other wealthy countries can count on 4-6 weeks a year of vacation, workers in the United States are guaranteed no paid time off. As a result, the average work year in the United States involves almost 20 percent more hours than the work year in Western European countries. As fringe benefits a shorter work year can be more family friendly and also we can be less polluting if we take the benefits of our productivity growth in leisure instead of income.

Stimulus and Stagnation

by the Sandwichman

Economic stimulus is the talk of the town. Over at Talking Points Memo (and on his own blog), Robert Reich has raised the specter of "secular stagnation" -- what happens if we stimulate the economy but consumers refuse to go back to their old, pre-crisis spending ways?

Dean Baker thinks secular stagnation is easy and takes a page from the Sandwichman's blog: reduce the hours of work. Sandwichman thinks "secular stagnation" is just the economists' way of being dissing cornucopia. Sandwichman engages Randall Wray in a discussion of shorter working time in which Professor Wray warns against saddling the good idea of shorter hours with "unwarranted claim that they will relieve involuntary idleness."

Deflation??

A pretty good economic journalist, David Leonhardt, finds the happy side of falling prices. Let's look into the issue more.

The New York Times / December 17, 2008
Economic Scene: Finding Good News in Falling Prices
By DAVID LEONHARDT

Very few Americans alive today can remember a time when prices across the economy were falling. But they're falling now.

The cost of fruits, vegetables, clothing and vehicles are all dropping. Housing prices have been falling for more than two years, and a barrel of oil costs about $45, down from $145 in July.

The inflation report released by the government on Tuesday showed that the Consumer Price Index was 3 percent lower last month than it had been three months earlier. It was the steepest such drop since 1933.

Note that most of the prices that are falling are "commodity" prices that are inelastically supplied and demanded (like those of gasoline, fruits, veggies, etc.) The economist Michal Kalecki (who developed a lot of Keynesian economics before Keynes) called this the "demand-determined price" sector. We should expect falling demand to hit this sector hardest.


In general, significantly falling prices have not spread to the manufacturing or service sector (where prices are mostly determined by costs), with the obvious exception of autos.

By the way, falling housing prices do not show up in a big way in the usual measures of the "cost of living," which only cover newly-produced goods and services. The falling house prices that Leonhardt points to are like falling stock prices in that they refer only to assets, not newly-produced items. So they don't show up in the CPI or similar measures.

The cost of living measures do not assume that each person buys a house each year (or some period like that). Instead, they measure what the statisticians believe people would pay if they rented the houses. Thus, as house prices fall, that might affect the rental cost of housing and the cost of living. But actual rents did not rise as much as the asset price of housing in the late bubble, so they're not likely to fall as much either. Most workers -- who are mostly renters -- won't benefit much.

In any event, falling house prices will not be a benefit to those of us who are strapped for cash due to lay-offs or stagnant income and have a really hard time borrowing. Mostly, they will hurt those who (partially) own houses, pushing them in the direction of being "upside down" (having negative equity in the house). Many have already achieved that fate. This encourages the recession by depressing consumer spending further.

These [price] declines have raised fears of a deflationary spiral — fears that help explain the Federal Reserve's surprisingly large interest rate reduction on Tuesday. And there is good reason to fear deflation. Once prices start to fall, many consumers may decide to reduce their spending even more than they already have. Why buy a minivan today, after all, if it's going to be cheaper in a few months? Multiplied by millions, such decisions weaken the economy further, forcing companies to reduce prices even more.

This "expectations effect" is only one reason why deflation is a bad thing. In addition, deflation raises the real value of the debts of the debtors. It's true that it also raises the real value of the assets of the creditors. But debtors are usually the bigger spenders, so the net effect is to depress demand. Further, as the debtors are squeezed, more and more of them go bankrupt. This undermines the real value of the winnings of the creditors, further depressing demand.

In simple terms, if you borrowed a bunch of money last year and your money income falls now, then you discover very quickly that your interest and principal payments have not fallen, pushing you to the wall.

One rule is that the more debt people and companies have accumulated in the past, the more they and the economy suffer due to deflation. We in the US have just ended a monumental debt-powered splurge, at least among consumers. So avoiding deflation is especially important.

In passing, it's interesting to note that the very orthodox economist Irving Fisher developed his "debt-deflation theory of great depressions" back during the last serious deflation (the early 1930s). Somehow, the role of debt has been elided.

But a truly destructive cycle of deflation is still not the most likely outcome. For one thing, the price of oil cannot fall by another $100 in the next few months. For another, the federal government will soon, finally, be fully engaged in trying to stimulate the economy.

In mechanical terms, the Fed's rate cut is actually a decision to pump more money into the economy (which will cause short-term interest rates to fall). Starting next year, the Obama administration is planning to spend hundreds of billions of dollars on public works and other programs.

It should be mentioned that the Federal Reserve has just run out of interest rate ammunition to stimulate the economy. Maybe "Helicopter Ben" can do something just by printing a lot of money, but we'll see how effective that is. On the other hand, Obama's stimulus plan will not happen for months... Who knows what will happen in the meantime or how large the deficit hawks will allow the stimulus to be.

All else being equal, more money sloshing around an economy causes prices to rise. In this case, it will probably keep them from falling as much as they otherwise would have.

Right.

So amid all the legitimate worries about deflation, it's worth considering what may be the one silver lining in the incredibly bad run of recent economic news: The cost of living is falling.

Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn't over yet, will make life easier on millions of people. It's possible, in fact, that the current recession will do less harm to the typical family's income than it does to many other parts of the economy.

There's a lot of truth to this (Leonhardt's main point). My grandparents used to tell me about how they (who weren't hurt by the 1929 Crash or the 1929-33 Collapse) were able to get real bargains because of the deflation then, even buying luxury goods that they normally couldn't afford.

But a lot of other people suffered big time. My research has found that the amount of nutrition received fell significantly. Per capita food energy per day fell about 5% between 1929 and 1933.

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers' pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

The Post-Keynesian economist Paul Davidson also praises the sticky money (nominal) wage as a nominal anchor that prevents deflation.

The stickiness of money wages is crucial, because without it, falling prices could start a downward wage-price spiral, with wages falling due to falling prices and prices falling due to falling wages. It's this spiral which represents true deflation, the kind of deflation that's been so destructive in the past. A merely temporary fall in prices does not have this kind of negative effect.

Traditional economic theory doesn't do a good job of explaining this [wage stickiness]. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It's sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

"Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes," he wrote in his book "Why Wages Don't Fall During a Recession," summarizing the view of a typical executive he interviewed. "The advantage of layoffs over pay reduction was that they 'get the misery out the door.' "

This makes a lot of sense. I hope that orthodox economists are going to follow this lead and return to the 1930s fashion of actually talking to businesscritters and workers as a way of finding out the nature of economic behavior, to supplement the standard abstract/deductive or statistical techniques.

However, it's not true that "Traditional economic theory doesn't do a good job of explaining" downwardly sticky wages. The problem instead is that the dominant schools of economists ignore a very traditional reason why workers resist or resent money-wage cuts (perhaps because of an obsession with "representative agent" models). It's a version of the prisoners' dilemma.

The standard story is that if workers accept a nominal wage cut, it will lead to falling prices, ceteris paribus. Thus, real wages won't fall much, but they will fall a bit, raising employment. The problem with this story is that each group of workers fear that no other groups of workers will take wage cuts. If one group takes a money-wage cut and others don't, prices won't fall much and the group will suffer real wage declines. There won't be a significant increase in employment (especially given the aggregate demand failure). Fearing this fate, most groups of workers resist nominal wage cuts. This means that the only price decreases are in the commodity sector (gasoline, food, etc.) and assets (houses, stocks, etc.)

If money wages in the manufacturing and service sectors don't fall, but the demand for products is falling, then employers will employ lay-offs because their profits will be squeezed. They will also refrain from expanding their operations (as they're doing right now). This encourages further falls in employment.

Lay-offs mean that the average money wage of the entire labor force (employed and unemployed) may fall even though that of employed workers does not. Falling asset prices will also hurt those workers who own houses or other assets, discouraging consumer spending. This encourages further production cut-backs and lay-offs. A downward spiral can occur even though money wages don't fall.

Wage stickiness, by the way, is likely less important in the U.S. economy than it was a generation ago. That's because of the "neoliberal policy revolution" of the 1980s and after (starting with the resistable rise of Paul Volcker to power in August 1979). This revolution has meant that more and more workers are treated as commodities. Fewer and fewer of them belong to labor unions (outside of the government sector). So it's more and more likely that nominal wages will fall during the current recession.

It's just possible the neoliberal policy revolution, which aimed at returning the economy to its pre-1929 state, has brought back the deflationary disaster of the 1930s. Of course, we won't know until it happens. If the reflation efforts of the Fed and the federal government succeed, any undermining of the sticky wages phenomenon is irrelevant in practice.

If the anti-government rhetoric of the neoliberals is to be taken seriously, it's ironic that its policies have put so much responsibility has been put in the Fed's and federal government's hands.

Companies resort to cutting jobs and giving only meager pay increases, increases that are even smaller than the low rate of inflation that's typical during a recession. This recession may well be the worst in a generation — but thanks to the stickiness of wages, the pay drop for most families may not be much worse than that of a typical recession.

The forecasting firm IHS Global Insight predicts that prices will fall by an additional 1 percent in 2009. That would bring the total drop, from the summer of 2008 to the end of 2009, to roughly 4 percent. But you can be sure that most executives will not force their workers to take a 4 percent cut in their paychecks. The fears about morale will be too great.

Should we rely on this forecast? I doubt it. The accuracy of economic forecasts has dived even lower in recent years. Forecasts seem better measures of what people expect than of what might actually happen in the world.

Strange as it sounds, the drop in prices will keep real incomes — inflation-adjusted incomes — from dropping too much.

I don't mean to make things sound better than they are. The economy is bad and getting worse. A deflationary spiral remains a real threat, even if it's not the most likely result. No matter what, unemployment is headed much higher.

People who keep their jobs, meanwhile, will suffer through some stealth pay cuts — higher health insurance premiums, for instance. Raises will also remain meager in 2010, even if prices start rising again. Like every other recent recession, this one will force families to take an effective pay cut, and a significant one.

Alas, "stealth pay cuts" are not really stealthy: they hit people directly in the pocketbook, having the same effect as non-stealthy pay cuts. Higher health insurance premia reduce the amount of income left over for other purposes. And they're hard or impossible to avoid, just like a payroll tax increase. They encourage resentment -- and cut-backs in consumer spending -- just like non-stealthy pay cuts.

But the drop in prices will still soften the blow. And at this point, American families can use any bit of economic help that they can get.

E-mail: leonhardt@nytimes.com

Copyright 2008 The New York Times Company

True, but methinks that Leonhard is a tad too optimistic.
--
Jim Devine