Looking Backward to See the Future, by Tim Duy: Is this our future, brought back from the past? A contact referenced the last hike cycle via the FOMC statements from 2003-04 (emphasis added):
October 28, 2003:
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. In contrast, the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level. The Committee judges that, on balance, the risk of inflation becoming undesirably low remains the predominant concern for the foreseeable future. In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.
December 9, 2003:
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.
January 28, 2004:
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
March 16, 2004:
The Committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
May 4, 2004:
The Committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. Similarly, the risks to the goal of price stability have moved into balance. At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.
June 30, 2004:
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 1-1/4 percent.
"Patient" lasted for two meetings before being replaced by "measured." This is fairly consistent with my expectations. My baseline scenario is that the Fed drops "considerable" entirely in January, retains "patient" in March, drops "patient" in April, and raise rates in June. In her press conference, Federal Reserve Chair Janet Yellen said:
There certainly has been no decision, you know, decision on the part of the Committee to move at a measured pace or to use language like that. I think quite a few people looking back on the use of that language in the--I can't remember if it was 12 or 16 meetings, where there were 25 basis point moves. We'd probably not like to repeat a sequence in which there was a measured pace and 25 basis point moves at every meeting. So I certainly don't want to encourage you to think that there will be a repeat of that.
If she really believes this, Yellen will not push to replace "patient" with "measured," but instead some more vague data-dependent type language.
Bottom Line: Assuming the data holds, maybe history will repeat itself. If it really is this easy, I have no idea what I will be writing about for the next six months.
Posted by Mark Thoma on Monday, December 22, 2014 at 12:45 PM in Economics, Fed Watch, Monetary Policy |
Do safer banks mean less economic growth?: One reason the financial crisis was so severe was that banks were highly leveraged. That is, they relied heavily on borrowed funds to acquire risky financial assets. This left them highly vulnerable when those assets' prices collapsed and the banks were unable to raise the funds they needed to pay off their loans.
In response, regulators have increased the capital requirements for banks. This limits the amount of leverage they can use and provides a safety buffer against losses. But banks protest that these more stringent capital requirements interfere with their ability to provide the financing the economy needs to function optimally, and hence this will slow economic growth.
However, recent research calls this into question. ...
Posted by Mark Thoma on Monday, December 22, 2014 at 11:32 AM in Economics, Financial System, Regulation |
War. What is it good for?:
Conquest Is for Losers, by Paul Krugman, Commentary, NY Times: More than a century has passed since Norman Angell, a British journalist and politician, published “The Great Illusion,” a treatise arguing that the age of conquest was or at least should be over. He didn’t predict an end to warfare, but he did argue that aggressive wars no longer made sense — that modern warfare impoverishes the victors as well as the vanquished.
He was right, but ... Vladimir Putin never got the memo. And neither did our own neocons, whose acute case of Putin envy shows that they learned nothing from the Iraq debacle.
Angell’s case was simple: Plunder isn’t what it used to be. You can’t treat a modern society the way ancient Rome treated a conquered province without destroying the very wealth you’re trying to seize. And meanwhile, war or the threat of war, by disrupting trade and financial connections, inflicts large costs over and above the direct expense of maintaining and deploying armies. War makes you poorer and weaker, even if you win. ....
The point is that there is a still-powerful political faction in America committed to the view that conquest pays, and that in general the way to be strong is to act tough and make other people afraid. One suspects, by the way, that this false notion of power was why the architects of war made torture routine — it wasn’t so much about results as about demonstrating a willingness to do whatever it takes.
Neocon dreams took a beating when the occupation of Iraq turned into a bloody fiasco, but they didn’t learn from experience. (Who does, these days?) And so they viewed Russian adventurism with admiration and envy. ...
The truth, however, is that war really, really doesn’t pay. The Iraq venture clearly ended up weakening the U.S. position in the world, while costing more than $800 billion in direct spending and much more in indirect ways. America is a true superpower, so we can handle such losses — although one shudders to think of what might have happened if the “real men” had been given a chance to move on to other targets. But a financially fragile petroeconomy like Russia doesn’t have the same ability to roll with its mistakes.
I have no idea what will become of the Putin regime. But Mr. Putin has offered all of us a valuable lesson. Never mind shock and awe: In the modern world, conquest is for losers.
Posted by Mark Thoma on Monday, December 22, 2014 at 03:05 AM in Economics |
Asked and Answered. Mostly, by Tim Duy: Last week I had six questions for Federal Reserve Chair Janet Yellen. Here is my attempt to piece together the answers from her post-FOMC press conference:
Question 1: If you want to know what the Fed is thinking at this point, a journalist needs to push Yellen on the secular stagnation issue at next week's press conference. Does she or the committee agree with Fischer? And does she see any inconsistency with the SEP implied equilibrium Federal Funds rates and the current level of long bonds?
Yellen, in answer to Peter Coke of Bloomberg Television: "(The Committee) are optimistic that those conditions will lift. They see the longer-run normal level of interest rates as around 3-3/4 percent. So there's no view in the Committee that there is secular stagnation in the sense we won't eventually get back to pretty historically normal levels of interest rates."
Yellen, in answer to Robin Harding of the Financial Times: "There are a number of different factors that are bearing on the path of market interest rates. I think including global economic developments. It is often the case that when oil prices move down, and the dollar appreciates, that tends to put downward pressure on inflation compensation and on longer-term rates. We also have safe haven flows that may be affecting longer-term Treasury yields. So I can't tell you exactly what is driving market developments. But what I can say is that we are trying to communicate our thoughts as clearly as we can."
The Federal Reserve believes that the current level of long rates is an artifact of safe-haven flows, not an indication of secular stagnation. They must anticipate that the yield curve will not flatten further or invert when they begin raising rates.
Question 2: I would like a journalist to press Yellen on her interpretation of the 5-year, 5-year forward breakeven measure of inflation expectations. Does she see this measure as important or too noisy to be used as a policy metric? What is her preferred metric?
Yellen, in answer to Greg Ip of the Economist: "Oh, and longer-dated expectations. Well I would say we refer to this in the statement as inflation compensation, rather than inflation expectations. The gap between the nominal yields on 10-year Treasuries for example. And TIPS have declined -- that's inflation compensation, and five-year, five-year forwards, as you've said, have also declined. That could reflect a change in inflation expectations. But it could also reflect changes in assessment of inflation risks. The risk premium that's necessary to compensate for inflation. That might especially have fallen if the probabilities attached to very high inflation have come down. And it can also reflect liquidity effects in markets and for example, it's sometimes the case that -- when there is a flight to safety, that flight tends to be concentrated in nominal Treasuries, and can also serve to compress that spread. So I think the jury is out about exactly how to interpret that downward move in inflation compensation. And we indicated that we are monitoring inflation developments carefully."
The Federal Reserve does not believe market-based measures of inflation expectations as indicative of actual inflation expectations. Watch surveys, Cleveland Fed-type measures, and actual inflation instead.
Question 3: Considering that recent updates of your optimal control framework now suggest that the normalization process should already be underway, how useful do you believe such a framework is for the conduct of monetary policy? What specific framework are you now using to dismiss the results of your previously preferred framework?
Yellen, in answer to Greg Ip of the Economist: "So you -- your first question is why is it that the committee sees unemployment as declining slightly below its estimate of the longer-run, natural rate? And I think in part, the reason for that is that inflation is running below our objective, and the committee wants to see inflation move back toward our objective over time. And a short period of a very slight under shoot of unemployment below the natural rate will facilitate slightly faster return of inflation to our objective. It is, I should say, a very small undershoot in a situation where there is great uncertainty about exactly what constitutes maximum employment, or a longer-run, normal rate of unemployment."
This is the general story of optimal control - hold unemployment below the natural rate to accelerate return to target inflation. Ignore any overshooting of inflation in such an analysis; Yellen was never really serious about that. Only thing preventing Fed from raising rates now is tweeking the optimal control results to account for still-high unemployment.
Question 4: St. Louis Federal Reserve President James Bullard has defined a specific metric to assess the Fed's current distance from its goals. What is your specific metric and by that metric how far is the Fed from it's goals? What does this metric tell you about the likely timing of the first rate hike of this cycle?
Yellen, in answer to Binyamin Appelbaum of the New York Times: "And with respect to inflation -- and our forecast for inflation, and inflation expectations, let me start by saying I think it's important that monetary policy be forward-looking. The lags in monetary policy are long. And therefore the committee has to base its decisions on how to set the federal funds rate looking into the future. Theory is important, and theories that are consistent with historical evidence will be something that governs the thinking of many people around the table. Typically we have seen that as long as inflation expectations are well-anchored, that as the labor market recovers, we'll gradually see upward pressure on both wages and prices. And that inflation will tend to move back toward 2 percent. I think historically we have seen, as the economy strengthens and slack diminishes, that inflation does tend to gradually rise over time. And as long -- you know, I just -- speaking for myself, that I will be looking for evidence that I think strengthens my confidence in that view, and you know, looking at the full range of data that bears on, whether or not that's a reasonable view of how events will unfold. But it's likely to be a decision that's based on forecasts and confidence in the forecast."
No firm metrics. Raising rates is like pornography - we know it is time when we see it.
Question 5: Why is the Fed setting the stage for raising interest rates next year while inflation measures remain below target? What is the risk, exactly, of explicitly committing to a zero interest rate policy until inflation reaches at least your target?
Yellen, in answer to Greg Ip of the Economist: "But it's important to point out that the committee is not anticipating an over-shoot of its 2 percent inflation objective."
From the Fed's perspective, not an interesting question. Theory says monetary policymakers need to move ahead of seeing inflation at target. If inflation was actually at target, they would be behind the curve in this economic environment. Also refer to San Francisco Federal Reserve President John Williams, via the Wall Street Journal:
“There’s no question that core inflation will likely be below 2% when liftoff is appropriate,” Mr. Williams said.
You have to love that statement - only an economist could piece together a sentence with "no question" and "likely" in this context. In short, they have no intention of allowing inflation to drift above 2%. The 2% goal is a ceiling, not a target. They are perfectly happy tolerating modestly below-target inflation as long as unemployment is below 6%. If you thought that any mention of above-target inflation was anything more than an acknowledgement of potential forecast errors, you were wrong. As far as the Fed is concerned, 2% inflation was handed down by God. It's in the Bible. Look it up.
Question 6: High yield debt markets are currently under pressure from the decline in oil prices. Are you confident that macroprudential tools are sufficient to contain the damage to energy-related debt? If the damage cannot be contained and contagion to other markets spreads, what does this tell you about the ability to use low interest rate policy without engendering dangerous financial instabilities?
Yellen, in answer to Greg Robb of MarketWatch: "So I mean there is some--you're talking about in the United States exposure? I mean we have seen some impacts of lower oil prices on the spreads for high-yield bonds, where there's exposure to oil companies that may see distress or a decline in their earnings, and we have seen some increase in spreads on high-yield bonds more generally. I think for the banking system as a whole the exposure to oil, I'm not aware of significant issues there. This is the kind of thing that is part of risk management for banking organizations and the kind of thing they look at in stress tests. But the movements in oil prices have been very large, and undoubtedly unexpected.
We--in terms of leverage, and whether or not levered entities could be badly effected by movements in oil prices, leverage in the financial system in general is way down from the levels before the crisis. So it's not a major concern that there are levered entities that would be badly affected by this, but we'll have to watch carefully. There have been large and unexpected movements in oil prices."
I honestly think that Yellen was surprised the rest of us were worried about this. Don't worry, be happy -high yield energy debt problems are contained.
Bottom Line: Final result is data dependent, but nothing at the moment is dissuading the Fed from their intention to hike rates in the middle of 2015.
Posted by Mark Thoma on Monday, December 22, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, December 22, 2014 at 12:06 AM in Economics, Links |
I find it incredibly sad that people feel they have to make "The Case Against Torture" (NY Times). What is wrong with us?
Posted by Mark Thoma on Sunday, December 21, 2014 at 07:47 PM in Economics, Links |
Bill McBride at Calculated Risk:
Katie Couric and the Net Petroleum Exporter Myth: To understand what the general public is hearing about oil, I watched a Yahoo video yesterday with Katie Couric explaining the decline in oil prices.
In general the piece was very good. Couric started by explaining that the decline in oil prices could be explained in two words: Supply and Demand. She discussed reasons for more supply and softening demand. ...
But then Couric mentioned a myth I've heard several times recently. She said:
In fact, [the U.S.] is now the world’s largest producer of petroleum, and for the last two years, it has been selling more to other countries than it’s been buying. Who knew?
"Who knew?" No one, because it is not true. Yes, the U.S. is the largest producer this year (ahead of Saudi Arabia and Russia), but the U.S. is NOT "selling more to other countries than it's been buying".
The source of this error is that the U.S. is a net exporter of refined petroleum products, such as refined gasoline. Here is the EIA data on Weekly Imports & Exports of crude oil and petroleum products. The U.S. is importing around 9 million barrels per day of crude oil and products, and exporting around 4 million per day (mostly refined products). The U.S. is a large net importer! ...
Posted by Mark Thoma on Sunday, December 21, 2014 at 11:59 AM in Economics, International Trade, Oil |
Posted by Mark Thoma on Sunday, December 21, 2014 at 12:06 AM in Economics, Links |
Posted by Mark Thoma on Saturday, December 20, 2014 at 12:06 AM in Economics, Links |
Is the financial industry is winning the war over regulation?:
Volcker lambasts Wall Street lobbying, FT: Paul Volcker, the former Federal Reserve chairman, has lambasted the "eternal lobbying" of Wall Street after regulators granted the industry more time to comply with a rule designed to prevent them from owning hedge funds.
In a withering statement ... Mr Volcker said: “It is striking, that the world's leading investment bankers, noted for their cleverness and agility in advising clients on how to restructure companies and even industries however complicated, apparently can't manage the orderly reorganization of their own activities in more than five years.”
“Or, do I understand that lobbying is eternal, and by 2017 or beyond, the expectation can be fostered that the law itself can be changed?”
The Fed and its fellow regulators this week gave the banks until 2017 to comply... Banks had been supposed to comply by next year. The law containing the Volcker rule was passed in 2010. ...
Posted by Mark Thoma on Friday, December 19, 2014 at 12:08 PM in Economics, Financial System, Regulation |
Digitized Products: How about just giving up?: In a very interesting talk, music producer, Steve Albini, reviewed the impact of the internet on the music industry’s woes. ...
From my part, I believe the very concept of exclusive intellectual property with respect to recorded music has come to a natural end, or something like an end. Technology has brought to a head a need to embrace the meaning of the word “release”, as in bird or fart. It is no longer possible to maintain control over digitized material and I don’t believe the public good is served by trying to.
Basically, he is saying that the whole notion of getting people to pay for music itself that they want to listen to at their leisure is not worth pursuing.
What I like about this analysis is that it gets us to fundamentals. In music, there are people who want to supply music and there are people who want to listen to it. The problem is that the competition for listener’s attention is intense. That’s the core of the economics of the industry. If there is a fundamental imbalance in competition — in this case, favoring listeners — you can’t assume that suppliers will get much. Unless, of course, the suppliers can supply something else that is scarce — for instance, connections through online communities or, mostly likely, through concerts. The Eagles — yes, The Eagles from the 1970s — earned $100 million last year. I don’t recall any Number One albums from them. It was all from other stuff.
Last time I saw the Eagles live was "A Day on the Green" at the Oakland Coliseum long, long ago (I think it was 1975).
Posted by Mark Thoma on Friday, December 19, 2014 at 11:20 AM in Economics |
The Russian economy is in trouble:
Putin’s Bubble Bursts, by Paul Krugman, Commentary, NY Times: If you’re the type who finds macho posturing impressive, Vladimir Putin is your kind of guy. Sure enough, many American conservatives seem to have an embarrassing crush on the swaggering strongman. “That is what you call a leader,” enthused Rudy Giuliani, the former New York mayor, after Mr. Putin invaded Ukraine without debate or deliberation.
But Mr. Putin never had the resources to back his swagger. Russia has an economy roughly the same size as Brazil’s. And, as we’re now seeing, it’s highly vulnerable to financial crisis...
For those who haven’t been keeping track: The ruble has been sliding gradually since August, when Mr. Putin openly committed Russian troops to the conflict in Ukraine. A few weeks ago, however, the slide turned into a plunge. Extreme measures ... have done no more than stabilize the ruble far below its previous level. And all indications are that the Russian economy is heading for a nasty recession.
The proximate cause of Russia’s difficulties is, of course, the global plunge in oil prices... And this was bound to inflict serious damage on an economy that ... doesn’t have much besides oil that the rest of the world wants; the sanctions imposed on Russia over the Ukraine conflict have added to the damage. ...
Putin’s Russia is an extreme version of crony capitalism, indeed, a kleptocracy in which loyalists get to skim off vast sums for their personal use. It all looked sustainable as long as oil prices stayed high. But now the bubble has burst, and the very corruption that sustained the Putin regime has left Russia in dire straits.
How does it end? The standard response ... is an International Monetary Fund program that includes emergency loans and forbearance from creditors in return for reform. Obviously that’s not going to happen here, and Russia will try to muddle through on its own, among other things with rules to prevent capital from fleeing the country — a classic case of locking the barn door after the oligarch is gone.
It’s quite a comedown for Mr. Putin. And his swaggering strongman act helped set the stage for the disaster. A more open, accountable regime — one that wouldn’t have impressed Mr. Giuliani so much — would have been less corrupt, would probably have run up less debt, and would have been better placed to ride out falling oil prices. Macho posturing, it turns out, makes for bad economies.
Posted by Mark Thoma on Friday, December 19, 2014 at 12:24 AM in Economics, Financial System, International Finance |
Posted by Mark Thoma on Friday, December 19, 2014 at 12:06 AM in Economics, Links |
Via Real Time Economics at the WSJ:
No Sign Yet of Labor Cost Inflation in U.S. or U.K., by Paul Hannon: Despite falling unemployment rates, there are few signs that rising wages will soon start to push inflation higher in either the U.S. or the U.K., where central banks are expected to raise their benchmark rates next year and in early 2016 respectively.
In both countries, policy makers expect tightening labor markets to result in a pickup in wages that will translate into higher consumer prices, as businesses act to protect their profit margins...
But an internationally comparable measure of labor costs released Thursday by the Organization for Economic Cooperation and Development showed no sign of a buildup in inflationary pressures from that source in either country.
Indeed, the Paris-based research body recorded a 0.1% drop in unit labor costs in the U.S. during the third quarter, which followed a 0.6% decline in the second quarter. ...
Posted by Mark Thoma on Thursday, December 18, 2014 at 10:27 AM in Economics, Inflation |
Maybe There's No Such Thing as a Business Cycle: ...The word “cycle” conjures up images of waves and seasons, but the business cycle isn’t a regular cycle like that (if it were, it would be easy to predict the next recession). Economists actually think that recessions and booms are random temporary disturbances of a smooth trend of long-term growth. ...
In other words, modern macroeconomic theories all assume that recessions are temporary -- that they don’t permanently damage the economy’s productive potential. If that assumption is wrong, then most modern macroeconomic theories are barking up the wrong tree. ...
In fact, the evidence is now piling up that the 2008 recession did have lasting effects. ... It may simply be time to stop thinking of the business cycle as a cycle.
For more on this issue, I encourage you to read "You’ve Got Potential" at the Growth Economics Blog.
Posted by Mark Thoma on Thursday, December 18, 2014 at 10:02 AM in Economics |
Arnold Packer and Jeff Madrick respond to Alan Blinder in the NYRB, and he replies:
‘What’s the Matter with Economics?’: An Exchange: In response to: What’s the Matter with Economics? from the December 18, 2014 issue ...
To the Editors:
Alan Blinder is one of the finest mainstream economists around. But to read his review of my book, you’d think that nothing was wrong with economics in recent decades except as it is practiced by a few right-wingers.
This is of course not the case. ...
New York City
Alan S. Blinder replies:
According to both Jeff Madrick and Arnie Packer, I claim “that except for some right-wingers outside the ‘mainstream’…little is the matter” with economics. (These are Packer’s words; Madrick’s are similar.) But it’s not true. I think there is lots wrong with mainstream economics.
For starters, my review explicitly agreed with Madrick that (a) ideological predispositions infect economists’ conclusions far too much; (b) economics has drifted to the right (along with the American body politic); and (c) some economists got carried away by the allure of the efficient markets hypothesis. I also added a few indictments of my own: that we economists have failed to convey even the most basic economic principles to the public; and that some of our students turned Adam Smith’s invisible hand into Gordon Gekko’s “greed is good.” ...
Yet Madrick still insists that “economists rely on a fairly pure version of the invisible hand most of the time.” Not us mainstreamers. I’m a member of the tribe, I live among these people every day, and—trust me—we really don’t apply the “pure version” to the real world. For example, many of us see reasons for a minimum wage, mandatory Social Security, progressive taxation, carbon taxes, and a whole variety of financial regulations—to name just a few. ...
[Hard to summarize this one with a few excerpts -- I left a lot out...]
Posted by Mark Thoma on Thursday, December 18, 2014 at 09:49 AM in Economics, Macroeconomics |
Posted by Mark Thoma on Thursday, December 18, 2014 at 12:06 AM in Economics, Links |
Quick FOMC Recap, by Tim Duy: Running short on time today....
Today's FOMC statement was a reminder that in normal times the Federal Reserve moves slowly and methodically. Policymakers were apparently concerned that removal of "considerable time" by itself would prove to be disruptive. Instead, they opted to both remove it and retain it:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
If you thought they would drop "considerable time," they did. If you thought they would retain "considerable time," they did. Everyone's a winner with this statement.
Federal Reserve Chair Janet Yellen explained the change in language as necessary to shift away from the increasingly dated reference to the end of quantitative easing. In addition to the lower inflation and interest rate expectations in the Summary of Economic Projections, the statement was initially regarded as dovish. The press conference, however, was in my opinion anything but dovish.
During the presser, Yellen explained that "patience" was only likely guaranteed through the next "couple" of meetings, later clarified to be two. Hence, the April meeting is still on the table, although I still suspect that is too early. Yellen also said that a press conference was not required to raise rates; if necessary, they could always opt to have a presser even if one not scheduled. She dismissed falling market-based inflation expectations as reflecting inflation "compensation" rather than expectations. She dismissed the disinflationary impulse from oil, calling it transitory and drawing attention to the expected positive implications for US growth (much as she corrected described "noisy" inflation indicators earlier this year). She indicated that inflation did not need to return to target prior to raising rates, only that the Fed needed to be confident it would continue to trend toward target. She was very obviously unconcerned about the risk of contagion either via Russia or high yield energy debt - I think she almost seemed surprised anyone was worried about the latter.
In short, Yellen dismissed virtually all of the reasons to expect the Federal Reserve to delay rate hikes past its expectation of mid-2015. They have their eyes set firmly on June. My sense is that they see the accelerating economy and combine that with, as Yellen mentioned, the long lags of monetary policy, and worry that it will not be long before they are behind the curve.
To be sure, it is easy to outline a scenario that derails the Fed's plans. The impact of the oil shock on core inflation may be more than expected. Or rising labor force participation stabilizes the unemployment rate and wage growth continues to move sideways. My guess is that if they see an acceleration in wage growth between now and June, a June hike is pretty much in the bag.
Bottom Line: Like it or not, believe it or not, the Fed is seriously looking at mid-2015 to begin the normalization process. And there is no guarantee that it will be a predictable series of modest rate hikes. As much as you think of the possibility that the hike is delayed, think also of the possibility of 1994.
Posted by Mark Thoma on Wednesday, December 17, 2014 at 05:39 PM in Economics, Fed Watch, Monetary Policy |
Some of you might find this interesting:
“Minimal Model Explanations,” R.W. Batterman & C.C. Rice (2014), A Fine Theorem: I unfortunately was overseas and wasn’t able to attend the recent Stanford conference on Causality in the Social Sciences; a friend organized the event and was able to put together a really incredible set of speakers: Nancy Cartwright, Chuck Manski, Joshua Angrist, Garth Saloner and many others. Coincidentally, a recent issue of the journal Philosophy of Science had an interesting article quite relevant to economists interested in methodology: how is it that we learn anything about the world when we use a model that is based on false assumptions? ...
Posted by Mark Thoma on Wednesday, December 17, 2014 at 12:59 PM in Economics, Methodology |
Surprise! Or not (more concerned with this than whether the Fed changed a few words in its Press Release following the FOMC meeting):
Wall Street Salivating Over Further Destruction of Financial Reform, by Kevin Drum: Conventional pundit wisdom suggests that Wall Street may have overreached last week. Yes, they won their battle to repeal the swaps pushout requirement in Dodd-Frank, but in so doing they unleashed Elizabeth Warren and brought far more attention to their shenanigans than they bargained for. They may have won a battle, but ... they're unlikely to keep future efforts to weaken financial reform behind the scenes, where they might have a chance to pass with nobody the wiser.
Then again, maybe not. Maybe it was all just political theater and Wall Street lobbyists know better than to take it seriously. Ed Kilgore points to this article in The Hill today:
Banks and financial institutions are planning an aggressive push to dismantle parts of the Wall Street reform law when Republicans take control of Congress in January. ...
Will Democrats in the Senate manage to stick together and filibuster these efforts to weaken Dodd-Frank? ... I'd like to think that Elizabeth Warren has made unity more likely, but then again, I have an uneasy feeling that Wall Street lobbyists might have a better read on things than she does. Dodd-Frank has already been weakened substantially in the rulemaking process, and this could easily represent a further death by a thousand cuts. ...
Posted by Mark Thoma on Wednesday, December 17, 2014 at 12:58 PM in Economics, Financial System, Politics, Regulation |
A Big Safety Net and Strong Job Market Can Co-Exist. Just Ask Scandinavia: It is a simple idea supported by both economic theory and most people’s intuition: If welfare benefits are generous and taxes high, fewer people will work. ... Here’s the rub, though: The idea may be backward.
Some of the highest employment rates in the advanced world are in places with the highest taxes and most generous welfare systems, namely Scandinavian countries. The United States and many other nations with relatively low taxes and a smaller social safety net actually have substantially lower rates of employment. ...
In short, more people may work when countries offer public services that directly make working easier, such as subsidized care for children and the old; generous sick leave policies; and cheap and accessible transportation. ...
And this analysis may leave out some other factors... Robert Greenstein, the president of the Center on Budget and Policy Priorities, notes that wages for entry-level work are much higher in the Nordic countries than in the United States, reflecting a higher minimum wage, stronger labor unions and cultural norms that lead to higher pay. ... Perhaps more Americans would enter the labor force if even basic jobs paid that well, regardless of whether the United States provided better child care and other services. ...
Posted by Mark Thoma on Wednesday, December 17, 2014 at 10:17 AM in Economics, Social Insurance, Unemployment |
A follow up to this:
Higher capital requirements: The jury is in, by Stephen Cecchetti, Vox EU: Summary Regulators forced up capital requirements after the Global Crisis – triggering fears in the banking industry of dire effects. This column – by former BIS Chief Economist Steve Cecchetti – introduces a new CEPR Policy Insight that argues that the capital increases had little impact on anything but bank profitability. Lending spreads and interest margins are nearly unchanged, while credit growth remains robust everywhere but in Europe. Perhaps the requirements should be raised further.
Posted by Mark Thoma on Wednesday, December 17, 2014 at 10:08 AM in Economics, Financial System, Regulation |
Posted by Mark Thoma on Wednesday, December 17, 2014 at 12:06 AM in Economics, Links |
The Ruble and the Textbooks: OK, this is a bit funny: This morning Tim Duy addresses the woes of the ruble, which is in free fall despite a big rate hike, and declares that it “appears really quite textbook”. Meanwhile Matthew Yglesias says that what Russia is doing is “the textbook approach to handling a currency crisis”, and speculates about why it isn’t working.
I’m with Duy here; not sure if it’s actually in any textbook, but as I explained yesterday, for aficionados of emerging-market currency crises this is all quite familiar. ... When you have big balance-sheet problems involving foreign-currency debt, an interest-rate hike that tries to discourage capital flight damages the economy, and hence those same balance sheets, from another direction, and it’s common, even standard, for the effort to fail. Most notably, tight-money policies were really really unsuccessful during the Asian financial crisis of 1997-8, on which you can read my take here. ...
So Russia isn’t that unusual a story, except for the nukes.
Posted by Mark Thoma on Tuesday, December 16, 2014 at 08:21 AM in Economics, International Finance |
I have a new column:
How Fiscal Policy Failed During the Great Recession: Fiscal policy failed us during the Great Recession. We did get a fiscal stimulus package shortly after Obama took office, and it helped. But it wasn’t big enough and did not last long enough to make the kind of difference that was needed. Fear of deficits stood in the way, though all the dire predictions that were made about the debt associated with the stimulus package did not come to pass. We could have done so much more. ...
Posted by Mark Thoma on Tuesday, December 16, 2014 at 08:15 AM in Economics, Fiscal Policy, Fiscal Times, Monetary Policy, Politics |
IP, Russia, by Tim Duy: The string of solid US economic news continued with industrial production advancing 1.3% in November. Year-over-year growth (5.2%) is now comparable to the late-90's:
Meanwhile, the international fallout from the oil price drop continues. Russia is a classic emerging market crisis story. The decline in energy prices reveals a currency mismatch between assets and liabilities. The decline in oil dries up the dollars needed to support those liabilities, so the value of the ruble is bid down as market participants scramble for dollars. One suspects that capital flight from Russia only aggravates the problem; those oligarchs are seeing their fortunes whither. Currency plummets, aggravating the cycle. The sanctions were the beginning of this crisis, the oil price shock the culmination.
The Central Bank of Russia is forced into defending its currency via either depleting reserves or hiking interest rates. Both are losing games in a full blown crisis. The Central Bank of Russia has tried both, upping the ante by jacking up rates to 17% this afternoon, a hike of 650bp. That, however, is no guarantee of stability. Tight policy will crush the financial sector and the economy with it, triggering further net capital outflows that my guess will swamp the net inflows the rate hike was intended to create. Everything heads into free-fall until a new, lower equilibrium is established.
It is all appears really quite textbook. At this point, an IMF program would be on the horizon. But that's where the textbook changes. Hard to see the IMF just handing out a lifeline to an economy probably viewed by most as currently invading its neighbor (that's the point of the sanctions after all). And I am guessing that Russian Premier Vladimir Putin is not going to easily acquiesce to an IMF program in any event. At the moment, looks like Russia is toast. (Update: Arguably I am being a little pessimistic here. Joseph Cotterill points out that the rate hike falls well short of 1998.)
Venezuela is heading down the tubes as well, but that was always a given. Just a matter of time on that one.
Back at the Federal Reserve ranch, a fascinating experiment is underway. Have policymakers been successful in insulating the financial sector from these kinds of shocks? There will be losses, but will those losses cascade throughout the financial sector and into the real economy, or will they be contained? If the answer is containment, then interestingly Russia will lose a bargaining chip and the Fed's willingness to counter the potential risks of low interest rates with macroprudential policy will look like a sustainable policy mix.
If, however, contagion takes hold, we will once again be revisiting regulatory policy. And if the proximate cause of the contagion is deemed high-yield energy sector debt, and the excessively low rates in high-yield in general is deemed a consequence of ZIRP, then the Fed will be pushed to rethink its faith in macroprudential policy. The Austrians would have plenty of grist to chew on.
Bottom Line: All of this will be on the table at tomorrow's two-day FOMC meeting. The Fed will be forced to balance the US picture against the global shock. The primary argument to pull "considerable time" is the current US economic momentum. Furthermore, changing the language is not a policy change in any event; arguably, the language itself is already meaningless if the Fed is truly data dependent. In addition, policymakers may be wary to appear overly sensitive to financial markets. They may also be concerned that not eliminating the language will make the Fed appear less hawkish and more pessimistic than it is, thus risking disrupting financial markets at a later time if data suggests a rate hike is appropriate. The issue of "considerable time" however, is in my opinion, no longer of much interest. The macroprudential/regulatory experiment is far more important now.
Posted by Mark Thoma on Tuesday, December 16, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Tuesday, December 16, 2014 at 12:06 AM in Economics, Links |
Cecchetti & Schoenholtz:
Higher capital requirements didn't slow the economy: During the debate over the 2010 Basel III regulatory reform, one of the biggest concerns was that higher capital requirements would damage economic growth. Pessimists argued that forcing banks to increase their capitalization would lower long-run growth permanently and that the transitional adjustment would impose an extra drag on the recovery from the Great Recession. Unsurprisingly, the private sector saw catastrophe, while the official sector was more positive.
The Institute of International Finance’s (IIF) 2010 report is the most sensational example of the former and the Macroeconomic Assessment Group (MAG) one of the most staid cases of the latter. The IIF concluded that banks would need to increase capital levels dramatically and that this would drive lending rates up, loan volumes down and result in an annual 0.6-percentage-point hit to GDP growth in the United States, the euro area and Japan. By contrast, the MAG reported that the implied increase in capital would drive lending rates up only modestly, loan volumes down a bit, and result in a decline in growth of only 0.05 percentage point per year for five years – one-twelfth the IIF’s estimate.
Four years on we can start to take stock, and our reading of the evidence is that the optimistic view was correct. Since the crisis, capital requirements and capital levels have both gone up substantially. Yet, outside the still-fragile euro area, lending spreads have barely moved, bank interest margins have fallen and loan volumes are up. To the extent that more demanding capital regulations had any macroeconomic impact, it would appear to have been offset by accommodative monetary policy. ...
[There is much, much more in the post.]
Posted by Mark Thoma on Monday, December 15, 2014 at 09:42 AM in Economics, Financial System, Regulation |
The battle over financial reform is far from over:
Wall Street’s Revenge, by Paul Krugman, Commentary, NY Times: On Wall Street, 2010 was the year of “Obama rage,” in which financial tycoons went ballistic over the president’s suggestion that some bankers helped cause the financial crisis. They were also, of course, angry about the Dodd-Frank financial reform, which placed some limits on their wheeling and dealing.
The Masters of the Universe, it turns out, are a bunch of whiners. But they’re whiners with war chests, and now they’ve bought themselves a Congress. ...
Wall Street overwhelmingly backed Mitt Romney in 2012, and invested heavily in Republicans once again this year. And the first payoff to that investment has already been realized. Last week Congress passed a ... rollback of one provision of the 2010 financial reform.
In itself, this rollback is significant but not a fatal blow to reform. But it’s utterly indefensible. ... One of the goals of financial reform was to stop banks from taking big risks with depositors’ money. ... If banks are free to gamble, they can play a game of heads we win, tails the taxpayers lose. ...
Dodd-Frank tried to limit this kind of moral hazard in various ways, including a rule barring insured institutions from dealing in exotic securities, the kind that played such a big role in the financial crisis. And that’s the rule that has just been rolled back. ...
What just went down isn’t about free-market economics; it’s pure crony capitalism. And sure enough, Citigroup literally wrote the deregulation language that was inserted into the funding bill.
Again, in itself last week’s action wasn’t decisive. But it was clearly the first skirmish in a war to roll back much if not all of the financial reform. And if you want to know who stands where in this coming war, follow the money: Wall Street is giving mainly to Republicans for a reason. ...
Meanwhile, it’s hard to find Republicans expressing major reservations about undoing reform. You sometimes hear claims that the Tea Party is as opposed to bailing out bankers as it is to aiding the poor, but there’s no sign that this alleged hostility to Wall Street is having any influence at all on Republican priorities.
So the people who brought the economy to its knees are seeking the chance to do it all over again. And they have powerful allies, who are doing all they can to make Wall Street’s dream come true.
Posted by Mark Thoma on Monday, December 15, 2014 at 12:24 AM in Economics, Financial System, Politics, Regulation |
More Questions for Yellen, by Tim Duy: FOMC meeting this week. We all pretty much know the lay of the land. "Considerable time" is on the table, and whether it stays or goes is a close call. The existence of the press conference this week argues for the change over just waiting until January. Stupid reason, I know, but we are just playing the Fed's game here. No real reason not to wait until January other than to keep a March rate hike in play, but only a few policymakers are seriously looking at March anyway. Uncertainty regarding the financial market impact of the oil price drop and its subsequent impact on credit markets seems sufficient to stay the Fed's hand - but they may be hesitant to appear reactive to every dip in financial markets. If the statement is changed, they will probably replace "considerable time" with the intention to be "patient" when considering the timing of the first rate hike.
They will be navigating some tricky currents when constructing the rest of the statement. The opening paragraph will need to acknowledge the improved data - the US economy clearly has some momentum. They will also acknowledge again the expected impact of energy prices on headline inflation, but emphasize the temporary nature of the impact and fairly stable survey-based expectations. This suggest another dismissal of market-based measures.
The Fed could argue that improving domestic indicators at a time of softening in the global economy leaves the risks to the outlook as nearly balanced. They can't both suggest that risks are weighted to the downside and pull the "considerable time" language. That would, I think, be just silly. If they want to suggest there is a preponderance of downside risks, then they will leave in "considerable time." It will be interesting to see if they mention the external environment at all - we know from the minutes of the previous meeting that they were concerned about appearing overly pessimistic.
I have previously suggested two questions for Federal Reserve Chair Janet Yellen at the post-FOMC press conference:
If you want to know what the Fed is thinking at this point, a journalist needs to push Yellen on the secular stagnation issue at next week's press conference. Does she or the committee agree with Fischer? And does she see any inconsistency with the SEP implied equilibrium Federal Funds rates and the current level of long bonds?
I would like a journalist to press Yellen on her interpretation of the 5-year, 5-year forward breakeven measure of inflation expectations. Does she see this measure as important or too noisy to be used as a policy metric? What is her preferred metric?
Now I have four additional questions. The first refers to Yellen's previous endorsement of optimal control theory, which as stated in 2012 suggests the extension of zero rate policy well into 2015. Recent research from the Federal Reserve indicates that the same framework is now signaling that liftoff should occur in late 2014, suggesting that the Federal Reserve is now behind the curve. Did Yellen embrace this methodology only until it began to give results she did not like? The obvious question is thus:
Considering that recent updates of your optimal control framework now suggest that the normalization process should already be underway, how useful do you believe such a framework is for the conduct of monetary policy? What specific framework are you now using to dismiss the results of your previously preferred framework?
The second, arguably related, question refers to St. Louis Federal Reserve President James Bullard's argument that the Fed is very close to reaching its monetary policy goals:
Thus another question is:
St. Louis Federal Reserve President James Bullard has defined a specific metric to assess the Fed's current distance from its goals. What is your specific metric and by that metric how far is the Fed from it's goals? What does this metric tell you about the likely timing of the first rate hike of this cycle?
A third question is obvious. Given current readings on inflation:
Why is the Fed setting the stage for raising interest rates next year while inflation measures remain below target? What is the risk, exactly, of explicitly committing to a zero interest rate policy until inflation reaches at least your target?
The fourth question addresses the potential financial instability related to oil price shock. Note that critics of Fed policy have posited that the low interest rate policy would encourage excessive risk taking in the reach for yield. High yield debt markets have come under particular scrutiny. The Fed has responded that they need to address any financial market instabilities first with macroprudential policy rather than tighter monetary policy. That approach is going to come under sharp criticism if the oil-related debt defaults cascade destructively throughout US financial markets. A natural question is thus:
High yield debt markets are currently under pressure from the decline in oil prices. Are you confident that macroprudential tools are sufficient to contain the damage to energy-related debt? If the damage cannot be contained and contagion to other markets spreads, what does this tell you about the ability to use low interest rate policy without engendering dangerous financial instabilities?
If anyone uses these questions or variations thereof, feel free to give me some credit. Or at least when you speak of me, speak well.
Bottom Line: Odds are high that the Fed alters the statement to increase their policy flexibility next year. But even if they drop "considerable time," Yellen will emphasize via the press conference that this change does not mean a rate hike is imminent. She will emphasize that the timing and pace of rate hikes remains firmly data dependent. The current oil-related disruptions in financial markets loom like a dark cloud over a both the FOMC meeting and the generally improving US outlook.
Posted by Mark Thoma on Monday, December 15, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, December 15, 2014 at 12:06 AM in Economics, Links |
Assessing the Outcome of the Lima Climate Talks: In the early morning hours of Sunday, December 14th, the Twentieth Conference of the Parties (COP-20) of the United Nations Framework Convention on Climate Change (UNFCCC) concluded in Lima, Peru with an agreement among 195 countries, the “Lima Accord,” which represents both a classic compromise between the rich and poor countries, and a significant breakthrough after twenty years of difficult climate negotiations. ...
The Lima Accord
By establishing a new structure in which all countries will state (over the next six months) their contributions to emissions mitigation, this latest climate accord is important, because it moves the process in a productive direction in which all nations will contribute to the reduction of greenhouse gas emissions. ... The ... Lima Accord constitutes a significant departure from the past two decades of international climate policy, which ... have featured coverage of only a small subset of countries, namely the so-called Annex I countries (more or less the industrialized nations, as of twenty years ago).
The expanded geographic scope of the Lima Accord ... represents the best promise in many years of a future international climate agreement that is truly meaningful. ...
The Key Roles Played by China and the United States
Throughout the time I was in Lima, it was clear that the joint announcement on November 12th of national targets by China and the United States (under the future Paris agreement) provided necessary encouragement to negotiations that were continuously threatened by the usual developed-developing world political divide. ...
As I predicted in my previous essay at this blog,... the Lima Accord will surely disappoint some environmental activists. Indeed, there have already been pronouncements of failure of the Lima/Paris talks from some green groups, primarily because the talks have not and will not lead to an immediate decrease in emissions and will not prevent atmospheric temperatures from rising by more than 2 degrees Celsius (3.6 degrees Fahrenheit), which has become an accepted, but essentially unachievable political goal.
As I said in my previous essay, these well-intentioned advocates mistakenly focus on the short-term change in emissions among participating countries..., when it is the long-term change in global emissions that matters.
They ignore the geographic scope of participation, and do not recognize that — given the stock nature of the problem — what is most important is long-term action. Each agreement is no more than one step to be followed by others. And most important now for ultimate success later is a sound foundation, which is what the Lima Accord provides. ...
The Bottom Line
Although it is fair to say that the Lima text was watered down in the last 30 hours (largely as a result of effective opposition by developing countries), the fact remains that a new way forward has been established in which all countries participate and which therefore holds promise of meaningful global action to address the threat of climate change.
So, despite all the acrimony among parties and the 30-hour delay in completing the talks, the negotiations in Lima these past two weeks may turn out to be among the most valuable steps in two decades of international climate negotiations.
Posted by Mark Thoma on Sunday, December 14, 2014 at 03:43 PM in Economics, Environment |
Real business cycle theory and the high school Olympics: I have lost count of the number of times I have heard students and faculty repeat the idea in seminars, that “all models are wrong”. This aphorism, attributed to George Box, is the battle cry of the Minnesota calibrator, a breed of macroeconomist, inspired by Ed Prescott, one of the most important and influential economists of the last century.
Of course all models are wrong. That is trivially true: it is the definition of a model. But the cry has been used for three decades to poke fun at attempts to use serious econometric methods to analyze time series data. Time series methods were inconvenient to the nascent Real Business Cycle Program that Ed pioneered because the models that he favored were, and still are, overwhelmingly rejected by the facts. That is inconvenient. Ed’s response was pure genius. If the model and the data are in conflict, the data must be wrong. ...
After explaining, he concludes:
We don't have to play by Ed's rules. We can use the methods developed by Rob Engle and Clive Granger as I have done here. Once we allow aggregate demand to influence permanently the unemployment rate, the data do not look kindly on either real business cycle models or on the new-Keynesian approach. It's time to get serious about macroeconomic science...
Posted by Mark Thoma on Sunday, December 14, 2014 at 02:41 PM in Economics, Macroeconomics, Methodology |
Posted by Mark Thoma on Sunday, December 14, 2014 at 12:06 AM in Economics, Links |
Citigroup Will Be Broken Up: Citigroup is a very large bank that has amassed a huge amount of political power. Its current and former executives consistently push laws and regulations in the direction of allowing Citi and other megabanks to take on more risk, particularly in the form of complex highly leveraged bets. Taking these risks allows the executives and traders to get a lot of upside compensation in the form of bonuses when things go well – while the downside losses, when they materialize, become the taxpayer’s problem.
Citigroup is also, collectively, stupid on a grand scale. The supposedly smart people at the helm of Citi in the mid-2000s ran them hard around – and to the edge of bankruptcy. A series of unprecedented massive government bailouts was required in 2000-09 – and still the collateral damage to the economy has proved enormous. Give enough clever people the wrong incentives and they will destroy anything.
Now the supposedly brilliant people who run Citigroup have, in the space of a single working week, made a series of serious political blunders with long-lasting implications. Their greed has manifestly proved Elizabeth Warren exactly right about the excessive clout of Wall Street, their arrogance has greatly strengthened a growing left-center-right coalition concerned about the power of the megabanks, and their public exercise of raw power has helped this coalition understand what it needs focus on doing – break up Citigroup. ...
If we can't stop Citigroup from inserting changes to Dodd-Frank it desires into the "Cromnibus", then how, exactly -- with that sort of political influence -- does it get broken up?
Posted by Mark Thoma on Saturday, December 13, 2014 at 12:16 PM in Economics, Financial System, Regulation |
Posted by Mark Thoma on Saturday, December 13, 2014 at 12:06 AM in Economics, Links |
Data Supportive of Fed Plans, by Tim Duy: Incoming data in the second half of this week continues to support the Federal Reserve's plans to begin normalizing policy in the middle of next year, with the removal of "considerable time" language next week a likely first step.
Retail sales for November were unquestionably strong and reveal an acceleration in the pace of core sales:
You were right if you dismissed the early earnings on the holiday shopping season as useless noise. Similarly, consumer confidence is pushing to pre-recession levels:
And note this from Reuters:
"Expected wage gains rose to their highest level since 2008, and consumers voiced the most favorable buying attitudes in several decades," survey director Richard Curtin said in a statement.
As I have said before, nothing interesting happens until we get unemployment below 6%. Be prepared for a better equilibrium.
Even as the economic data improve, however, Wall Street remains on edge. Lower oil prices and the resulting impact on high yield bonds are resonating throughout credits markets while equity prices struggle. Despite warnings from Fed officials about the likely path of policy, long-dated US Treasury yields continue to remain under pressure. It is difficult to assess the impact on policy-making at this point. Fed officials will be torn between the market turmoil and expectations that lower energy prices will boost an already accelerating economy. And note that New York Federal Reserve President William Dudley was very dismissive of the idea that the Fed would respond to every financial market disruption as policy moved toward normalization:
Because financial market conditions affect economic activity only slowly over time, this suggests that we should look through short-term volatility and movements in financial markets. We should not respond until we become convinced that the movements will likely, without action on our part, prove sufficiently persistent to conflict with achievement of our objectives. Often, financial markets can be quite volatile and move a lot without disturbing underlying economic performance.
Similarly, he has been dismissive of market-based measures of inflation expectations.
In assessing inflation expectations, I currently put more weight on survey-based measures of inflation expectations as opposed to market-based measures. Survey-based measures have been generally stable, consistent with inflation expectations remaining well-anchored. However, market-based measures, such as those based on breakeven inflation derived from the difference between yields on nominal versus Treasury Inflation-Protected Securities (TIPS), have registered declines over the past few months, even on a 5-years forward basis. Research done by my staff suggests that much of this decline in market-based measures of inflation compensation reflects a fall in the inflation risk premium—that is, what investors are willing to pay to protect themselves against inflation risk. Adjusting for the fall in the inflation risk premium, inflation expectations appear to have declined much less than implied by TIPS inflation breakeven measures.
Market participants believe the Fed leans heavily on the 5-year, 5-year forward inflation metric. That measure is heading toward lows last seen on the eve of operation twist:
The Fed dares not defy this chart. Or do they? Jim O'Sullivan at HFE accurately notes that the 5-year, 5-year forward breakeven has been inordinately driven by oil prices:
Why Fed prefers "survey based:" 5y5yf TIPS swing with oil even tho current infl irrelevant for pic.twitter.com/StxfsvubNh
— Jim O'Sullivan (@osullivanEcon) December 12, 2014
The Fed may be losing faith in these measures. As Dudley suggests, they may feel that such metrics are too simplistic, and find themselves favoring metrics like that offered by the Cleveland Fed that shows a firming of inflation expectations in recent months:
Note also that the resilience of survey-based metrics of inflation expectations. Back to Reuters and the confidence report:
The survey's one-year inflation expectation rose to 2.9 percent from 2.8 percent, while its five-year inflation outlook also rose to 2.9 percent from 2.6 percent last month.
And that leads me to my bottom line - another question for Federal Reserve Chair Janet Yellen at next week's post-FOMC press conference.
Bottom Line: I would like a journalist to press Yellen on her interpretation of the 5-year, 5-year forward breakeven measure of inflation expectations. Does she see this measure as important or too noisy to be used as a policy metric? What is her preferred metric?
Posted by Mark Thoma on Friday, December 12, 2014 at 11:24 AM in Economics, Fed Watch, Monetary Policy |
Symmetric Application of Dynamic Scoring: Republicans are keen to sacrifice CBO’s role as impartial arbiter of fiscal measures on the altar of “dynamic scoring” of tax measures. But there is no economic reason for restricting this approach to only tax measures.
First, on tax measures,... there is a tremendous amount of uncertainty — model and parameter — associated with the intertemporal models necessarily used dynamic scoring of tax policies. See also this discussion of the Bush Administration’s foray, in this post. (Of course, I am skipping nonsensical analyses such as the Heritage Foundation’s Center for Data Analysis of, for instance, the Ryan plan   ).
Second, as pointed out by Alan Auerbach, there is no reason to only analyze tax policies. For instance, spending on Head Start which might enhance labor productivity should in principle be scored dynamically. And, so too should infrastructure. Consider this assessment from the IMF’s Research Department, regarding public investment. ...
Notice that debt declines 4 percentage points of GDP in response to an exogenous 1 percentage point of GDP increase in public investment. In addition output increases 1.5 percentage points relative to baseline. Now, one could argue — particularly with respect to debt-to-GDP — the response is only statistically significantly different from zero in the short term. However, one has even less empirical evidence regarding statistical significance for tax revenue responses to tax rate changes in many instances.
So, let’s think twice about dynamic scoring…
Posted by Mark Thoma on Friday, December 12, 2014 at 11:09 AM in Economics |
Part 1 of Tankersley's series on the problems facing the middle class ("Liftoff & Letdown: The American middle class is floundering, and it has been for decades. The Post examines the mystery of what’s gone wrong, and shows what the country must focus on to get the economy working for everyone again. Monday: The devalued American worker."):
Why America’s middle class is lost, by Jim Tankersley, Washington Post: ... Yes, the stock market is soaring, the unemployment rate is finally retreating after the Great Recession and the economy added 321,000 jobs last month. But all that growth has done nothing to boost pay for the typical American worker. Average wages haven’t risen over the last year, after adjusting for inflation. Real household median income is still lower than it was when the recession ended.
Make no mistake: The American middle class is in trouble.
That trouble started decades ago, well before the 2008 financial crisis, and it is rooted in shifts far more complicated than the simple tax-and-spend debates that dominate economic policymaking in Washington. ...
In this new reality, a smaller share of Americans enjoy the fruits of an expanding economy. This isn’t a fluke of the past few years — it’s woven into the very structure of the economy. And even though Republicans and Democrats keep promising to help the middle class reclaim the prosperity it grew accustomed to after World War II, their prescriptions aren’t working. ...
The great mystery is: What happened? Why did the economy stop boosting ordinary Americans in the way it once did?
The answer is complicated, and it’s the reason why tax cuts, stimulus spending and rock-bottom interest rates haven’t jolted the middle class back to its postwar prosperity. ...
Posted by Mark Thoma on Friday, December 12, 2014 at 10:14 AM in Economics, Income Distribution, Unemployment |
What's the real lesson from the troubles in Greece?:
Mad as Hellas, by Paul Krugman, Commentary, NY Times: The Greek fiscal crisis erupted five years ago, and its side effects continue to inflict immense damage on Europe and the world. But I’m not talking about the side effects you may have in mind — spillovers from Greece’s Great Depression-level slump, or financial contagion to other debtors. No, the truly disastrous effect of the Greek crisis was the way it distorted economic policy...
Suddenly, we were supposed to obsess over budget deficits... In reality,... the experience of Greece and other European countries that were forced into harsh austerity measures should ... have convinced you that slashing spending in a depressed economy is a really bad idea... And the devastation in Greece is awesome to behold. ...
The ... news that has roiled Europe these past few days is that the Greeks may have reached their limit. The details are complex, but basically the current government is trying a fairly desperate political maneuver to put off a general election. And, if it fails, the likely winner in that election is Syriza, a party of the left that has demanded a renegotiation of the austerity program, which could lead to a confrontation with Germany and exit from the euro.
The important point here is that it’s not just the Greeks who are mad as Hellas (their own name for their country) and aren’t going to take it anymore. Look at France, where Marine Le Pen, the leader of the anti-immigrant National Front, outpolls mainstream candidates of both right and left. Look at Italy, where about half of voters support radical parties like the Northern League and the Five-Star Movement. Look at Britain, where both anti-immigrant politicians and Scottish separatists are threatening the political order.
It would be a terrible thing if any of these groups — with the exception, surprisingly, of Syriza, which seems relatively benign — were to come to power. But there’s a reason they’re on the rise. This is what happens when an elite claims the right to rule based on its supposed expertise,... then demonstrates both that it does not, in fact, know what it is doing, and that it is too ideologically rigid to learn from its mistakes.
I have no idea how events in Greece are about to turn out. But there’s a real lesson in its political turmoil that’s much more important than the false lesson too many took from its special fiscal woes.
Posted by Mark Thoma on Friday, December 12, 2014 at 12:24 AM in Economics, Fiscal Policy |
Posted by Mark Thoma on Friday, December 12, 2014 at 12:06 AM in Economics, Links |
Inequality harms the most vulnerable among us: The large increase in inequality in recent years has been well documented by Thomas Piketty and Emmanuel Saez, among others. But less is known about the consequences. What impact has rising inequality had on the overall economy and on individual households?
Evidence is mounting that inequality is harmful to economic growth, and recent findings also suggest that increasing inequality "is linked to more deaths among African Americans." ...
Posted by Mark Thoma on Thursday, December 11, 2014 at 09:06 AM in Economics, Income Distribution |
Lant Pritchett and Lawrence H. Summers:
Growth slowdowns: Middle-income trap vs. regression to the mean, by Lant Pritchett, Lawrence H. Summers, Vox EU: Dozens of nations think they are in the ‘middle-income trap’. Lant Pritchett and Larry Summers present new evidence that this trap is actually just growth reverting to its mean. This matters since belief in the ‘trap’ can lead governments to misinterpret current challenges. For lower-middle-income nations the 21st century beckons, but there are still 19th century problems to address. Moreover, sustaining rapid growth requires both parts of creative destruction, but only one is popular with governments and economic elites.
No question is more important for the living standards of billions of people or for the evolution of the global system than the question of how rapidly differently economies will grow over the next generation. We believe that conventional wisdom makes two important errors in assessing future growth prospects.
- First, it succumbs to the extrapolative temptation and supposes that, absent major new developments, countries that have been growing rapidly will continue to grow rapidly, and countries that have been stagnating will continue to stagnate.
In fact, when it comes to growth, our research (Pritchett and Summers 2014 ) suggests that the past is much less the prologue than is commonly supposed.
- Second, conventional wisdom subscribes to the notion of a ‘middle-income trap’ – the idea that when countries reach some intermediate income threshold, growth becomes much more difficult.
Our work suggests that any tendency of this type is very weak, and that what is often ascribed to the middle-income trap is better thought of as growth rates reverting to their means.
Sportswriters refer often to the phenomenon of the ‘sophomore slump’ – the tendency for outstanding rookies to perform less well in their second seasons. In that same vein, reference is often made to the ‘cover of Time magazine curse’ – the observation that public figures or celebrities seem to be on the cover of Time at the peak of their careers, and that it is downhill from there. Both of these phenomena reflect the statistical principle of mean reversion. In any process where there are transitory random fluctuations, there will be a tendency for increases to be followed by decreases, and above-average levels to be followed by declines.
In Pritchett and Summers (2014), we apply this frame to the analysis of national growth rates and find that regression to the mean is a robust regularity. We corroborate earlier findings (e.g. Easterly et al. 1993) that find the correlation across decades in national growth rates is surprisingly low, typically in the range of 0.2 to 0.3. This is in sharp contrast to typical forecasts, which assume much more persistence in growth rates – with both success and failure expected to continue. It is also inconsistent with many prevailing theories of growth that seek to explain growth performance in terms of highly stable national features like culture, institutional quality, or the degree of openness. We suggest that the prevailing pattern of regression to the mean in growth rates should create substantial doubt about extrapolative forecasts of China’s growth, and we believe that there is a significant risk of a major growth slowdown in China at some point over the next decade.
It is natural to ask whether there is any content to the idea of a ‘middle-income trap’ over and above regression to the mean. Since countries that have recently entered into any classification of ‘middle-income’ are, almost by definition, countries that have had recent rapid growth, it is obviously difficult to distinguish between these two phenomena. We think there are three ways in which ‘middle-income trap’ is overstated as a concern relative to regression to the mean.
Which countries should count as ‘middle-income’?
First, we find it difficult to understand the meaning of the ‘middle-income trap’ when it is used to discuss countries that range from Latin American countries to Russia to China to Indonesia to India to Vietnam to Ethiopia. We agree that all of these (and other) rapidly growing countries should be greatly concerned about the risk of a growth deceleration. But, it is not at all clear what the ‘middle-income trap’ means – outside of some arbitrary threshold the World Bank set decades ago for concessional lending – if countries at less than 11% of US GDP per capita (Indonesia 10.2, India 8.5, Vietnam 8.0 and Ethiopia 1.8) qualify and are considered at risk. The 2011 world average GDP per capita was $14,467 and the median was $8,491. Countries like Mexico (average GDP $12,709), Malaysia ($13,468), and Turkey ($14,437) are clearly ‘middle-income’ countries, and having reached these levels of economic sophistication might make continued progress more difficult. But, India could grow for 20 more years at 6% per capita before reaching Mexico’s 2011 level of $12,709, and for Ethiopia it would take 47 years. It is impossible to disentangle the ‘middle-income trap’ from regression-to-the-mean growth dynamics if all growing countries – regardless of their current level of income – are considered at risk of a ‘middle-income trap’.
Income level is a poor predictor of growth slowdowns
Second, if we run an empirical horse race of the correlates of growth decelerations (discrete transitions to lower growth), we find rapid growth a much more powerful predictor of the likelihood of a deceleration than level of income. In our recent paper, Pritchett and Summers (2014), we the use the timing of growth episodes from Kar et al. (2013) to estimate a dummy for a growth deceleration, and regress that on current growth and a quartic in the level of per capita income.
There are three points, all visibly detectable in Figure 1, that plot the predicted values for a country at the average growth rate, at India’s growth rate of 6.3% per annum, and at China’s growth rate of 8.6% per annum.
First, we take an F-test of whether the income terms are jointly significant at the 0.037 level. We find significance, but this is entirely driven by the difference between the very highest income countries and the rest of the sample – the tapering risk for high-income countries. If one estimates the same regression for just those under $25,000 (or any lower threshold), the income terms are not jointly significant.
Second, while the quartic has some ‘middle-income trap’ features – particularly, that decelerations are more likely at higher income ranges up to a point, and less likely above that point – the peak to trough difference is small. For a country at the average growth rate, the smallest likelihood of a deceleration is 4.3% at an income level of roughly $5,500, which then increases, but only to 5.7% at income of roughly $19,000. Going from the range of incomes of Mongolia or Jamaica all the way to the upper middle-income range of Hungary or Bahrain would increase the predicted deceleration in any given year by only 1.4%. Not surprisingly, given the low value of the F-test, this is much smaller than the standard error of the prediction, so within this range, the highest and lowest risks of the ‘middle-income trap’ are not significantly different.
Rapid growth is a strong predictor of future slowdowns
Third, in contrast to the very weak impact of level of income, the impact of the current growth rate on the likelihood of deceleration is large, significant, and important. A 1% higher growth rate leads to a 1.46% higher risk of deceleration – equal to the trough to peak rise due to moving into the ‘middle-income’ range. The T-statistic on past growth is 13.3. As Figure 1 shows, the predicted likelihood of a slowdown in China is 14.4% at its current growth rate of 8.63%, and at the country sample growth rate of 1.84%, but the same income level it is only 4.5% – a 10 percentage point difference.
So, by these predictions of the correlates of growth slowdowns, there is a substantial risk of slowdown for countries that are growing rapidly, but it is almost entirely due to regression to the mean; whereas, the effect of the ‘middle-income trap’ is small, and even moves to the peak ‘middle-income trap’ risk on these estimates empirically add little value.
Figure 1. Risk of growth slowdown from ‘middle-income trap’ is small compared to risk from regression to the mean
Source: Pritchett and Summers 2014.
These three findings – low statistical significance, small empirical magnitudes, much larger differences in predicted change in growth – also hold true for simple panel regressions of growth acceleration rates on lagged growth rates and a quartic in level of income at five-year frequencies. There is some increase in the likelihood of acceleration up to a point, and then a decline above that point – but the magnitude of pure ‘middle-income’ decreasing acceleration in growth at income levels above $11,000 is small compared to the regression-to-the-mean effect. The coefficient on lagged growth is 0.83 – consistent with strong mean reversion.
Why do we care whether the impetus for adopting policies to sustain growth is based on a narrative of regression to the mean as opposed to the ‘middle-income trap’? Both emphasise that sustaining rapid growth is hard and that the quickest way to slow growth is complacency during rapid growth. However, we think there are three important differences.
Three important differences for policy thinking
First, the cause of the sophomore slump cannot be found by asking, “What went wrong in athletes’ second years?” The cause of sophomore slumps may just be exceptionally good luck in their first years. It was not that success was qualitatively harder in their second year or that they got worse, just that things tend to even out. As we have learned excruciatingly from experience with the financial crisis in the US, the time when things seem to be going well is the time it is most important to be prudent about the future. Labelling the problem of sustaining growth as the ‘middle-income trap’ might suggest that the risk of a growth slowdown is much more controllable by policy than it actually is.
We have had a number of people suggest that China will not have a growth slowdown because a slowdown would be politically costly and hence Chinese policymakers have every incentive to avoid that. Thus, they will act to prevent it – and a known ‘trap’ should be easily avoidable. But acting to sustain an unsustainably high growth rate may lead subsequent adjustment to be much harsher. As our friend Ricardo Hausmann puts it, “the path from 8 percent growth to 4 percent growth often goes through negative 2 percent.”
Second, labelling the generic risk of growth slowdowns a ‘middle-income trap’ risks posing current challenges in the wrong light – of how to handle the final stages of the transition from middle-income into developed economy, with the accompanying ‘bright lights’ temptations of picking cutting-edge industries to attract, for example, biotech and software engineering firms. But, the complexity for most countries in the World Bank ‘lower-middle-income’ band is that the 21st century beckons, but there are still 19th century problems to address. Sixty percent of Indians still practice open defecation – because the urban water and sanitation is so inadequate. The average food share in Vietnam in 2010 was still 50% – and so core agriculture issues must remain on the agenda.
Third, one of the factors that makes sustaining rapid growth so difficult is that growth depends on both parts of creative destruction, but only one is popular with governments and economic elites. Everyone loves the ‘creative’, as it brings new investments, new industries, and new profits. But sustained economic growth typically relies on continued structural transformation in which new industries arise, but also old industries shrink – sometimes just relatively, but sometimes absolutely. While essential to sustained economic growth, neither governments nor existing firms like destruction – with its geographic shifts, employment shifts, and firm exits that are a necessary part of weeding out uncompetitive industries. This makes it much harder to sustain rapid growth (which few do) than to get it going (which many do). While this happens at ‘middle-income’ levels, it is also a part of economic transformation at every stage – from the challenges posed by the threat of new industrialists to the landed aristocracy in the Industrial Revolution to the difficulties facing the most advanced countries today. Sustaining growth is not a ‘middle-income’ problem – it is the fundamental challenge of progress at all stages.
At the end of the day, our reading of the statistical evidence is that rapid growth is not something that can be taken for granted, even for those who have enjoyed for a long time. Its continuation requires the constant renewal of good policy along with good luck. This is the challenging reality for all countries, not just those who have been deemed to have middle incomes.
Easterly W, M Kremer, L Pritchett and L Summers (1993), “Good Policy or Good Luck: Country Growth Performance and Temporary Shocks”, Journal of Monetary Economics 32(3): 459–483.
Kar S, L Pritchett, S Raihan and K Sen (2013), “Looking for a Break: Identifying Transitions in Growth Regimes”, Journal of Macroeconomics 38(B): 151–166.
Pritchett, L and L H Summers (2014), “Asiaphoria Meets Regression to the Mean ”, NBER Working Paper 20573.
Posted by Mark Thoma on Thursday, December 11, 2014 at 12:24 AM in Economics |
Challenging the Fed, by Tim Duy: Both Paul Krugman and Ryan Avent are pushing back on the Federal Reserve's apparent intent to raise rates in the middle of next year. Why is the Fed heading in this direction? Krugman offers this explanation:
My guess — and it’s only that — is that they have, maybe without knowing it, been bludgeoned into submission by the constant attacks on easy money. Every day the financial press, many of the blogs, cable financial news, etc, are full of people warning that the Fed’s low-rate policy is distorting markets, building up inflationary pressure, endangering financials stability. Hard-money arguments, no matter how ludicrous, get respectful attention; condemnations of the Fed are constant. If I were a Fed official, I suspect that I would often find myself wishing that the bludgeoning would just stop, at least for a while — and perhaps begin looking for an opportunity to prove that I’m not an inflationary money-printer, that I can take away punchbowls too.
I don't think that the Fed is reacting to external criticism. What I think is that there are two basic views of the world. In one view, the post-2007 malaise is simply the hangover from a severe financial crisis. Time heals all wounds, including this one, and the recent data suggests such healing is underway. The alternative view is that the economy is suffering from secular secular stagnation similar although not to the same extreme as Japan. The latter view suggests the need for a very low or negative real interest rates to maintain full employment, the former view suggests a fairly significant normalization of monetary policy.
I believe that the consensus view on the Fed is the former, that the malaise is simply temporary ("a temporary inconvenience") and now ending. I think this is evident from the Summary of Economic Projections - the implied equilibrium Federal Funds rate is around 3.75%. Perhaps this is below what might have been perceived as normal ten years ago, but the difference could be attributed to slower potential growth rather than secluar stagnation.
If you don't like that argument, then take the more explicit route. Gavin Davies did the intellectual legwork here so we don't have to, and catches Vice Chair Stanley Fischer saying that he doesn't believe the situation calls for protracted negative interest rates. In other words, he rejects the main monetary policy implication of the secular stagnation hypothesis.
And, I don't know if Krugman agrees, but I find it hard to believe that Fischer carries anything but extreme intellectual weight within the Fed. So I would hardly be surprised that the Fed would be moving in a direction he defined. One wonders where Fed Chair Janet Yellen's leadership is on this point? That was always a risk of adding Fischer to the Board - that what might have seemed to be a dream team turned into a power struggle.
This is not to say that I do not share Krugman's and Avent's concerns. I most certainly do. Fischer claims that markets do not believe the secular stagnation story either, but in my mind the flattening of the yield curve is a red flag that the Fed has less room to maneuver than implied by the SEP. But maybe once the Fed actually starts hiking rates, market participants get the clue and the yield curve shifts up. I am not sure I am interested in taking that risk at this point, but no one is asking me to serve on the Federal Reserve Board.
One quibble with Krugman regarding his interpretation of the Phillips Curve:
Suppose the Fed waits too long. Well, inflation ticks up — probably not much, since the short-run Phillips curve looks very flat. And the Fed has the tools to rein the economy in. It would be annoying, unpleasant, and no doubt there would be Congressional hearings berating the Fed for debasing the dollar etc.. But not a really big problem.
Maybe two quibbles. First is that if you asked policymakers why the Phillips Curve was flat, I think they would say that nominal wages rigidities hold up the back end, while tighter policy holds down the front. In other words, the reason inflation does not accelerate at low unemployment rates is that the Fed tightens policy accordingly. Second, I think they equate "reigning the economy in" as triggering a recession. I think they find this more than unpleasant.
Bottom Line: If you want to know what the Fed is thinking at this point, a journalist needs to push Yellen on the secular stagnation issue at next week's press conference. Does she or the committee agree with Fischer? And does she see any inconsistency with the SEP implied equilibrium Federal Funds rates and the current level of long bonds?
Posted by Mark Thoma on Thursday, December 11, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Thursday, December 11, 2014 at 12:06 AM in Economics, Links |
And so it begins:
What is Congress Trying to Secretly Deregulate in Dodd-Frank?, by Mike Konczal: There are concerns that the budget bill under debate in Congress will eliminate Section 716 of Dodd-Frank, using language previously drafted by Citigroup. So what is this all about?
Section 716 of Dodd-Frank says that institutions that receive federal insurance through FDIC and the Federal Reserve can’t be dealers in the specialized derivatives market. Banks must instead “push out” these dealers into separate subsidiaries that don’t benefit from the government backstop. They can still trade in many standardized derivatives and hedge their own risks, however. This was done because having banks act as swap dealers put taxpayers at risk in the event of a sudden collapse. That’s it.
Why would you want a regulation like this? The first is that it acts as a complement to the Volcker Rule. ...
A second reason is 716 will also prevent exotic derivatives from being subsidized by the government’s safety net. ...
The third reason is for the sake of financial stability. ...
Stiglitz reiterated this point today, saying “Section 716 facilitates the ability of markets to provide the kind of discipline without which a market economy cannot effectively function. I was concerned in 2010 that Congress would weaken 716, but what is proposed now is worse than anything contemplated back then.”
Now many on Wall Street would argue that this rule is unnecessary. However, their arguments are not persuasive. ...
We should be strengthening, not weakening, financial reform. And removing this piece of the law will not benefit this project.
See also Barney Frank Criticizes Planned Roll-Back of Namesake Financial Law.
Posted by Mark Thoma on Wednesday, December 10, 2014 at 12:03 PM in Economics, Financial System, Politics, Regulation |
Via a tweet from Bruce Bartlett:
Labor Union Membership and Life Satisfaction in the United States, by Patrick Flavin and Gregory Shufeldt: Abstract While a voluminous literature examines the effects of organized labor on workers’ wage and benefit levels in the United States, there has been little investigation into whether membership in a labor union directly contributes to a higher quality of life. Using data from the World Values Survey, we uncover evidence that union members are more satisfied with their lives than those who are not members and that the substantive effect of union membership on life satisfaction rivals other common predictors of quality of life. Moreover, we find that union membership boosts life satisfaction across demographic groups regardle ss if someone is rich or poor, male or female, young or old, or has a high or low level of education. These results suggest that organized labor in the United States can have significant implications for the quality of life that citizens experience.
Posted by Mark Thoma on Wednesday, December 10, 2014 at 10:45 AM in Economics, Unions |
For worker control: ... Social democrats used to think that they did not need to challenge the fundamental power structures of capitalism because, with a few good top-down economic and social policies, capitalism could be made to deliver increased benefits for workers and the poor in terms both of rising real wages and better public services. ...
The "golden era" in which this was true has vanished. Instead, we face harsher times... Times have changed. So the left must change. ...
There's one context in which this is especially necessary - the workplace. ... If firms cannot or will not offer rising wages, they should at least offer non-pecuniary benefits: more control over working conditions and the assurance of good rewards if the business thrives in future. There are ... big benefits to doing so...
Of course, there are countless types and degrees of worker ownership and control, some compatible with capitalism and some not. But this is a strength, not a weakness.
My point here is a simple one. The days when the leftist politics could ignore the "hidden abode of production" because lightly modified capitalism would deliver the goods have gone. Our new times require new politics. ...
Posted by Mark Thoma on Wednesday, December 10, 2014 at 09:50 AM in Economics |
Posted by Mark Thoma on Wednesday, December 10, 2014 at 12:06 AM in Economics, Links |
From the OECD Insights blog:
Is inequality good or bad for growth?, by Brian Keeley: If you’ve been following the income inequality debate, you’ll know there’s been much discussion of the question in the headline above. Until just a few years ago, it’s probably fair to say that mainstream opinion leaned towards the “good for growth” side of the debate. Yes, inequality might leave a bad taste in the mouth, but it was worth it if it meant a strong economy. ...
But over the past couple of years,.... that inequality is good, or at least not bad, for growth ... has come under increasing fire, including from the IMF, the OECD and even Standard & Poor’s. And now comes new research from the OECD indicating that “income inequality has curbed economic growth significantly”.
Much of the coverage of rising inequality has focused on the incomes of “the 1%”. But the OECD research, which was led by Michael Förster and Federico Cingano, indicates that it’s the situation of people at the other end of the earnings scale that has the biggest impact on growth. These lower-income households are not a small group. They represent some 40% of the population...
Where overall inequality is higher in a society, a clear pattern emerges: People from such backgrounds invest much less in developing their human capital – essentially their education and skills. By contrast, it has almost no impact on the educational investment of middle-income and wealthy families. The implications for social mobility are clear – an ever-widening education and earnings gap between society’s haves and have-nots. ...
Just how bad is clear from the OECD research. It estimates that rising inequality knocked more than 10 percentage points off growth in Mexico and New Zealand in the two decades up to the Great Recession. The impact of rising inequality was also felt – albeit not as strongly – in a number of other OECD countries, including Italy, the UK and the US and even in countries with relatively low levels of inequality like Sweden, Finland and Norway
To be sure, the debate over inequality and growth will certainly continue. Just last week (before publication of the new OECD paper), Nobel laureate Paul Krugman admitted he was a “skeptic” who remained to be convinced of the link. But the fact that the debate is happening at all is surely a good thing. Rising inequality is one of the most significant socioeconomic trends of our time. Understanding its possible impact on our societies and economies has surely never been more important.
In the report, they authors also say:
... Tackling inequality through tax and transfer policies does not harm growth, provided these policies are well designed and implemented. In particular, redistribution efforts should focus on families with children and youth, as this is where key decisions on human capital investment are made and should promote skills development and learning across people’s lives. ...
Posted by Mark Thoma on Tuesday, December 9, 2014 at 10:21 AM in Economics, Income Distribution |