« May 2014 |
| July 2014 »
Yifan Cao and Adam Shapiro:
Will Inflation Remain Low?, by Yifan Cao and Adam Shapiro, FRBSF Economic Letter: Over the past two years, inflation has remained persistently low. As measured by the core personal consumption expenditures price index (core PCEPI), which excludes volatile energy and food prices, annual inflation has been below the Federal Reserve’s 2% target since April 2012. Given the recent path of inflation, a natural question to consider is how likely it is to remain low in the future. Recent research using financial market forecasts (Bauer and Christensen 2014) shows that inflation will remain low going forward. In this Economic Letter, we examine the outlook for inflation using model-based forecasts.
We rely on the well-known Phillips curve model and examine its implications for inflation over the next two years. In its most basic form, this model posits that inflation depends on past inflation and a measure of slack in the overall economy. We show that a basic Phillips curve implies that inflation is likely to remain low over the next two years.
As with any forecasting model, the basic Phillips curve is sensitive to the assumptions inherent in its underlying structure. The basic model has very few components and leaves out several potentially important determinants of inflation. Indeed, over the years, numerous extensions to the basic Phillips curve framework have incorporated additional factors that are likely to affect the dynamics of inflation. In this Economic Letter, we focus on two simple extensions that are potentially important to the current inflation outlook.
The first extension incorporates anchored inflation expectations with the constraint that long-run inflation eventually returns to the Fed’s inflation target of 2% (see Williams 2006, Stock and Watson 2010, and Cogley, Primiceri, and Sargent 2010). The second extension uses an alternative measure of economic slack that excludes the long-term unemployed and focuses on the short-term unemployed (see Gordon 2013, Rudebusch and Williams 2014, and Watson 2014). A Phillips curve model that incorporates these two extensions predicts a path for inflation that is still low but is higher than implied by the basic model.
The basic Phillips curve model
The Phillips curve framework is based on the premise that, during times of economic prosperity when overall demand rises higher than overall supply in the economy, there will be increasing pressure to push prices up. By contrast, during times of economic distress when demand falls relative to supply, there is a downward pressure on prices. The model therefore suggests that inflation depends on some indicator of unused productive capacity in the economy, or “slack.” While there are numerous measures of slack, a popular choice among economists is a measure referred to as the unemployment gap. This gap is defined as the difference between the level of the current unemployment rate and what the unemployment rate should be if the economy were operating at its full capacity. This latter measure is referred to as NAIRU, or the non-accelerating inflation rate of unemployment, and an estimate of it is produced by the Congressional Budget Office. The underlying intuition is that, when the economy is in distress, the unemployment rate will lie above NAIRU.
The basic Phillips curve describes the behavior of current inflation as a function of the past unemployment gap and past inflation. We estimate this model using data going back to 1985. We then use the parameters from our estimates to project future inflation, assuming that the unemployment gap follows some specified future path. We assume that the unemployment rate for the second quarter of 2014 will be 6.3%, as measured in May 2014, and thereafter it will move at a steady pace toward 5.55% by the end of 2015, which is the average unemployment rate projection from the Fed’s most recent Summary of Economic Projections (Board of Governors 2014).
Projected PCEPI inflation: Basic Phillips curve model
Sources: Bureau of Economic Analysis (BEA) and
Board of Governors, Summary of Economic Projections.
Figure 1 depicts actual inflation, measured by the annualized quarterly change in core PCEPI and the projection for inflation using the basic Phillips curve model. The basic model implies inflation is very persistent and projects core PCEPI inflation will remain below 2% through the end of 2015.
Extensions to the basic model
The basic Phillips curve is a parsimonious model and therefore leaves out a myriad of different variables that may affect the path of inflation. Indeed, throughout the past few decades, economists have extended the basic Phillips curve in a host of different ways. Looking at these variations can help give some insights into how certain components can change the outlook for future inflation. For this Economic Letter, we consider two simple extensions of the model that are particularly relevant given the current situation.
In our first exercise, we examine how much a credible Fed inflation target would affect the inflation forecast generated by the Phillips curve. Specifically, we impose a restriction that steady-state core PCEPI inflation lies at the Fed’s perceived inflation target, currently 2%. This is equivalent to assuming that, on average, consumers and firms believe that future inflation is “well anchored” around the Fed’s inflation target level (see Williams 2006). The assumption is reasonable if firms are forward-looking, setting prices based on expectations of future demand and cost, and incorporating the Fed’s explicit inflation target.
Projected inflation: Basic vs. anchored expectations
Sources: BEA and Board of Governors, Summary of Economic Projections.
Figure 2 depicts this Phillips curve model that imposes inflation expectations anchored at the Fed’s target, alongside the basic model projection. The modified projection is slightly higher, but still lies below 2% by the end of 2015. This slow movement of inflation from its current level, even assuming anchored expectations at 2%, highlights the strong persistence of inflation implied by the data and the model. Generally, most models of inflation dynamics agree on this key trait, that is, inflation moves sluggishly over time.
Breakdown of unemployment: Short-term vs. long-term
Source: Bureau of Labor Statistics.
In our second exercise, we alter the measure of slack used in the Phillips curve inflation forecast. The years since the most recent recession have been marked not just by higher overall unemployment, but also by different durations of unemployment taking divergent paths. As Figure 3 shows, the short-term unemployment rate, defined as the number of people out of work for less than 27 weeks divided by the labor force, has dropped precipitously since the most recent recession ended. In terms of the short-term unemployed, the economy is back to its historical average. By contrast, the long-term unemployment rate has remained elevated. As Robert Gordon (2013) and Mark Watson (2014) recently pointed out, these long-term unemployed may be exerting less upward pressure on wages and prices than the short-term unemployed. For instance, this may be the case if firms compete more for potential employees who have only recently become unemployed than for those whose skills may have eroded or who may otherwise be scarred by prolonged unemployment.
For this exercise, we alter our measure of economic slack to account for this dichotomy. Rather than using overall unemployment, we focus on the short-term unemployed. Specifically, we create a short-term unemployment gap measure by gauging how monthly rates over the 1985 to 2014 sample period deviate from the average short-term unemployment rate.
Projected inflation: Short-term unemployment as slack
Sources: BEA and Board of Governors, Summary of Economic Projections.
Figure 4 shows that the projections for inflation using the short-term unemployment gap exceed the projections of the basic model using the overall unemployment gap. If we also impose well-anchored inflation expectations, inflation rises at a relatively fast pace, surpassing 2% by the end of 2015. The reason for the higher inflation projection is that, in terms of the short-term unemployment rate, there is currently little economic slack. In fact, the short-term unemployment rate projects excess demand over the next two years, which implies strong upward pressure on prices.
Inflation, as measured by the core PCEPI, currently stands below the Fed’s 2% target. A simple empirical Phillips curve implies that inflation will remain relatively low in the near future. Estimating just how low depends a great deal on the assumptions in the model. We test two specific variations to the basic model, altering the measure of slack and the assumptions about inflation expectations. We find that these variations produce some higher projections for future inflation. However, it is difficult to prove that any one specification of the model is the true one. Instead, examining the effects of various specifications can be instructive in exploring how various factors affect forecasts of inflation.
Bauer, Michael D., and Jens H.E. Christensen. 2014. “Financial Market Outlook for Inflation.” FRBSF Economic Letter 2014-14 (May 12).
Board of Governors of the Federal Reserve System. 2014. “Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, June 2014.” Table 1, Summary of Economic Projections.
Cogley, Timothy, Giorgio E. Primiceri, and Thomas J. Sargent. 2010. “Inflation-Gap Persistence in the U.S.” American Economic Journal: Macroeconomics 2(1), pp. 43–69.
Gordon, Robert. 2013. “The Phillips Curve Is Alive and Well: Inflation and the NAIRU during the Slow Recovery.” NBER Working Paper 19390.
Rudebusch, Glenn, and John Williams. 2014. “A Wedge in the Dual Mandate: Monetary Policy and Long-Term Unemployment.” FRB San Francisco Working Paper 2014-14 (May).
Stock, James, and Mark Watson. 2010. “Modeling Inflation after the Crisis.” NBER Working Paper 16488.
Watson, Mark. 2014. “Inflation Persistence, the NAIRU, and the Great Recession.” American Economic Review 104(5, May), pp. 31–36.
Williams, John. 2006. “Inflation Persistence in an Era of Well-Anchored Inflation Expectations.” FRBSF Economic Letter 2006-27 (October 13).
Posted by Mark Thoma on Monday, June 30, 2014 at 12:38 PM in Economics, Inflation |
At macroblog, Julie L. Hotchkiss, a research economist and senior policy adviser at the Atlanta Fed, and Fernando Rios-Avila, a research scholar at the Levy Economics Institute of Bard College look at the relationship betwen education and inequality:
... There is little debate about whether income inequality has been rising in the United States for some time, and more dramatically recently. The degree to which education has exacerbated inequality or has the potential to reduce inequality, however, offers a more robust debate. We intend this post to add to the evidence that growing educational attainment has contributed to rising inequality. This assertion is not meant to imply that education has been the only source of the rise in inequality or that educational attainment is undesirable. The message is that growth in educational attainment is clearly associated with growing inequality, and understanding that association will be central to the understanding the overall growth in inequality in the United States.
Posted by Mark Thoma on Monday, June 30, 2014 at 11:51 AM in Economics, Income Distribution, Universities |
I didn't realize the share of the securitization market that is government-backed was so high. This is from Cecchetti & Schoenholtz:
How securitization really works: ... The success of U.S. securitization – as an alternative to bank finance – is a key factor behind the current push of euro-area authorities to increase securitization. ... Because finance is predominantly bank based in Europe – and banks faced heightened capital requirements – governments and potential borrowers are anxious to shift at least some financing into capital markets (including bonds and equities). ...
Yet, emulating American securitization ... probably means providing government guarantees at a scale that people currently do not envision. ...
To see what we mean, we can look at a few numbers regarding U.S. securitization. According to the Federal Reserve’s flow of funds statistics (the Z.1 release), total securitization stood at $9,360.4 billion as of end-March 2014... But government-backed securitizations – these are mortgages, student loans and the like – accounted for $7,721 billion of this total... That is, only 18% of U.S. securitization – primarily auto loans and credit card debt – are free from government guarantees! Even at the peak of private-sector securitization in mid-2007 ... the government-backed share exceeded 60%. ...
To put these numbers into perspective, we can look at another part of the U.S. financial system: insured bank deposits. You may be surprised to learn that ... only ... 61% of bank deposits are government backed ... versus 82% of securitizations. ...
We believe that U.S. government backing of securitizations can (and should) be scaled back... Nevertheless, it also seems difficult to jumpstart a large-scale securitization market in Europe without sizable public support. ...
The bottom line: If the euro area wishes to get securitization going in a big way, it will still need more of the mutual insurance among nations that has been so difficult to achieve. That doesn’t seem to be in the cards for now.
Posted by Mark Thoma on Monday, June 30, 2014 at 10:22 AM in Economics, Financial System |
James Surowiecki explains why we have "Moaning Moguls":
Moaning Moguls, by James Surowiecki: The past few years have been very good to Stephen Schwarzman, the chairman and C.E.O. of the Blackstone Group, the giant private-equity firm. ... Schwarzman is now worth more than ten billion dollars. You wouldn’t think he’d have much to complain about. ... He recently grumbled that the U.S. middle class has taken to “blaming wealthy people” for its problems. Previously, he has said that it might be good to raise income taxes on the poor so they had “skin in the game,” and that proposals to repeal the carried-interest tax loophole—from which he personally benefits—were akin to the German invasion of Poland.
Schwarzman isn’t alone..., the basic sentiment is surprisingly common. ...[examples]... That’s not how it’s always been. ...
If today’s corporate kvetchers are more concerned with the state of their egos than with the state of the nation, it’s in part because their own fortunes aren’t tied to those of the nation the way they once were. In the postwar years, American companies depended largely on American consumers. Globalization has changed that... The well-being of the American middle class just doesn’t matter as much to companies’ bottom lines. And there’s another change. Early in the past century, there was a true socialist movement in the United States, and in the postwar years the Soviet Union seemed to offer the possibility of a meaningful alternative to capitalism. Small wonder that the tycoons of those days were so eager to channel populist agitation into reform. Today..., corporate chieftains have little to fear... Moguls complain about their feelings because that’s all anyone can really threaten.
Posted by Mark Thoma on Monday, June 30, 2014 at 09:38 AM in Economics, Income Distribution |
"The enduring power of bad ideas":
Charlatans, Cranks and Kansas, by Paul Krugman, Commentary, NY Times: Two years ago Kansas embarked on a remarkable fiscal experiment: It sharply slashed income taxes without any clear idea of what would replace the lost revenue. Sam Brownback, the governor, proposed the legislation — in percentage terms, the largest tax cut in one year any state has ever enacted — in close consultation with the economist Arthur Laffer. And Mr. Brownback predicted that the cuts would jump-start an economic boom...
But Kansas isn’t booming — in fact, its economy is lagging both neighboring states and America as a whole. Meanwhile, the state’s budget has plunged deep into deficit, provoking a Moody’s downgrade of its debt.
There’s an important lesson here — but it’s not what you think. Yes, the Kansas debacle shows that tax cuts don’t have magical powers, but we already knew that. The real lesson from Kansas is the enduring power of bad ideas, as long as those ideas serve the interests of the right people. ...
For the Brownback tax cuts didn’t emerge out of thin air. They closely followed a blueprint laid out by the American Legislative Exchange Council, or ALEC, which has also supported a series of economic studies purporting to show that tax cuts for corporations and the wealthy will promote rapid economic growth. The studies are embarrassingly bad, and the council’s Board of Scholars — which includes both Mr. Laffer and Stephen Moore of the Heritage Foundation — doesn’t exactly shout credibility. ...
And what is ALEC? It’s a secretive group, financed by major corporations, that drafts model legislation for conservative state-level politicians.... And most of ALEC’s efforts are directed, not surprisingly, at privatization, deregulation, and tax cuts for corporations and the wealthy.
And I do mean for the wealthy. ...ALEC supports ... cutting taxes at the top while actually increasing taxes at the bottom, as well as cutting social services.
But how can you justify enriching the already wealthy while making life harder for those struggling to get by? The answer is, you need an economic theory claiming that such a policy is the key to prosperity for all. So supply-side economics fills a need backed by lots of money, and the fact that it keeps failing doesn’t matter.
And the Kansas debacle won’t matter either. Oh, it will briefly give states considering similar policies pause. But the effect won’t last long, because faith in tax-cut magic isn’t about evidence; it’s about finding reasons to give powerful interests what they want.
Posted by Mark Thoma on Monday, June 30, 2014 at 12:24 AM in Economics, Politics, Taxes |
Posted by Mark Thoma on Monday, June 30, 2014 at 12:06 AM in Economics, Links |
Thelen on the prospects for egalitarian capitalism:
source: Kathleen Thelen, Varieties of Liberalization (kl 3310)
There is a version of economic historical thinking that we might label as "capitalist triumphalism" -- the idea that the institutions of a capitalist economy drive out all other economic forms, and that they tend towards an ever-more pure form of unconstrained market society. "Liberalization," deregulation, and reduction of social rights are seen as economically inevitable. On this view, the various ways in which some countries have tried to ameliorate the harsh consequences of unconstrained capitalism on the least well off in society are doomed -- the welfare state, social democracy, extensive labor rights, or universal basic income (link). Through a race to the bottom, any institutional reforms that impede the freedom and mobility of capital will be forced out by a combination of economic and political pressures.
The graphs above demonstrate the current structural differences among Denmark, Sweden, Germany, Netherlands, and USA when it comes to training and income support for the unemployed and underemployed. It is visible that the four European economies devote substantially greater resources to support for the unemployed than the United States. And on the triumphalist view, the states demonstrating more generous benefits for the less-well-off will inevitably converge towards the profile represented by the fifth panel, the United States.
Kathleen Thelen is a gifted historical sociologist who has studied the institutions of labor education and training throughout the past twenty years. Her book How Institutions Evolve: The Political Economy of Skills in Germany, Britain, the United States, and Japan is an important contribution to our understanding of these basic economic institutions, and it also sheds important light on the meta-issues of stability and change in important social institutions. With James Mahoney she also edited the valuable collection Explaining Institutional Change: Ambiguity, Agency, and Power on this topic.
Thelen's most recent book, Varieties of Liberalization and the New Politics of Social Solidarity addresses the question of capitalist triumphalism. (That isn't a term that she uses, but it seems descriptive.) She locates her analysis within the "varieties of capitalism" field of scholarship, which maintains that there is not a single pathway of development for capitalist systems. "Coordinated" capitalism and neoliberal capitalism represent two poles of the space considered by the VofC literature.
From the beginning, the VofC literature challenged the idea that contemporary market pressures would drive a convergence on a single best or most efficient model of capitalism. (kl 228)
Thelen is interested in assessing the prospects for what she calls "egalitarian" capitalism -- the variants of capitalist political economy that feature redistribution, social welfare, and significant policy support for the less-well-off. She focuses on several key institutions -- industrial relations, vocational education and training, and labor market institutions, and she argues that these are particularly central for the historical issue of the development of capitalism towards harsher or gentler versions.
Different varieties of liberalization occur under the auspices of different social coalitions, and this has huge implications for the distributive outcomes in which many of us are ultimately interested. (kl 243)
This point is key to her view of the plasticity and path-dependency of basic economic institutions: these institutions change as a result of economic imperatives and the strength of various social groups who are in a position to influence the form that change takes. "The conclusions I reach here are based on a view of institutions that emphasizes the political-coalitional basis on which they rest" (kl 259). But there is no simple calculus proceeding from power group to institutional outcome; instead, the results for institutional change are a dynamic consequence of strategy, coalition, and constraint.
I suggest that the institutions of egalitarian capitalism survive best not when they stably reproduce the politics and patterns of the Golden Era, but rather when they are reconfigured -- in both form and function -- on the basis of significantly new political support coalitions. (kl 330)
A key finding in Thelen's analysis is that "coordinated" capitalism and "egalitarian" capitalism are not the same. Coordinated capitalism corresponds to the models associated with social democracies of the 1950s and 1960s, the "Nordic" model. But Thelen holds that egalitarian capitalism can take more innovative and flexible forms and may be a more durable alternative to neoliberal capitalism.
Is a more "egalitarian" capitalism possible? The data on labor markets that Thelen presents shows that there are major differences across OECD economies when it comes to wage inequality. Here is a striking chart:
Source: Thelen, Figure 3.3. Share of Employees in Low-Wage Work, 2010
Fully a quarter of US workers are employed in low-wage work in 2010. This is about double the rate of Denmark and quadruple the rate of low-wage workers in Sweden. Plainly this reflects a US economy that is creating substantially greater numbers of low-income people than any other OECD country. And yet all of these countries are capitalist economies, some with rates of growth that are higher than the United States. This demonstrates that there are institutional and policy choices available that are consistent with the imperatives of a capitalist market economy and yet that give rise to more egalitarian outcomes than we observe in the US, Canada, and the UK.
A key element in common among the more egalitarian labor outcomes that Thelen studies (Netherlands, Denmark, Sweden, Germany) is the expansion of part-time work, mini-jobs, and "flexi-curity". This phenomenon reflects a combination of liberalization (relaxation of work rules and requirements of long labor contracts), with a set of arrangements that allows a smoother allocation of labor to jobs and an improvement in income and security for the lower end of the labor market. This trend is part of what Thelen calls a strategy of "embedded flexibilization", which she regards as the best hope for a pathway towards equitable capitalism.
Thelen closes with a realistic observation about the uncertain coalitional basis that is available in support of the policies of embedded flexibilization. Xenophobic tendencies in countries like the Netherlands and Denmark have the potential for destroying the social consensus that currently exists for this model, and the leaders of nationalistic anti-immigrant parties have made this a key to their efforts at political mobilization (kl 5541). Maintenance of these policies will require strong political efforts on the part of progressive coalitions in those countries, and organized labor is key to those efforts.
This analysis is deeply international and comparative, but it has an important consequence for the political economy of the United States: where are the coalitions that can help steer our economy towards a more egalitarian form of capitalism?
(Readers may be interested in an earlier discussion of the Nordic model; link.)
Posted by Mark Thoma on Sunday, June 29, 2014 at 09:48 AM in Economics, Social Insurance |
Posted by Mark Thoma on Sunday, June 29, 2014 at 12:06 AM in Economics, Links |
Simon Wren-Lewis (my comments are at the end):
Understanding the New Classical revolution: In the account of the history of macroeconomic thought I gave here, the New Classical counter revolution was both methodological and ideological in nature. It was successful, I suggested, because too many economists were unhappy with the gulf between the methodology used in much of microeconomics, and the methodology of macroeconomics at the time.
There is a much simpler reading. Just as the original Keynesian revolution was caused by massive empirical failure (the Great Depression), the New Classical revolution was caused by the Keynesian failure of the 1970s: stagflation. An example of this reading is in this piece by the philosopher Alex Rosenberg (HT Diane Coyle). He writes: “Back then it was the New Classical macrotheory that gave the right answers and explained what the matter with the Keynesian models was.”
I just do not think that is right. Stagflation is very easily explained: you just need an ‘accelerationist’ Phillips curve (i.e. where the coefficient on expected inflation is one), plus a period in which monetary policymakers systematically underestimate the natural rate of unemployment. You do not need rational expectations, or any of the other innovations introduced by New Classical economists.
No doubt the inflation of the 1970s made the macroeconomic status quo unattractive. But I do not think the basic appeal of New Classical ideas lay in their better predictive ability. The attraction of rational expectations was not that it explained actual expectations data better than some form of adaptive scheme. Instead it just seemed more consistent with the general idea of rationality that economists used all the time. Ricardian Equivalence was not successful because the data revealed that tax cuts had no impact on consumption - in fact study after study have shown that tax cuts do have a significant impact on consumption.
Stagflation did not kill IS-LM. In fact, because empirical validity was so central to the methodology of macroeconomics at the time, it adapted to stagflation very quickly. This gave a boost to the policy of monetarism, but this used the same IS-LM framework. If you want to find the decisive event that led to New Classical economists winning their counterrevolution, it was the theoretical realisation that if expectations were rational, but inflation was described by an accelerationist Phillips curve with expectations about current inflation on the right hand side, then deviations from the natural rate had to be random. The fatal flaw in the Keynesian/Monetarist theory of the 1970s was theoretical rather than empirical.
I agree with this, so let me add to it by talking about what led to the end of the New Classical revolution (see here for a discussion of the properties of New Classical, New Keynesian, and Real Business Cycle Models). The biggest factor was empirical validity. Although some versions of the New Classical model allowed monetary non-neutrality (e.g. King 1982, JPE), when three factors are present, continuous market clearing, rational expectations, and the natural rate hypothesis, monetary neutrality is generally present in these models. Initially work from people like Barrow found strong support for the prediction of these models that only unanticipated changes in monetary policy can affect real variables like output, but subsequent work and eventually the weight of the evidence pointed in the other direction. Both expected and unexpected changes in the money supply appeared to matter in contrast to a key prediction of the New Classical framework.
A second factor that worked against New Classical models is that they had difficulty explaining both the duration and magnitude of actual business cycles. If the reaction to an unexpected policy shock was focused in a single period, the magnitude could be matched, but not the duration. If the shock was spread over 3-5 years to match the duration, the magnitude of cycles could not be matched. Movements in macroeconomic variables arising from informational errors (unexpected policy shocks) did not have enough "power" to capture both aspects of actual business cycles.
The other factor that worked against these models was that information problems were a key factor in generating swings in GDP and employment, and these variations were costly in aggregate. Yet no markets for information appeared to resolve this problem. For those who believe in the power of markets, and many proponents of New Classical models were also market fundamentalists, the lack of markets for information was a problem.
The New Classical model had displaced the Keynesian model for the reasons highlighted above, but the failure of the New Classical model left the door open for the New Keynesian model to emerge (it appeared to be more consistent with the empirical evidence on the effects of changes in the money supply, and in other areas as well, e.g. the correlation between productivity and economic activity).
But while the New Classical revolution was relatively short-lived as macro models go, it left two important legacies, rational expectations and microfoundations (as well as better knowledge about how non-neutralities might arise, in essence the New Keynesian model drops continuous market clearing through the assumption of short-run price rigidities, and about how to model information sets). Rightly or wrongly, all subsequent models had to have these two elements present within them (RE and microfoundaions), or they would be dismissed.
Posted by Mark Thoma on Saturday, June 28, 2014 at 10:27 AM in Economics, Macroeconomics, Methodology |
Inequality Is Not Inevitable, by Joseph Stiglitz, Commentary, NY Times: An insidious trend has developed over this past third of a century. A country that experienced shared growth after World War II began to tear apart, so much so that when the Great Recession hit in late 2007, one could no longer ignore the fissures that had come to define the American economic landscape. How did this “shining city on a hill” become the advanced country with the greatest level of inequality?
One stream of the extraordinary discussion set in motion by Thomas Piketty’s timely, important book, “Capital in the Twenty-First Century,” has settled on the idea that violent extremes of wealth and income are inherent to capitalism. In this scheme, we should view the decades after World War II — a period of rapidly falling inequality — as an aberration.
This is actually a superficial reading of Mr. Piketty’s work, which provides an institutional context for understanding the deepening of inequality over time. Unfortunately, that part of his analysis received somewhat less attention than the more fatalistic-seeming aspects.
Over the past year and a half, The Great Divide, a series in The New York Times for which I have served as moderator, has also presented a wide range of examples that undermine the notion that there are any truly fundamental laws of capitalism. The dynamics of the imperial capitalism of the 19th century needn’t apply in the democracies of the 21st. We don’t need to have this much inequality in America. ....[continue]...
Posted by Mark Thoma on Saturday, June 28, 2014 at 12:24 AM in Economics, Income Distribution |
Posted by Mark Thoma on Saturday, June 28, 2014 at 12:06 AM in Economics, Links |
From the editors at BloombergView:
How to Avoid the Next Crash: ... Many central banks, led by the U.S. Federal Reserve, have innovated boldly when it comes to monetary policy. They have pumped money into the financial system. They have provided banks with emergency loans. They have started providing "forward guidance" in an attempt to stabilize markets. Some even pay negative interest rates on reserves as a way to encourage private lending. Many countries have overhauled their financial regulatory systems as well.
There is a third category of innovation, however -- known as macroprudential policy -- that has lagged behind. It shouldn’t.
As the name suggests, macroprudential policies are a kind of hybrid: financial regulations attuned to the condition of the system as a whole, rather than the soundness of particular banks or other institutions. ...
Few deny the need for macroprudential policy. If speeches and conferences on the topic were a measure of progress, there'd be no cause for concern. Sadly, they aren't. Governments should develop a sense of urgency before it's too late.
For me, stopping the equivalent of bank runs within the shadow banking system -- a big problem during the financial crisis that has not yet been fully addressed -- is a top priority.
Posted by Mark Thoma on Friday, June 27, 2014 at 01:11 PM in Economics, Financial System, Regulation |
Greg Ip echoes Tim Duy on 'Inflation Hysteria':
The spontaneous combustion theory of inflation: In the last few weeks, ominous warnings of inflation's imminent resurgence have multiplied... On factual, theoretical and strategic grounds, I find the panic over inflation perplexing.
First, factual. Yes, core CPI inflation has rebounded to 2% from 1.6% in February and today we learned that core PCE inflation has risen to 1.5% from 1.1%. What should we infer from this? Nothing. In the short run inflation oscillates...
Second, theoretical. ... The New Keynesian theory, to which the Fed subscribes, considers inflation a function of slack and expectations. The evidence is pretty persuasive that while slack has shrunk in the last five years..., it remains ample. Expectations, likewise, have oscillated but shown no trend up or down. ...
What if you consider inflation always and everywhere a monetary phenomenon? I consider the money supply pretty useless for forecasting anything, but even if were a monetarist, I wouldn't be worried..., M2 is up just 6.5% in the last year...
Third, strategic. ... Of course, the Fed might wait too long to tighten and inflation could eventually rise above the 2% target. But,... overshooting inflation is clearly a lesser evil than undershooting inflation. This, more than anything else, is why the panic over inflation is misplaced.
Posted by Mark Thoma on Friday, June 27, 2014 at 10:55 AM in Economics, Inflation, Monetary Policy |
Why heve predictions from "the enemies of health reform" been so wrong?:
The Incompetence Dogma, by Paul Krugman, Commentary, NY Times: Have you been following the news about Obamacare? The Affordable Care Act has receded from the front page, but information about how it’s going keeps coming in — and almost all the news is good. Indeed, health reform has been on a roll ever since March, when it became clear that enrollment would surpass expectations despite the teething problems of the federal website.
What’s interesting about this success story is that it has been accompanied at every step by cries of impending disaster. At this point, by my reckoning, the enemies of health reform are 0 for 6. That is, they made at least six distinct predictions about how Obamacare would fail — every one of which turned out to be wrong.
“To err is human,” wrote Seneca. “To persist is diabolical.” Everyone makes incorrect predictions. But to be that consistently, grossly wrong takes special effort. So what’s this all about?
Many readers won’t be surprised by the answer:... a dogmatic belief in public-sector incompetence — is now a central part of American conservatism, and the incompetence dogma has evidently made rational analysis of policy issues impossible.
It wasn’t always thus. If you go back two decades, to the last great fight over health reform, conservatives seem to have been relatively clearheaded about the policy prospects, albeit deeply cynical. ...
But that was before conservatives had fully retreated into their own intellectual universe. Fox News didn’t exist yet; policy analysts at right-wing think tanks had often begun their careers in relatively nonpolitical jobs. It was still possible to entertain the notion that reality wasn’t what you wanted it to be.
It’s different now. It’s hard to think of anyone on the American right who even considered the possibility that Obamacare might work, or at any rate who was willing to admit that possibility in public. Instead, even the supposed experts kept peddling improbable tales of looming disaster...
And let’s be clear: While it has been funny watching the right-wing cling to its delusions about health reform, it’s also scary. After all, these people retain considerable ability to engage in policy mischief, and one of these days they may regain the White House. And you really, really don’t want people who reject facts they don’t like in that position. I mean, they might do unthinkable things, like starting a war for no good reason. Oh, wait.
Posted by Mark Thoma on Friday, June 27, 2014 at 12:24 AM in Economics, Health Care, Politics |
Posted by Mark Thoma on Friday, June 27, 2014 at 12:06 AM in Economics, Links |
Even after years of "recovery" it's not too late t help those struggling to find employment, and to improve our future potential for growth at the same time. Of course, that would require Congress -- particularly those on the political right -- to actually care about the unemployed, and to recognize the critical role that government (and taxes) must play in meeting our infrastructure needs:
The Enormous Wage Potential of Infrastructure Jobs, by Joseph Kane and Robert Puentes, Brookings: This month marks five years since the U.S. economic recovery began, but we clearly have a long way to go to address our nation’s jobs deficit. Even though more workers are gradually finding employment, their wages continue to stagnate and hold back widespread economic growth. ...
Cutting across multiple industries and geographies, infrastructure jobs offer needed stability. Since these jobs also typically require less formal education and pay competitive wages across a variety of occupations, they give workers from all backgrounds a chance to make a decent living in today’s unforgiving economy.
As our recent report reveals, infrastructure jobs tend to pay 30 percent more to lower income workers—wage earners at the 10th and 25th percentile—relative to all jobs nationally...
Infrastructure occupations not only employ thousands of workers with a high school diploma or less, but they also frequently offer higher wages compared to many other jobs, particularly those involved in sales, maintenance, production, and other support activities. ...
Over time, by forging stronger connections between our infrastructure investments and workforce needs, we can help boost the long-term opportunity available to American workers.
Posted by Mark Thoma on Thursday, June 26, 2014 at 10:45 AM in Economics, Fiscal Policy, Unemployment |
Are the Rating Agencies About to Get Their Comeuppance?: This week in encouraging news, we learn that the Securities and Exchange Commission may finally be pursuing one of the prime enablers of the financial crisis — the ratings companies. Previously, it was reported that disclosure violations were on the SEC’s radar, but truth be told, those are minor offenses.
The SEC’s Office of Credit Ratings, a division whose sole purpose is essentially to oversee Moody’s and Standard & Poor’s, seems to be stirring. ... Multiple cases have reportedly been referred to the SEC’s enforcement division, and new regulations are due.
And a welcome change it would be. Of all the players that helped cause the financial crisis, the ratings companies have gotten off scot-free. Banks have had massive fines while many mortgage and derivative underwriters have had their garbage securities put back to them at great cost. Since 2008, there have been 388 mortgage companies that have gone bankrupt. All of that junk paper found its way into AAA-rated securitized products and derivatives. The penalty for Moody’s and S&P has been essentially nil. ...[continue]...
It may be "encouraging news" but why has it taken so long?
Posted by Mark Thoma on Thursday, June 26, 2014 at 10:16 AM in Economics, Financial System, Regulation |
David Hendry and Grayham Mizon with an important point about DSGE models:
Why DSGEs crash during crises, by David F. Hendry and Grayham E. Mizon: Many central banks rely on dynamic stochastic general equilibrium models – known as DSGEs to cognoscenti. This column – which is more technical than most Vox columns – argues that the models’ mathematical basis fails when crises shift the underlying distributions of shocks. Specifically, the linchpin ‘law of iterated expectations’ fails, so economic analyses involving conditional expectations and inter-temporal derivations also fail. Like a fire station that automatically burns down whenever a big fire starts, DSGEs become unreliable when they are most needed.
Here's the introduction:
In most aspects of their lives humans must plan forwards. They take decisions today that affect their future in complex interactions with the decisions of others. When taking such decisions, the available information is only ever a subset of the universe of past and present information, as no individual or group of individuals can be aware of all the relevant information. Hence, views or expectations about the future, relevant for their decisions, use a partial information set, formally expressed as a conditional expectation given the available information.
Moreover, all such views are predicated on there being no unanticipated future changes in the environment pertinent to the decision. This is formally captured in the concept of ‘stationarity’. Without stationarity, good outcomes based on conditional expectations could not be achieved consistently. Fortunately, there are periods of stability when insights into the way that past events unfolded can assist in planning for the future.
The world, however, is far from completely stationary. Unanticipated events occur, and they cannot be dealt with using standard data-transformation techniques such as differencing, or by taking linear combinations, or ratios. In particular, ‘extrinsic unpredictability’ – unpredicted shifts of the distributions of economic variables at unanticipated times – is common. As we shall illustrate, extrinsic unpredictability has dramatic consequences for the standard macroeconomic forecasting models used by governments around the world – models known as ‘dynamic stochastic general equilibrium’ models – or DSGE models. ...[continue]...
Update: [nerdy] Reply to Hendry and Mizon: we have DSGE models with time-varying parameters and variances.
Posted by Mark Thoma on Thursday, June 26, 2014 at 09:24 AM in Economics, Macroeconomics, Methodology |
Posted by Mark Thoma on Thursday, June 26, 2014 at 12:06 AM in Economics, Links |
The optimal number of immigrants: Hoover's Peregrine asked me to write an essay with the title, "What is the optimal number of immigrants to the U.S?" (Original version and prettier formatting here. Also a related podcast here.) My answer: Two billion, two million, fifty-two thousand and thirty-five (2,002,052,035). Seriously.
The United States is made up of three and a half million square miles, with 84 people per square mile. The United Kingdom has 650 people per square mile. If we let in two billion people, we’ll have no more population density than the UK.
Why the UK? Well, it seems really pretty country and none too crowded on “Masterpiece Theater.” The Netherlands is also attractive with 1,250 people per square mile, so maybe four billion. Okay, maybe more of the US is uninhabitable desert or tundra, so maybe only one billion. However you cut it, the US still looks severely underpopulated relative to many other pleasant advanced countries.
As you can see by my playful calculation, the title of this essay asks the wrong question. ...
Posted by Mark Thoma on Wednesday, June 25, 2014 at 09:32 AM in Economics, Immigration |
For those who might be interested, an excerpt from a new book by José A. Scheinkman, Speculation, Trading, and Bubbles (with contributions by Sanford J. Grossman, Patrick Bolton, Kenneth J. Arrow, and Joseph E. Stiglitz):
Posted by Mark Thoma on Wednesday, June 25, 2014 at 09:32 AM in Books, Economics, Financial System |
Whoa! Whassup With That Big Negative Q1 GDP Revision?: Yes, you read those headlines right: real GDP contracted at a 2.9% rate according to revised data released this AM. That’s contracted, as in went down.
So, are we, like, back in recession (granting that a lot of people think we never left)?
Nope. That was a truly lousy quarter but it’s highly unlikely to be repeated any time soon. The particularly bad winter weather played a role; both residential and commercial building were negative. Heavy inventory buildups in earlier quarters were reversed, which usually implies a positive bounce-back in coming quarters. Exports were revised down and imports up, so the trade deficit subtracted a large 1.5 points from the bottom line; that drag will likely diminish in coming quarters.
Health care spending, a strong contributor in earlier estimates of Q1 growth, went from contributing 1 percentage point to growth in an earlier vintage of Q1 GDP to subtracting 0.16 points in this update, suggesting earlier estimates of the pace of increased coverage were overstated. That doesn’t mean they’re not happening; it just means they’ll be spread out over more quarters. [Update: check that--a colleague tells me that what's really happening here is that people didn't use as many services as first thought. I'll try to look further into this.] ...
Year-over-year—a good way to squeeze out some quarterly noise—real GDP is up 1.5%. That’s better than the headline number, but it too is actually a weak number. The trend over the last two years is 2.1% growth... I don’t believe today’s revisions really signal a decline in that trend rate and most analysts expect coming quarters to clock in at 2.5-3%. ...
I still think that policymakers should revise their priors (downward), particularly given their tendency to brush off any bad news as temporary changes that will surely be reversed in coming quarters.
Posted by Mark Thoma on Wednesday, June 25, 2014 at 09:02 AM in Economics, Fiscal Policy, Monetary Policy, Policy |
Posted by Mark Thoma on Wednesday, June 25, 2014 at 12:06 AM in Economics, Links |
Sympathy for the Trustafarians: A number of people have asked me to comment on Greg Mankiw’s defense of inherited wealth. It’s a strange piece... But let me focus on two key problems... – one purely economic, one involving political economy.
So, on the economics: Mankiw argues that accumulation of dynastic wealth is good for everyone, because it increases the capital stock and therefore trickles down to workers in the form of higher wages. Is this a good argument? ...
In fact, what we’re really talking about here is taxation of wealth, and the question is what would happen to that revenue versus what happens if the rich get to keep the money. If the government uses the extra revenue to reduce deficits, then all of it is saved – as opposed to only part of it if it’s passed on to heirs. If the government uses the revenue to pay for social insurance and/or public goods, that’s likely to provide a lot more benefit to workers than the trickle-down from increased capital.
The point is that you can only justify Mankiw’s claim that inherited wealth is necessarily good for workers by insisting that the government would do nothing useful with the revenue from inheritance taxes. I’d call that assuming your conclusions...
But the larger criticism of Mankiw’s piece is that it ignores the main reason we’re concerned about the concentration of wealth in family dynasties – the belief that it warps our political economy, that it undermines democracy. ...
If Mankiw wants to argue that the costs of any attempt to limit wealth concentration would exceed the benefits, fine. But “more capital is good” is not a helpful contribution to the discussion.
Posted by Mark Thoma on Tuesday, June 24, 2014 at 11:35 AM in Economics |
Republicans in Congress will ignore this bipartisan report and continue to block action on climate change. This "toxic mix of ideology and anti-intellectualism" is endangering our future:
Bipartisan Report Tallies High Toll on Economy From Global Warming, by Justin Gillis, NY Times: More than a million homes and businesses along the nation’s coasts could flood repeatedly before ultimately being destroyed. Entire states in the Southeast and the Corn Belt may lose much of their agriculture as farming shifts northward in a warming world. Heat and humidity will probably grow so intense that spending time outside will become physically dangerous, throwing industries like construction and tourism into turmoil.
That is a picture of what may happen to the United States economy in a world of unchecked global warming, according to a major new report released Tuesday by a coalition of senior political and economic figures from the left, right and center, including three Treasury secretaries stretching back to the Nixon administration.
At a time when the issue of climate change has divided the American political landscape, pitting Republicans against Democrats and even fellow party members against one another, the unusual bipartisan alliance of political veterans said that the country — and business leaders in particular — must wake up to the enormous scale of the economic risk. ...
Posted by Mark Thoma on Tuesday, June 24, 2014 at 11:03 AM in Economics, Environment |
The last paragraph from a much longer argument by Simon Wren-Lewis:
Was the neoclassical synthesis unstable?: ... Of course we have moved on from the 1980s. Yet in some respects we have not moved very far. With the counter revolution we swung from one methodological extreme to the other, and we have not moved much since. The admissibility of models still depends on their theoretical consistency rather than consistency with evidence. It is still seen as more important when building models of the business cycle to allow for the endogeneity of labour supply than to allow for involuntary unemployment. What this means is that many macroeconomists who think they are just ‘taking theory seriously’ are in fact applying a particular theoretical view which happens to suit the ideology of the counter revolutionaries. The key to changing that is to first accept it.
Posted by Mark Thoma on Tuesday, June 24, 2014 at 10:44 AM in Economics, Macroeconomics, Methodology |
Posted by Mark Thoma on Tuesday, June 24, 2014 at 12:06 AM in Economics, Links |
From the Liberty Street Economics blog at the NY Fed:
The Capitol Since the Nineteenth Century: Political Polarization and Income Inequality in the United States, by Rajashri Chakrabarti and Matt Mazewski, Liberty Street Economics: Even the most casual observer of American politics knows that today’s Republican and Democratic parties seem to disagree with one another on just about every issue under the sun. Some assume that this divide is merely an inevitable feature of a two-party system, while others reminisce about a golden era of bipartisan cooperation and hold out hope that a spirit of compromise might one day return to Washington. In this post, we present evidence that political polarization—or the trend toward more ideologically distinct and internally homogeneous parties—is not a recent development in the United States, although it has reached unprecedented levels in the last several years. We also show that polarization is strongly correlated with the extent of income inequality, but only weakly associated with the rate of economic growth. We offer several tentative explanations for these relationships, and discuss whether all forms of polarization are created equal. ...
Posted by Mark Thoma on Monday, June 23, 2014 at 01:35 PM in Economics, Income Distribution, Politics |
John Kandrac (a former Ph.D. student):
Bank Failure, Relationship Lending, and Local Economic Performance, by John Kandrac, Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series: Abstract Whether bank failures have adverse effects on local economies is an important question for which there is conflicting and relatively scarce evidence. In this study, I use county-level data to examine the effect of bank failures and resolutions on local economies. Using quasi-experimental techniques as well as cross-sectional variation in bank failures, I show that recent bank failures lead to lower income and compensation growth, higher poverty rates, and lower employment. Additionally, I find that the structure of bank resolution appears to be important. Resolutions that include loss-sharing agreements tend to be less deleterious to local economies, supporting the notion that the importance of bank failure to local economies stems from banking and credit relationships. Finally, I show that markets with more inter-bank competition are more strongly affected by bank failure. [Download Full text]
Posted by Mark Thoma on Monday, June 23, 2014 at 01:17 PM in Academic Papers, Economics, Financial System |
How much do we care about future generations?, by Mark Thoma: Former U.S. Treasure Secretary Henry Paulson's recent warning that "We're staring down a climate bubble that poses enormous risks to both our environment and economy" and his call for a carbon tax brings up an important question. How do we assess the benefits to future generations from taking action on climate change now, especially benefits that may be decades or even centuries away?
To answer this question, it's necessary to consider what's known as the "discount rate" on such policies. ...
Posted by Mark Thoma on Monday, June 23, 2014 at 08:28 AM in Economics, Environment |
Are Republicans willing to settle for second best solutions to climate change?:
The Big Green Test, by Paul Krugman, Commentary, NY Times: On Sunday Henry Paulson, the former Treasury secretary and a lifelong Republican, had an Op-Ed article about climate policy... In the article, he declared that man-made climate change is “the challenge of our time,” and called for a national tax on carbon emissions... Considering the prevalence of climate denial within today’s G.O.P., and the absolute opposition to any kind of tax increase, this was a brave stand to take.
But not nearly brave enough. Emissions taxes are the Economics 101 solution to pollution problems... But that isn’t going to happen in the foreseeable future. ... Yet there are a number of second-best things ... that we’re either doing already or might do soon. ... Let me give some examples of what I’m talking about.
First, consider rules like fuel efficiency standards, or “net metering” mandates requiring that utilities buy back the electricity generated by homeowners’ solar panels. Any economics student can tell you that such rules are inefficient compared with the clean incentives provided by an emissions tax. But we don’t have an emissions tax, and fuel efficiency rules and net metering reduce greenhouse gas emissions. So a question for conservative environmentalists: Do you support the continuation of such mandates, or are you with the business groups (spearheaded by the Koch brothers) campaigning to eliminate them and impose fees on home solar installations?
Second, consider government support for clean energy via subsidies and loan guarantees. ... Are you O.K. with things like loan guarantees for solar plants, even though we know that some loans will go bad, Solyndra-style?
Finally, what about the Environmental Protection Agency’s proposal that it use its regulatory authority to impose large reductions in emissions from power plants? ... Are you willing to support this partial approach? ...
In policy terms, climate action — if it happens at all — will probably look like health reform. That is, it will be an awkward compromise dictated in part by the need to appease special interests... It will be the subject of intense partisanship, relying overwhelmingly on support from just one party, and will be the subject of constant, hysterical attacks. And it will, if we’re lucky, nonetheless do the job.
Did I mention that health reform is clearly working, despite its flaws?
The question for Mr. Paulson and those of similar views is whether they’re willing to go along with that kind of imperfection. If they are, welcome aboard.
Posted by Mark Thoma on Monday, June 23, 2014 at 12:33 AM in Economics, Environment, Politics |
Inflation Hysteria, by Tim Duy: It appears that a case of inflation hysteria is gripping Wall Street. Joe Weisenthal at Business Insider sums up the current state of play:
Here's what's on Wall Street's mind right now: Inflation is finally happening, and the Fed will end up being behind the curve.
...there were two big moments this week.
1) There was the jump in Core CPI that was the biggest since 2009.
2) And then there was the Janet Yellen press conference, in which she said that the CPI jump could be just "noise" and that the recent drop in the unemployment rate was not actually reflective of the true state of the labor market (which she regards as considerably weaker due to measures of worker discouragement).
In other words, despite data showing that the Fed is getting close to hitting its economic goals, Yellen doesn't believe the numbers.
But Wall Street does believe the numbers.
Hence the view that the Fed will be behind the curve.
Goodness, you would think it is 1975. It is probably instructive to stop and see what all the fuss is about:
Missed it? Maybe we should zoom in:
Although core-CPI is about to brush up on 2%, core-PCE remains well below, and it is the latter that is most important to policy. You might note that the Fed was raising interest rates in the late 1990s despite sub-2% core PCE, apparently responding to high CPI inflation. But that episode needs to be considered in light of the job market at the time, which, if you recall, was clearly on fire. There was no concern that broader measures of unemployment were signalling excess slack:
The current situation is different - there is excess slack in the labor market, as revealed by restrained wage growth. This is important. Wall Street might believe the CPI numbers that Yellen dismissed, but that is jumping the gun in any event. As Across the Curve explains succinctly:
The labor market remains less than robust and wage gains are stagnant. Until we see consistent wage gains which would foster spending which fosters revenue and net income and then the virtuous cycle fulfills itself via business investment it is hard to imagine that we get a sustained uptick in inflation.
Which is essentially what Federal Reserve Chair Janet Yellen explained in her press conference:
You know, I see compensation growth broadly speaking as having been very well contained. By most measures, compensation growth is running around 2 percent. So that's real wage growth or real compensation growth that's essentially flat rather than rising, and real wage growth really has not been rising in line with productivity. My own expectation is that as the labor market begins to tighten, we will see wage growth pick up some to the point where real wage growth, where compensation or nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay. And within limits--well, that might be signs of a tighter labor market. Within limits, it's not a threat to inflation because consistent with the level of inflation we have for our 2 percent inflation objective, we could see wages growing at a more rapid rate and a somewhat more rapid rate. And indeed, that would be part of my forecast of what we would see as the labor market picks up. If we were to fail to see that, frankly I would worry about downside risk to consumer spending. So I think part of my confidence and the fact we'll see a pickup in growth relates to the fact that I think consumer spending will continue to grow at a healthy rate. And in part, that's premised on some pickup in the rate of wage growth so that it's rising greater more than inflation.
So what is going on here? Inflation is not a sustained phenomenon in the absence of participation from wage dynamics. If inflation accelerates while wage growth remains stagnant, demand will soften and so too will any incipient price pressures. Hence why Yellen sees the potential for downside risk for consumer spending in the absence of stronger wage growth. Moreover, as she notes, wage growth itself is not inflationary. We would expect wage growth should exceed inflation such that real wages grow to account for rising productivity. We might then expect inflation to be correlated with unit labor costs, and it is:
If you expect to see sustained higher inflation, you need to see sustained higher unit labor cost growth. No way around it. And even then you need to assume that firms respond by raising prices, rather than seeing profit erode. Note in particular sustained high unit labor cost growth in the late 1990s.
In short, you shouldn't be looking at the inflation numbers without understanding the underlying wage dynamic. It isn't until wages start to push higher that inflation becomes a more interesting issue.
So how should we be thinking about this? The Fed recognizes that they are coming closer to meeting their goals based on their traditional unemployment metrics. They are discounting those metrics for the moment, and with good reason. In the absence of accelerated wage growth, pops of inflation are just noise. They anticipate that wage growth will not emerge more forcefully until after underemployment measures fall to more normal levels. Hence as the measures approach normal levels - sometime next year - they will begin raising interest rates. I suspect this will be prior to a substantial acceleration in wage growth, on the assumption that they will feel a need to be somewhat ahead of the curve.
What would accelerate this process? First, a more rapid improvement in underemployment. Second, sufficient wage acceleration such that they are confident labor market slack has been eliminated prior to normalization of unemployment measures (in essence, the acceptance of permanent damage from the recession). If conditions one and two hold, but core-PCE measures hold below 2.25%, they will likely raise rates gradually. If core-PCE accelerates beyond 2.25%, the pace of rate increases will accelerate.
Finally, the Fed will likely be watching 5-year, 5-year forward inflation expectations as a gauge of how far they are falling behind the curve. I can't imagine they are worried yet:
Bottom Line: Tighter policy is coming. If you are worried the Fed will accelerate the timing and pace of tightening (and I do believe the risk is weighted in this direction), your focus should be on the labor market and wage growth dynamic. Note too that if Wall Street believes the Fed will need to tighten more aggressively than currently planned on the basis of recent inflation readings, market participants must clearly expect that Yellen and Co. take the 2% inflation target more than seriously.
Posted by Mark Thoma on Monday, June 23, 2014 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, June 23, 2014 at 12:06 AM in Economics, Links |
...suppose that at the moment real wages or inflation begin to rise, the central bank tightens monetary policy. This would raise the cost of capital, and could be interpreted as an attempt to prevent real wages rising. ... Monetary policy, which in theory is just keeping inflation under control, is in fact keeping real wages and productivity low.
Monetary policy makers would describe this as unfair and even outlandish. A gradual rise in interest rates, begun before inflation exceeds its target, is designed to maintain a stable environment. ...
I also have another concern about a monetary policy which tightens as soon as real wages start increasing. What little I know about economic history suggests an additional dynamic. As long as the firm is employing labour rather than buying a machine, there is no incentive for anyone to improve the productivity of machines. The economy where real wages and labour productivity stay low may also be an economy where innovation slows down. The low productivity economy becomes the low productivity growth economy.
[The extract does not fully reflect the argument in the post -- see here for more.]
Posted by Mark Thoma on Sunday, June 22, 2014 at 10:24 AM in Economics, Monetary Policy, Productivity |
Posted by Mark Thoma on Sunday, June 22, 2014 at 12:06 AM in Economics, Links |
On calculating long-run discount rates:
Discounting the very distant future, by Stefano Giglio, Matteo Maggiori, and Johannes Stroebel, Vox EU: Many important policy decisions require a consideration of costs and benefits that arise in the distant future. For example, many of the costs of climate change occur 100 or more years from now, yet actions to reduce greenhouse gas emissions have to be taken today to avert those long-run costs. In recent weeks, the Intergovernmental Panel on Climate Change mitigation report, or UN climate change report, presented and discussed different options for reducing such emissions, but contended that “most mitigation strategies have costs in the present and yield benefits in the future. Policy making involves assessing the values of these benefits and costs and weighing them against each other.”
A crucial step in evaluating distant costs and benefits is the choice of an appropriate discount rate. How much do individuals value cash flows that arise hundreds of years from now and will accrue to future generations? The literature on environmental policy has long focused on the importance of these long-run discount rates in assessing the benefits of policies such as reducing carbon emissions (Weitzman 2001, 2013, Barro 2013, Gollier 2012, Pindyck 2013). For example, Stern (2007) calls for immediate action to reduce future environmental damage based on the assumption of very low discount rates, arguing that while agents discount the future over their lifetimes, they have an ethical impetus to care about future generations. This assumption has been criticised amongst others by Nordhaus (2007), who points out that the private return to capital is 4-6%.
Much of this disagreement about the appropriate long-run discount rate is driven by the fact that little direct empirical evidence exists on how households actually discount payments over very long horizons because of the scarcity of finite, long-maturity assets necessary to estimate households' valuation of very long-run claims.
Estimating valuations of very long-run (but finite) assets
In Giglio, Maggiori and Stroebel (2014), we provide direct estimates of households' discount rates for payments very far in the future, by studying the valuation of very long (but finite) assets. We exploit a unique feature of residential housing markets in the UK and Singapore, where property ownership takes the form of either very long-term leaseholds or freeholds. Leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities ranging from 99 to 999 years, while freeholds are perpetual ownership contracts. The price discount for very long-term leaseholds relative to prices for otherwise similar properties that are traded as freeholds is informative about the implied discount rates of agents trading these housing assets. This allows us to gather information on discount rates much beyond the usual horizon of 20-30 years spanned by bond markets.
Our empirical analysis is based on proprietary information on the universe of residential property sales in the UK (2004-2013) and Singapore (1995-2013). These data contain information on transaction prices, leasehold terms, and property characteristics such as location and structural attributes. We estimate long-run discount rates by comparing the prices of leaseholds with different maturities to each other, and to the price of freeholds across otherwise identical properties. We use hedonic regression techniques to control for possible heterogeneity between leasehold and freehold properties; this allows us to identify price discounts associated with differences in lease length.
Figure 1. Estimated leasehold discounts for the UK
Figure 1 presents estimates from the UK of the log difference in prices between leaseholds with varying remaining maturity at the time of sale and otherwise identical freeholds. Leaseholds with 80-99 years remaining are valued about 15% less than otherwise identical freeholds; leaseholds with maturity of 100-124 years are valued 10% less than freeholds. In other words, households attach substantial present value to owning the housing asset in 100 or 125 years. There are no price differences between leaseholds with maturities of more than 700 years and freeholds.
In Giglio, Maggiori and Stroebel (2014), we document how the differences in prices between leaseholds and freeholds can be attributed to their different duration (i.e., the fact that a freehold entitles the owner to ownership of the property after the leasehold expires). We also show that these price differences cannot be explained by dimensions unrelated to contract duration. For example, we can exclude that price differences are driven by unobserved differences in the properties trading as freeholds and leaseholds, since we show that they have the same annual rent. We also show that other possible concerns, such as differences across contracts in the presence of covenants, the liquidity of the assets, financing frictions, or differences in buyer characteristics, cannot explain the observed price discounts.
We use these estimated price discounts to back out the implied discount rate that households use to value cash flows to housing that arise more than 100 years from now. We find the discount rate for very long-run housing cash flows to be about 2.6% per year. Interestingly, we find similar implied discount rates in both the UK and in Singapore – two countries with very different institutional settings.
The estimated discount rate reveals how today’s households value payoffs to future generations, and, as such, has implications for intergenerational fiscal policy and climate change policy. In particular, our estimate of 2.6% provides some empirically-grounded guidance for choosing discount rates to evaluate long-term projects where the benefits arise hundreds of years from now. While the full implications of our findings for climate change policy depend on the precise modelling of the risks inherent to climate change and housing, our result of low long-run discount rates provides early evidence that agents are more willing than previously thought to invest today for the benefit of future generations, particularly if such benefits occur with certainty.
Barro, Robert J (2013), “Environmental Protection, Rare Disasters, and Discount Rates.” National Bureau of Economic Research Working Paper 19258.
Giglio, Stefano, Matteo Maggiori, and Johannes Stroebel (2014), “Very Long-Run Discount Rates.” National Bureau of Economic Research Working Paper 20133.
Gollier, Christian (2012), “Evaluation of long-dated investments under uncertain growth trend, volatility and catastrophes.” Toulouse School of Economics (TSE) TSE Working Papers 12-361.
Nordhaus,William D (2007), “A Review of the Stern Review on the Economics of Climate Change”, Journal of Economic Literature, 45(3): 686–702.
Pindyck, Robert (2013), “Climate Change Policy: What Do the Models Tell Us?” Journal of Economic Literature, 51(3): 860–872.
Weitzman, Martin L (2001), “Gamma Discounting”, The American Economic Review, 91(1): 260–271.
Weitzman, Martin L (2013), “Tail-Hedge Discounting and the Social Cost of Carbon”, Journal of Economic Literature, 51(3): 873–882.
Posted by Mark Thoma on Saturday, June 21, 2014 at 08:41 AM in Economics |
Cecchetti & Schoenholtz
Monetary policy target regimes: inflation, price level, nominal GDP, etc.: Should central banks target inflation, the price level or nominal GDP? The question of the appropriate policy target has been a subject of analysis at least since the 1980s and has become a matter of intense debate (see here and here) for the past several years. Many proponents of price-level or nominal GDP targeting share the idea that – by credibly committing to make up the shortfalls in the price level or in nominal GDP relative to the pre-crisis trend – policymakers could drive down the current real interest rate and accelerate the economic recovery.
Looking at where we are today, what would this mean? ...
The bottom line:
All of this leads us to conclude that returning to the price path implied by the pre-crisis trend is a realistic possibility. Returning to the earlier nominal GDP path is not. That said, the inflation overshoot that our rough calculations suggest is moderate, so the benefits are likely to be limited. But the costs could include a loss of credibility in the inflation-targeting framework. Would that really be worth it?
Posted by Mark Thoma on Saturday, June 21, 2014 at 07:55 AM in Economics, Monetary Policy |
Posted by Mark Thoma on Saturday, June 21, 2014 at 12:06 AM in Economics, Links |
Don't let "zombie arguments" derail health care reform:
Veterans and Zombies, by Paul Krugman, Commentary, NY Times: You’ve surely heard about the scandal at the Department of Veterans Affairs. A number of veterans found themselves waiting a long time for care, some of them died before they were seen, and some of the agency’s employees falsified records to cover up the extent of the problem. It’s a real scandal...
But the goings-on at Veterans Affairs shouldn’t cause us to lose sight of a much bigger scandal:... the Veterans Affairs scandal, while real, is being hyped out of proportion by people whose real goal is to block reform of the larger system.
The essential, undeniable fact about American health care is how incredibly expensive it is — twice as costly per capita as the French system, two-and-a-half times as expensive as the British system. You might expect all that money to buy results, but the United States actually ranks low on basic measures of performance...
As you might guess, conservatives don’t like the observation that American health care performs worse than other countries’ systems because it relies too much on the private sector and the profit motive. So whenever someone points out the obvious, there is a chorus of denial... It turns out, however, that such claims invariably end up relying on zombie arguments — that is, arguments that have been proved wrong, should be dead, but keep shambling along because they serve a political purpose.
Which brings us to veterans’ care. ... It’s still true that Veterans Affairs provides excellent care, at low cost. Those waiting lists arise partly because so many veterans want care, but Congress has provided neither clear guidelines on who is entitled to coverage, nor sufficient resources to cover all applicants. ...
Yet, on average, veterans don’t appear to wait longer for care than other Americans. And does anyone doubt that many Americans have died while waiting for approval from private insurers?
A scandal is a scandal... But beware of people trying to use the veterans’ care scandal to derail health reform.
And here’s the thing: Health reform is working. Too many Americans still lack good insurance, and hence lack access to health care and protection from high medical costs — but not as many as last year, and next year should be better still. Health costs are still far too high, but their growth has slowed dramatically. We’re moving in the right direction, and we shouldn’t let the zombies get in our way.
Posted by Mark Thoma on Friday, June 20, 2014 at 12:33 AM in Economics, Health Care |
Piketty and Saez (from the May issue of Science):
Inequality in the long run, by Thomas Piketty and Emmanuel Saez: The distribution of income and wealth is a widely discussed and contraoversial topic. Do the dynamics of private capital accumulation inevitably lead to the concentration of income and wealth in ever fewer hands, as Karl Marx believed in the 19th century? Or do the balancing forces of growth, competition, and technological progress lead in later stages of development to reduced inequality and greater harmony among the classes, as Simon Kuznets thought in the 20th century? What do we know about how income and wealth have evolved since the 18th century, and what lessons can we derive from that knowledge for the century now under way? For a long time, social science research on the distribution of income and wealth was based on a relatively limited set of firmly established facts together with a wide variety of purely theoretical speculations. In this Review, we take stock of recent progress that has been made in this area. We present a number of basic facts regarding the long-run evolution of income and wealth inequality in advanced countries. We then discuss possible interpretations and lessons for the future. ...
Posted by Mark Thoma on Friday, June 20, 2014 at 12:24 AM in Economics, Income Distribution |
Posted by Mark Thoma on Friday, June 20, 2014 at 12:06 AM in Economics, Links |
One more from Tim Duy:
Janet Yellen the Hawk, by Tim Duy: Yesterday I wrote a fairly conventional analysis of the outcome of the FOMC meeting and the subsequent press conference by Federal Reserve Chair Janet Yellen. I think that analysis is consistent with that of the median policymaker on Constitution Avenue: As long as the economy continues to grind upward at a moderate pace and inflation pressures remain constrained, the expected path of short term interest rates is one of a slow rise with the first hike somewhere around a year away.
That view is, of course, data dependent, and given the current readings on inflation and unemployment, combined with a policy stance that is basically ignoring both in favor of untested measures of underemployment, the risk is that the rate path is steeper, and the first hike comes sooner, than currently anticipated. Under the current circumstances, I expect the median policymaker's willingness to risk falling behind the curve will decrease during the next six months.
Moreover, I would caution against interpreting Yellen's soft inflation outlook as her being soft on inflation. I think quite the opposite message came through at yesterday's press conference. Yellen was showing her hawkish side.
First, note that the Fed's terminal Federal Funds rate edged down to 3.75% from 4% in March, a consequence of falling estimates of potential growth. The Fed thus appears to be conforming to the "new normal" in which equilibrium interest rates have fallen. In short, the Fed appears to take the terminal Fed Funds rates as exogenous.
The terminal Fed Funds rates, however, is not exogenous. It is an inflation markup over estimates of potential growth. The Fed could allow interest rates to return to normal by allowing expected inflation to rise. From the Fed's point of view, however, the inflation rate is really not an endogenous choice. They view the 2% target is essentially exogenous, a number handed down in scripture, an element of the Ten Commandments. That the Fed should allow estimates of the terminal Fed Funds rate to fall is a testament to their commitment to the 2% target.
Second, it is not clear that the potential growth rate is entirely exogenous. In her press conference, Yellen commented that lower potential growth estimates are a consequence of slower investment (less capital formation) and persistent damage to the labor market. In the secular stagnation scenario, however, these are arguably the consequences of holding real interest rates too high and deliberately allowing the cyclical damage to become structural. But at the zero bound, the Fed would need to target higher inflation expectations to lower the real interest rate further. That is not on the table. The lower bound on real interest rates is -2% because the upper bound on inflation is 2%.
In other words, Yellen and Co. are so committed to the 2% inflation target that they are willing to tolerate a persistently lower level of national output to maintain that target. That sounds pretty hawkish to me.
Finally, Yellen's willingness of allow overshooting of the inflation target are, in my opinion, less than meets the eye. Financial reporters very much need to pin her and other policymakers down on this topic. I suspect when they say overshooting, what they mean is no more than 25bp over target in the context of anchored inflation expectations. If inflation expectations are anchored, however, expected real interest rates are not changing. The loose comments about overshooting are nothing more than a commitment to not overreact to forecast errors. It doesn't mean that the Fed will not raise interest rates in the face of overshooting, only that they will calibrate the rate of increase relative to their confidence that the overshooting is a forecast error.
Bottom Line: Soft on the inflation forecast is not the same as soft on inflation. Don't underestimate the Fed's commitment to the 2% target. That commitment is what pushes the risk to the hawkish side of the policy equation in the current environment.
Posted by Mark Thoma on Thursday, June 19, 2014 at 08:59 AM in Economics, Fed Watch, Monetary Policy |
In case you missed this:
Does He Pass the Test?, by Paul Krugman: Midway through Timothy Geithner’s Stress Test, the former treasury secretary describes a late-2008 conversation with the then president-elect. Obama “wanted to discuss what he should try to accomplish.” Geithner’s reply was that his accomplishment would be “preventing a second Great Depression.” And Obama shot back that he didn’t want to be defined by what he had prevented.
It’s an ironic tale for Geithner to be telling, although it’s not clear whether he himself realizes just how ironic. For Stress Test is meant to be a story of successful policy—but that success is defined not by what happened but by what didn’t. America did indeed manage to avoid a full replay of the Great Depression—an achievement for which Geithner implicitly claims much of the credit, and with some justification. We did not, however, avoid economic disaster. By any plausible accounting, we’ve lost trillions of dollars’ worth of goods and services that we could and should have produced; millions of Americans have lost their jobs, their homes, and their dreams. Call it the Lesser Depression—not as bad as the 1930s, but still a terrible thing. Not to mention the disastrous consequences abroad.
Or to use one of the medical metaphors Geithner likes, we can think of the economy as a patient who was rushed to the emergency room with a life-threatening condition. Thanks to the urgent efforts of the doctors present, the patient’s life was saved. But while the doctors kept him alive, they failed to cure his underlying illness, so he emerged from the procedure partly crippled, and never fully recovered.
How should we think about the economic policy of these past seven or so years? ...
Posted by Mark Thoma on Thursday, June 19, 2014 at 08:56 AM in Economics, Financial System |
Still a Dove, by Tim Duy: The FOMC delivered as expected today, with virtually no change to policy. The tapering continues with another $10 billion cut to the pace of asset purchases, which was essentially the only change to the FOMC statement aside from the description of the economy. The Wall Street Journal tracks the changes here.
The Fed downgraded their GDP forecast, as expected given the weak Q1 numbers. They did not include any upward offsets in subsequent years. Consequently, the expected trajectory of output falls further short of current estimates of potential:
Expect estimates of potential output to come down even further. In contrast, the unemployment forecast was revised to the more optimistic side:
while the inflation forecast was virtually unchanged. As might be expected given an improving unemployment outlook, the interest rate projections were slightly more hawkish. Still, Yellen cautioned against reading this as a change in the outlook, instead attributing it to a change in FOMC members. The unstated implication is that the FOMC has moved in a slightly more hawkish direction, raising the possibility that Yellen could become more isolated in the months ahead in her generally dovish stance, assuming of course that the tension between the Fed's stated policy goals and the stance of policy continues to grow.
And, as Joe Weisenthal at Business Insider notes, Yellen again proves she is indeed a dove. She dismissed recently higher inflation readings as noise, specifically drew attention to broad measures of unemployment, and said (correctly) that wage growth itself does not necessarily indicate inflation pressures would be far behind. No indication that she is in any rush to raise rates whatsoever.
Bottom Line: Policy remains the same - the Fed continues to expect a long-period of relatively low interest rates. Given current unemployment and inflation numbers, I continue to expect the risk remains on the more hawkish side of that story. But that is my assessment of the risk, not of the baseline.
Sorry for the quick post - scheduled to be in Portland in a few hours.
Posted by Mark Thoma on Thursday, June 19, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Thursday, June 19, 2014 at 12:06 AM in Economics, Links |
Dear FOMC: Please be patient:
How close are we to full employment?, by Mark Thoma: How far is the economy from a full recovery? When should Federal Reserve policymakers, who are finishing their two-day meeting today, begin raising interest rates? Should the Fed speed the pace of its tapering of quantitative easing?
All of these questions depend critically on a piece of data economists call the output gap...
Posted by Mark Thoma on Wednesday, June 18, 2014 at 09:33 AM in Economics, Monetary Policy, Unemployment |
Dietz Vollrath at the Growth Economics blog:
Does Culture Matter for Economic Growth?: There’s been an increasing number of papers concerned with culture and its relationship to economic growth. I happened to just see this working paper by Di Tella and MacCulloch (2014), but the idea of culture being an important determinant of economic development levels has been hanging out there in the literature for a long time. Weber’s theory of the Protestant work ethic is probably the starting point for any discussion of this topic. More recent work tends to try and be more empirical than Weber, often using World Values Surveys as a means of measuring cultural elements. This is what Di Tella and MacCulloch do in their working paper. [If you'd like a good introduction to the culture literature, check out James Fenske's course materials, in particular his "Foundations of Development" course].
I think this is pretty interesting reading, but I’m starting to get a little antsy about the use of the cross-country empirical work. Not in a standard “Identification!!” way, although that’s an issue, but in a slightly deeper way. In particular, why bother regressing GDP per capita (or growth, or any measure of economic activity) on cultural variables at all? ...
So here’s the issue... If culture leads to different utility functions, which in turn lead to different measurable economic outcomes, then why should we bother with measuring economic outcomes? Let me take this from the opposite angle. If everyone has identical utility functions, then measurable economic outcomes (GDP, average wages) have some information about relative welfare across countries. But if everyone has a different utility function, then measurable economic outcomes don’t necessarily provide any information about relative welfare. If one culture derives utility from having massive families with lots of kids, and doesn’t really care about consumption goods, then what does their low GDP per capita tell me? Nothing. It doesn’t tell me they have lower welfare than a high GDP per capita culture.
If you tell me that culture is important for economic outcomes, then you’re telling me that utility functions vary across cultures. But if utility functions vary across cultures, then cross-culture comparisons of economic outcomes don’t imply anything about welfare. So aren’t the regressions with culture as an explanatory variable self-defeating, even if they are econometrically sound?
I could well be over-thinking this, and I’d be happy to hear a good argument for what the culture/growth or culture/income regressions are supposed to be telling me.
Posted by Mark Thoma on Wednesday, June 18, 2014 at 07:47 AM in Economics |
Posted by Mark Thoma on Wednesday, June 18, 2014 at 12:06 AM in Economics, Links |
The CEPR Euro Area Business Cycle Dating Committee has just issued its findings following a meeting last week in London. This is the summary from a companion Vox EU piece:
Eurozone mired in recession pause, by CEPR Business Cycle Dating Committee, Vox EU: The simplest business cycle dating algorithm declares recessions over after two consecutive quarters of positive GDP growth. By that metric, the Eurozone recession has been over since 2013Q1. This column argues that growth and improvements in the labour market have been so anaemic that it is too early to call the end of the Eurozone recession. Indeed, if this is what an expansion looks like, then the state of the Eurozone economy might be even worse than economists feared.
Posted by Mark Thoma on Tuesday, June 17, 2014 at 10:00 AM in Economics |